Efficiency of IPO pricing mechanisms: Comparison of book building and fixed price methods in China

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This paper compared the efficiency of IPO pricing mechanisms namely Fixed Price (FP) and Book-Building (BB) in China by analyzing IPOs' underpricing level. Findings include the FP regime was more efficient than the BB one because the BB did not reduce the underpricing level in China as expected,... and other contents.

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Nội dung Text: Efficiency of IPO pricing mechanisms: Comparison of book building and fixed price methods in China

JOURNAL OF SCIENCE, Hue University, Vol. 70, No 1 (2012) pp. 121-132 EFFICIENCY OF IPO PRICING MECHANISMS: COMPARISON OF BOOK-BUILDING AND FIXED PRICE METHODS IN CHINA Ho Tu Linh1, Wang Yixia2, Nguyen Dinh Chien2 1 2 College of Economics, Hue University, Vietnam School of Management, Huazhong University of Science and Technology, China Abstract. This paper compared the efficiency of IPO pricing mechanisms namely Fixed Price (FP) and Book-Building (BB) in China by analyzing IPOs' underpricing level. Findings include (1) the FP regime was more efficient than the BB one because the BB did not reduce the underpricing level in China as expected; and (2) reasons for this were (i) information transparency of the BB has not reduced other external effects, for example, impacts of some firm quality and exante uncertainty proxies were still tight or even stronger since 2005; and (ii) investors were optimistic toward market conditions as higher quality underwriters invited in the BB procedure as well as the fact that underwriters often lowered offer price after collecting information from the BB process, which made the underpricing level rise. Keywords: IPOs, Fixed Price, Book-Building, underpricing. 1. Introduction Initial Public Offerings (IPOs) are priced by distinct mechanisms in different nations. Before 1990, Auction and Fixed Price (FP) were commonly adopted. In the recent two decades, Book-Building (BB) and its hybrids have nearly become dominant all over the world (Jagannathan et al., 2010). Different IPO pricing mechanisms have different efficiency levels of underpricing. Kucukkocaoglu and Sezgin (2007) found some mixed results supporting this point. BB was considered as the most effective method because it resulted in more efficient pricing for sellers compared to FP and Auctions almost half of the studies listed in their research. The underpricing phenomenon in Chinese stock market has been studied since the 1990s. The dramatic high level of IPOs underpricing in the early years of this equity market is often researched and quoted as an emerging-market problem in many studies. According to Ritter and Welch (2002), average Initial Returns (IR) in China from 19902000 was the highest at 256.9%. In 2005, the BB pricing mechanism was introduced for 121 122 Efficiency of IPO pricing mechanisms: comparison of book-building and… Chinese IPO pricing regulation by the China Securities Regulatory Commission (CSRC), which is considered as a milestone of transforming from FP to BB in this country. The first purpose of this transformation is to make offer price more exact and deals with the high level of underpricing issue which nearly all IPOs listed on China’s A-stock market suffer on the first trading day. However, the transformation's results were unexpected because while most recent studies found a drop of the underpricing level after 2005, Fei Jiehui (2009) pointed out a different trend in China’s IPO market. Hence, in order to find out a uniform answer for the current IPO pricing mechanism’s efficiency, this paper attempted to explore two research questions: (1) in China, whether the current pricing mechanism - the BB was more efficient than the previous one - the FP; and (2) why the BB mechanism was more or less efficient in China. To discover those questions, a set of 709 IPOs listed on Shanghai and Shenzhen stock market between 2001 and 2009 was used, among which 409 IPOs were listed after Jan. 1st, 2005 - called the post-BB regulation period. The period before 2005 was the pre-BB regulation one. Methods for analyzing factors believed significant in determining the underpricing level were regression models’ establishment and statistical analysis by a software namely Statistical Package for the Social Sciences (SPSS). 2. Study models In this paper, Market Adjusted Initial Return (MAR) were calculated in order to explain the underpricing level of IPOs. MAR was used as dependent variable in empirical study because it kept away the influence of market conditions and therefore was more accurate for detecting the efficiency of IPO pricing. The dependent and independent variables used in this paper were mainly chosen based on past empirical studies on China's IPOs and proved significant in explaining the underpricing phenomenon. Their definitions were listed in Table 1. Three study models used in this paper are: Model 1: MARi = β0 + β1BKBDi + β2EXCHi + εi Model 2: MARi = β0 + β1GOVOWNi + β2CNTOWNi + β3ONEYRPRFi + β4EPSi + β5ROEi + β6NICAGRi + β7INDUSTRYi + β8LGIPOPRCi + β9DEi + β10PRIEPSi + β11AGEi + β12PRMKTRETi + β13TIMELAGi + β14LOTTODDi + β15UNDRWRTRi + β16EXCHi + εi Model 3: MARi = β0 + β1GOVOWNi + β2CNTOWNi + β3ONEYRPRFi + β4EPSi + β5ROEi + β6NICAGRi + β7INDUSTRYi + β8LGIPOPRCi + β9DEi + β10PRIEPSi + β11AGEi + β12PRMKTRETi + β13TIMELAGi + β14LOTTODDi + β15UNDRWRTRi + β16EXCHi + β17PRIRANi + β18PRIADJi + εi HO TU LINH, WANG YIXIA, NGUYEN DINH CHIEN 123 Table 1. Definition of Variables Variables Definition Dependent Variable: MAR The percentage increase of IPO’s first-trading day closing price from its offer price, adjusted by market index return in this same period. P M  MAR (%) =  1 − 1  ×100  P0 M 0  Independent Variables: Proxies for firm quality GOVOWN Percentage of government or state-owned enterprise ownership of IPO post offering CNTOWN Percentage of controlling stockholder ownership post offering Market-adjusted cumulative return of IPO stock one year post offering. (P1 and MI1 are IPO’s price of the first listing date of each month and market index of the same date respectively. P21 and MI21 are values in the 21 listing date of the month i = 1, 11 ; Yearly Initial ONEYRPRF Return-YIR; Yearly Market Return-YMR): IRi (%) = P21 − P1 ; MI 21 − MI 1 ; MRi (%) = P1 MI 1 ONEYRPRF = YIR − YIM = (IR1 + IR 2 + ... + IR11 ) − (MR1 + MR 2 + ... + MR11 ) EPS Historical average earnings per share in last three years before IPO offering: EPS = ROE EPS−1 + EPS−2 + EPS−3 3 Historical average return on equity in last three years before IPO offering: ROE = ROE−1 + ROE−2 + ROE−3 3 Compound Annual Growth Rate of Net income in last three years before offering NICAGR NI − 2 − NI −3 NI −1 − NI − 2 + NI −3 NI − 2 NICAGR = 2 124 Efficiency of IPO pricing mechanisms: comparison of book-building and… INDUSTRY Industry dummy: if IPO belongs to manufactoring industry, INDUSTRY=1; otherwise 0 Proxies for ex-ante uncertainty LGIPOPRC DE Logarithm of IPO proceeds Historical average Debt/Equity in the last three years before IPO offering DEi = Debti ; DE = DE−1 + DE− 2 + DE−3 3 Debti + Equity i PRIEPS Offer Price/earnings per share before offering AGE Time between the date of IPO firm filing registration with China’s Commerce Bureau and listing date Proxies for controlling BKBD Book-building period dummy: if IPO listed after 2005, BKBD=1; otherwise 0 PRMKTRET Market index’s cumulated return 30 days before offering TIMELAG Lag of time between the date of IPO offering and listing LOTTODD Odd of winning the lottery of online IPO allocation, equal to reciprocal of oversubscription ratio Underwriters’ ranking, UNDRWRTR=0 if IPO’s total capital (TC) > UNDRWRTR 1000 billion RMB, 1 if 100 < TC ≤ 1000, 2 if 10 < TC ≤ 100, 3 if 1 < TC ≤ 10, otherwise 4 EXCH Exchange dummy: EXCH=1 if IPO is listed on Shanghai Stock Exchange, otherwise 0 Other proxies PRIRANGE Percentage of offer price range settled in preliminary book-building process. PRIADJUST Percentage adjustment of final offer price from the expected offer price (arithmetic average of high-end and low-end prices in price range) implied in preliminary BB. 3. Hypothesis development In this section, hypotheses were developed according to previous researches. Regarding the theme of (1) whether BB was more efficient than FP in China or not, although the efficiency of IPO pricing mechanisms is on debates, a lot of international HO TU LINH, WANG YIXIA, NGUYEN DINH CHIEN 125 researchers have believed that the BB efficient was over others’. Beside this, excluding one domestic scholars of China, most authors found evidence proving the BB’s ability in significantly reducing the IPO underpricing level. Moreover, Fei Jiehui (2009) who found the negative results of this method predicted that there would be a better scenario for its underpricing level in the long run. So, we assumed Hypothesis 1 to be tested by Model 1 (Table 2). In terms of the second question of (2) why the BB mechanism was more or less efficient in China, two key possible reasons were information asymmetry related to firm characteristics and uncertainty and investors’ optimistic toward market conditions. Basing on reviewing a literature, other 5 hypotheses were assumed and tested through Model 2 and Model 3 (Model 3 equals Model 2 plus PRIRANGE and PRIADJUST). Table 2. Research Questions, Hypotheses and Study Models Question Hypothesis (1) Whether BB 1. Book-Building was more efficient than Fixed Price was more in China. efficient than FP in China or not? Model 1 2. Effect of firm characteristics on underpricing significantly decreased after BB was introduced in China. 2 3. Effect of ex-ante uncertainty on underpricing significantly decreased after BB was introduced in China. (2) Why the BB mechanism was more or less efficient in China? 4. Private companies significantly explained the underpricing level in China, especially after using the BB mechanism. 5. Higher quality underwriters in the BB procedure significantly reduced the underpricing level on both SHSE and SZSE. 6. In preliminary BB process, higher percentage of offer price range settled and higher percentage adjustment of final offer price from the expected offer price implied would associated with higher underpricing on both SHSE and SZSE. 3