Ebook Investor Sentiment, Governance Mechanisms and Post-IPO Performance in China
This paper examines the determinants of post-IPO long-term return and operating performance of companies in China. Most previous studies on IPO long-term performance focus on the U.S. market, where the legal and institutional settings are considered to be well-developed. In contrast, the institutional settings of China’s stock market are still evolving. In addition, there are still official rules preventing stock market from competitive. For example, the artificial division of ownership shares into tradable and non-tradable limits the supply of common stock in the market. This causes severe over-valuation of stock when too much capital is chasing too few investment opportunities. In addition, with majority control remains in the hands of the state and legal persons whose objectives are not necessary value-maximization, the US-styled market disciplines and corporate governance are ineffective in protecting minority shareholders’ interests.
While China’s stock market is still very different from stock markets of other countries, the gap has been taking much effort to narrow the gap, such as relaxation of B-share trading to local investors and further sales of non-tradable ownership to public investors in attempt to reduce the influence of the government to the market. Therefore, we expect China’s stock market to become more rational and to behave more closely to the developed markets over time. This paper aims to examine if previous theories and empirical results on post-IPO performance of US companies applies also to the special institutional settings in China. In particular, we test if certain proxies of market sentiment, underwriter reputation and corporate governance explain post-IPO performance and if their explanatory powers are changing over time as the market becomes more developed. Post-IPO performance is well-studied for the US market. Ritter (1991) and Loughran and Ritter (1995, 1997) find that IPO firms under perform their benchmarks for three to five years post-IPO, in terms of both stock returns and operating performance. Brav and Gompers (1997), Carter, Dark and Singh (1998) and Field and Lowry (2005) show that certain sophisticated agents in the market, such as venture capitalists, reputable underwriters and institutional investors play a certification role in the IPO process. However, recent studies by Fama (1998), Mitchell and Stadford (2000), Eckbo, Masulis and Norli (2000) and Eckbo and Norli (2005) point out the bad-model problems of previous long-term event studies. They show that abnormal performance disappears once risk factors are appropriately adjusted for.
Studies on IPOs in China are infant. Among them, Sun and Tong (2003) find that while firms generate more revenues after IPOs, the higher revenues do not turn into better operating performance. Indeed, most firms perform worse than they did before IPOs. Chan, Wang and Wei (2004) examine both stock and operating performance of IPOs in China. In contrast to the results for the US market, A-share IPOs in China only slightly under perform the size and/or/M-benchmarks while B-share IPOs outperform the benchmarks. In addition, post-IPO returns reflect the changes in operating performance. Therefore, post-IPO stock performance is not purely driven by speculation. Focusing on the effect of ownership structure as a corporate governance device, Wang (2005) show that legal-entity ownership and concentration of non-state ownership explain the change in performance of IPO firms.
We examine post-IPO stock performance using calendar-time Fama-French 3-factor regression and buy-and-hold return. To summarize, more under priced firms and firms with higher P/E ratio at offering earn lower subsequent returns than other IPO firms, In other words, stronger investor sentiment at the time of offering predict negatively post-IPO stock performance. On the other hand, first-day tradable share turnover has mixed effects on post-IPO stock performance, depending on the measurement methods. This contrasts to the finding of Wang and Cheng (2004) that higher trading volumes are associated with significantly lower subsequent returns. Board size is related negatively but weakly to post-IPO returns in a calendar-time regression setting but the relation disappears in a multivariable regression setting. Non-tradable share ownership shows opposite effects on post-IPO returns in sub-period analysis. Non-tradable share ownership is negatively related to post-IPO returns in the first sub-period but positively related to post-IPO returns in the second sub-period. Therefore, while state ownership is previously regarded as harmful to performance as state-appointed managers have to fulfill political objectives other than to maximize shareholders’ value, the managers become more profit-oriented over time. Underwriter reputation also has stronger explanatory in the second sub-period. Underwriter reputation has insignificant explanatory power to post-IPO return in the first sub-period but positively explains post-IPO return in the second sub-period. It seems that over time, reputable underwriters can differentiate themselves from others by carefully selecting the deals they handle.
As opposed to the results for stock performance, both higher IPO underpricing and higher P/E ratio are associated with better post-IPO operating performance. The contradicting findings on stock performance and operating performance suggest that while investors give a higher value to firms that are likely to improve their profitability, they tend to overestimate the effect of IPOs on improving operating performance of issuing firms. As a result, stock price could drop while operating performance is improving and vice versa. Share turnover, board size and underwriter have little explanatory power to change in operating performance. Non-tradable share ownership explains positively to the change in operating performance, but the explanatory power is much stronger in the second sub-period than it is in the first sub-period, consistent with the finding on stock performance. Managerial ownership also has stronger positive effect to operating performance in the second sub-period and its effect is geared by the existence of lower non-tradable ownership. The finding seems to suggest that the incentive effect of managerial ownership is stronger when top managers are under fewer constraints by block holders.
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