4

The effect of ownership structure on the underpricing of Initial Public Offerings

Introduction

The IPO is an important step when a firm is in the process of going public, and is often the largest equity issue that a company ever makes. Furthermore, it is also an important event in the transformation of the governance structure. As new outside capital is taken into the company, the new owners obtain both residual claimant rights as well as residual control rights. During this process, the under-pricing of the IPO of common stock has been a well-documented 'anomaly', and there exists a substantial body of empirical work documenting the underpricing phenomenon in many countries. In the United States, for example, Ibbotson and Ritter (1995) found that the amount of short-run IPO underpricing was 15.3 per cent over the 1960-92 period. Are the issuers of the stock deliberately underpricing the new stock offer to outsiders? Is it rational for secondary market investors to buy stocks at higher prices than the primary market investors?

The objective of this chapter is to extend existing theories and to investigate the impact of governance structure on the pricing of IPOs. It is argued that the IPO is not merely a process by which the firm finds new capital, but that it involves conflicts of interest between the different shareholders, especially between the large, controlling shareholder and small, outside shareholders. It will be argued that the pattern of corporate control plays an important role in the determination of the underpricing of IPOs, and that the initial owners of a firm going public are concerned about retaining control over the corporation because control brings private gains.

The basic argument is that corporate control brings private benefits for the controlling shareholders, and that the market recognises the potential transfer of wealth from the minority or outside shareholders and reduces the returns of the IPOs. We try to combine various theories based on the idea of asymmetric information with theories of corporate control. Whilst we agree that the theories of asymmetric information can explain why an IPO is commonly underpriced, they cannot explain the full extent of the underpricing and thus other theories are also needed. Therefore, our main objective is not to justify why the IPOs are underpriced, but to investigate the role of ownership structure in influencing the degree of IPO underpricing.

-62-

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Corporate Governance in China
Table of contents

Table of contents

  • Title Page iii
  • Contents vii
  • Figures x
  • Tables xi
  • Preface xiii
  • Acknowledgements xiv
  • Abbreviations xv
  • 1 - Introduction 1
  • 2 - Theoretical Approaches to Corporate Governance 10
  • 3 - The Evolution of Corporate Governance in China 31
  • 4 - The Effect of Ownership Structure on the Underpricing of Initial Public Offerings 62
  • 5 - Ownership Structure as a Corporate Governance Mechanism 88
  • 6 - The Determinants of Capital Structure 105
  • 7 - Chinese Corporate Groups 123
  • 8 - General Conclusions and Future Work 146
  • Notes 153
  • References 157
  • Index 170
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