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8/6/2019 Under Pricing and Long-term Performance of IPOs in China
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Underpricing and long-term performance of
IPOs in China
Kalok Chana,*, Junbo Wangb, K.C. John Weia
a
Department of Finance, Hong Kong University of Science and Technology, Clear Water Bay,Kowloon, Hong Kong, China
bDepartment of Finance, School of Management, Syracuse University, Syracuse, NY 13244, USA
Received 31 December 2001; received in revised form 28 January 2002; accepted 25 October 2002
Abstract
We study the underpricing and long-term performance of A- and B-share initial public offerings
(IPOs) issued in China during the 19931998 period. The average underpricing for A- and B share
IPOs are 178% and 11.6%, respectively. The underpricing of A-share IPOs is positively related to thenumber of days between the offering and the listing and the number of stock investors in the
province from which the IPO comes, and negatively related to the number of shares being issued.
None of these characteristics explain the underpricing of B-share IPOs. In the long run, A-share IPOs
slightly underperform the size- and/or book/market (B/M)-matched portfolios while B-shares
outperform the benchmark portfolios.
D 2003 Elsevier B.V. All rights reserved.
JEL classification: G30; G31
Keywords: IPO; China; Underpricing; Long-term performance
1. Introduction
This paper investigates the underpricing and long-term performance of initial public
offerings (IPOs) of common stocks in China. The purpose of this study is not limited to
adding another piece of evidence to the vast literature on IPO underpricing. Rather, we
would like to investigate how the underpricing of IPOs is affected by some institutional
factors in the centrally planned IPO market in China. In addition, we want to examine
whether the long-term IPO underperformance documented in the United States and other
developed markets also applies to a transition economy with central planning such as China.
0929-1199/$ - see front matterD 2003 Elsevier B.V. All rights reserved.
doi:10.1016/S0929-1199(03)00023-3
* Corresponding author. Tel.: +852-2358-7680; fax: +852-2358-1749.
E-mail address: kachan@ust.hk (K. Chan).
www.elsevier.com/locate/econbase
Journal of Corporate Finance 10 (2004) 409430
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IPO underpricingthe phenomenon of a large positive gain to a new issue (relative to
its offering price) immediately after listinghas been found in many markets. Loughran et
al. (1994) document evidence of IPO underpricing in 25 countries, with higher IPO
underpricing in developing than in developed markets.1 Compared with evidence fromother countries, the magnitude of underpricing in China is even more phenomena l. Mok
and Hui (1998) find that the underpricing of A shares in Shanghai was 289%. Su and
Fleisher (1999) show that the underpricing could exceed 948% if IPOs from earlier years
were included in the sample. Many different theories, such as information asymmetry and
signaling models, have been offered to explain the IPO underpricing phenomenon (Allen
and Faulhaber, 1989; Grinblatt and Hwang, 1989; Welch, 1989; Chemmanur, 1993).2
However, it is unlikely that these models can adequately explain underpricing of such a
magnitude as that happening in China.
An interesting characteristic of the Chinese IPO market is that the aggregate amount of
new shares issued each year is determined by the central government. Furthermore, the
new issues typically represent a small proportion of the outstanding shares, as the majority
of other shares are owned by the state or other legal entities and are not available to public
investors.3 As a result, the amount of new shares made available in the market is not
sufficient to satisfy the demand of Chinese investors who have very few alternative
investment choices. Another rigidity in the IPO market is that the offering price is
monitored by the China Securities Regulatory Commission (CSRC). In order to muster the
enthusiasm of the investors and to guarantee a full subscription, the offering price is set far
below what the market is willing to pay. As a result, this creates massive speculation on
IPOs when they are listed.Several researchers have investigated the IPO underpricing phenomenon in China. Mok
and Hui (1998) examine the pricing of IPOs in the early years of Chinas stock market
(before 1993), while Su and Fleisher (1999) focus on the signaling model to explain the
underpricing of IPOs in China. In this paper, we examine the performance of the IPOs
using a more recent sub-period (A-share IPOs from 1993 to 1998 and B-share IPOs from
1995 to 1998). Another contribution is that we examine what institutional factors can
explain differences in IPO underpricing across different stocks. Consistent with previous
studies, we find that there are large abnormal returns (178%) to the A-share IPOs on the
first trading day. The underpricing is mainly driven by the institutional setups in China,
which price IPO shares substantially below their non-IPO counterparts, especially for Ashares, based on firms fundamentals such as price/earnings (P/E) ratios and the book/
market (B/M) ratios. We show that the cross-sectional variations of abnormal returns can
be explained by some institutional characteristics, including the percentage of equity
retained by the state and legal entities, the time lag between offering and listing, and the
stage of development of the province from which the IPO firm comes, which is proxied by
the number of stock investors in that province. As for B shares, since foreign investors
1 Please visit Jay Ritters website at http://bear.cba.ufl.edu/ritter/interntl.htm for the most recent updated
information.2 There are some theories to explain the IPO underpricing that focuses on the role of underwriters in resolving
the asymmetric information. See, for example, Sherman (2000) and Sherman and Titman (2002), among others.3 The shares owned by the state or legal entities cannot be traded in the stock exchanges.
K. Chan et al. / Journal of Corporate Finance 10 (2004) 409430410
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have a large investment opportunity set outside China, there is less speculation on B-share
Chinese IPOs, and the average return of the IPOs on the first day of trading is only 11.6%.
Furthermore, the underpricing of the B-share IPOs cannot be explained by institutional
characteristics.We also investigate the long-term performance of the IPOs after the listing. Despite the
fact that the initial IPO returns for A shares are abnormally high, we find that the long-term
under performance for A shares is only moderate as compared with the IPOs in the U.S.
(i.e., Loughran and Ritter, 1995; Ritter, 1991) and other developed markets (i.e., Levis,
1993; Cai and Wei, 1997).4 Therefore, the abnormally high returns for the A-share IPOs
on the initial day are due to heavy underpricing rather than to excessive optimism on pure
speculation. On the other hand, B-share IPOs significantly outperform their benchmarks.
Based on a 1- to 3-year window, A-share IPOs underperform all benchmarks slightly with
the wealth relatives ranging from 0.90 to 0.98. In addition, the long-run stock price
performance is partially related to operating performance. On the other hand, B-share IPOs
outperform all benchmarks with the wealth relatives ranging from 1.105 to 1.453.
The remainder of this paper is organized as follows. Section 2 discusses the institutional
characteristics of the Chinese IPO market. Section 3 presents the data and preliminary
analysis. Section 4 provides evidence on the determinants of cross-sectional variations of
underpricing, while Section 5 shows the results on long-term performance of IPOs.
Section 6 reports the results on the operating performance for A-share IPO firms
surrounding the offering year. Finally, Section 7 concludes the paper.
2. Characteristics of the Chinese IPO market
Following the economic reforms that began in 1978, the Chinese stock market was
finally established in the early 1990s. The Shanghai Securities Exchange was opened in
1990, followed by the establishment of the Shenzhen Stock Exchange in 1991. At the
same time, the Chinese stock market was made partially accessible to foreign investors.
Non-PRC nationals could trade B shares listed on the two stock exchanges in Shanghai
and Shenzhen, H shares listed on the Stock Exchange of Hong Kong, and N shares listed
on the New York Stock Exchange.
There are five types of shares in China: (1) government shares, which are held by theState Assets Management Bureau (SAMB); (2) legal entity shares (or C shares), which are
held by other state-owned enterprises; (3) employee shares, which are held by managers
and employees; (4) ordinary domestic individual shares (or A shares), which can be
purchased only by Chinese citizens of the PRC on the Shanghai Securities or the Shenzhen
Stock Exchange; and (5) foreign shares, which can be purchased only by foreign investors
in Mainland China (B share), in Hong Kong (H share), or on the NYSE (N share). Only A
shares and B shares are listed on the Shanghai Securities and Shenzhen Stock Exchanges.
The first three types of shares are not tradable in the official exchanges, although employee
shares are allowed to be listed 3 years after the IPO.
4 However, Megginson et al. (2000) find long-run return outperformance for share issue privatizations from
33 countries. See Megginson and Netter (2001) for an excellent review of this literature.
K. Chan et al. / Journal of Corporate Finance 10 (2004) 409430 411
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The initial public offering process in China has vestiges of Chinas transitional economy
with socialist planning. First, the aggregate value of new shares to be issued each year is
part of the national investment and credit plan. The new share issue quota is determined
jointly by the State Council Securities Committee (SCSC), the State Planning Commission(SPC), and the Peoples Bank of China (PBOC) (which is the central bank in China). The
quota is allocated to provinces as well as to municipalities. The criteria used for allocation
among provinces include the assessment of regional needs based on the production
structure and industrial base and recognition of balanced regional development to attain
distribution objectives. Within each regional quota, the local securities authorities invite
enterprises to request a listing and then make a selection based on the criteria that combines
good performance as well as sectional development objectives. This process of selecting
enterprises for listing in China differs considerably from a more mature market economy,
where the decision to list an enterprise is usually determined by the stock exchange.
Because the aggregate supply of new shares is controlled by the central government,
the supply fails to meet the demand of public investors who generally lack alternative
investment choices. This is because the financial markets remain poorly developed and
Chinese capital controls make it difficult to invest overseas. As a result, this creates huge
speculation on the IPOs as public investors invariably rush to submit applications
whenever there are new issues. The speculation is further fueled by the inefficiency of
the offering price determination process, which is monitored by the CSRC. In order to
rouse the enthusiasm among investors and to guarantee a full subscription, the offering
price is set far below what the market would be willing to pay. From 1993 to 1998, the
IPOs in China essentially adopted an administrative pricing policy. During this time, theIPO price was set around 15 times of the earnings per share and in the range of 1316
times.5 Furthermore, the offering price was chosen months before the official trading
began and, for a great majority of offerings, there was no feedback mechanism that
allowed the market demand to influence the final offering price.
Another factor contributing to the speculation on IPOs is the method of share
allocation. At the beginning, the share allocation was based primarily on a lottery system
in which there was a fixed number of application forms. Each retail investor was allowed
to purchase a limited number of lottery forms, and lottery winners were entitled to a certain
number of shares per winning form. The lottery mechanism has undergone several changes
subsequently. One modification is to allow an unlimited number of application forms, so
5 However, there is no official regulation about what the exact P/Eratio is used for pricing IPOs. In addition,
the detailed IPO pricing policies have been changed several times in the past. Before 1996, IPO pricing was based
on the forecasted P/E ratio. The CSRCs December 26, 1996 notice changed IPO pricing to be based on the
realized arithmetic average P/Eratio in the past 3 years. The CSRCs September 10, 1997 notice modified the IPO
pricing formula to: IPO price = EPS*P/E, where EPS = 0.7*EPS in the year before the IPO + 0.3*Forecasted
diluted EPS during the IPO year, and the P/E should be within the maximum and minimum allowed P/Es with a
very complicated formula. The CSRCs March 17, 1998 notice changed the IPO pricing formula to: IPO
price=(Forecasted Earnings/Weighted Average Number of Shares Outstanding in the IPO year)*P/E. The CSRCs
July 28, 1999 notice began to allow issuers and underwriters to set an initial offering price range subject to the
approval from the CSRC. The final offering price must fall in the price range approved by the CSRC. If the final
offering price is outside the price range, it needs to be re-approved by the CSRC. Recently, the CSRC issued a
consultancy paper to solicit public opinions on how to use the online auction method to price IPOs.
K. Chan et al. / Journal of Corporate Finance 10 (2004) 409430412
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that investors can buy as many application forms as they would like. Another modification
is to require the investors to deposit a certain amount of money into a special savings
account when submitting applications for shares, with the deposit frozen until the lottery
was completed. Despite these changes, there is no feedback from market demand in settingthe offering price. Although an auction mechanism was introduced in recent years, the
price was fixed to a certain extent and investors could only bid on the quantity of shares
they would buy, not on the price of the shares.
Another characteristic of the Chinese IPO market is that new issues reflect only a small
proportion of outstanding shares. The majority of shares are still owned by the government
or other legal entities. The retention of equity by the government has two opposing
implications for IPO underpricing. When the state retains a high percentage of shares so
that only a small percentage of shares are available to public investors, there could be more
speculation so that returns on the first day of trading would be higher. On the other hand, a
high percentage of shares being retained by the state may be equated with inefficiency and
low productivity, leading to fewer investors buying the new shares on the first day of
trading, so the initial return would be lower.
3. Data and summary statistics
Our data are retrieved from the Taiwan Economic Journal (TEJ) database. The sample
period for A-share IPOs is from January 1993 to December 1998. As for B shares,
although the first B-share IPO was in February 1992, it was not until 1995 that more newissues were regularly introduced into the market. Consequently, we study the B-share IPOs
only from January 1995 to December 1998. As we mentioned earlier, there is a long time
lag between the offering date and the listing date. We exclude those new issues that have
elapsed time between these dates longer than 360 days. The final sample includes 570 A-
share IPOs and 39 B-share IPOs.
The underpricing of an IPO issue is calculated as the return on the first day of trading
(relative to the offering price):
Ret0 1
nX
n
i1
Pi0
Pil 1 1
where Ret0 is the average return (underpricing) of the IPOs on the first trading day (day 0),
Pi0 is the closing price of stock i on day 0, and Pil is the offering price of stock i. We also
adjust the return for the market effect:
Adjret0 1
n
Xni1
Pi0
Pil
Pi;m0
Pi;ml
2
where Adjret0 is the average of the market-adjusted returns (including dividends) of IPOson day 0, Pi,m0 is the closing value of the corresponding Shanghai or Shenzhen A-share or
B-share market index on the first trading day of the new issue i, Pi,ml is the closing value of
K. Chan et al. / Journal of Corporate Finance 10 (2004) 409430 413
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the corresponding Shanghai or Shenzhen A-share or B-share market index on the offering
day of the new issue i.
We will include several variables to explain cross-sectional variations of underpricing.
The first variable is the number of days between offering and listing (Lday). Unlike indeveloped markets where only a short time elapses between the offering and the listing, it
is typical in China for the new issues to be offered for public subscription more then 2
months before their listing on the stock exchanges. Due to the asymmetric information
distribution among the issuer, underwriters and investors (Baron, 1982; Rock, 1986) and
to the fact that funds will be tied up, the longer time gap between the offering and the
listing will increase the risk to investors so that a larger underpricing is required.
Therefore, we expect a positive relation between Lday and underpricing.
The second variable is the number of shares being issued (Lnum). There is extensive
evidence that suggests that the demand curve for shares in an individual company is not
perfectly elastic (Shleifer, 1986 and others). When there are more shares being issued,
investors do not need to buy the shares urgently on the first day of trading so that initial
returns will be lower. Thus, a negative relationship between Lnum and underpricing is
predicted.
The third variable is the number of stock investors in the area (province or municipal-
ity) during the year when the IPO is issued (Investor). Since the listing criteria is not solely
based on the quality of the companies, but is also determined by the central government
that tries to balance the development of different provinces, not all IPOs are of similar
quality. We conjecture that the IPOs from the more developed provinces are of higher
quality than those from less developed ones. The number of stock investors in the provinceis used as a proxy for the stage of development (wealth) of the area. The correlation
between Investor and underpricing is expected to be positive.
The fourth variable is the percentage of the non-negotiable state and institution
shares (Percent). When the state or legal entities retain a high percentage of shares, this
might be perceived as an indicator of bureaucratic control and operating inefficiency.
Therefore, fewer investors would be willing to pay a higher price. We conjecture that there
is a negative relationship between Percent and the underpricing.
Table 1 presents the unadjusted and the market-adjusted underpricing for A-share and
B-share IPOs. Panel A contains the results for the whole sample period from 19931998
as well as for each year. The average underpricing for A-share IPOs was 177.8% for thewhole period, while that for B-share IPOs was only 11.6%. The underpricing for both A-
share and B-share IPOs was only slightly lower, when the initial returns were adjusted for
market movements. A breakdown of the IPOs by year shows that the underpricing of A
shares was quite persistent. Except for 1995 when there were only four IPOs, the
underpricing was greater than 100% in all years studied.
Since the CSRC began to allow issuers and underwriters to set an initial offering price
range subject to the approval from the CSRC, instead of a fixed pricing formula starting
July 1999, it would be interesting to briefly discuss whether the short-term underpricing in
the post-1999 period is different from the underpricing in the pre-1999 period.6 There are a
6 The 19992001 sample is only used to examine the short-term underpricing. It is too short to investigate
the long-term performance.
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total of 286 A-share IPOs from 1999 to 2001, and only 7 B-share IPOs from 1999 and 2000.
There are no B-share IPOs in 2001. This was due to a policy change in China in 2001. To
pave the road for B shares to gradually converge to A shares, in February 2001, the CSRC
announced that the PRC citizens whoever have the foreign currencies could start to trade B
shares and that the B-share IPOs market would be suspended. The result reported in Panel B
of Table 1 indicates that the average underpricing for A-share IPOs during the period 1999
2001 was 107.5% (the average market-adjusted initial return = 105.7%), which is much
lower than the underpricing in the earlier years but it is still very high. The year-by-year
result shows that, except for the most recent year 2001, the underpricing for A-share IPOswas more than 110%. However, the underpricing for A-share IPOs has reduced substan-
tially to less than 20% in the year 2001. Whether this is due to the effectiveness of the
Table 1
Underpricing of the IPOs in China from 1993 to 2001
Year A share B share
Unadjusted Adjusted N Unadjusted Adjusted N
Ret t-Value Ret t-Value Ret t-Value Ret t-Value
Panel A. Underpricing for A-share and B-share IPOs: 19931998
1993 3.378*** 11.78 3.289*** 11.75 120
1994 1.266*** 10.36 1.379*** 10.93 70
1995 0.140* 1.90 0.168* 1.83 4 0.053* 1.72 0.063** 2.04 9
1996 1.167*** 18.75 1.103*** 17.89 144 0.060*** 2.60 0.025 0.74 13
1997 1.495*** 26.64 1.497*** 27.27 186 0.240*** 3.39 0.297*** 4.14 14
1998 1.375*** 11.14 1.335*** 10.81 46 0.03 0.72 0.030 0.52 3Avg 1.778*** 23.00 1.754*** 23.23 570 0.116*** 3.74 0.132*** 3.78 39
Panel B. Underpricing for A-share and B-share IPOs: 19992001
1999 1.130*** 14.15 1.098*** 14.31 81 0.293 0.322 1
2000 1.509*** 20.16 1.484*** 20.00 135 0.332*** 9.11 0.395*** 11.16 6
2001 0.173** 2.33 0.144* 1.92 70
Avg 1.075*** 19.33 1.047*** 18.98 286 0.326*** 10.43 0.385*** 12.14 7
This table reports the unadjusted and adjusted initial returns of A-share and B-share IPOs in China. Panel A
reports the sample that includes 570 A-share IPOs between January 1993 and December 1998 and 39 B-share
IPOs between January 1995 and December 1998, while Panel B reports the sample from 1999 to 2001. The
unadjusted and adjusted initial returns of the IPOs are defined as
Ret0 1
n Xn
i1
Pi0
Pil 1
and
Adjret0 1
n
Xni1
Pi0
Pil
Pi;m0
Pi;ml
;
respectively. Pil is the closing price of stock i on the first trading day, Pi0 is the offering price of stock i, Pml is the
closing price of the appropriate Shanghai or Shenzhen A-share or B-share market index on the first trading day of
the new issue i, Pm0 is the closing price of the appropriate Shanghai or Shenzhen A-share or B-share market index
corresponding to the offering day of the new issue i.
* Significant at the 10% level.
** Significant at the 5% level.
*** Significant at the 1% level.
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Table 3
Regression results for the underpricing of IPOs in China from 1993 to 1998
Intercept Lday Lnum Percent Investors Age Exch Mktret
Panel A: Regression results for the underpricing of A-share IPOs (N = 570)
Coeff 4.835*** 0.661*** 0.348*** 0.013** 0.116* 0.006* 0.031 1.618*t-Value (4.56) (7.71) ( 4.14) ( 2.13) (1.87) ( 1.72) (0.23) (5.78)
Panel B: Regression results for the underpricing of B-share IPOs (N = 39)
Coeff 0.096 0.009 0.003 0.001 0.001 0.003* 0.069 0.028 t-Value (0.09) ( 0.15) ( 0.04) ( 0.18) ( 0.03) (1.68) (0.98) (0.07)
Panel A reports the underpricing regression for A-share IPOs and Panel B for B-share IPOs.
Lday is the number of days between the offering and listing dates, Lnum is the number of shares issued, Percent is the pe
institution shares, Investors is the number of investors in the region from which the IPO comes, Age is the number of years th
Exch is a dummy variable which is equal to 1 if the new issue is listed on the Shenzhen Stock Exchange and 0 if it is listed on t
the return on the corresponding stock market index between the offering and listing dates, Issp is the issue price, and Offshore
new issue has issued any offshore shares and 0 otherwise. t-Values are in parentheses.
* Significant at the 10% levels.
** Significant at the 5% level.
*** Significant at the 1% level.
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Exchange, the issue price (Issp), the age of the company (Age), and a dummy variable
(Offshore) that is equal to one if the company issues some kind of offshore shares, such as
H shares in Hong Kong or N shares in New York, and zero otherwise.
The regression results are reported in Table 3. Panel A contains the results for A-shareIPOs. In the multivariate regression, the underpricing of A-share IPOs is positively and
significantly related to the number of days between offering and listing (Lday), and the
number of stock investors in the area in the year when the IPO is issued (Investor); and
negatively and significantly related to the number of shares being issued (Lnum) and the
percentage of the non-negotiable state and institution shares (Percent).7 Panel B
contains the results for B-share IPOs. Unlike that of the A-share IPOs, the underpricing
of B-share IPOs cannot be explained by any of the four institutional variables. In fact, none
of the control variables explains the variations in the underpricing. Therefore, the
underpricing of B-share IPOs is quite different from that of A-share IPOs. First, the
magnitude of underpricing of B shares, as documented in Table 1, is much smaller.
Second, there is no systematic force that explains the underpricing of B shares.
5. Long-term performance
5.1. The stock price long-term performance
Given that the exceptionally high returns for A-share IPOs on the first day of trading, an
interesting question is whether such underpricing, maybe due to investors overreaction,will be corrected by stock price performance in the long run. For example, Ritter (1991)
and Loughran and Ritter (1995) found that IPOs in the U.S. underperform significantly
relative to non-issuing firms for 3 to 5 years after the listing date. Many studies also
provide international evidence on the long-run underperformance of IPOs that is consistent
with what has been observed in the U.S. market.8 However, Megginson et al. (2000)
examine the long-run (1 to 5 years) performance of 158 share issue privatizations from 33
countries (including Chinese state-owned enterprises that list their shares on the Hong
Kong Exchange) during the period 19811997 and find statistically significant positive
net returns for all holding periods as compared to a variety of benchmarks.
We therefore follow the performance of the IPOs in the 36 months after listing.9
Insteadof using the calendar month, we follow Ritter (1991) and assume that there are 21 trading
days in 1 month. Therefore, the first month consists of the first 21 trading days after the
first day (denoted as day 0) listing, the second month consists of day 22 through day 42
after listing, and so on.
Previous studies suggest that the measure of long-run performance for IPOs is sensitive
to the benchmark used. Furthermore, Barber and Lyon (1997) show that when long-run,
7 The results from the univariate regressions (not reported here) are consistent with those from the
multivariate regression, except for Percent, which is positively related to the underpricing.8 For example, see Levis (1993) for the U.K. market and Cai and Wei (1997) for the Japanese market.9 Since the history of the stock market in China is short, unlike in Ritter (1991), Loughran and Ritter (1995),
and Megginson et al. (2000), we only follow the IPO performance for 3 years after the issues.
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buy-and-hold abnormal returns are calculated using a reference portfolio, the test statistics
are negatively biased. This bias is, however, not present when abnormal returns are
calculated as the return of a sample firm less the return of a single control firm matched on
size or book/market ratio.10 As a result, we follow Ritters (1991) procedure to constructthree benchmarks to measure the adjusted performance of the IPO firms: the size-matched,
the B/M-matched, and the size-and-B/M-matched non-IPO portfolios. The size and book-
to-market characteristics have been documented extensively as important determinants of
stock returns (Banz, 1981; Chan et al., 1991; Daniel and Titman, 1997; Daniel et al., 2001;
Fama and French, 1992; Davis et al., 2000; Davis, 1994; Lakonishok et al., 1994;
Loughran and Ritter, 1995).
For the size-matched portfolio, each IPO firm is matched with a firm that has been
listed for at least 2 years and has the closest market value at the end of the issuing calendar
month.11 The procedure for matching by B/M is the same except that the book value for
the issuing firm also includes the issuing proceeds.12 To control for both size and B/M
effects, a non-IPO firm in the previous 2 years is chosen such that the absolute percentage
difference between size and B/M is minimal. Since there are two types of shares for every
listed company in China: tradable and nontradable, we will use both measures to compute
the market value. Specifically, when total shares are used, the market value (more
precisely, the total market equity) is defined as the number of total shares outstanding
multiplied by the stock price at the end of the issuing month, and B/M is defined as the
previous years book equity divided by the total market equity. Similarly, when the traded
shares are used, the market value (more precisely, tradable market equity) is defined as the
number of tradable shares multiplied by the stock price at the end of the issuing month,and the B/M is defined as the previous years book equity multiplied by the ratio of
tradable shares to total shares and then divided by tradable market equity. However, the
results are essentially the same for both measures of market value. To save space, in the
following, we only report the results based on the tradable shares.
Barber and Lyon (1997), Conrad and Kaul (1993), and Kothari and Warner (1997)
demonstrate that there are potential biases from summing up average benchmark-adjusted
returns over long horizon. Therefore, we focus on the holding period return and the wealth
relative as suggested by Ritter (1991) and Loughran and Ritter (1995) as the performance
measure:
Wealth relative 1 average T period total return on IPOs
1 average T period total return on matching firms3
By definition, a wealth relative of greater than 1.00 can be interpreted as IPOs out-
performing a portfolio of matching firms. Similarly, a wealth relative of less than 1.00
suggests that IPOs underperform a portfolio of matching firms.
10 This idea of matching firms was first suggested by Ritter (1991) and followed by Loughran and Ritter
(1995) and others.11 Since the history of the stock market in China is only slightly over 10 years, unlike in Ritter (1991), we
choose 2 years instead of 3 years to identify our non-IPO matching firms.12 We use the market value at the end of the issuing calendar month.
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Table 4
The long-term performance of the IPOs in China
Months N CRet Size-matched B/M-matched Size-and-B/M-matched
CBenret Wealthrelative
CBenret Wealthrelative
CBenret Wealthrelative
Panel A. A-share IPOs
1 570 1.690 5.170 0.967 6.042 0.959 6.970 0.951
2 570 1.251 4.846 0.942 4.021 0.949 5.275 0.9383 570 0.879 4.902 0.945 2.665 0.965 4.209 0.9514 570 2.910 8.718 0.947 6.496 0.966 7.308 0.959
5 570 4.135 7.927 0.965 6.322 0.979 6.936 0.974
6 570 5.745 8.553 0.974 6.373 0.994 5.884 0.999
7 570 8.024 11.250 0.971 9.217 0.989 8.388 0.997
8 570 8.989 11.093 0.981 10.675 0.985 10.242 0.989
9 570 10.467 13.000 0.978 11.648 0.989 11.126 0.99410 570 12.079 16.507 0.962 14.637 0.978 13.814 0.985
11 570 13.814 17.559 0.968 15.312 0.987 14.915 0.990
12 570 11.551 15.280 0.968 14.526 0.974 13.471 0.983
13 570 11.357 16.772 0.954 16.188 0.958 15.074 0.968
14 570 11.231 17.538 0.946 16.711 0.953 15.816 0.960
15 570 12.582 19.380 0.943 17.885 0.955 16.514 0.966
16 570 15.196 20.399 0.957 20.595 0.955 18.226 0.974
17 570 16.874 20.473 0.970 21.320 0.963 20.277 0.972
18 570 18.139 22.092 0.968 23.080 0.960 20.984 0.976
19 558 21.055 22.956 0.985 25.736 0.963 21.680 0.995
20 548 25.689 29.654 0.969 29.450 0.971 26.450 0.994
21 540 27.782 33.359 0.958 30.278 0.981 29.440 0.98722 537 27.482 32.416 0.963 29.807 0.982 29.296 0.986
23 526 29.453 34.293 0.964 31.022 0.988 30.661 0.991
24 522 30.657 34.963 0.968 32.698 0.985 33.697 0.977
25 514 29.548 34.011 0.967 32.812 0.975 32.129 0.980
26 506 32.640 37.070 0.968 35.739 0.977 35.942 0.976
27 497 33.294 38.412 0.963 38.633 0.961 38.443 0.963
28 492 34.253 39.667 0.961 40.709 0.954 38.905 0.967
29 481 39.622 45.831 0.957 44.687 0.965 43.298 0.974
30 435 43.512 49.447 0.960 49.571 0.959 48.697 0.965
31 401 46.611 56.046 0.940 56.581 0.936 54.408 0.950
32 374 53.039 64.386 0.931 59.058 0.962 60.517 0.953
33 366 60.606 70.637 0.941 65.210 0.972 69.952 0.945
34 353 66.599 72.919 0.963 71.566 0.971 76.606 0.943
35 337 71.238 81.040 0.946 73.826 0.985 87.181 0.915
36 319 75.067 89.505 0.924 78.631 0.980 94.837 0.899
Panel B. B-share IPOs
1 39 14.443 2.562 1.116 2.688 1.114 7.074 1.069
2 39 15.609 0.207 1.154 1.480 1.173 5.375 1.0973 39 13.490 3.305 1.099 3.318 1.174 6.304 1.068
4 39 15.386 5.868 1.090 2.285 1.181 8.537 1.0635 39 26.155 5.867 1.192 2.126 1.235 12.845 1.118
6 39 27.431 0.957 1.262 1.365 1.257 10.982 1.1487 39 27.375 1.561 1.254 3.512 1.231 13.750 1.120
8 39 37.314 5.833 1.297 7.560 1.277 19.506 1.149
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suggest that A-share IPOs in China underperform the corresponding benchmarks. How-
ever, the underperformance is modest compared with the IPOs in the U.S. and Japan.
Loughran and Ritter (1995) find that the three-year wealth relative for U.S. IPOs is 0.80
when IPO firms are matched with non-IPO firms by size. Cai and Wei (1997) find that the
3-year wealth relative for Japanese IPOs ranges from 0.67 to 0.77 when IPO firms arematched by size, B/M, or both size and B/M. Results for B-share IPOs are shown in Panel
B of Table 4 and plotted in Fig. 2. In contrast to the result for A shares, B-share IPOs
Fig. 1. A-shares monthly cumulative return.
Fig. 2. B-shares monthly cumulative return.
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outperform the market as the wealth relatives are always greater than 1.00 during these 36
months after listing. At the end of month 36, the wealth relatives against different
benchmarks range from 1.28 to 1.36.
Panel A of Table 5 reports the buy-and-hold return for different periods of A-share IPOsand their matching firms. Although the IPOs underperform their matching firms for all
Table 5
Average percentage returns during the 3 years after issuing for A- and B-share IPO firms, and their matching firms
First 6 months First year First 2 years First 3 years
Return t-Value Return t-Value Return t-Value Return t-Value
Panel A. A-share IPO firms and their matching firms
A1. Based on size-matched portfolios
IPO firms (%) 5.74*** 2.90 11.55*** 4.41 30.66*** 7.72 75.07*** 9.52
Matching firms (%) 8.55*** 4.35 15.28*** 5.76 34.96*** 8.93 89.51*** 9.72
Difference 2.82 1.22 3.75 1.20 4.30 0.93 14.44 1.32Sample size 570 570 522 319
A2. Based on B/M-matched portfolios
IPO firms (%) 5.74*** 2.90 11.55*** 4.41 30.66*** 7.72 75.07*** 9.52
Matching firms (%) 6.37*** 3.42 14.53*** 5.88 32.70*** 8.05 78.63*** 9.42
Difference 0.63 0.27 2.97 1.48 2.04 0.45 3.56 0.36Sample size 570 570 522 319
A3. Based on size-and-B/M-matched portfolios
IPO firms (%) 5.74*** 2.90 11.55*** 4.41 30.66*** 7.72 75.07*** 9.52
Matching firms (%) 5.88*** 3.19 13.47*** 4.93 33.70*** 7.60 94.84*** 9.25
Difference 0.14 0.02 1.92 0.69 3.03 0.01 19.77* 1.74Sample size 570 570 522 319
Panel B: B-share IPO firms and their matching firms
B1. Based on size-matched portfolios
IPO firms (%) 27.43** 2.54 43.54** 2.18 16.75 0.81 13.88 0.72
Matching firms (%) 0.96 0.14 1.23 0.12 10.56 0.72 16.17 1.46
Difference 26.47*** 3.58 44.77*** 2.77 27.31 1.14 30.04 1.19
Sample size 39 39 36 22
B2. Based on B/M-matched portfolios
IPO firms (%) 27.43** 2.54 43.54** 2.18 16.75 0.81 13.88 0.72
Matching firms (%) 1.36 0.20 14.76 1.19 2.59 0.18 12.71 1.22
Difference 26.07*** 4.48 28.78** 2.25 14.16 0.60 26.58 1.09Sample size 39 39 36 22
B3. Based on size-and-B/M-matched portfolios
IPO firms (%) 27.43** 2.54 43.54** 2.18 16.75 0.81 13.88 0.72
Matching firms (%) 10.98 1.43 13.71 1.24 5.62 0.35 11.19 1.02Difference 16.45** 2.47 29.83* 1.93 11.12 0.44 25.06 0.98
Sample size 39 39 36 22
This table reports the average holding period returns for IPO firms and their matching firms after the first trading
day based on three benchmarks: the size-matched, the B/M-matched, and the size-and-B/M-matched bench-
marks. The tradable shares are used to compute the market values. The detailed matching procedure is described
in Table 4.
Panel A reports the results for A shares, and Panel B for B shares.
* Significant at the 10% level.
** Significant at the 5% level.
*** Significant at the 1% level.
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growth rate (CE). We also calculate industry-adjusted changes in operating performance,
which is defined as the deviation of a given firm from the industry median.
Results indicate that ROA, CFOA, and ATO decline significantly after the issuance,
regardless of which event window we use. For example, if we measure changes in
performance from year t 1 to year t+ 1, ROA declines by 7.57%, CFOA by 7.30%,and ATO by 37%. On an industry-adjusted basis, the changes in operating performance
remain statistically significant. These results are consistent with Jain and Kini (1994) and
Mikkelson et al. (1997) who find that IPO firms in the U.S. exhibit a decline in their post-
issuance operating performance. However, in a survey paper on the privatization of state-owned enterprises (SOEs), Megginson and Netter (2001) document that privatized firms
become more efficient, more profitable, and financially healthier, and reward investors.
Table 7
Changes in operating performance of IPO firms surrounding the issuing year
Measure of operating performance Year relative to the IPO year
From 1 to 0 From 1 to 1 From 1 to 2 From 1 to 3
Panel A. Operating return on assets (ROA)
Mean change (%) 4.79*** 7.57*** 9.71*** 9.22***Mean industry-adjusted change (%) 3.58*** 4.50*** 5.12*** 3.58*** Number of observations 254 253 212 85
Panel B. Operating cash flows/total assets (CFOA)
Mean change (%) 4.78*** 7.30*** 9.59*** 10.36***Mean industry-adjusted change (%) 3.39*** 3.86*** 4.77*** 4.27*** Number of observations 254 253 212 85
Panel C. Sales growth rate (Sale_G)Mean change (%) 19.57*** 51.96*** 90.08*** 169.06***
Mean industry-adjusted change (%) 12.75*** 40.53*** 74.46*** 152.34***
Number of observations 343 342 299 132
Panel D. Asset turnover (ATO)
Mean change (%) 33.20*** 37.00*** 46.07*** 47.65***Mean industry-adjusted change (%) 27.06*** 22.31*** 24.44*** 20.27*** Number of observations 343 342 299 132
Panel E. Capital expenditures growth rate (CE)
Mean change (%) 146.88*** 250.99*** 253.90*** 37.29
Mean industry-adjusted change (%) 136.44*** 233.01** 243.47*** 92.87*** Number of observations 248 248 248 207
This table presents the mean change/growth in operating performance of IPO firms during the period of 1993
1998.
ROA is return on assets and is measured as the operating income before depreciation and amortization as a
percentage of total assets. CFOA is the operating cash flow on assets and is defined as the operating income less
capital expenditures. Sale_G is the growth rate of net sales. ATO is the asset turnover measured as net sales over
total assets. CE is measured as the growth rate of capital expenditures compared with the year prior to IPOs. The
industry-adjusted change/growth for a given firm is the deviation from the industry median. Year 0 is the fiscal
year during which the firm goes public.
** Significant at the 5% level.
*** Significant at the 1% level.
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We also find that both the sales growth rate and the capital expenditure growth rate of
IPO firms exhibit substantial increases relative to the industry. Therefore, the inferior
operating performance in ROA, CFOA, and ATO is not related to a decline in business
activity. Rather, these results are consistent with the hypothesis that managers attempt to
window-dress their accounting reports prior to going public, which leads to pre-IPO
performance being over-stated and post-IPO performance being understated.15
6.2. The relationship between operating performance and stock performance
Table 8 reports the results of cross-sectional regressions of post-issuance stock returns
on operating performance. The 1-year and 2-year abnormal returns are positively related to
DROA, DCFOA, and DSale_G. Therefore, although mangers tend to manipulate account-
ing reports before the IPOs, the information on the changes in operating performance is
Table 8
Cross-sectional regressions of post-issuing stock returns on operating performance
Variable Intercept DROA DCFOA DSale_G DATO DCE R2
Panel A. Regression results for 1-year accumulative abnormal returns (N = 248)Coeff. 9.648*** 0.602* 0.340*** 0.073 0.005 0.157t-Value ( 3.113) (1.908) (5.478) ( 1.274) ( 0.456)Coeff. 9.934*** 0.702** 0.340*** 0.082 0.004 0.159t-Value ( 3.244) (1.992) (5.472) ( 1.402) ( 0.345)
Panel B. Regression results for 2-year accumulative abnormal returns (N = 212)
Coeff. 8.261** 1.354*** 0.094*** 0.046 0.009* 0.199t-Value ( 2.117) (4.138) (2.806) ( 0.707) (1.786)Coeff. 9.376** 1.465*** 0.095*** 0.056 0.010* 0.201t-Value ( 2.470) (4.195) (2.862) ( 0.867) (1.920)
Panel C: Regression results for 3-year accumulative abnormal returns (N = 85)
Coeff. 22.187*** 0.168 0.153*** 0.082 0.022 0.230t-Value ( 3.555) (0.251) (3.441) ( 0.901) (1.485)
Coeff. 21.728*** 0.379 0.152*** 0.091 0.022 0.233t-Value ( 3.462) (0.537) (3.420) ( 0.992) (1.481)
This table reports the regression results of the post-issuing stock price performance on the post-issuing operating
performance.
The dependent variable is the 1-, 2-, and 3-year stock abnormal returns following the IPOs. The independent
variables are changes in industry-adjusted operating performance measures. ROA is return on assets and is
measured as the operating income before depreciation and amortization as a percentage of total assets. CFOA is
the operating cash flow on assets and is defined as the operating income less capital expenditures. Sale_G is the
growth rate of net sales. ATO is the asset turnover that is measured as net sales over total assets. CE is measuredas the growth rate of capital expenditures compared with the year prior to IPOs. The industry-adjusted change/
growth for a given firm is the deviation from the industry median.
* Significant at the 10% level.
** Significant at the 5% level.
*** Significant at the 1% level.
15 See Aharony et al. (2000) for the evidence of earnings manipulations of H shares and B shares before their
IPOs.
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Acknowledgements
The authors would like to thank Jeffrey M. Netter (the editor) and an anonymous
referee for insightful comments and Dr. Virginia Unkefer and Joanne Zhong for theeditorial assistance. We also acknowledge the Earmarked Research Grant of the Research
Grants Council of the Hong Kong Special Administration Region, China (HKUST601/
96H) for financial support.
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