Two essays on IPO underpricing

Abstract

This thesis focuses on the cross-sectional difference in the extent of IPO underpricing in different places. The first essay examines how the difference in institutional environment constitutes differential IPO underpricing across countries. Using the Heritage Foundation's Index of Economic Freedom (IEF) as a proxy for the cross-country heterogeneous institutional environment, and a large sample of 10,251 IPOs from 35 countries and regions over the period of 1993-2008, I find that countries with higher economic freedom have significantly less serious IPO underpricing problems. Moreover, among the ten economic freedom factors covered by the IEF, financial freedom related factors play a more important role in reducing the IPO underpricing problem. Finally, consistent with the market sentiment hypothesis, I find strong evidence that pre-IPO market sentiment influences the IPO first-day returns, and that the IPO underpricing problem is less severe when the market is bearish. The second essay examines how the difference in institutional environment across various provinces in China can explain IPO underpricing in the Chinese equity market. As the largest developing country in the world, the level of economic development and the institutional environments across China are extremely heterogeneous. In addition, China's IPO firms have quite complicated ownership structures and corporate governance mechanisms that are distinct from those in developed countries. Because most of the IPO firms in China are originally state-owned enterprises (SOEs), IPOs play the most important role in share issuing privatization (SIP) and are influenced by governments' political and economic considerations. Therefore, whether the cross-regional institutional heterogeneity and ownership structure play any role in IPO underpricing becomes an interesting and important issue. Using Chinese IPO data from 1999 to 2007, I find strong evidence that firms located in regions with better institutional environment (i.e., better credit market development, less governmental intervention and better legal environment) have significantly smaller IPO discounts than their counterparties. In addition private firms have less severe underpricing problems relative to SOEs. Finally, I find that local government controlled IPO firms have less severe underpricing problems than firms controlled by the central government.