Leverage, Insider Ownership, and the Underpricing of Chinese Ipos
31 Pages Posted: 3 Sep 1999
Date Written: August 13, 1999
Because of the high economic uncertainty inherent in the privatization process, financial markets in China are characterized by large information asymmetry. Using data of 283 non-financial firm-commitment initial public offerings (IPOs) between January 1994 and December 1997, we investigate whether an issuer chooses the level of pre-IPO debt, insider ownership, and degree of IPO underpricing to signal its quality to the market. We find that: (1) In contrast to the prediction of conventional theory of capital structure signaling, debt does not convey good news in the Chinese market. The quality of an issuer is negatively related to its pre-IPO leverage (debt-to-assets ratio). (2) Underpricing of IPO serves as a signal for the quality of an issuer, but the extent of insider ownership does not. (3) Issuers with lower pre-IPO leverage tend to retain smaller insider shares and on average underprice less than those with higher leverage. (4) Underpricing is correlated with proxies of ex ante uncertainty, such as market conditions surrounding an IPO. Our empirical results are largely consistent with "winner's curse" and signaling models.
JEL Classification: G15, G32, P34
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