Many companies on China's stock markets have separate, restricted classes of shares for domestic residents and foreigners. Other than who can own them, these shares are identical, but foreigners pay only about one-quarter the price paid by domestic residents. We show that plausible differences--about 4 percentage-points--in expected rates of return by foreign and domestic investors can account for the generally higher level and volatility of prices for domestic shares relative to foreign shares. We attribute low Chinese expected returns to the limited alternative investments available in China. We then explore the extent to which various company characteristics can explain cross-company differences in the relative price paid by foreigners. For example, foreigners pay a lower relative price for companies with a higher proportion owned by the state--reflecting, surprisingly, a higher absolute price paid by both foreigners and domestic residents. Several puzzles remain. For example, we are unable to explain why Chinese investors in Shanghai paid lower prices in 1994 and 1995 for companies with their foreign listings in Hong Kong rather than Shanghai.
