Received: 12 September 2020 Revised: 6 December 2020 Accepted: 5 March 2021

DOI: 10.1002/pa.2676

ACADEMIC PAPER

Institutional quality and initial public offering underpricing:

Evidence from Hong Kong

Haitian Wei1 | Rasidah Mohd-Rashid1 | Waqas Mehmood1 |

Ahmad Hakimi Tajuddin2

1
School of Economics, Finance and Banking,
Universiti Utara Malaysia, Sintok, Kedah,
Malaysia
2
School of Accounting & Finance, Taylor
University, Subang Jaya, Malaysia
Correspondence
Waqas Mehmood, School of Economics,
Finance and Banking, Universiti Utara
Malaysia, 06010, Sintok, Kedah, Malaysia.
Email: waqas.mehmood61@gmail.com
The main objective of this research is to investigate the impact of institutional quality
on the underpricing of IPOs in Hong Kong. Besides, ordinary least squares presented
in the study used quantile regression as a robust technique to investigate the associa-
tion of institutional quality and the underpricing level of 986 IPO from January 2000
to December 2017 in the Hong Kong stock market. Through research findings, it is
asserted that voice and accountability, regulatory quality, control of corruption and
firm size are significantly negatively correlated. Whereas, government effectiveness
and rule of law are significantly positively correlated in influencing the underpricing
of IPO in Hong Kong. Findings are consistent with the quantile regression analysis.
The research is beneficial to the main participants of the market, such as investors,
issuers and regulators.

KEYWORDS
Hong Kong, information asymmetry, institutional quality, IPO, underpricing

1 | I N T RO DU CT I O N average underpricing rate of IPOs in Hong Kong is over 15%, far

Underpricing of initial public offerings (IPOs) has been a common phe-
nomenon in global markets. However, there are different level of
underpricing within emerging markets and developing markets. The ini-
tial performance of new offering from companies from less developed
nations or developing nations always surpass those from developed-
market companies (Boulton et al., 2011; Loughran et al., 1994; Song &
Lee, 2012). In emerging countries, underpricing of newly listed compa-
nies in target countries is from 13.6 to 388%, and in developed markets
between 4.2% and 54.4% (Ritter, 2003). As one of the most developed
markets, H-shares had more than 2100 listed companies with over HK
$34 trillion in 2017. As shown in Figure 1, listed companies market
value to GDP increased from 131% in 1986 to 1053% in 2018. The
development of the equity market has become increasingly important
in Hong Kong.
Many equity investors have the preference of underpricing of
new offerings because underpricing is a channel as a compensation
for the risks faced by uninformed investors due to poor transaction
information, and underpricing is a signal that issuing companies
convey their valuable information to the public or institutions. The
below those emerging equity markets, but close to developed equity
markets (Chong et al., 2010; Deng et al., 2010; Lowry et al., 2017)
highlighted that basic IPO underpricing patterns mostly are related to
the theory of information asymmetry. In better-developed markets
with lower information asymmetry, the companies have less under-
pricing (Huang et al., 2019). A good institutional quality probably is
the reason for the relatively low underpricing level in Hong Kong
stock exchange. The high intensity of voice and accountability, regula-
tory quality and control of corruption can increase information trans-
parency and lower uncertainties in the equity market (Wang &
Jiang, 2019). Autore et al. (2014) found that institutional quality is
strongly associated with underpricing of IPO in developed markets,
including H-shares, but a nearly absent relationship in emerging mar-
kets. Autore et al. (2014) also proposed that political stability, govern-
ment efficiency, regulatory burden and corruption control can
positively affect the underpricing. However, other researchers argue
that there is an unrelated or inversely related association on the qual-
ity of institutional and IPO underpricing. If institutions of great quality
can reduce investors' alarm by reducing ex-ante uncertainty, institu-
tional quality may likely associate with IPO underpricing (Engelen &

J Public Affairs. 2021;e2676. wileyonlinelibrary.com/journal/pa © 2021 John Wiley & Sons, Ltd 1 of 12
https://doi.org/10.1002/pa.2676
2 of 12 WEI ET AL.

1400
1200
1000
800
600
400
200
0
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
F I G U R E 1 Market capitalisation of listed domestic companies (% of GDP).
Source: World bank

Van Essen, 2010). Based on the mutually exclusive points of view,
there is no empirical evidence to support the relationship between
the governance index and the underpricing specifically in the Hong
Kong market. Similarly, the results of the overall data of the developed
markets cannot explain the specific characteristics of the single mar-
ket due to the unique regulation of certain developed markets. Fur-
ther, there is insufficient evidence that the interpretations of global
IPO underpricing can interpret the underpricing of IPO in H-shares
(Chong et al., 2010). Also, it lacks insufficient evidence to interpret
the specific relation of dimensions of institutional quality with the
level underpricing of H-shares. Hence, in this paper, we continue to
discuss the determinants, including institutional quality, on the level
underpricing of IPO in H-shares.
In the IPO market, institutional quality information is essential in
influencing market sentiment. The government's effectiveness reflects
the country's good performance in regulating policy, the rule of law
and better control of corruption, which is beneficial to current
research on the impact of IPO investment. Low government efficiency
leads to information asymmetry, leading to uncertainty. Investors tend
to invest in effective markets with high transparency and low informa-
tion asymmetry. Weaker information transparency can cause more
ex-ante uncertainty, hence pushing up IPO underpricing (Beatty &
Ritter, 1986). This would affect the investors' final decision. There-
fore, information reflecting investor sentiment is crucial to investors'
decision-making. Autore et al. (2014) have suggested the positive
association of control of corruption with firm-level IPO underpricing
in developed markets. Thus, strong ability to control corruption will
help increase the stock market performance and reduce underpricing
level, as well as reissuing firms must have suitable tactics to encounter
country-level governance quality. Issuing firms can list their compa-
nies in countries which have higher and better in institutional quality
to affirm their sustainability in the market.
Regulators are government agencies which the statutory bodies
and regulatory commissions that are responsible for generating,
retaining, and enforcing regulatory and sound policies. The positive
association of regulatory quality with IPO underpricing in developed
markets has been proven (Autore et al., 2014). Better regulatory qual-
ity tends to increase the underpricing. Regulatory authorities should
pay more attention and has the policy related to individual, business
entity, interest and professional organisation to take the preventive
precaution against the impact of institutional quality on underpricing
of IPOs. As a result, this study investigates the influence determinants
of IPO underpricing on the Hong Kong market. By doing so, this anal-
ysis tends to fill the void in IPO research by meeting the following
objective:
• Identify the foremost factors such as, voice and accountability,
political stability, government effectiveness, regulatory quality, rule
of law and control of corruption that affect IPO underpricing in
Hong Kong.
In the following parts, the second section discusses the literature
review and hypotheses development. The third section presents the
data and methodology. The fourth section exhibits data analysis and
findings. In the last section, conclusion, implication, limitation and
future study will be interpreted.
2 | LI T E RA T U R E RE V I E W A N D
HY P O T H E S E S D EV E L O P M EN T
This section discusses the fundamental theory used in this study
namely the information asymmetry theory which proposes that high
IPO underpricing are driven by poor information transparency. Infor-
mation asymmetry occurs between the pre-IPO owners and new
investors (Carter & Manaster, 1990; Leland & Pyle, 1977). Company
information is mostly held by company insiders including pre-IPO
owners. Meanwhile, new external investors have restricted access to
company information which only the pre-IPO owners can provide.
Although the companies are legally required to disclose relevant infor-
mation in the form of accessible prospectuses, pre-IPO owners can
still potentially provide misrepresented information (Riley, 1979;
Spence, 1976). Consequently, investors will reject the presented
information and look for other indications of the company's actual
value (Downes & Heinkel, 1982; Spence, 1976). Uncertainties and
risks will emerge in financial transactions when one party has less
information than the other. Information asymmetry is more prevalent
with IPOs as the presented prospectuses are the sole source of infor-
mation for the investors and underwriters. Smaller and newer compa-
nies have limited or no trail of public disclosures. Information
WEI ET AL.
asymmetry is also affected by disclosure requirements which are
determined by the security laws of a country. As such, poor institu-
tional quality disclosure can lead to market information failures which
can ultimately decrease information transparency.
As such the institutional factors are important in the development of
economy and finance and require policymakers to establish reforms to
deal with uncertainty (Cherif & Gazdar, 2010). In the case of emerging
markets, maintaining political stability, regulating and implementing the
law, and managing quality of bureaucracy is vital for the performance of
the capital market (Yartey, 2010). Papaioannou (2009) applied similar
institutional quality indicators to examine the role of an institutional
factor in international capital mobilisation, demonstrates that well-
functioning institutions are vital and a dynamic force of international
bank flows. Shaghaghi et al. (2019) interpreted that government can
improve the development of the capital market by strengthening the
institutional quality due to the positive relationship of market stock index
and institutional quality. Asongu (2012) determined a positive and signifi-
cant connection of institutional quality and equity market performance
on developing countries; the results have proposed that countries with
improved institutional quality framework assure high market value, trad-
ing volume, optimistic turnover ratio. Greater governance index has posi-
tive and negative aspects for companies aiming to obtain external funds
through share offerings (Boulton et al., 2010). They also found that when
a company is listed in a nation with sound regulations to protect inves-
tors, its share price is more undervalued, and ownership is more dis-
persed. Autore et al. (2014) established that several dimensions of
institutional quality are significantly connected with the underpricing of
IPO in developed markets, while the relationship is not clear in emerging
markets. However, some researchers have different viewpoints that
there may be an unrelated or inversely related relationship between insti-
tutional quality and underpricing. If strong institutions may reduce the
fear of investors by reducing ex-ante uncertainty, the correlation may
exist between strong institutional efficiency and underpricing of IPOs
(Engelen & Van Essen, 2010). The companies controlled by a family trust
in countries with more developed systems get more benefits over the
costs, while centralised family ownership enterprises hardly need to
under-price of IPO to maintain control (Peng & Jiang, 2010). Country-
level institutional quality has six dimensions; voice and accountability,
political stability, government effectiveness, regulatory quality, rule of
law and control of corruption.
2.1 | Voice and accountability
Voice and accountability imply the level of involvement of people in
governmental elections, as well as freedom of speech and free media
(Kaufmann et al., 2009). This indicator examines whether the govern-
ment can be held accountable for its political actions (Daude &
Stein, 2007). Asongu (2012) shows that the performance of the stock
market can be significantly associated with the quality of government.
These outcomes of empirical evidence indicate that markets with
high-quality institutions would have equity markets with greater firm
size, higher turnover ratio, larger trading and a higher number of listed
3 of 12
companies. However, less evidence shows that voice and accountability
significantly affect stock performance (Shaghaghi et al., 2019). Likewise,
Hearn (2012) describes negative significant association among voice and
accountability and IPO underpricing. In terms of emerging markets,
Ajide (2014) found that the voice and accountability negative affect the
stock prices in Nigeria market. Boadi and Amegbe (2017) also reveal that
voice and accountability significantly affect stock market performance by
analysing 23 markets from emerging countries and developed countries.
Hence, it hypothesis that;
Hypothesis H1. Voice and accountability have a negative influence
on IPO underpricing.
2.2 | Political stability and absence of violence/
terrorism
Political stability assesses political instability expectations of politically
motivated crime, including terrorism (Kaufmann et al., 2009).
Yartey (2010) asserted that the overall performance of capital market
depends on the political stability, quality management of bureaucra-
cies, implementation and legal regulation. However, in countries with
higher uncertainty and political risks, Stulz (2005) predicted that IPO
activities would be weaker because those listed companies could be
plundered by the state. Satta et al. (2017) found that IPO develop-
ment of the host nation with a high degree of political stability was
more satisfactory, while the discourse power and accountability of
the host country insignificant influence the development of IPO. A
study of industrialised countries, Cherif and Gazdar (2010), claimed
that political factors are critical for financial markets development. A
comparative analysis of the impact of political instability on the equity
earnings of developing and developed markets shows that developed
markets are more likely to be affected by this risk than emerging mar-
kets with higher returns on stocks. Privatisation is an important stimu-
lator of political risk that in turn brings volatility in stock market
development, in particular, more explicit effect on local markets, while
accelerated return in emerging markets, performing a price function
(Perotti & Van Oijen, 2001). Shaghaghi et al. (2019) argue that political
stability positively affects total stock price index, meaning that better
political stability can improve equity market performance. Countries
with greater political risk are more prone to IPO underpricing for their
financial markets. In this case, the issuers are more risk-averse than the
investors and hence underpricing can be a part of the compensation for
the country risks. The hypothesis is proposed:
Hypothesis H2. Political stability and the absence of violence have a
positive influence on IPO underpricing.
2.3 | Government effectiveness
The efficiency of the government relates to the legitimacy of the
government's policy commitment. A study of developing countries
4 of 12
from the African continent signifies the positive role of government
effectiveness in superior stock market performance, particularly
(Hearn, 2014). Government effectiveness parameters illustrate
impressive market capitalisation, high turnover ratio, trading volume
and a large number of listed companies (Asongu, 2012). Those coun-
tries where effective government policies truly implemented and effi-
cient institutional environment are available to investors guarantee an
improvement in stock market performance and the optimistic and
effective policies reduce transaction and agency costs, which enhance
shareholding. Autore et al. (2014) also found that government effec-
tiveness positively associates with IPO underpricing in developed
markets. While Chong et al. (2010) argued that other markets' evi-
dence of IPO underpricing is inadequate to assess the underpricing in
H-shares. Consequently, the connection should be tested. The
hypothesis is proposed;
Hypothesis H3. There is a positive relationship between government
effectiveness and IPO underpricing.
2.4 | Regulatory quality
Regulatory effectiveness tests whether the government is capable of
implementing and enforcing legislation and regulations (Kaufmann
et al., 2009). For non-U.S. companies listed in the U.S. exchange, they
have less IPO underpricing if the home country of those companies has
more effective public law enforcement (Wang & Jiang, 2019).
Hearn (2013) found evidence that information disclosure at the comp-
any's positive association with the quality of supervision, from the per-
spectives of IPO prospectuses length. Especially after the country fixed
effect is used to consider the potential heterogeneity among sample
countries, the institutional quality index always has a strong correlation.
Supporting demonstrations of Smith Jr and Watts (1992), Hearn (2013)
also found evidence that the company's ability of earnings positively con-
nects with the level of corporate information disclosure, which indicated
that it was necessary to infer economic growth opportunities and
increase disclosure to alleviate litigation problems (Bloomfield, 2008).
Pistor et al. (2000) studied the laws protecting shareholders and creditors
and find an increasing paradigm of remarkable changes governing such
laws in transition economies, suggest strong trends towards convergence
of statutory laws through transition economies. The degree of corporate
information asymmetry has an inverse correlation with law implement,
and corporate information asymmetry in developed countries is also rela-
tively low. The following hypothesis is proposed;
Hypothesis H4. Regulatory quality has a negative influence on IPO
underpricing.
2.5 | Rule of law
According to the Kaufmann et al. (2009) who explained the “rule of
law capturing perceptions of the extent to which agents have
WEI ET AL.
confidence in and abide by the rules of society, and in particular the
quality of contract enforcement, and property rights.” Thus, the rule
of law shows investors' self-assurance on country regulation and rules.
Porta et al. (1998) advocated that in countries where weak legal system
existed can be turned into strong legal enforcement. When a country
has strong legal enforcement can protect the investors' interest besides
managers and potential shareholders. Further, Hope (2003) explained
that the quality of the disclosure of firm is influenced by strong enforce-
ment of a legal system that improves the investors' confidence intensity
in return respectively. Thus, due to the effective legal system, it is
possible to protect the vulnerability of external investors.
On the other hand, countries where the rules and regulations are
stringent limits the chances for an insider to make more profits or to
transfer profits from the firm to external investors. Therefore, when rules
and regulations are stringent reduces the uncertainty when IPOs are
going to the public. According to Engelen and Van Essen (2010), who
explained that expropriation risk was higher, ex-ante uncertainty
increased; therefore, issuers had to offer an underprice to attract inves-
tors. When regulations and rules are implemented in a better way,
reduces the ex-ante uncertainty and respectively underpricing. The find-
ing suggested a negative association among the rule of law and under-
pricing. In contrast, Autore et al. (2014) shows a positive relationship
between the rule of law and underpricing. The hypothesis is proposed;
Hypothesis H5. Rule of law has a positive influence on IPO
underpricing.
2.6 | Control of corruption
The control of corruption reflects the public's perception of the degree
of private use of public power and the level of government corruption
governance, both on a small scale and a large scale (Kaufmann
et al., 2009). Bolgorian (2011) examined the corruption perception index
and equity market development of 46 countries throughout 2007–2009,
taking firm scale and the trading value as measures of equity market
development. The research proves a strong and inverse association of
corruption and equity market development. Lalountas et al. (2011) argue
that global development is a powerful tool to deal with corruption, par-
ticularly in middle and high-income countries, and seem least effective in
the case of low-income countries. Love (2011) has shown that political
stability and a low tendency to corruption will assist in improving the
capital market. Wang and Jiang (2019) provided evidence that those
companies from the countries with high level of corruption have
greater underpricing of IPO among the non-U.S. companies listed in
U.S. exchange. They explained that high corruption increased the ex-ante
uncertainty of IPO valuation.
The research results of Chiou et al. (2010) also show that
effective legal and political environment and low level of corruption
can improve stock investment performance and reduce its risk. Li and
Filer (2007) agreed that increasing stock investors prefer markets with
better protection of property rights, fair and transparent legal sys-
tems, helping increase investors' confidence. The empirical results of
WEI ET AL.
Low et al. (2011) suggested that the absence of corruption control
can increase equity returns after risk adjustment. Corruption can
lower investors' confidence in the stock market and regulators of trad-
ing rules. It also increases investors' risk level. Song and Tang (2015)
established that market sentiment is inversely associated with IPO
underpricing. The hypothesis is proposed
Hypothesis H6. Control of corruption has a negative influence on
IPO underpricing.
2.6.1 | IPO setting in the Hong Kong market
A number of regulatory changes have occurred in the Hong Kong IPO
market over the last several decades. At the beginning of the 1990s, the
majority of IPOs were carried out through fixed-price offerings. After the
first H-share listing in July 1993, hybrid equity offerings involving Hong
Kong subscriptions for retail investors and international investment for
both domestic and foreign institutional investors became widespread.
Previously, the issuers and the underwriters decided on subscription and
allocations. However, in view of the substantial decline in shares allo-
cated to the subscription tranche in 1994 and 1995 (SEHK, 1997),
amendments were made to the SEHK listing requirements on 26 June
1998 to ensure that at least 10% of the IPO shares are allocated to retail
investors and that a compulsory claw-back provision is made for over-
1
subscribed issues. As far as the claw-back provision is concerned, under-
writers must allocate 30 per cent of the issue to retail investors if the
subscription demand is about 15 to 50 times the initial allocation, 40% if
it is about 50 to 100 times, and 50% if it is N100 times. Hong Kong
underwriters still hold the main responsibility in determining the alloca-
tion method for oversubscribed issues. Oversubscribed subscription
shares are normally allocated by ballot, down-scaling or a mixture of
both.2 Under the balloting method, there is a high likelihood that the
reception of an allocation is lower than unity as the IPO shares are allot-
ted to fewer applicants via random selection. Under the down-scaling
method, all the investors will be allotted shares albeit each will only
receive a portion of the overall shares applied.
3 | D A T A A N D M E T H O D O LO G Y
In this section, data source, sample and variables used are explained. This
study incorporated 986 listed IPOs in the Hong Kong market from
January 2000 to December 2017 to explain underpricing phenomena.
The present study chosen data from January 2000 as the beginning spe-
cifically to avoid the effect of the Asian Financial crisis period in the
1
More details are available in the SEHK consultation paper (1997). In 1994, the average
subscription size was 31% of the total issue size, in comparison to 12.5% when the claw-back
effect is disregarded and 18.75% when the maximum claw-back effect is taken into account
in 1995.
2 The present work proposed to investigate the model efficiency using
Further descriptions of these methods can be derived from McGuinness (1993) and Vong
and Trigueiros (2009).
5 of 12
Hong Kong market. The data utilised were extracted from Bloomberg,
DataStream and worldwide governance indicators. The only dependent
variable in the study is underpricing (initial return). Underpricing is the
percentage difference between the closing price on the first day of
public listing and the offer price (Mehmood et al., 2020a; Mehmood
et al., 2020b). When the offer price is below to closing price on the
first listing day, the stock is considered underpriced. To analyse IPOs
underpricing, this study used formula in the following:
Pit −Pit− 1
Initial return ðRit Þ = ð1Þ
Pit− 1
Further, the independent variables are six aspects of institutional quality,
including voice and accountability, political stability and violence, govern-
ment effectiveness, regulatory quality, and control of corruption. While,
institutional quality (political stability and violence, regulatory quality, and
control of corruption) is measured by the percentile rank that indicates the
country's rank among all countries covered by the aggregate indicator,
with 0 corresponds to lowest rank, and 100 to highest rank (Kaufmann
et al., 2009). While government effectiveness is measure by the estimate
that gives the country's score on the aggregate indicator, in units of stan-
dard normal distribution, that is, ranging from approximately −2.5 to 2.5
(Kaufmann et al., 2009).
Lastly, firm size is used as control variable in this study. The firm size
which is a market capitalization computed as the total number of shares
issued multiply be offer price (Ong et al., 2020a). The higher the issue
size is, the lower the underpricing, and vice versa (Alanazi & Al-
Zoubi, 2015; Chi & Padgett, 2005; Samarakoon, 2010). Mohd-Rashid
et al. (2018) and Yung and Zender (2010) asserted that firm size is the
most suitable proxy to describe information asymmetry, as such, the
large firms shows lower uncertainty as compared to smaller, which there
by influence final IPO offer price. Due to the informed investor's partici-
pation, the existence of information asymmetry is confirmed, which gives
strong signals of the firm's prospects and growth. Usually, informed
investors are institutional investors have detailed firms information that
tends to provide quality signals to uninformed investors (Chowdhry &
Sherman, 1996). In line, information asymmetry is higher in developing
countries as compared to developed. The preceding literature shows a
negative relationship among firm size and underpricing of IPO
 ska, 2012; Marisetty & Subrahmanyam, 2010).
(Jewartowski & Lizin
The cross-sectional regression model for analysing the connection
of six dimensions on governance indicators and IPO underpricing is as
shown in the following.
UND = a + β1 VAi + β2 PAi + β3 GEi + β4 RQi + β5 RLi + β6 CCi + β7 FSi + εi
ð2Þ
3.1 | Robust equation
the quantile regression analysis. As such, the quantile regression
6 of 12 WEI ET AL.

analysis is used to determine the more comprehensive picture of pre-
dictor variable effects. Therefore, present work used specific quantile
such as 50th, 75th, 90th to explain the predictor variable relationship
because specific percentiles parameter estimates the changes by a
unit change in the predictor variable.
yi = xi β0 + εθi with Quantðyi , xi Þ = xi β0
Q0:50 UNDi = β0:50,1 VAi + β0:50,2 PSi + β0:50,3 GEi + β0:50,4 RQi + β0:50,5 RLi
+ β0:50,6 CCi + β7 FSi + εi
Q0:75 UNDi = β0:75,1 VAi + β0:75,2 PSi + β0:75,3 GEi + β0:75,4 RQi + β0:75,5 RLi
+ β0:75,6 CCi + β7 FSi + εi
Q0:90 UNDi = β0:90,1 VAi + β0:90,2 PSi + β0:90,3 GEi + β0:90,4 RQi
+ β0:90,5 RLi + β0:90,6 CCi + β7 FSi + εi
4 | DATA ANALYSIS AND FINDINGS
4.1 | Descriptive statistic
computed by percentile rank, while government effectiveness is com-
puted by estimates. The highest value of voice and accountability is
69.9531 and the lowest value is 51.7413 that show relatively lower
percentile rank level; while the mean value is 60.364. The mean
(median) of political stability is 82.4607 (79.8942) and a maximum of
95.6311 and minimum of 72.3810, meaning the relatively high fluctu-
ð3Þ ation. Government effectiveness is the only independent variable
using an estimate. The average mean value is 1.6777 and the median
is 1.7459. The maximum level of government effectiveness is 1.9146
while the minimum is 1.3263. The mean of regulatory quality is
ð4Þ 98.6815 and the median is 99.5192. The highest and lowest degree
of control of corruption is 94.7619 and 86.2944, respectively. The
rule of law mean value is 88.89 with the maximum and minimum
range of 95.19, 74.75 respectively. The control of corruption's mean
ð5Þ of 91.8737 and median of 92.3077 is relatively close. Compared with
the percentile rank of the other four institutional quality index, regula-
tory quality keeps comparatively stable and has a small gap of the
ð6Þ
largest value of 100 and the lowest value of 95.9184. Further, Table 1
also offers a statistical description of the control variable, namely the
firm size. The mean value of market capitalization in Hong Kong stock
exchange is HK$700.7583 million and its median value is HK$100
million. During 2000 until 2017, the firm size of offerings fluctuated
at the range from the highest value of HK$24126.6 million to the low-
est value of HK$0.0019 million.

Table 1 demonstrates the descriptive statistic that concludes the
entire data of samples. As shown in Table 1, the average underpricing
level is 64.82% and the median is 0.0566. The maximum and minimum
underpricing are from −0.95 to 21 with a standard deviation of
2.3011 during 2000 and 2017. This indicates the existing of the huge
gap of underpricing of newly listed firms of Hong Kong stock
exchange.
The statistical description of voice and accountability, political
stability, regulatory quality, rule of law and control of corruption
4.2 | Pearson correlation
The coefficients of correlation on the variables are shown in Table 2.
Correlation coefficients are used in statistics to test the connection of
two variables and their range is from +1 to −1. The result stated that
voice and accountability, government effectiveness, regulatory qual-
ity, rule of law and control of corruption are positively correlated
whereas, political stability and firm size is negatively correlated with
underpricing of IPO. Maddala and Lahiri (1992) explained that

TABLE 1 Descriptive statistics

Mean Median Max Min SD
UND (percentage) 0.6482 0.0566 21.0000 −0.9500 2.3011
VA (percentile) 60.3640 60.5911 69.9531 51.7413 5.4430
PS (percentile) 82.4607 79.8942 95.6311 72.3810 6.6546
GE (estimate) 1.6777 1.7459 1.9146 1.3263 0.2163
RQ (percentile) 98.6815 99.5192 100.0000 95.9184 1.6584
RL (percentile) 88.8940 90.9953 95.1923 74.7525 6.6519
CC (percentile) 91.8737 92.3077 94.7619 86.2944 2.6447
FS 700 100 24,126 0.0019 2175

Note: Underpricing refers to the percentage change between the closing price on the first day of public
listing and the offer price. Voice and accountability, (VA) percentile rank that shows 0 lowest to 100
highest. Political stability, (PS) percentile rank that shows 0 lowest to 100 highest. Government
effectiveness, (GE) shows estimate value between −2.5 and 2.5. Regulatory quality, (RQ) percentile rank
that shows 0 lowest to 100 highest. Rule of law, (RL) percentile rank that shows 0 lowest to 100 highest.
Control of corruption, (CC) percentile rank that shows 0 lowest to 100 highest. Firm size, (FS) refers to
the total value of a company's stock within the stock market.
WEI ET AL. 7 of 12

TABLE 2 Correlation matrix

1 2 3 4 5 6 7
VA 0.0512 1
PS −0.0614 0.3798 1
GE 0.1798 0.6827 0.2306 1
RQ 0.1039 0.7028 0.3657 0.7107 1
RL 0.1489 0.5848 0.2149 0.6825 0.6544 1
CC 0.0138 0.6488 0.3170 0.6214 0.6367 0.6993 1
FS −0.0743 0.1118 0.1173 0.0777 0.0461 0.0780 0.1338

Note: Underpricing refers to the percentage change between the closing price on the first day of public
listing and the offer price. Voice and accountability, (VA) percentile rank that shows 0 lowest to 100
highest. Political stability, (PS) percentile rank that shows 0 lowest to 100 highest. Government
effectiveness, (GE) shows estimate value between −2.5 and 2.5. Regulatory quality, (RQ) percentile rank
that shows 0 lowest to 100 highest. Rule of law, (RL) percentile rank that shows 0 lowest to 100 highest.
Control of corruption, (CC) percentile rank that shows 0 lowest to 100 highest. Firm size, (FS) refers to
the total value of a company's stock within the stock market.

T A B L E 3 Results of regression of
Variable Expected sign Coefficient SE t-statistic Prob.
IPO underpricing on selected variables,
2000–2017 C 52.799 10.1889 5.182 0.0000
VA Negative −0.0265 0.0159 −1.6623 0.0968*
PS positive 0.0108 0.0152 0.7119 0.4767
GE Positive 2.7723 0.5442 5.094 0.0000***
RQ Negative −0.2909 0.0881 −3.301 0.0010***
RL Positive 0.2323 0.0348 6.6713 0.0000***
CC Negative −0.5225 0.0755 −6.9192 0.0000***
FS Negative −0.0001 0.0002 −3.894 0.0001***
R-squared 0.1157
Adjusted R-squared 0.1093
Durbin-Watson stat 1.3373

Note: Asterisks ***, **, * indicate significance at 1%, 5%, and 10%. Underpricing refers to the percentage
change between the closing price on the first day of public listing and the offer price. Voice and
accountability, (VA) percentile rank that shows 0 lowest to 100 highest. Political stability, (PS) percentile
rank that shows 0 lowest to 100 highest. Government effectiveness, (GE) shows estimate value between
−2.5 and 2.5. Regulatory quality, (RQ) percentile rank that shows 0 lowest to 100 highest. Rule of law,
(RL) percentile rank that shows 0 lowest to 100 highest. Control of corruption, (CC) percentile rank that
shows 0 lowest to 100 highest. Firm size, (FS) refers to the total value of a company's stock within the
stock market.

independent and dependent variable effects can change where a
strong correlation exists.
4.3 | Regression analysis
To verify the hypotheses towards the connection of institutional qual-
ity with an underpricing level of IPO, the cross-sectional ordinary least
square (OLS) is discussed in this section. As regression outcomes are
shown in Table 3, the model produces R2 of 11.57% and adjusted R2
of 10.93%. The adjusted R2 of 10.93% indicates that all independent
variables tested in this study can interpret the 10.93% of the varia-
tions in IPO underpricing, which is consistent with (Ong et al., 2020b).
Voice and accountability have a negative significant relationship
with IPO underpricing. This result is consistent with the findings of
(Hearn, 2012). The result indicates that lower development in voice
and accountability are tied to raise higher information asymmetric
level, which thereby increases IPO underpricing. This result is also tied
with information asymmetry theory that asserted that lower develop-
ment in voice and accountability presents lower information transpar-
ency, results in higher underpricing. The results also show the
significant positive relationship between government effectiveness
and IPO underpricing at 1% of significant degree. The stock market
would have better performance and lower transaction and agency
cost in those markets with stronger government effectiveness
(Asongu, 2012; Hooper et al., 2009). Result indicates that economic
growth of Hong Kong depends on the solidity and stability of govern-
ment effectiveness. This argument is confirmed by Alam et al. (2017)
who asserted significant positive relationship among government
effectiveness and economic growth. Autore et al. (2014) also have the
8 of 12 WEI ET AL.

same findings with this study on the association of government effec-
tiveness and IPO underpricing.
Regulatory quality tests whether the government have the ability
to implement and execute laws and regulations. Regulatory quality
has a negative connection with IPO underpricing at 1% of significant
degree, implying that a stronger degree of regulatory quality, lower
underpricing. It is argued that a stronger level of law enforcement can
lead to higher information asymmetry and Beatty and Ritter (1986)
prove that greater ex-ante uncertainty can promote higher under-
pricing of IPO. The efficiency of the government relates to the legiti-
macy of the Government's policy commitment. The rule of law is
positively significant with IPO underpricing. Porta et al. (1998) advo-
cated that in countries where the existing weak legal system can be
converted into strong legal enforcement. When a country has strict
legal enforcement, it can protect the investors' interest besides man-
agers and potential shareholders. In line, Autore et al. (2014) have
shown a positive relationship between the rule of law and
underpricing.
The control of corruption measures the ability of the government
to manage corruption. The regression results indicate that it has a sig-
nificantly negative association at 1% between corruption control with
underpricing. Countries with stronger corruption control have lower
underpricing. The empirical results of Low et al. (2011) have shown
that weak control corruption will increase equity returns after risk
adjustment. The absence of corruption control can reduce investors'
confidence in the transaction regulation of the stock market and raise
their doubts towards reality and effectiveness of market information
or news. Song and Tang (2015) prove that investors sentiment can
negatively affect IPO underpricing. Also, the market information fail-
ure arising from corruption issues seemed to make the information
not transparent and unreliable. Due to the positive correlation of
information asymmetry level and IPO underpricing, absence of corrup-
tion control would lead to higher underpricing of IPO. With respect to
the control variable, the finding is that market capitalisation has a neg-
ative association with the underpricing of IPO significant at 1%. This
implied that firm size has a meaningful relationship with IPO under-
pricing, and market capitalisation of firms have a visible impact on
underpricing of offerings while political stability is insignificant to
explain underpricing in Hong Kong.
4.4 | Robustness regression
The result of quantile regression analysis is presented in Table 4 to
explain the association of underpricing. Angrist and Pischke (2008),
advocated that due to quantile regression, dependent variable

T A B L E 4 Results of quantile
50th Quantile 75th Quantile 90th Quantile
regression analysis
Variable Coefficient Prob. Coefficient Prob. Coefficient Prob.
C 3.2426 0.0002 15.9117 0.0000 67.1747 0.0000
3.7429 5.9658 9.5408
VA 0.0002 0.9205 −0.0011 0.8886 −0.0579 0.0001***
0.0999 −0.1401 −3.8643
PS −0.0010 0.4517 −0.0126 0.0315** −0.1435 0.0000***
−0.7529 −2.1539 −5.7746
GE 0.1331 0.0418** 1.0350 0.0000*** 4.6786 0.0000***
2.0386 5.2082 6.6714
RG −0.0195 0.0180*** −0.0550 0.0170*** 0.0637 0.2054
−2.3699 −2.3910 1.2671
RL 0.0106 0.0033*** 0.0658 0.0005*** 0.5090 0.0000***
2.9450 3.4823 7.8774
CC −0.0256 0.0003*** −0.1798 0.0000*** −1.1860 0.0000***
−3.6213 −4.5568 −7.7949
FS 0.0000 0.0059*** 0.0000 0.0345** 0.0000 0.4017
−2.7621 −2.1173 −0.8390
Pseudo R-square 0.0063 0.0293 0.1940

Note: Asterisks ***, **, * indicate significance at 1%, 5%, and 10%. Underpricing refers to the percentage
change between the closing price on the first day of public listing and the offer price. Voice and
accountability, (VA) percentile rank that shows 0 lowest to 100 highest. Political stability, (PS) percentile
rank that shows 0 lowest to 100 highest. Government effectiveness, (GE) shows estimate value between
−2.5 and 2.5. Regulatory quality, (RQ) percentile rank that shows 0 lowest to 100 highest. Rule of law,
(RL) percentile rank that shows 0 lowest to 100 highest. Control of corruption, (CC) percentile rank that
shows 0 lowest to 100 highest. Firm size, (FS) refers to the total value of a company's stock within the
stock market.
WEI ET AL.
distributional characteristics become easier and this is the reason it is
considered as a powerful tool to examine on cross-section IPO under-
pricing (Andriansyah & Messinis, 2016; Mehmood et al., 2020a).
Besides, a quantile regression analysis has exclusive benefits to dem-
onstrate the association of the independent and dependent variable
with outside mean. Therefore, due to the quantile regression, it is pos-
sible to generate useful details understanding of dependent and inde-
pendent variables which have normally non-linear relationship among
variables. Thus, it is useful to explain; how median values influence
dependent variable percentile on independent variable besides using
minimum, maximum and mean value. Wherein, voice and accountabil-
ity, political stability, government effectiveness, regulatory quality,
rule of law and control of corruption are the main variables and firm
size is the only control variable in this study. Accordingly, at 90th qua-
ntile voice and accountability, political stability, control of corruption
are negatively significant. Government effectiveness, regulatory qual-
ity, and the rule of law are positively significant and firm size is not
significant to explain underpricing. At 75th quantile, political stability
regulatory quality and control of corruption is negatively significant.
While, government effectiveness, rule of law and firm size are posi-
tively significant to explain IPO underpricing. Further, at 50th quantile
government effectiveness, rule of law and firm size is positively signif-
icant. Regulatory quality and control of corruption are negatively sig-
nificant to influence underpricing. These results are similar to the
findings of ordinary least square. Thus, based on prior model quantile
regression is used to determine key influencing factors of under-
pricing. The Pseudo R-squared of 50th, 75th, and 90th is 0.06%, 2.9%,
and 19.40%.
5 | C O N CL U S I O N
This paper mainly investigated the relationship between governance
indicators and underpricing of IPOs through using ordinary least
square for the H-shares. A sample of 986 listed companies of Hong
Kong from 2000 until 2017 is used for this study. The preliminary
findings suggested 64.82% underpricing. While, results from OLS
advocated that voice and accountability, regulatory quality, control of
corruption and firm size is negatively significant. Wherein, govern-
ment effectiveness, rule of law, are positively significant and political
stability is not significant to explain IPO underpricing in Hong Kong.
The result suggested that institutional quality increases information
asymmetry among issuers and investors due to poor country-level
efficiency, thereby reducing transparency and increasing the IPOs'
underpricing vice versa.
The outcomes of this paper are beneficial to the main participants
of the market, such as investors, issuers and regulators. For instance,
the absence of effective institutional quality would cause market
information failures and hence further lower the transparency of
information. For example, investors were worried about the reality
and accuracy of market information, thus a lower level of institutional
quality can increase IPO underpricing. Therefore, the investors should
observe the ability of the Hong Kong government or regulators to
9 of 12
manage improvement at the country-level institutional quality. Stron-
ger information asymmetry on account of reducing regulator quality
level would bring more uncertainties and higher risk, further affecting
underpricing level. Therefore, issuers should implement appropriate
strategies to follow the change of regulator quality. Likewise, lack of
high level of government effectiveness and corruption control may
reduce information transparency and affect the underpricing level at
different degree. Higher underpricing of IPO can help issuers increase
the demand of investors because investors have the preference for
new offerings with the lower issued price and high return. The regula-
tors should focus on building or improving an effective and efficient
legal system in ensuring the regulation is efficient in lowering informa-
tion asymmetry and promoting a higher level of decision-making for
all markets participants. Regulators and other relevant government
departments must realise that all disclosed information or change of
regulation may affect the degree of IPO underpricing and decision of
investors and issuers.
This study did not consider the characteristics of firm age and
industry, because the difference in the characteristics of the com-
pany age and size will have a specific effect on the financial condi-
tion of the firm, and thus affect the assessment and decision-
investment of investors on target IPO companies. On the other
hand, this study did not make a comparison for underpricing of
those companies simultaneously listed in A-share and H-shares and
hence find the difference and offer further suggestions for inves-
tors. This study's suggestion will provide important contributions to
future researchers in understanding the relation of institutional
quality and the degree of underpricing of IPOs due to distinct
uniqueness in different markets, including across companies' infor-
mation asymmetry as per issuance year. In addition, the future
study should include the Hang Seng Index because the perfor-
mance of the Hang Sang Index may affect investors sentiment on
the underpricing of IPO. As such, the study sample size is from
January 2000 to December 2017, the future studies may extend
the time frame onward to 2017 to investigate the relationship
between country level institutional quality and IPO underpricing in
Hong Kong market. This study did not take into account firm-
specific attributes, such as business age or the nature of its indus-
try. This kind of firm age and industry characteristic may be impor-
tant to determine the level of underpricing. Future researches
can examine in more detail the effects and interactions of issues,
companies and industry characteristics on underpricing.
ACKNOWLEDG MENTS
The authors are grateful to the anonymous referees of the journal
for their extremely useful suggestions to improve the quality of
the paper. The authors also would like to acknowledge their
gratitude for funding from the Fundamental Research Grant Scheme
FRGS/1/2018/SS01/UUM/02/7) (S/O Code: 14203) provided by the
Ministry of Higher Education, Malaysia.
DATA AVAILABILITY STAT EMEN T
The data set is available on request.
10 of 12
ORCID
Haitian Wei https://orcid.org/0000-0001-8818-4817
Rasidah Mohd-Rashid https://orcid.org/0000-0001-7231-2319
Waqas Mehmood https://orcid.org/0000-0002-7975-220X
Ahmad Hakimi Tajuddin https://orcid.org/0000-0002-7697-3234
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AUTHOR BIOGRAPHIES
Haitian Wei is a Master's degree student at the School of Eco-
nomics, Finance and Banking, Universiti Utara Malaysia (UUM).
His research interests are in the areas of corporate finance and
investment.
Rasidah Mohd-Rashid is an associate professor of finance at the
School of Economics, Finance and Banking, Universiti Utara
Malaysia (UUM). She joined the Universiti Utara Malaysia (UUM)
in 2008. Her research areas are investment and corporate finance.
She is currently the Managing Editor of the International Journal
of Banking and Finance, published by UUM publisher. She is a
Research Fellow at the Economic and Financial Policy Institute
(ECoFI), Senior Associate Fellow at the Asian Research Institute
for Corporate Governance (ARICG) and Associate Fellow at the
Institute for Strategic & Sustainable Accounting Development
(ISSAD). She is also a reviewer of few international refereed
journals including Emerging Market Finance and Trade, Interna-
tional Journal of Emerging Market, Journal of Financial Reporting
and Accounting and others. She has published in a number of
scholarly journals such as Economic Systems, Emerging Market
Review, Borsa Istanbul Review, Pacific Accounting Review, Manage-
rial Finance, Review of Behavioral Finance, Asian Academy of Man-
agement of Accounting and Finance, International Journal of
Economics and Management, Asian Journal of Business and Account-
ing, Global Business Review, Journal of Islamic Accounting and Busi-
ness Research, and others.
Waqas Mehmood is a PhD candidate at School of Economics,
Finance and Banking, Universiti Utara Malaysia. His area of inter-
est is Corporate Finance, Investment Finance, specifically in Initial
public offerings. He is also a reviewer of few international refer-
eed journals including Pacific Accounting Review, Global Business
Review, South Asian Journal of Business Studies, Journal of
Financial Economic Policy. Nankai Business Review International
and others. He has published in a number of scholarly journals
such as Pacific Accounting Review, Review of Behavioral Finance,
Global Business Review, International Journal of Business and Society
and others.
Ahmad Hakimi Tajuddin is a finance and banking lecturer at the
School of Accounting and Finance, Taylor's University since
March 2018. Prior to that, he served for seven years as a credit
officer and treasury dealer in two financial institutions in Malaysia.
His research areas focus on initial public offering, Sukuk and the
stock market. His written works have appeared in refereed
journals such as International Journal of Islamic and Middle East-
ern Finance, International Journal of Economic & Management,
12 of 12 WEI ET AL.

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How to cite this article: Wei H, Mohd-Rashid R, Mehmood W,
Journal of Finance and Accounting, Journal of Islamic Accounting
Tajuddin AH. Institutional quality and initial public offering
and Business Research and International Journal of Social
underpricing: Evidence from Hong Kong. J Public Affairs. 2021;
Economics.
e2676. https://doi.org/10.1002/pa.2676