The Effects of Income Inequality and OFDI on Underpricing and Underperformance of Chinese IPO Firms

Abstract

Purpose - This study examines whether the underpricing of initial public offerings (IPOs) and the long-term performance of IPO firms in the Chinese market are affected by income inequality between firms or regions and the OFDI (OFDI) of firms. Design/Methodology/Approach - We introduce inequality and OFDI in the models to conduct multivariate regressions. Using 1,503 IPO firms listed on the Shanghai Exchange and Shenzhen Exchange from 2003 to 2015 and financial and regional data extracted from a merged dataset from the RESSET and China Stock Market & Accounting Research (CSMAR) databases, we measure the relative Gini index and initial returns to test IPO underpricing markets and test long-term underperformance using long-term cumulative abnormal returns (LCAR) and long-term buy-and-hold (LBHAR) in the regression analyses. Findings - The Gini coefficients of firms in China show a positive effect on IPO underpricing for all sample and for both stock exchange samples, separately. They also show a positive effect on IPO underpricing by OFDI firms in all sample and separately for each sample. In addition, the Gini coefficients of provinces in China also show a positive effect on IPO underpricing in all sample and each stock exchange sample, separately. They also show a positive effect on IPO underpricing by OFDI firms in all sample and in both samples, separately. Based on our examination of the effects of income inequality across regions and firms of IPO firms on underpricing and long-term financial performance, we have verified more severe IPO underpricing and negative effects on the long-term stock market price. Research Implications - Our findings regarding the effect of income inequality across firms and regions, which is found to be severe in China and of major concern, on the initial pricing of IPO firms under the influence of the China Securities Regulatory Commission (CSRC) or government policies and their long-term performance in the stock market are generally consistent with prior conjectures that the Chinese government or firms attempt to alleviate income inequality during and after an IPO for firms in regions with severe inequality. Further study on the causes of income inequality for different regions and industries and its change over time is required in future studies.