Deliberate IPO Underpricing or Market Misvaluation? New Evidence from China

J Ginger Meng,Wei Zhang,Gaofeng Zou

doi:10.7603/s40570-016-0013-6

J Ginger Meng, Wei Zhang + Show 1 more

Open Access

https://doi.org/10.7603/s40570-016-0013-6

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Abstract

Abstract We study IPO initial returns in China’s new ChiNext market by examining 484 ChiNext IPOs from 2009 to 2015, and investigate the impact of the China Securities Regulatory Commission’s pricing and trading mechanism reform on the IPO market. We estimate IPO fair offering prices using the stochastic frontier approach, and decompose the IPO initial returns into a deliberate underpricing component and a market misvaluation component. We further analyse various factors affecting initial returns. Our results show that the irrationality of individual investors can drive post-IPO prices to deviate from fair values and lead to market misvaluation. The high IPO initial returns in China’s ChiNext market result primarily from market misvaluation rather than deliberate underpricing, consistent with other studies.

Highlights

It is well documented that initial public offerings (IPOs) generally exhibit significantly positive initial returns and that this phenomenon exists in almost all international stock markets (Ritter and Welch, 2002)
Contrary to findings on IPOs in developed capital markets, our results suggest that misvaluation, rather than deliberate underpricing, is the dominant factor in the high IPO initial returns in China’s ChiNext market
Because this paper focuses on the initial day return and the effect of investor sentiment, we chose independent variables including turnover ratio, the possibility of receiving IPO share, and the market index price on the first trading day, as proxies for investor sentiment and market condition in the regression where the dependent variable is the initial day return: RETURNi

Summary

Introduction

It is well documented that initial public offerings (IPOs) generally exhibit significantly positive initial returns and that this phenomenon exists in almost all international stock markets (Ritter and Welch, 2002). A number of academic papers argue that IPO positive initial returns result from deliberate underpricing (see Baron, 1982; Rock, 1986; Welch, 1989). Others, such as Derrien (2005), ascribe IPO initial returns to market misvaluation of the offerings or the existence of speculative bubbles in secondary markets. Some researchers conjecture that the cause of positive initial returns could be a mix of underpricing, market misvaluation, and other factors such as underwriter stabilisation (Chan et al, 2002)

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