Didi, a Chinese internet company, has had its stock prices tumble in recent weeks. The company’s shares have tumbled over forty percent in the past three weeks, dropping to just below one dollar per share. The steep fall comes as the government in China is planning to implement an unprecedented series of financial penalties against company employees who are believed to have attempted to manipulate the price of the company’s stock. On paper, the penalties are huge: up to six years in prison, heavy fines, and major restrictions on the number of shares that company employees can buy or sell. However, Didi is not planning to do this, to fear that the country’s new laws will prevent it from doing so.
The first part of the new rules seems fairly straightforward. On July 15th, China’s State Council approved a new set of minimum share sale limits for listed companies. These limits are designed to reduce share price fluctuations, especially between major shareholders – meaning that if one company is experiencing rapid growth, and the next is experiencing steep declines, the shares of the second company will be sold at a lower price, to force the second company to increase its share value to compensate for the first company’s decline. It’s hard to say how effective this plan will actually be. While it does appear to target a problem common to many small-cap stocks, Didi is one of the smaller companies on the Chinese market – it’s not often affected by market movements in other countries. The impact of these new rules could thus be limited, if not entirely eliminated, on the global market.
The second part of the new regulations seems to be creating more of a problem for the Chinese company. Because it is currently listed on the OTCBB, (over the counter), it is only possible for brokers to communicate with the market. This means that all requests for shares are manually handled and on a daily basis. This obviously presents a significant time delay in executing orders, reducing liquidity, and increasing the potential for human error.
As a result, most brokers now request any advanced notice prior to placing an order to buy or sell shares. This notification will allow brokers to better fulfill their duties and reduce the risk of human errors during order execution. However, because Didi is still listed on the OTCBB and not traded on the Global Market, most brokers are unable to communicate information directly with the marketplace. This effectively eliminates the ability to place and receive trades on the OTCBB, further limiting liquidity.
In addition, the stipulations regarding minimum size requirements for share offerings also seem to have resulted in reduced liquidity. On the one hand, many brokers will only trade a range of size picks, making them unavailable to smaller traders. On the other hand, as the minimum size requirement for placing a trade has increased, it has also increased the cost of order execution, which could have adverse effects on the share price. As the cost of capital requirements for larger investors has increased in response to increased trading volume, small-cap stocks have dropped in price and may be difficult to find a position in the marketplace. This is another reason why brokers are not disclosing minimum size requirements to clients.
Even if a small trader is able to find a position in the market, the profitability is unlikely to be substantial. It is currently estimated that fewer than 1% of all share prices are earned by small-cap stocks. Additionally, as the share price of these stocks declines, they become more difficult to unload and the negative sentiment associated with them tends to have an even greater effect. If the decline is prolonged, the effect of the sentiment may become negative and have a negative effect on the share price, even as the market continues to increase in value.
There are several possible reasons why Didi began to drop on the OTCBB. One possibility is that the company over-leveraged its assets, creating too much leverage in its debt and equity positions and becoming vulnerable to declines in either area. Another possibility is that it became too expensive to service its debts when interest rates were falling. The third possibility is that the market for trading shares has simply dried up due to the high number of shares listed and the difficulty of finding buyers for the shares held in the order execution business. Regardless of the reason, Didi is likely to experience a short-term decrease in its share price as the company works to address issues related to its debt issues and increase its cash balances.
Many observers expect the Didi share price to continue to decline in light of the fact that the company will need to raise funds to mitigate some of its debt problems. One concern for buyers is that the company will have limited liquidity once it raises the funds. However, if the underwriters take a positive view of the company and the stock is able to raise the funds necessary to service its obligations, there is a good chance that the shares will soon start to rise again in value. In addition, small-cap and penny stocks are often attractive to investment banks as they offer a high probability of becoming traded in the open stock exchange.
