China's fledgling M&A market has produced a series of takeovers of listed companies in the past year at discounts as steep as 91 per cent to the target's quoted price, according to a research centre under the Chinese Academy of Social Sciences, an official think tank.

These largely unremarked deals were typified by the sale late last year of a controlling stake in a listed electrical machinery company in coastal Fujian to another enterprise in the same business.

The struggling Tianyu Electric sold a controlling 46.01 per cent stake to the Xuji group, based in central Henan, for Rmb200m (Dollars 24m), representing a discount of some 80 per cent compared with the then share price.

Such deals, mostly in domestic A shares, happen quietly, often illegally, before they are later registered with the authorities, and almost never attract regulators' scrutiny.

That they can take place at all, and at such knock-down prices, is because of the different categories of share ownership in China, an enduring problem that has confounded all efforts at reform.

"The stock market is basically dysfunctional - you cannot depend on it to do the job it is set up to do," said Fraser Howie, a Beijing-based consultant.

The government's aversion to full privatisation means that, on average, companies listed on the domestic stock market - all of which are former state-owned enterprises - have a public float of only about 30 per cent. The balance is held in two other categories - those owned by the government, and so-called "legal person" shares, which are held by approved state institutions.

It is shares in these categories that change hands in the off-market auctions, or in sales negotiated by creditors for enterprises which cannot meet their debts.

The three different categories have produced three often vastly different prices in the shares of the same company.

The pricing disparity gives the lie to the oft-quoted claims about the size of the local stock market.

The official estimate of market capitalisation at the end of March, Dollars 524bn, is calculated by extrapolating the high prices of the limited number of tradeable shares to the entire market.

But the market capitalisation of tradeable shares was only Dollars 170bn, equal to about 15 per cent of China's GDP, and about the same as the value of mainland companies listed overseas.

Explaining how the same shares trade at vastly different prices is a struggle even for local experts. The authoritative monthly, Caijing ('Finance'), recently balked at explaining how to value "legal person" shares, saying it was "too complicated".

The relatively high prices commanded by the publicly traded shares is at least partly due to their scarcity. In turn, the "legal person" shares inevitably trade at a slight discount because they are relatively illiquid and need official approval to be transferred, even if this approval sometimes comes after the deal has been done.

Matthew Rudolph, of Cornell University, says that auctions of non-tradeable shares are not a good proxy for the market's value overall, as the sales are primarily used by the government to bail out struggling companies.

"My guess is that, in many of these cases, a larger, healthier firm is being coerced to buy the shares of a less healthy company with which it has some nominal synergies," he said.

"The radical discount you see is the central government's admission that the buyer is getting a raw deal." Predictions that the government would allow full privatisation of listed companies created a market in "legal person" stock last year, as eligible traders sought to arbitrage the different types of share.

"In the long run, we can hold the shares until they are finally allowed to be traded and profit from the wide gap," said Liu Yiqian, of the Xin Liyi Asset Management, which specialises in trading "legal person" shares. "In the meantime, we can hold the shares to get dividends. And in the worst scenario, we can sell them, and make our money back that way."

Wary of the speculators, the China Securities Regulatory Commission (CSRC) banned auctions outside of the established exchanges in Shanghai and Shenzhen earlier this year in an effort to keep the share transfers under control.

Although the biggest losers in these transactions seem to be the tens of millions of small retail investors, who pay the top price for shares, Mr Rudolph says they know what they are doing: "My research shows that most investors are well aware of the risks and know that it is a rigged game," he says. "It's just like betters in Las Vegas. They play anyway."