Abstract
The controlling shareholder of a firm may suffer from its control of the firm due to unfavorable market reactions associated with concerns on his private benefit extraction. Thus, the controlling shareholder has an incentive to build a good governance mechanism as a commitment device to discipline himself, which allows him to sell shares at a higher price in the initial public offering (IPO). An improvement in IPO pricing efficiency will give the controlling shareholder more incentive to do so. Therefore, we propose that, the development of the financial market can shape the corporate governance of firms in an economy, thus improving firm operation efficiency. A model of IPO is constructed to demonstrate this mechanism of market discipline. Using data from China stock market on the regulatory changes in IPO pricing and firm ownership structure, we find evidence consistent with the model's implications.
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