Invesment Bank Reputaion - IPO in Hongkong

Ž .Pacific-Basin Finance Journal 9 2001 101–117www.elsevier.comrlocatereconbase

Investment bank reputation and relaxed listingrequirements: Evidence from infrastructure firm

IPOs in Hong Kong

Kathryn L. Dewenter a,), Laura Casares Field b

a Department of Finance, UniÕersity of Washington, Box 353200, Seattle, WA 98125, USAb Penn State UniÕersity, UniÕersity Park, PA, USA

Abstract

In early 1996, the Stock Exchange of Hong Kong allowed firms focusing on infrastruc-Ž .ture projects to issue initial public offerings IPOs under a relaxed set of listing require-

ments, allowing these firms to go public with a shorter history or lower profitability levels.We provide evidence that these firms are no more speculative than firms listing under theregular requirements. To the contrary, we find that firms listed under the relaxed require-ments are taken public by reputable investment banks and that these firms have character-istics that otherwise mitigate their lack of earnings history. These patterns are consistentwith investment banks avoiding highly speculative issues to protect their reputations.q 2001 Elsevier Science B.V. All rights reserved.

JEL classification: G15; G24

Ž .Keywords: Initial public offerings IPOs ; Hong Kong; Infrastructure finance; Investment bank;Relaxed listing requirements

1. Motivation

The need for funds to develop infrastructure in emerging markets is huge andgrowing. For example, the World Bank estimates that Latin America and theCaribbean currently need to invest 4.5% of GDP each year on power, transport,

) Corresponding author. Tel.: q1-206-685-7893; fax: q1-206-685-9392.Ž .E-mail address: [email protected] K.L. Dewenter .

0927-538Xr01r$ - see front matter q 2001 Elsevier Science B.V. All rights reserved.Ž .PII: S0927-538X 01 00006-3

( )K.L. Dewenter, L.C. FieldrPacific-Basin Finance Journal 9 2001 101–117102

telecoms, sewage, and water supply upgrades.1 These funding requirements are farbeyond what multilateral agencies and federal governments can provide. There-fore, emerging market countries have had to turn to private sources to help financethese projects.

To date, private equity funds have been the primary vehicle for infrastructureinvestments. Market participants, though, argue that public funds, via stock marketlistings, are needed to both expand the pool of available money and to provide anexit strategy for the initial private investors. Several countries, recognizing theneed for public funds and the short lives of most infrastructure firms, havedeveloped relaxed listing requirements for infrastructure firm initial public offer-

Ž .ings IPOs . Hong Kong, Malaysia, and Singapore, for example, all announcedplans to establish relaxed listing requirements for infrastructure firms in late1995.2

By relaxing the requirements on trading record period and profit levels, HongŽ .Kong’s relaxed listing requirements, called sub-rule 8.05 2 , allow infrastructure

Ž .project companies to list on the Stock Exchange of Hong Kong SEHK at anearlier stage of their lives. Before the stock exchange implemented the relaxedrules, all firms had to meet the basic, or regular, listing criteria. Among theserules, the SEHK requires that, AA new applicant must normally have a tradingrecord of not less than 3 years under substantially the same management. Theprofit attributable to shareholders must, for the most recent year, be not less thanHK$20 million and, for the 2 preceding years, be in aggregate not less thanHK$30 million.B 3 Under the relaxed rules for infrastructure project companies,firms are allowed to issue an IPO even if they have fewer than 3 years of auditedfinancial statements andror lower profit levels than the formal thresholds.

Since implementation of the special rules for infrastructure project companies,infrastructure firms can choose whether to issue stock on the exchange early intheir lives by listing under the relaxed requirements, or, alternatively, to wait untilthey are more seasoned and list under the regular requirements. One might askhow investors react to stock issues by firms under the relaxed rules. Are therelaxed listing firms considered more risky or speculative than comparable regularlisting firms? Or, do the investment banks, concerned about their reputations, onlysponsor those firms that somehow compensate for the lack of a comparableearnings history?

This paper provides evidence on Hong Kong’s experience to date with relaxedlisting requirements for infrastructure firm IPOs. We study infrastructure listings

1 Ž .Economist, APrivacy please: Infrastructure in Latin AmericaB July 27, 1996 54–55.2 In the late 1990s, listing requirements in several exchanges were also lowered for internet firms

Ž .for example, Mothers in Japan .3ATrading recordB refers to years of operation. This quote is from the SEHK

website,www.sehk.com.hk. Throughout the 1990s, the Hong Kong dollar was pegged at HK$7.8 per$US1.

( )K.L. Dewenter, L.C. FieldrPacific-Basin Finance Journal 9 2001 101–117 103

made on the Hong Kong exchange during 1996 and the first half of 1997 toexamine whether there are any noticeable differences in those firms issuing IPOsunder the regular listing requirements vs. those issuing IPOs under the relaxedlisting requirements.4 We look at the characteristics of the offerings to see if thereis any evidence that the IPOs issued under the relaxed requirements are morespeculative than the regular requirement listings. We examine how the relaxedofferings were received by investors compared to infrastructure offerings issuedunder the regular guidelines, and at the post-IPO stock-price reaction to accountingperformance announcements. Since our post-IPO period includes the Asian finan-cial crisis, we are also able to compare how the two groups fared duringextraordinarily poor economic times. Finally, we look to see whether the relaxedlisting firms have characteristics that otherwise mitigate their lack of earningshistory.

Ž .We begin with the population of i all infrastructure firms issuing IPOs on theŽ .Hong Kong Stock Exchange under sub-rule 8.05 2 from January 1996 through

Ž .1997, and ii all infrastructure firms issuing under the regular listing requirementsover the same period. During this time, there were four relaxed and 13 regularlisting infrastructure firms. Three of the relaxed listing firms focused exclusivelyon road projects in China, one focused on port development. The regular listing

Ž . Ž . Ž .firms focused on railroads 1 , power stations 1 , telecoms or satellites 3 , roadsŽ . Ž .in China 4 , or were diversified across infrastructure projects 4 . Since we knew

we were going to have a small sample, no matter what criteria we used, wedecided to construct the cleanest possible set of matching firms. As a result, werestrict our analysis to the seven firms that focused exclusively on road projects inChina.

ŽThree of the relaxed listing firms fit this criterion. One firm, Road King IPO.issue date: July 4, 1996 , was forced to use the relaxed requirements because it

had earned negative net profits within the previous 3 years, and two firms, GZIŽ . Ž .Transport January 30, 1997 and Jiangsu Expressway June 27, 1997 , had been

in business less than 3 years. The four regular listing firms are: Anhui ExpresswayŽ . Ž .November 13, 1996 , Shenzhen Expressway March 12, 1997 , Zhejiang Express-

Ž . Ž .way May 15, 1997 , and Sichuan Expressway October 7, 1997 . A morecomplete description of all seven firms is provided in Appendix A.

While this sample is small, it does provide two sets of firms with very similarprofiles. It allows us an early comparison of the listing and subsequent stock priceperformance of the relaxed vs. regular requirement firms. We find no evidence ofany striking differences consistent with the relaxed listing firms being relativelymore risky or speculative than the regular listing firms. Instead, we find evidencethat the relaxed listing firms were, in some respects, actually less speculative than

4 Given the recent market turmoil in Asia, no firms issued IPOs under sub-rule 8.05 from June 30,1997 through June 30, 1999.


the regular listing firms. Indeed, well-known, reputable investment banks under-wrote the relaxed as well as the regular listing firms. Moreover, prior to the IPOissue, the relaxed listing firms were larger or more profitable than the regularlisting firms despite the fact that they did not meet the regular listing requirements.All of this evidence is consistent with investment bankers avoiding highlyspeculative issues to protect their reputations.

Below, Section 2 discusses the empirical evidence. In the conclusion, Section 3,we discuss whether or not the findings of this small sample can be generalized.

2. Empirical evidence

This section compares the relaxed and regular listing firms along severaldifferent dimensions. Unless otherwise noted, the data on the issues come from theprospectuses or press reports, while the stock price data come from DatastreamInternational.

2.1. IPO structure

Table 1 provides descriptive data on the IPOs for the three firms using therelaxed rules as well as the four firms listing under the regular rules. The bottomrow of the table provides the difference in the averages for the relaxed vs. regularfirms. The results of a non-parametric Wilcoxon rank test for differences in theaverages are reported in the table. The difference is never statistically significant

Ž . 5using a t-test with pooled variances results not reported in the table .Column 1 provides the first trading date. These IPOs occurred between July

1996 and October 1997.Column 2 provides the offer price. The two groups seem to have substantially

different offer prices with an average of HK$4.91 for firms under the relaxed rulesand HK$1.98 for firms under the regular rules. Indeed, the offer price ranges fromHK$3.11 to HK$8.40 for firms under the relaxed rules, while it is only HK$1.55–2.38 for the regular listing firms. Over 1996–1997, the mean offer price across allSEHK IPOs was HK$3.06, with a range of HK$1.00–19.80.6 A Wilcoxon ranktest rejects that the two sets of prices for these infrastructure firm IPOs come from

5 Note both the t-test and the rank sum test assume independence.6 Ž .According to Angel 1997 , the median US stock price is about US$40.00, while a typical Hong

Kong share sells for about US$2.00. Angel argues that differences in average stock prices acrosscountries are at least partly due to different rules on tick sizes. While the US uses a single absolute ticksize that applies to most stocks, AHong Kong has the most extreme version of a step function, with 10

Ž .different tick sizes in its rule book.B p. 658 .

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Table 1Background on infrastructure firm IPO issues

First trading Offer price Funds raised Fraction sold International tranche Subscription rateŽ . Ž . Ž . Ž . Ž .date HK$ HK$ million % % times

1 2 3 4 5 6

Relaxed rules firmsRoad King 7r4r1996 8.40 1180.5 26.0 85.0 2.1GZI Transport 1r30r1997 3.23 928.6 25.0 75.0 528.4Jiangsu Expresswayy 6r27r1997 3.11 3800.4 25.0 61.0 2.4Average 4.91 1969.8 25.3 73.6 177.63

Regular rules firmsAnhui Expressway 11r13r1996 1.77 872.6 35.0 85.0 1.0Shenzhen Expressway 3r12r1997 2.20 1644.5 33.9 90.0 36.6Zhejiang Expressway 5r15r1997 2.38 3412.5 30.0 90.0 118.0Sichuan Expressway 10r7r1997 1.55 1387.7 35.0 65.0 1.7Average 1.98 1829.3 33.5 82.5 39.33

a a( )Difference relaxedIregular 2.94 140.5 y8.2 y8.9 138.3

Ž .The sample consists of all infrastructure finance firms focused exclusively on road projects in China which issued an initial public offering IPO of equity onthe Hong Kong Stock Exchange during the period of July 1996 through October 1997. Column 1 provides the offering dates. Column 2 provides the offeringprices, in Hong Kong dollars. Column 3 provides the Hong Kong dollars raised in the offering, in millions. Column 4 provides the fraction sold in the offering,measured as the ratio of shares sold to total shares outstanding after the IPO. Column 5 provides the fraction of the offering sold abroad. Column 6 providesthe subscription rate, which is measured as the number of shares requested from underwriters divided by the number of shares offered. During 1996–1997, theUS DollarrHK Dollar exchange rate was approximately 1:7.8.

a Indicates significant difference in a non-parametric Wilcoxon rank test at the 5% level.


the same sample at the 5% level. Thus, we find that the relaxed firms haverelatively higher offer prices than the regular firms. In the US, Seguin and

Ž .Smoller 1997 show that more speculative IPO offers tend to have lower offerprices.

Despite the apparent difference in offer price, the averages of the funds raisedŽ .column 3 across the two groups are substantially similar: HK$1970 million forfirms listing under the relaxed rules, compared to HK$1829 million for firmslisting under the regular rules. Looking at the firms individually, there appear to beno major differences in the funds raised across the two groups.

Firms listing under the relaxed rules sold an average of 25% of the firm in theŽIPO, compared with 33% for firms listing under the regular requirements column

.4 . In fact, all three firms listing under the relaxed requirements offered between25% and 26%, while all four firms listing under the regular rules issued at least30%, with two offering 35% of the firm to the public. A Wilcoxon rank test rejectsthat these two sets of numbers come from the same sample at the 5% level,providing evidence that the relaxed firms offered a smaller portion of their firmsthan did the regular listing firms. In the signaling model of Leland and PyleŽ .1977 , the fraction of equity retained by an entrepreneur upon taking his firmpublic signals firm value. A lower retained portion signals lower quality. Leland

Ž .and Pyle 1977 would thus interpret the pattern in column 5 as evidence ofrelatively higher firm value for the relaxed listing firms.7

The fraction of the offer sold outside of Hong Kong, in column 5, seems to befairly similar across the two groups, with an average 74% for firms listing underthe relaxed rules compared to 83% for firms listing under the regular rules. Therange for firms under the relaxed rules is 61–85%, while for firms under theregular rules the range is 65–90%. In other words, all of these IPOs have a largeinternational tranche.

The final column in Table 1 provides the subscription rate. GZI TransportŽ .listed under the relaxed rules was severely oversubscribed with a subscription

Žrate of 528 times, as were Shenzhen Expressway and Zhejiang Expressway both. Žlisted under the regular rules at 37 times and 118 times, respectively. Over

1996–1997, the average subscription rate across all SEHK IPOs was 102, with a.range of 0.66–1276. The average subscription rate for firms listing under the

7 Ž . Ž .In a generalization of Leland and Pyle 1977 , Grinblatt and Hwang 1989 provide a model inwhich both the mean and variance of future cash flows are unknown to investors. In contrast to Lelandand Pyle, in the Grinblatt and Hwang model the issuer’s fractional holding alone is insufficient to

Ž .signal firm value. Grinblatt and Hwang argue that two signals are required: i the fraction of sharesŽ .retained by the entrepreneur, and ii the degree of underpricing. Thus, our finding of a significantly

larger proportion retained for relaxed rules firms is consistent with these firms being of higher quality,as in the Grinblatt and Hwang model. However, as shown below in column 1 of Table 2, we do notfind a significant difference in underpricing for firms listing under the relaxed vs. regular rules.


relaxed rules is 178 times, far more than the subscription rate of 39 times for firmslisting under the regular rules. The difference, however, is driven exclusively byGZI Transport’s huge subscription rate and is not significant.

In sum, Table 1 does not provide much evidence of differences in the offeringsof the relaxed listings vs. the regular listings. The offer characteristics are quitesimilar across the two sets of firms. The only evidence we do have of differences,that the relaxed firms had higher offer prices and offered a smaller portion of theirfirms, is inconsistent with these firms being more speculative than firms issuingunder the regular requirements.

2.2. Short-run stock price moÕements

Table 2 provides data on short-run stock price movements after the IPO. Allnumbers are expressed as percentages. Column 1 provides the 1-day initial returnafter the IPO issue. The initial return is defined as the percentage change from thefixed IPO offer price to the closing price on the first day of trading.

Column 1 in Table 2 shows that on average, firms issuing under the relaxedrequirements earned a 10.39% initial return, but only one firm, GZI Transport,

Ž .earned a positive initial return 51% . The other two firms listing under the relaxedrules earned negative initial returns, with Road King earning y8.33% and JiangsuExpressway earning y11.57%. On average, firms listing under the regular rulesearned a very small initial return of only 0.37%, but again there was considerablevariation across firms. Two firms earned positive initial returns, Shenzhen Ex-pressway with 25.90% and Zhejiang Expressway with 5.04%, while two earnednegative initial returns, Anhui Expressway with y10.73% and Sichuan Express-way with y18.71%. The difference between the two sets of returns is notsignificant with either a t-test or a Wilcoxon rank test. Overall, it appears wecannot infer that the initial returns differ across the two groups

Columns 2 and 3 of Table 2 provide the standard deviation of stock returns forthe first 20 days of trading after the firm’s IPO, and for the first common 6-month

Ž . Ž .period for all seven firms October 1997–April 1998 . Ritter 1984 uses thestandard deviation of stock returns in the immediate post-offer period to proxy forex-ante uncertainty. He finds that this variable is positively related to initialreturns. If there is more ex-ante uncertainty about the relaxed listings, one mightexpect these listings to have a larger standard deviation of returns.

In column 2, the mean standard deviation for the first 20 days is 2.90% for therelaxed listing firms and 5.40% for the regular listing firms.8 The relaxed firms

8 For comparison, the range of standard deviations for the middle one-third of the IPOs in RitterŽ .1984 is 3.3–5.7%.

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Table 2Short-term stock price movements

Ž . Ž .Standard deviation of returns % Asia financial crisis event days: firm’s 1-day stock return %

Initial return First 20 days October 1997–April 1998 8r15r1997 9r4r1997 10r20r1997 10r21r1997 10r22r1997 10r23r1997 10r24r1997

1 2 3 4 5 6 7 8 9 10

Relaxed rules firmsRoad King y8.33 2.11 4.35 y1.86 y8.89 y0.74 y4.98 y3.40 y20.60 y2.73GZI Transport 51.08 2.76 5.17 y1.48 y1.55 y2.56 y5.90 y7.14 y24.39 10.92Jiangsu Expressway y11.57 3.81 5.02 y6.34 y4.79 y8.09 y4.95 y14.76 y5.60 4.68Average 10.39 2.90 4.85 y3.23 y5.08 y3.80 y5.28 y8.44 y16.86 4.29

Regular rules firmsAnhui Expressway y10.73 2.66 5.53 y5.72 y6.09 y3.80 y1.60 y2.38 y13.99 4.78Shenzhen Expressway 25.90 3.97 6.07 y3.84 y7.60 y6.64 y7.85 y18.02 y12.08 7.97Zhejiang Expressway 5.04 3.78 6.43 y6.19 y3.16 y5.36 y5.03 y11.92 y13.53 13.04Sichuan Expressway y18.71 11.17 6.06 NA NA y10.22 y11.38 y3.99 y18.57 16.43Average 0.37 5.40 6.02 y5.25 y5.61 y6.50 y6.47 y9.08 y14.54 10.55

a( )Difference relaxedI regular 10.02 y2.50 y1.18 2.02 0.53 2.70 1.19 0.64 y2.32 y6.26

Ž .The sample consists of all infrastructure finance firms focused exclusively on road projects in China which issued an initial public offering IPO of equity on the Hong Kong Stock Exchangeduring the period of July 1996 through October 1997. Column 1 provides the initial return, which is measured from the offering price to the first day of trading. Column 2 provides the standarddeviation of returns measured over the first 20 days of trading, while column 3 provides the standard deviation of returns for the first common 6-month period for the entire sample. Columns 4–10

Ž . Ž .provide the 1-day stock returns =100 for the infrastructure firms over various days during the Asia Financial Crisis. 8r15r1997 the date over which returns are measured for Column 4 andŽ . Ž10r20r1997–10r24r1997 Columns 6–10 were days of intense speculation against the Hong Kong dollar and stock market. 9r4r1997 the date over which returns were measured in Column

.5 was the date that the Malaysian government announced the cancellation of several high profile infrastructure projects. All numbers are in percentages.a Indicates significant difference in a non-parametric Wilcoxon rank test at the 5% level.


appear to have lower variability, although a t-test and a Wilcoxon rank test do notreject equality of these two sets of numbers.

The highest variability in column 2 is recorded for Sichuan ExpresswayŽ .11.17% , a firm listing under the regular requirements. The 20-day periodcovered in this calculation includes a week of great market turmoil on the whole

Ž .SEHK. See the discussion of the Asia financial crisis below. This relatively highnumber might bias the inferences. As a result, we also calculate the standarddeviation over a longer and common period for all seven firms. The mean standarddeviation for the relaxed firms over the 6-month period of October 1997 throughApril 1998 is 4.85% and for the regular firms is 6.02%. A Wilcoxon rank testrejects that the two sets of numbers come from the same distribution at the 5%level. This finding, that the variability of returns is relatively lower for the relaxedlisting firms, suggests that the relaxed listing firms are no more speculative thanfirms listing under the regular requirements.

A third dimension of short-run stock returns that we examine is how these IPOoffers behaved during the Asian financial crisis. All seven of the offers occurredshortly before or during the Asian financial crisis that began when Thailanddevalued its currency, the Baht, in early July 1997. Even though the primaryvictims were in Thailand, Indonesia, and Korea, the crisis had relevance for theseven Hong Kong infrastructure firms we are looking at. First, a common factorcontributing to the problems was bloated federal budget deficits. Beginning withMalaysia in September 1997, several of the countries announced drastic budgetcutbacks, including the cancellation of many high profile infrastructure projects.This news had negative implications for all infrastructure firms in the region.Second, the Hong Kong dollar and the Stock Exchange of Hong Kong came underintense speculative pressure as the resolve of China to defend Hong Kong’scurrency was tested. If the relaxed listing firms were considered more risky thanthe regular listing firms, then we might expect relatively larger stock pricereactions for these firms on the key Asia crisis event dates.

In Table 2, columns 4–10, we provide the 1-day stock return for the seveninfrastructure firms for the date when Malaysia announced the cancellation of

Ž .several infrastructure projects September 4, 1997 , and for two periods of intenseŽspeculation against the Hong Kong dollar August 15, 1997 and October 20–24,

.1997 . These dates do appear to be significant events for these firms. For example,the mean drop in firm value on October 23, 1997 was 16.86% for the relaxedfirms and 14.54% for the regular firms. However, there is no striking difference inreturns across the relaxed vs. regular listing firms. A t-test and a Wilcoxon ranktest fail to reject equality across the two groups for all of these event dates.

A fourth and final dimension of short-run stock price movements that weŽexamine is reaction to earnings announcements. Pownall and Waymire 1989, p.

.103 argue that managers are more likely to release earnings forecasts whensubstitute sources of information are not available. This argument suggests that therelaxed listing firms might release forecasts more frequently and that these


announcements may be more informative due to the lack of alternative, orhistorical, information. We conjecture that firms issuing under the relaxed require-ments may try to compensate for the lack of knowledge or history by making morefrequent, voluntary interim earnings announcements. In addition, the stock pricereaction for any given announcement would be larger for firms issuing under the

Ž .relaxed rules i.e., each announcement would contain more information .From IPO issue to mid-1999, six of the seven firms had biannual earnings

announcements reported in the South China Morning Post corresponding to thepublishing of mid-year and year-end results.9 The exception, Sichuan Expressway,a regular listing firm, has only issued annual announcements. Across the relaxedlisting firms there were three press reports of interim, voluntary earnings an-nouncements. Across the regular listing firms, there were four reports of interim,voluntary earnings announcements. Thus, there is little evidence that one set offirms provided more frequent earnings announcements than the other.

Across all seven firms, we were able to calculate stock price reactions for 16annual earnings announcements that also provided the percentage change inearnings. These calculations are 3-day market adjusted buy and hold returnsaround the date the announcement appeared in the South China Morning Post. Weuse Datastream’s Total Market index for Hong Kong to calculate market returns.The mean return for the six announcements made by the relaxed listing firms is1.86%, with a mean change in reported earnings of 14.56 times. This includes anobservation for Jiangsu Expressway which reported an earnings jump of 83 timesin 1997. Without this observation, the mean change in reported earnings for therelaxed firms is 88.03%. The mean return for the 10 announcements made by theregular listing firms is 0.122% with a mean change in reported earnings of253.0%.

To test whether the stock price reactions were larger for the relaxed listingfirms, controlling for the change in earnings, we ran the following OLS regression:

Return sb qb Earnings qb Relaxed q´i 0 1 i 2 i i

where Return s the 3-day market adjusted buy and hold return for firm i,i

Earnings equals the reported percentage change in earnings for firm i, andi

Relaxed is a binary variable set equal to 1 for the six announcements made by thei

relaxed listing firms and zero otherwise. For the full sample of 16 observations, orfor a sample of 15 that excludes the Jiangsu observation, the beta coefficientestimates for Earnings or for Relaxed are never significantly different from zero.Thus, there is no evidence that stock price reactions to earnings announcements bythe relaxed listing firms are larger, a finding that would have been consistent with

9 ŽOne of these firms, Jiangsu Expressway has no announcements after April 1998 i.e., it is missing.a mid-year and an annual announcement .


relatively more information in those announcements. The lack of earnings historyfor the relaxed rules IPOs does not appear to affect the informativeness of theirlater earnings announcements.

2.3. Long-run returns

Although no cohesive theory on long-run performance of IPOs exists, there issome evidence that IPOs issued by more speculative firms perform especially

Ž . Ž .poorly in the long run. Ritter 1991 , Loughran and Ritter 1995 and Brav andŽ .Gompers 1998 find that smaller issues perform especially poorly in the long run.

Ž .Michaely and Shaw 1994 find that IPOs managed by high prestige investmentŽ .bankers have less negative returns over a 2-year period, while Carter et al. 1998

find similar results over a 3-year period.Ž . Ž .Ritter 1991 and Loughran and Ritter 1995 argue that firms going public take

advantage of Awindows of opportunityB by going public when investors areAoverly optimistic.B Firms issuing under the relaxed requirements may do sobecause they are anxious to go to the market immediately, rather than wait untilthey are seasoned enough to list under the regular requirements. Thus, firms listingunder the relaxed requirements may be those most likely to be taking advantage ofAwindows of opportunity,B rather than just waiting a year or two until they meetthe requirements for normal listing. In this case, one might expect firms listingunder the relaxed requirements to experience poorer performance in the longerterm.

Fig. 1 provides the stock performance over a longer time period, from October7, 1997 through June 30, 2000. October 7, 1997 is the first date that all sevenfirms are listed. As can be seen from Fig. 1, there is no discernible differencebetween the three relaxed listing IPOs and an equally weighted index of the fourIPOs under the normal requirements. Had one invested HK$100 in each onOctober 7, 1997, one would have HK$68.27 worth of stock in Road King,HK$57.38 in Jiangsu, and HK$39.58 in GZI. Alternatively, an equally weightedindex composed of the regular listing IPOs would have been worth HK$56.81 onJune 30, 2000. Overall, the longer-run returns do not seem to be different betweenthe regular listing IPOs and IPOs listing under the relaxed requirements.

2.4. Compensating characteristics

The data above provide no evidence supporting the contention that the relaxedlisting firms were more speculative than the firms that listed under the regularrequirements. The two sets of firms are surprisingly similar along almost alldimensions. Moreover, where there appear to be differences, they indicate loweruncertainty or variability for the relaxed listing firms.

These results suggest that the relaxed listing firms may have been taken publicby reputable investment banks who only sponsored relaxed listing firms that


Fig. 1. Long-run stock price performance. The sample consists of all infrastructure finance firmsŽ .focused exclusively on road projects in China which issued an initial public offering IPO of equity on

the Hong Kong Stock Exchange during the period of July 1996–October 1997. The figure provides agraph of the stock price performance for the three relaxed-listing firms, Road King, GZI and Jiangsu,as well as an equally weighted index of the returns of the firms listing under the regular rules over the

Ž .period from October 7, 1997 the first day all of these infrastructure firms are all traded through June10, 2000.

somehow compensated for the lack of a comparable earnings history. ChemmanurŽ .and Fulghieri 1994 argue that in assessing the credibility of investment banks,

Ž .investors use the past performance of previous issues. Beatty et al. 1998 provideevidence that SEC investigations of underwriters impose indirect penalties on both

Ž .the underwriter and its past IPO clients. Kroszner and Rajan 1994 find that priorto the passage of the Glass Steagall Act which formally separated commercial andinvestment banks in the US, banks appeared to have reacted to the public’sawareness of potential conflicts of interest by underwriting relatively high-quality

Ž . Ž .securities. Gompers and Lerner 1999 and Hamao et al. 2000 investigate theissuance of equity by firms where the underwriter has a prior equity stake througha venture capital subsidiary and find no evidence of conflicts of interest. All ofthese papers suggest that reputation concerns will affect bank behavior.


Column 1 of Table 3 provides the Listing Sponsor for all seven offers. This isthe investment bank that formally sponsored the firm’s listing on the SEHK.Usually, the listing sponsor is the same as the lead underwriter.10 Where appropri-ate, the parent bank of the listing sponsor is noted in the footnote at the bottom ofthe table. Most of the investment banks, or their parents, are readily recognizablenames. Securities Data’s investment bank rankings for these firms, based on 1996

11 Žglobal equity offerings, range from 3 for Merrill Lynch to 47 for HSBC. For ourŽ .calculations, we use the lower number closer to one ranking for either the

. Ž .investment bank or its parent. The range of rankings not shown in the tableacross relaxed listing firms is 9 to 47, with a mean of 24.6. The range acrossregular listing firms is 3 to 27, with a mean of 17.0. A t-test and a Wilcoxon ranktest do not reject that these rankings are from the same sample. So, the quality ofinvestment banks appears to be similar across the two sets of IPOs.

Columns 2–4 in Table 3 provide evidence on whether the relaxed listing firmshad characteristics that might compensate for the lack of a comparable earningshistory. Note, though, that t-tests and Wilcoxon rank tests never reject equality ofthe relaxed and regular sets along these three dimensions at the 5% level. Column2 indicates that, at the time of the IPO, the firms listing under the relaxed rules had5.3 operational projects on average, compared with only 2.5 operational projectsfor firms listing under the regular rules. In fact, two relaxed listing firms, RoadKing and GZI Transport, had nine and six operational projects, respectively.Jiangsu Expressway had only one operational project. By contrast, the largestnumber of operational projects for firms listing under the regular rules was fourŽ .for both Shenzhen Expressway and Zhejiang Expressway . The other two firmslisting under normal rules had one project each.

Ž .Examining the 1997 turnover total revenue , firms listing under the relaxedrules had average turnover of HK$391.2 million compared to HK$294.6 millionfor the regular listing firms. Examining turnover on a firm-by-firm basis, itappears that the difference is driven entirely by relaxed listed firm JiangsuExpressway. Indeed, Jiangsu Expressway had a 1997 turnover of HK$725 mil-lion–almost twice that of the largest turnover for any firm listing under the regular

Ž .rules Zhejiang Expressway with HK$408.9 million . So, even though Jiangsu hadonly one operational project, it was almost two times larger than any other roadfirm.

10 For all firms except Shenzhen Expressway, this firm was identified in the press as the ListingSponsor. For Shenzhen, Merrill Lynch was referred to as the Global Coordinator with no explicitreference to either a listing sponsor or a lead underwriter. For four of the other six firms, the listingsponsor was also identified as the lead underwriter. For Jiangsu Expressway and Sichuan Expressway,no firm was ever mentioned in the press as the lead underwriter for these two IPOs.

11 Securities Data’s League Tables rank underwriter quality by gross proceeds of equity underwrittenglobally during 1996, with full allocation given to the lead underwriter.

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Table 3Additional comparisons of infrastructure IPO firms

a Ž . Ž . Ž .Listing sponsor Operational projects as of IPO 1997 Turnover HK$ million Net profit HK$ million

1 2 3 4

Relaxed rules firmsbRoad King SBC Warburg 9.0 241.4 389.0

GZI Transport Peregrine 6.0 207.1 186.1Jiangsu Expressway HSBC Inv. Bk. 1.0 725.0 311.4Average 5.3 391.2 295.5

Regular rules firmsAnhui Expressway Crosby Cap. & CEF Cap. 1.0 209.9 129.9Shenzhen Expressway Merrill Lynch 4.0 242.7 196.7Zhejiang Expressway BZW Asia 4.0 408.9 275.5Sichuan Expressway JP Morgan Sec. 1.0 317.0 147.7Average 2.5 294.6 187.5

( )Difference relaxedIregular 2.8 96.6 108.0

Ž .The sample consists of all infrastructure finance firms focused exclusively on road projects in China which issued an initial public offering IPO of equity onthe Hong Kong Stock Exchange during the period of July 1996 through October 1997. The Listing Sponsor is the investment bank that formally sponsored thefirm’s listing on the SEHK. Usually, the listing sponsor is the same as the lead underwriter. Where appropriate, the parent bank is noted in the footnote at thebottom of the table. 1997 turnover is total revenue.

aSBC is associated with Swiss Bank, Crosby is associated with Societe Generale, CEF is associated with Canadian Imperial Bank, and BZW is associatedwith Barclay’s Bank.

bRoad King had income from joint ventures of HK$193.8 m that was not included in turnover.


Looking at net profit in column 4, the average net profit for firms listing underthe relaxed rules was HK$295.5 million compared with HK$187.5 million forfirms listing under the regular rules. Two of the firms listing under the relaxed

Žrules, Road King which listed under the relaxed rules because of negative net.profit in 1994 and Jiangsu Expressway, earned net income larger than any of the

firms listing under the normal rules, with 1997 net profit of HK$389.0 andHK$311.4 million, respectively. The third firm listing under the relaxed rules, GZITransport, earned HK$186.1 in net profit for 1997, which was larger than the 1997net income for two of the four firms listing under the regular rules.

In sum, Table 3 provides evidence that the relaxed listing firms had moreprojects, or were larger or more profitable than the regular listing firms. Thesepatterns are consistent with the investment bankers choosing firms which other-wise compensate for the lack of a comparable earnings history.

3. Conclusion

In this paper, we provide evidence on the Stock Exchange of Hong Kong’sŽexperience with relaxed listing requirements for infrastructure firm IPOs sub-rule

Ž ..8.05 2 . By comparing the characteristics and subsequent performance of therelaxed listing IPOs to IPOs listing under the regular requirements, we show thatthere is no discernible difference in performance across the two groups. Althoughthe firms listed under the relaxed listing requirements must do so due to a lack ofoperating history or profitability, it appears that the firms taken public under theserequirements to date are otherwise no more speculative than issues under theregular requirements.

We do find evidence, however, that firms going public under the relaxedrequirements sell a smaller fraction to the public at a higher offer price and havelower variability in stock prices. These findings suggest relatively less risk for therelaxed listing firms. There is also evidence that, prior to the IPO issue, thesefirms had a larger number of operational projects, more turnover, or higher netincome than the regular listing firms. These patterns are consistent with investmentbanks choosing not to take highly speculative issues public in order to protect theirreputations.

Clearly, this sample is small and the results cannot necessarily be generalized toother markets or industries. Indeed, there are several examples of exchanges withrelatively relaxed listing rules that have failed, at least in part, due to the failure of

Ž Ž .some highly speculative issues. For example, see Aggarwal and Angel 1999 for.a discussion of the American Stock Exchange’s Emerging Company Marketplace.

The SEHK’s experience with relaxed listing rules for infrastructure firms, how-ever, provides evidence that is consistent with reputation concerns promptinginvestment banks to carefully screen which firms to sponsor under the relaxedlisting rules.


Acknowledgements

We thank Phil Berger, Harold Mulherin, Cathy Schrand, and an anonymousreferee for helpful comments. Gerald Tsui at the Stock Exchange of Hong Kongprovided data on Hong Kong’s IPO issues.

Appendix A. Description of the sample firms

Road King was a spinoff of Wai Kee Development, a Hong Kong based firminvolved in quarrying, civil engineering, and construction. All of Wai Kee’s

Ž .People’s Republic of China PRC road projects were consolidated into Road Kingin October, 1994. At that time, AIG-AIF, a subsidiary of American InternationalGroup, acquired a 40% interest in Road King. In mid-1996, Road King had eighttoll roads in Guangdong, the PRC province next to Hong Kong, and two projectsin Jiangsu.

Ž .Road King was the first firm to issue an IPO under sub-rule 8.05 2 . It listedŽ .under sub-rule 8.05 2 because it did not have 3 years of positive earnings.

Earnings were negative in the 12 months ending 1994, but positive for 1995 and1996. The prospectus does state that the firm was listing under the relaxed listing

Žrules. A search of the press for 6 months prior to the IPO in the Asia Pacific.Library of LexisrNexis reveals 10 articles on the Road King IPO, with only three

indicating that Road King was listing under the new listing rules.GZI was the first Ared chipB infrastructure company to be listed in Hong Kong.

Red chip companies are firms with PRC ownership or management. GZI is aspinoff of Guangzhou Investment, the investment vehicle of the Guangzhoumunicipal government. At listing, GZI had six toll road projects in Guangzhou. Italso had right of first refusal for all future road projects in the region. Press reportsindicate that management was considering diversification into other infrastructureareas, including ports and freight forwarding.

Ž .GZI listed under sub-rule 8.05 2 because it did not have 3 full years of auditedstatements. The prospectus reports positive earnings for 10 1r2 months of 1994, afull year of 1995, and 8 months of 1996. The prospectus clearly states that the firm

Ž .was listing under sub-rule 8.05 2 . A search of the Asia Pacific library inLexisrNexis, however, finds no mention of the listing status in the 6 months priorto the IPO.

Jiangsu Expressway’s IPO was an H-share issue. H-shares are shares ofcompanies already incorporated in the PRC that are to be listed and traded on theHong Kong Stock Exchange. Jiangsu Expressway, which runs the Jiangsu sectionof the Shanghai–Nanjing expressway, was the only listed toll road operator in theJiangsu Province. Its primary owner is Jiangsu Communications Investment Co.,the investment arm of Jiangsu Communications Bureau. The proceeds from theIPO were to go towards the purchase of other roads in the province.


We were not able to get a prospectus for the Jiangsu Expressway IPO. PressŽ .reports suggest that the firm listed under sub-rule 8.05 2 because it did not have 3

Ž .years of audited statements rather than negative earnings . In the 6 months priorto the IPO, the Asia Pacific library in LexisrNexis has 10 articles on the JiangsuIPO, with only two mentioning that is listing under the relaxed rules.

Regular Listing Firms: All four of the firms issuing stock under the normalrules were H-share firms. The provincial governments control all these firms. Theyfully or partially own from one to four expressways in their respective provinces.

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