Extreme Underpricing: Determinants of Chinese Ipo Initial Returns

Abstract

The average underpricing of Chinese IPOs is 267 percent, the highest of any major world market. Using a sample of 1,124 IPOs listed on the Shanghai and Shenzhen Stock Exchanges between 1991 and 2000, we examine empirically the determinants of this extreme level of underpricing. We find it is caused partly by very high investment risks, of the type documented in many other markets, but mostly results from uniquely Chinese regulatory risks and costs. The government regulator sets a cap on pricing IPO shares and stipulates IPO allocation quotas to control the supply of IPO shares. There is also a very long time gap (34 day median, 305 days average) between going public and the actual listing of shares for trading, causing high lockup risk. Investors in China's primary market also discount IPO shares for extreme tunneling and grabbing risks, since these high initial returns benefit governmental political and financial interests and maximize the private benefits of key social elites.

Keywords: IPO Underpricing, Regulation, Investment Risks, Privatizations, Corporate Governance

JEL Classification: G23, G28