Underwriter ratings and risk-taking of IPO firms: evidence from China

Abstract

ABSTRACT Unlike the existing literature, which focuses on the underwriter reputation, this paper examines the effect of underwriters on the risks of IPO (initial public offering) firms from the perspective of the ability to control risks. Using the underwriter rating by CSRC (China Securities Regulatory Commission), we find that the underwriter rating provides incremental information over the underwriter reputation and mainly reflects the ability of the underwriter to control risks. Consistent with this hypothesis, we document a negative relationship between the underwriter rating and the earnings volatility of firms after an IPO. Our results remain qualitatively similar after a series of robustness tests. Additional analysis suggests that an underwriter with a higher ability to control risks, proxied by the risk index of the underwriter, can significantly lower firms’ risks. Moreover, we find that a highly rated underwriter can reduce stock return volatility, discretionary accruals, the potential for a decline in earnings, and penalties by the CSRC. This study enriches the literature on how underwriter plays an essential role in IPOs from the ability to control risks.