IPO Underpricing and Political Connection

: Evidence from Chinese IPOs

Abstract

Stock underpricing is a common occurrence in global financial markets, and the Chinese market is no exception. In fact, IPO companies in China suffer from the worst underpricing issues. Market participants respond to this issue differently, with IPO underwriters and investors seeking opportunities to profit from the situation. This mechanism works due to the lack of sufficient information, which requires these participants to seek compensation for their information-aversion position in the trade. On the other hand, IPO firms are motivated to mitigate the problem through rent-seeking behaviour, such as political connections. However, political connections can also become a burden, especially for state-owned enterprises (SOEs), which suffer from an agency issue. State-backed officers may prioritize the political advantage of the state over the benefit of the companies. It is important to understand this sophisticated mechanism, especially in the Chinese market after its privatization and improved market liberalization.
This research analyses the IPOs in China over the last decade to understand the role of political connections in IPO pricing. It focuses on companies in the Chinese mainland A- share market that have gone public from 01/01/2010 to 31/12/2020. Firstly, the study aims to distinguish different forms of political connections and their influence on IPO underpricing. The study applied different proxies to measure political connection. One is the proportion of state ownership; the other is the existence of political ties between the company board and the state. By testing the relationship between these different proxies and the degree of underpricing, the study found that even after privatization, SOEs with considerable state- owned shares still suffer from severe underpricing issues. However, political ties have a complex influence on underpricing levels. The study provides crucial insights that can help
improve the transparency, efficiency, and fairness of financial markets, particularly in contexts where privatized SOEs play a significant role. It also highlights the need for careful consideration of how government involvement and political connections influence market dynamics and investor perceptions.
Secondly, the study further explores the dynamics of how directors’ political ties impact underpricing. The research provides evidence to support the literature that private companies and state-owned counterparts do not share the same dynamics in impacting pricing. By using the same dataset and regression analysis to test the influence of political connections on pricing, the study discovers that local political ties of directors significantly worsen the degree of underpricing for both SOEs and non-SOEs. This evidence opposes the rent-seeking hypothesis that companies build political connections to mitigate the underpricing issue. Instead, the study advocates that political ties worsen agency issues in enterprises due to rampant local corruption and political expropriation. Another interesting finding is the negative influence of political ties with deputies of the National People’s Congress. Connection to the policymaker institution provides protection to the firms as a rent-seeking benefit. The research underscores the importance of a deeper, more critical examination of the role of political ties in corporate finance and governance. It also guides stakeholders in making more informed decisions that consider both the benefits and risks associated with political connections in different institutional contexts.
Finally, the research conducts an event study to explore the influence of the IPO market suspension in 2013. It uses the difference-in-differences (DID) method to analyse IPO underpricing and political connections. The model tests for any significant shift in the connection detected in the previous chapters. The study discovers that after the series of
reforms and policy changes, the level of underpricing has significantly increased, ironically.
Our research fills the gap by explaining that political ties play a role in this phenomenon. Connections have been modified to some extent after the event, but certain political ties continue to influence the degree of underpricing. The findings point out future directions for regulators: to improve market efficiency, policymakers must not only focus on reducing the quantity of the resource but also break up the mechanism through which these connections are built.

Date of Award	4 Oct 2024
Original language	English
Awarding Institution	University of Portsmouth
Supervisor	Konstantinos Kallias (Supervisor), Tarek Mohamed Hassan AbdelFattah (Supervisor) & Lei Tao (Supervisor)