Journal of Corporate Finance: Xiaorong Li, Steven Shuye Wang, Xue Wang T

Journal of Corporate Finance 56 (2019) 224–248
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Journal of Corporate Finance

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Trust and IPO underpricing

T
Xiaorong Lia, Steven Shuye Wangb, Xue Wangc,
⁎
a
School of Public Finance and Taxation, Central University of Finance and Economics, China
b
Business School, Renmin University of China, China
c
School of Banking and Finance, University of International Business and Economics, China
ARTICLE INFO ABSTRACT
JEL classifications: This study examines the impact of trust on initial public offering (IPO) underpricing using a large
G12 sample of IPO firms in China. We find that firms in regions of high social trust have lower
G14 underpricing, consistent with the notion that IPO firms in low-trust regions have to offer greater
G15 underpricing to secure participation. This result is robust to a battery of sensitivity tests and after
Z13
controlling for endogeneity using instrumental variables. We also find that the negative relation
Keywords: between social trust and underpricing is more prominent for small and growth firms, and firms in
Trust high-tech industries, consistent with trust playing a more important role in asymmetric in-
IPO underpricing
formation environments. This relation is less pronounced for firms with high insider ownership
Information asymmetry
and political connections, suggesting that investors rely less on trust in these cases; it is less
Formal and informal institutions
salient when firms are in regions with high quality legal institutions and high average education
levels, consistent with trust being a substitute for formal institutions.
1. Introduction
This paper investigates the economic impact of trust on underpricing of initial public offerings (IPOs). IPO underpricing, a
phenomenon characterized by a significant increase from the offer price to the first-day closing price, has been the subject of vast
theoretical and empirical work since Ibbotson (1975). We do not limit the objective of this study to adding another piece of evidence
to the massive literature on IPO underpricing; rather we investigate how underpricing of IPOs is affected by informal institutional
environments, such as trust. Prior studies (Williamson, 1993; Guiso et al., 2004; Carlin, 2009) argue that trust is a substitute for a
region's formal institutions. Although numerous studies investigate the relation between formal institutions and IPO underpricing,1
the impact of informal institutions, such as trust, on IPO underpricing has not been explored. This study fills this gap by examining
the relation between trust and IPO underpricing.
Trust is central to every financial relation between transaction counterparties and underlies virtually every economic exchange
(Arrow, 1972; Williamson, 1993). Gambetta (1988) describes trust as an agent's subjective assessment of the probability that certain
actions will be performed by another party. Studies have shown that trust enhances capital market participation (Guiso et al., 2004,
2008b), facilitates firms' financing and merger and acquisition (M&A) transactions (Duarte et al., 2012; Ahern et al., 2015; Bottazzi
et al., 2016), reduces corporations' future crash risk (Li et al., 2017), and narrows firms' bank loan spreads (Hasan et al., 2017). These
studies indicate that trust establishes credibility between contracting counterparties, encourages more efficient cooperation and
Corresponding author.
⁎
E-mail addresses: 0020130025@cufe.edu.cn (X. Li), wangshuye@rmbs.ruc.edu.cn (S.S. Wang), xuewang@uibe.edu.cn (X. Wang).
1
For example, Banerjee et al. (2011), Boulton et al. (2011), Hopp and Dreher (2013), and Autore et al. (2014) show that the legal system plays an
important role in cross-country differences in IPO underpricing. Jones et al. (1999) argue that government intervention affects underpricing. Chen
et al. (2015) suggest that credit market development has an impact on IPO underpricing.
https://doi.org/10.1016/j.jcorpfin.2019.02.006
Received 21 March 2018; Received in revised form 12 February 2019; Accepted 27 February 2019
Available online 28 February 2019
0929-1199/ © 2019 Elsevier B.V. All rights reserved.
X. Li, et al. Journal of Corporate Finance 56 (2019) 224–248
participations in the financial markets, and thus reduces the associated costs.
Investors' participation in any firm's IPO depends not only on the objective assessment of the risk and return trade-off given the
IPO prospectus and other available information, but also on trust, which is the subjective assessment of the reliability of the in-
formation and the probability of being cheated (Gambetta, 1988; Guiso et al., 2008b). The issuing firm located in low trust regions
therefore needs to provide a higher discount (underpricing) than those in high trust regions in order to attract investors with low trust
to participate in the IPO. Hence, the underpricing of an IPO in low-trust regions tends to be higher compared to that of an IPO in high-
trust regions. Therefore, we hypothesize that there is a negative and direct impact of trust on IPO underpricing through attracting
investor participation in those high trust regions' IPOs.
In addition to the direct impact explanation discussed above, we further propose an indirect explanation for the negative impact
of trust on IPO underpricing. Studies (Jha, 2017; Li et al., 2017) show that managers of firms in high-trust regions are affected by the
norms and social standards in the area and are less likely to expropriate shareholders. Hence, managers of IPO firms in high-social-
trust regions are less likely to manipulate financial information in the prospectuses. As a result, financial reporting quality tends to be
higher for firms in more trusting regions. Boulton et al. (2011) find that IPO firms in countries with higher quality financial in-
formation have lower underpricing, which suggests that high financial reporting quality reduces information asymmetry in the IPO
process and therefore lowers IPO underpricing. This conjecture suggests that trust has an indirect impact on IPO underpricing
through curbing managers' manipulation of financial information and lowering information asymmetry between the issuing firm and
investors. We expect both the direct and indirect explanations contribute to the negative relation between trust and IPO underpricing,
since these two explanations are not mutually exclusive.
Using 1953 Chinese IPO firms in the 2001–2016 period, we study whether trust at the province level affects IPO underpricing of
firms located in that province. China provides an ideal setting for our study. First, with a relatively weak legal system and institu-
tional environment in China, trust should play a more important role in IPO underpricing compared to more developed countries,
where formal institutional features are much better (Allen et al., 2005). Second, the large regional variations in trust2 in China
facilitate a cross-regional study of trust's impact on IPO underpricing, while at the same time avoiding potential contamination of the
trust measures from differing institutional features if a similar cross-country study were to be conducted.
We find that on average firms located in high-trust provinces tend to have smaller first-day returns3 compared to those in low-
trust provinces. This negative impact of trust on IPO underpricing is both statistically and economically significant, and remains
robust using alternative trust measures or samples excluding certain provinces with disproportionally large firm–year observations or
with extreme trust values. To ensure that the measures used are not picking up other province-level factors that may also affect IPO
underpricing, we incorporate relevant local variables documented in other studies (Chen et al., 2015; Li et al., 2017) and province-
fixed effects in explaining provincial differences in IPO underpricing.
We also find that both IPO issuing P/E (IssuePE) and P/B (IssuePB) ratios4 are significantly higher for IPO firms in high trust
regions relative to those in low trust regions in univariate comparisons, indicating that IPO firms in low trust regions tend to
provide larger discounts to attract investor participation compared to those in high trust regions. This interpretation is consistent
with our conjecture of the direct impact of trust on IPO underpricing, i.e., trust encourages investor participation, hence issuing
firms in high trust regions do not need to provide high discounts and have lower underpricing compared to those in low trust
regions.
Then we run a path analysis to formally investigate the economic mechanisms through which trust affects IPO underpricing.
Consistent with the indirect impact conjuncture, path analysis shows that trust is negatively associated with a firm's financial re-
porting quality and that higher quality financial reporting lowers underpricing. On the other hand, we also find evidence of sig-
nificantly lower underpricing in more trusting regions, even holding financial reporting quality constant. This evidence that trust has
a direct impact on IPO underpricing beyond its effect on financial reporting quality supports our direct impact hypothesis that
regional trust lowers the required underpricing to secure investors' participation in an IPO.
The negative relation between social trust and a firm's IPO underpricing may also be driven by reverse causality or omitted
variables. For example, both social trust and IPO underpricing may be affected by the same unobservable variables. We employ an
instrumental variables (IV) approach to address potential endogeneity problems. We show a significantly negative impact of trust on
IPO underpricing after controlling for endogeneity concerns.
Numerous studies document that people rely more on trust when there is severe information asymmetry and in weaker in-
stitutional environments (Williamson, 1993; Guiso et al., 2004, 2008a; Carlin et al., 2009; Pevzner et al., 2015). Therefore, the impact
of trust on IPO underpricing may vary with a firm's information asymmetry and institutional environments. Consistent with this
notion, we find that the negative effect of trust on IPO underpricing is more prominent for firms with higher information asymmetry,
for example, small firms, growth (high market-to-book) firms, and firms in high-tech industries. We also find that the impact of trust
on IPO underpricing is less pronounced for firms with high insider ownership, which is usually used to signal superior firm quality,
and for firms with political connections, which seems to play a “helping hand” role rather than a “grabbing hand” role in the process
2
China's vast social trust diversity originates from the existence of 56 ethnic groups in 31 provinces and more than 80 native dialects, which are
not comprehensible to non-native speakers. People across the 31 provinces of China differ in terms of ethnicity and native dialect as well as culture,
history, and religion.
3
First-day returns and underpricing are used interchangeably in this paper.
4
IssuePE is IPO offer price divided by earnings per share in the issuing year and IssuePB is IPO offer price divided by book value of net assets per
share in the issuing year.
225
of going public.5 The effect of trust on underpricing is less prominent for firms located in regions with better institutional en-
vironments, such as higher quality legal institutions and higher average education.
Several studies examine IPO underpricing using common stocks in China. For example, Chan et al. (2004) investigate the impact
of institutional factors on IPO underpricing of Chinese A-shares and B-shares in the 1990s. Using a sample of Chinese firms from 1999
to 2007, Chen et al. (2015) examine whether Chinese private firms or state-owned enterprises have higher IPO underpricing and the
impact of institutional environment on IPO underpricing. Bao et al. (2016) examine 413 Chinese IPOs from 2009 to 2012 and show
that politically connected issuing firms are more likely to get approved to be listed and incur smaller direct costs of going public. They
also find insignificant impact of political connections on IPO underpricing. The present paper examines underpricing of Chinese IPOs
using a longer and more recent period, 2001–2016. We contribute to the IPO literature by investigating the impact of an informal
institution, trust, on the underpricing of IPOs, an issue neglected in the literature.
Our study also adds to the large body of literature on social trust. Trust as an element of social capital plays an important role in
every commercial transaction (Arrow, 1972) and in economic development and growth (Putnam, 1993; Fukuyama, 1995; Knack and
Keefer, 1997; La Porta et al., 1997). As to the capital markets, Guiso et al. (2004, 2008b) argue that trust enhances stock market
participation. At the corporate level, regional trust reduces firms' future crash risks (Li et al., 2017) and county-level social capital
lowers firms' bank loan spreads (Hasan et al., 2017). To the best of our knowledge, we are among the first to report that regional trust
impacts an important capital market outcome, that is, underpricing of IPOs. We also provide the new insight that trust lowers IPO
underpricing both directly and indirectly through improving financial reporting quality of IPO firms.
The remainder of this paper proceeds as follows. Section 2 develops testable hypotheses. Section 3 presents the sample and the
measures of the main variables. Section 4 sets forth empirical evidence on the impact of trust on IPO underpricing and long-run
performance. Finally, Section 5 describes our conclusions.
2. Hypothesis development
Although a large body of literature investigates the relation between formal institutions, such as the level of legal system and
credit market development, and IPO underpricing (e.g., Banerjee et al., 2011; Boulton et al., 2011; Hopp and Dreher, 2013; Autore
et al., 2014; Chen et al., 2015), studies on the impact of informal institutions, such as trust, on IPO underpricing are scarce. Trust is
shown to play an important role in virtually every economic transaction (Williamson, 1993). Studies show that trust enhances
organizational performance, investment, trade, economic growth, and financial development, encourages investors' capital market
participation and firm use of trade credit, and facilitates corporate financing (La Porta et al., 1997; Knack and Keefer, 1997; Zak and
Knack, 2001; Guiso et al., 2004; Duarte et al., 2012; Wu et al., 2014). These studies suggest that trust helps establish credibility
between contracting counterparties, encourages cooperation and investors' participations in the financial market, and thus reduce
associated costs, such as financing costs.
There are two factors affecting an investor’ participation in a firm's IPO: (a) her objective assessment of the risk and return trade-
off of the IPO firm given all the information available; (b) whether she could trust the information, i.e., her subjective assessment of
the reliability of the information and the probability of being cheated (Gambetta, 1988; Guiso et al., 2008b). Therefore, in order to
attract investors to participate in the IPO, an issuing firm in low trust regions has to offer a larger discount, i.e., a higher underpricing,
compared to issuing firms in high trust regions. In other words, we expect IPO underpricing in high-trust regions to be lower
compared to that in low-trust regions. We thus state our first hypothesis.
Hypothesis 1. Trust reduces underpricing of IPO firms.
Previous studies6 suggest that information asymmetry is likely one of the driving forces behind IPO underpricing. Since greater
social trust facilitates the collection and dissemination of knowledge (Guiso et al., 2008a), the impact of social trust on IPO un-
derpricing is likely affected by firm-level information asymmetry. Trust plays a more important role when information asymmetry is
more severe between counterparties (Guiso et al., 2008a). This indicates that higher firm-level information asymmetry enlarges the
effect of trust on IPO underpricing. We phrase this prediction as our second hypothesis.
Hypothesis 2. The relation between trust and IPO underpricing is more salient for firms with higher information asymmetry.
Another strand of literature explains IPO underpricing from the signaling perspective. Allen and Faulhaber (1989), Grinblatt and
Hwang (1989), and Welch (1989) argue that IPO underpricing signals the firm's true value under asymmetric information, which will
be justified by higher prices in future seasoned equity offerings (SEOs). Leland and Pyle (1977) suggest that the insiders could signal
the quality of the firm to outside investors by holding a large stake in the company. Therefore, IPO underpricing is affected by the
share ownership of insiders. To the extent that trust promotes investors to participate in the IPO process, if the issuing firm has large
insider ownership to signal its superior quality, outside investors' participation decision depends less on trust. Hence, we state our
third hypothesis.
5
For studies supporting the “grabbing hand” argument, see Shleifer and Vishny (1998) and Fan et al. (2007). There are also studies (Fisman, 2001;
Faccio, 2006; Bao et al., 2016) lending support to the “helping hand” role of political connections.
6
For example, see Rock (1986), Beatty and Ritter (1986), Benveniste and Spindt (1989), Welch (1989), Baron (1982), and Allen and Faulhaber
(1989) among theoretical studies, and Hanley (1993), Michaely and Shaw (1994), Cornelli and Goldreich (2001), and Ljungqvist and Wilhelm
(2003) among empirical studies.
226
Hypothesis 3. The relation between trust and IPO underpricing is less prominent for firms with high insider holdings.
Numerous studies (Faccio, 2006; Leuz and Oberholzer-Gee, 2006; Chaney et al., 2010) show that political connections play an
important role in economic activities. Fan et al. (2007) use CEO political connections as a proxy for government intervention and
show that IPO underpricing is negatively related to CEO political connections. These authors interpret the results as that government
is expected to extract rents from politically connected IPO firms and outside investors lower the first-day closing price with that
anticipation. Contrasting with the “grabbing hand” argument (Shleifer and Vishny, 1998), political connections could also play a
“helping hand” role. Fisman (2001) suggests that political connections drive a large proportion of well-connected firms' value in
Indonesia. Faccio (2006) finds that firm value increases when a businessperson becomes a politician, especially when that person is
elected prime minister. Francis et al. (2009) also show that firms with political connections benefit significantly when going public.
Bao et al. (2016) examine 413 IPOs in China and find that politically connected firms incur smaller direct cost to go public and have a
higher probability to be approved to get listed. However, they find that the impact of political connections on IPO underpricing is
insignificant.
Given the mixed evidence on the role of political connections on IPO underpricing, how political connections and trust may
interact in affecting IPO underpricing becomes an empirical issue. We thus state the fourth hypothesis as nondirectional.
Hypothesis 4. The relation between trust and IPO underpricing is affected by firm's political connections.
Trust has been argued to serve as a substitute for a region's formal institutions (Williamson, 1993; Guiso et al., 2004; Carlin et al.,
2009). Along this line, Aghion et al. (2010) show that trust has an impact on adoption of stricter regulations, because people in low-
trust regions demand more government protection. Chen et al. (2015) and Chen et al. (2017a) find that better institutional en-
vironments reduce IPO underpricing. For IPO firms in regions with good institutional environments, investors are more willing to
participate in the financial markets and the quality of financial information in the prospectus is expected to be good, reducing the
impact of trust on IPO underpricing. In other words, we expect trust to play a substituting role for the institutional environment in the
context of IPO underpricing, that is, the impact of trust on IPO underpricing is weaker when formal institutions are stronger. This
leads to our fifth hypothesis.
Hypothesis 5. The negative relation between trust and IPO underpricing is less prominent for firms in regions with stronger formal
institutional environments.
3. Sample and variables
3.1. Sample
We construct our sample starting with all Chinese A-share listed IPO firms in the 2001–2016 period from the China Securities
Market and Accounting Research (CSMAR) database. The CSMAR database includes firms' stock issue dates, price, location, and
accounting information. During the sample period, there are 2063 IPOs totally. We remove financial services firms and firm–year
observations with missing information for the control variables. We winsorize the continuous variables at the 1% and 99% levels to
mitigate the effect of outliers. Our final sample includes 1953 IPO firms.
3.2. Measuring IPO underpricing
IPO firms' first-day return or underpricing is calculated in the following two ways following Chan et al. (2004) and Chen et al.
(2015), among others:
P1 P0
UnderP = ,
P0 (1)
P1 P0 M1 M0
UnderPadj = ,
P0 M0 (2)
where, P1 is the closing price of the first trading day, P0 is the IPO offering price, and M0 and M1 are the A-share market index closing
prices on the IPO issuing day and the first trading day, respectively.
3.3. Measuring trust
Following the previous literature on trust,7 we measure province-level social trust using several available proxies. The first proxy,
Trust1, measures the perceived enterprise trustworthiness at the firm's home province; this is obtained from a survey by the Chinese
Enterprise Survey System across the 31 provinces of China in 2000. Zhang and Ke (2002), Wu et al. (2014), and Ang et al. (2015) also
use this measure to proxy for trust. The main question in the survey related to trust is: “According to your experience, which five
provinces have the most trustworthy enterprises? Please list them in order.” The questionnaires were sent to over 15,000 managers of
7
For example, see Zhang and Ke (2002), Wu et al. (2014), Ang et al. (2015), and Li et al. (2017).
227
companies located in the 31 provinces, and more than 5000 valid responses were received. Following Zhang and Ke (2002), a
number-one ranking province from the survey is assigned a raw score of 5, a number-two ranking province has a raw score
of 4, and so on. The trust score for each province is then calculated by the weighted average of the assigned raw scores,
where the weights are the percentages of managers who indicated that a province ranks number one, number two, etc. For
example, Beijing is ranked number one by 16.6% of the responding managers, number two by 11.3%, number three by 8.3%,
number four by 5.5%, and number five by 4.9%. Therefore, the trust score of Beijing is calculated as 169%
(16.6% × 5 + 11.3% × 4 + 8.3% × 3 + 5.5% × 2 + 4.9% × 1).8 We use Trust1 as the main proxy for social trust because it eval-
uates the trustworthiness of enterprises, which provides a good fit for examining the impact of trust on firm IPO underpricing.
We also use alternative measures of trust to check the robustness of our results. Following Wu et al. (2014) and Ang et al. (2015),
we use the degree to which residents trust strangers, taken from a survey by the China General Social Survey in 2003, as Trust2; this
evaluates citizen trustworthiness rather than enterprise trustworthiness (Trust1) in a given province. One of the survey questions is
“Do you trust strangers.” We rank the five choices from 1 to 5 from the lowest trust choice “do not trust greatly” to the highest trust
choice “trust greatly”9 and take the average scores of the respondents' choices by province as Trust2.
We further use two non-survey-based measures of social trust, following Wu et al. (2014), Li et al. (2017), and Lins et al. (2017) to
avoid any endogeneity concern that historical IPO underpricing may affect survey responses and the two survey-based trust measures
(Trust1 and Trust2). As alternative trust measures, voluntary blood donations (Trust3) and non-government organizations (NGOs,
denoted as Trust4) are less likely to be affected by historical underpricing of IPO firms located in the province. Blood donation reflects
citizens' willingness to help others, altruism, and trust in the social system. Trust3 is calculated as the milliliters of blood donated on a
purely voluntary basis in 2000 in a province divided by the population of the province. The data are obtained from the Chinese
Society of Blood Transfusion. NGOs are developed by volunteers or organizations to meet social needs or solve social problems that
are neglected or not addressed by the market or government. Putnam (1993) suggests that the number of NGOs in a region represents
regional social capital. Therefore, Trust4 is calculated as the number of NGOs in a province divided by the population of the province.
We obtain NGO data for 2001–2014 from the National Bureau of Statistics of China (NBS), while we use the 2014 data for 2015–2016
as well.
3.4. Sample statistics
Panel A of Table 1 reports the total number of IPO firms in each province during our sample period of 2001–2016, as well as mean
values of trust and IPO underpricing for each province. The provinces are ranked according to their Trust1 scores, with the lowest
scoring province listed at the top and the highest scoring province at the bottom. Trust1 score varies substantially from 0.041 to
2.189, which provides enough variation to examine the impact of social trust on firm IPO underpricing. Panel A of Table 1 also shows
high variation in firm IPO underpricing, for example, average first-day return (UnderP) varies from 49.2% in Shandong province to
122.6% in Jiangxi province.
Panel B of Table 1 presents the distribution of IPO firms across industries and provinces. This table shows that IPO firms are
distributed unevenly across provinces and industries. For example, 215 out of 261 IPO firms in Zhejiang province are in the man-
ufacturing industry (denoted as C), while 197 out of 257 IPO firms in Jiangsu province are in the mining industry (denoted as B).
Fig. 1A and B plot the relation between average social trust (Trust1) and IPO firm first-day returns (UnderP) and market-adjusted
first-day returns (UnderPadj) by province, respectively. Both figures indicate that average IPO underpricing tends to drop with in-
creased provincial social trust.
Panel A of Table 2 shows sample statistics for measures of IPO underpricing, trust, and control variables (described in Appendix
A). The average unadjusted underpricing for Chinese IPOs (UnderP) is 59.4% for our sample period, while the market-adjusted first-
day return (UnderPadj) is 58.8%, on average. The mean and standard deviation of the underpricing measures are comparable to the
estimates of Wang et al. (2018b) for Chinese A-share IPO firms from 2005 to 2013, though we use a longer and more recent sample
period from 2001 to 2016.
The measures of social trust show large cross-sectional variation across provinces, which facilitates our empirical tests. The mean
value of the first proxy of social trust, provincial enterprise trustworthiness (Trust1), is 89.6%, with a standard deviation of 60.3%.
The average value of provincial-level residents' trust toward strangers, Trust2, is 2.27, with a standard deviation of 0.098. The average
level of provincial blood donation (Trust3) is approximately 1.441 mL per capita, with a standard deviation of 0.917. The number of
NGOs in a province per million of population (Trust4) is 2.012, on average, and has a standard deviation of 0.78. Our sample statistics
on the trust measures are similar to those reported in prior studies (Zhang and Ke, 2002; Wu et al., 2014; Ang et al., 2015; Li et al.,
2017).
Panel B of Table 2 reports the univariate comparison of IPO underpricing between firms in high- and low-trust regions. We classify
a region as high- (low-) trust when provincial Trust1 is higher (lower) than the sample median. The t-test of the difference between
the means and the Wilcoxon-test of difference between the medians show that both the unadjusted and market-adjusted first-day
returns of Chinese IPOs are significantly lower when the IPO firms are located in high-trust regions compared to those in low-trust
8
One concern is that the trust score may be affected by local bias, i.e., the responding managers may have been biased toward the trustworthiness
of firms located in their own province. To address this concern, Zhang and Ke (2002) alternatively calculate the score by excluding the managers
who ranked their own province as No. 1. Using a two-tailed t-test, they show that the two scores are not significantly different.
9
The other three choices are “do not trust,” “neutral,” and “trust.”
228
Table 1
Sample distribution.
Panel A: Mean of social trust (Trust1) and IPO underpricing (UnderP, UnderPadj) by province
Province Number of IPOs Trust1 UnderP UnderPadj
Hainan 9 0.041 0.577 0.540

Jiangxi 21 0.074 1.226 1.194
Guizhou 11 0.074 0.571 0.572
Gansu 15 0.082 1.092 1.097
Hunan 58 0.099 0.585 0.583
Neimenggu 7 0.116 0.863 0.844
Shanxi 15 0.121 0.552 0.540
Anhui 65 0.126 0.864 0.867
Guangxi 17 0.130 0.784 0.739
Hubei 42 0.136 0.531 0.529
Chongqing 21 0.141 0.646 0.635
Henan 49 0.144 0.567 0.567
Jilin 15 0.148 0.580 0.570
Shannxi 25 0.155 0.878 0.889
Xinjiang 25 0.156 0.931 0.916
Heilongjiang 11 0.159 0.638 0.633
Yunnan 15 0.188 0.930 0.927
Fujian 74 0.243 0.512 0.497
Sichuan 65 0.271 0.652 0.648
Hebei 31 0.301 0.514 0.513
Liaoning 34 0.321 0.684 0.668
Tianjin 24 0.499 0.661 0.638
Zhejiang 261 0.777 0.588 0.585
Shandong 115 0.962 0.492 0.484
Guangdong 349 1.172 0.580 0.576
Jiangsu 257 1.187 0.520 0.515
Beijing 206 1.690 0.532 0.523
Shanghai 116 2.189 0.514 0.504
Total/Mean 1953 0.896 0.594 0.588
Panel B: Distribution of sample IPO firms by province and industry
Industry classification
Province Total A B C D E F G H I J K L M N R
Hainan 9 2 1 3 0 1 1 1 0 0 0 0 0 0 0 0
Jiangxi 21 0 0 19 1 0 1 0 0 0 0 0 0 0 0 0
Guizhou 11 0 0 8 1 0 0 1 0 0 1 0 0 0 0 0
Gansu 15 2 1 11 0 0 0 0 0 0 0 0 0 0 0 1
Hunan 58 2 1 41 1 0 3 2 2 1 0 2 2 1 0 0
Neimenggu 7 0 1 5 0 1 0 0 0 0 0 0 0 0 0 0
Shanxi 15 0 3 8 0 0 1 1 1 1 0 0 0 0 0 0
Anhui 65 1 2 46 0 1 3 3 2 1 2 1 1 0 2 0
Guangxi 17 1 0 11 1 0 1 0 0 1 0 0 0 0 2 0
Hubei 42 0 0 30 0 2 3 3 1 1 1 1 0 0 0 0
Chongqing 21 0 0 15 3 0 1 0 0 0 0 2 0 0 0 0
Henan 49 3 2 40 0 0 1 2 0 1 0 0 0 0 0 0
Jilin 15 0 0 10 0 1 0 1 0 1 0 0 1 0 1 0
Shannxi 25 0 3 19 1 0 0 1 0 1 0 0 0 0 0 0
Xinjiang 25 4 3 10 3 3 1 1 0 0 0 0 0 0 0 0
Heilongjiang 11 1 0 10 0 0 0 0 0 0 0 0 0 0 0 0
Yunnan 15 1 1 9 1 1 0 0 0 0 0 2 0 0 0 0
Fujian 74 2 1 52 0 0 2 9 2 5 0 0 0 1 0 0
Sichuan 65 1 1 41 2 2 3 4 2 5 0 0 2 1 0 1
Hebei 31 1 1 25 0 0 1 1 1 0 1 0 0 0 0 0
Liaoning 34 2 0 25 0 0 2 2 0 0 0 2 1 0 0 0
Tianjin 24 0 4 18 0 0 1 0 0 0 0 0 0 1 0 0
Zhejiang 261 0 0 215 2 8 3 13 2 5 3 3 4 1 1 1
Shandong 115 6 2 94 1 1 3 4 1 1 0 2 0 0 0 0
Guangdong 349 3 2 248 1 16 8 34 6 13 5 6 4 2 0 1
(continued on next page)
229
Table 1 (continued)
Panel B: Distribution of sample IPO firms by province and industry
Industry classification
Province Total A B C D E F G H I J K L M N R
Jiangsu 257 0 197 1 7 5 0 17 7 5 6 6 2 3 0 1

Beijing 206 1 9 63 5 16 3 45 4 30 3 6 9 8 1 3
Shanghai 116 1 1 65 1 3 6 14 3 10 3 5 3 0 0 1
Total/Mean 1953 34 236 1142 31 61 48 159 34 82 25 38 29 18 7 9
Table 1, Panel A reports the total number of IPO firms, mean values of trust (Trust1), IPO underpricing level (UnderP), and market-adjusted IPO
underpricing level (UnderPadj) for each sample province between 2001 and 2016. The provinces are listed according to their mean Trust1 scores,
with the lowest scoring province listed at the top and the highest scoring province at the bottom. Panel B presents the distribution of sample IPO
firms by province and industry. Industries are denoted as follows: A = Agriculture, B = Mining, C = Manufacturing, D = Electricity, gas, and water,
E = Building and construction, F=Commerce, G = Transportation and logistics, H = Accommodation and restaurants, I=Information technology,
J = Finance and insurance, K = Real estate, L = Leasing and commercial services, M = Scientific research and technical services, N = Environment
and public facilities management, R = Culture, sports and entertainment. All variables are defined in Appendix A.
2.5
1.5
0.5
2.5
1.5
0.5
0
Shanxi
Anhui
Chongqing
Jilin
Shandong
Hainan
Jiangxi
Guizhou
Gansu
Henan
Shannxi
Xinjiang
Yunnan
Sichuan
Hebei
Hunan
Neimenggu
Guangxi
Hubei
Fujian
Heilongjiang
Tianjin
Zhejiang
Jiangsu
Shanghai
Liaoning
Beijing
Guangdong
B Trust1 UnderPadj
Fig. 1. IPO underpricing and trust. (A and B) plot the mean of social trust (Trust1) and IPO underpricing (UnderP) and market-adjusted underpricing
(UnderPadj) by province, respectively.
230
Table 2
Descriptive statistics.
Panel A: Sample statistics
Variable N Mean 25th pctl. Median 75th pctl. Std. dev.
UnderP 1953 0.594 0.265 0.440 0.679 0.660

UnderPadj 1953 0.588 0.272 0.418 0.675 0.654
Trust1 1953 0.896 0.243 0.962 1.187 0.603
Trust2 1953 2.267 2.225 2.249 2.344 0.098
Trust3 1953 1.441 1.086 1.259 1.331 0.917
Trust4 1953 2.012 1.510 1.799 2.441 0.781
Trust5 1953 0.525 0.092 0.431 0.777 0.507
CEOTrust1 676 0.705 0.148 0.777 1.172 0.541
EM1 1953 0.633 0.105 0.398 0.938 0.758
EM2 1913 0.064 −0.012 0.046 0.123 0.119
EM3 1913 0.069 −0.008 0.051 0.129 0.121
EM4 1913 0.063 −0.012 0.046 0.120 0.117
Size 1953 21.094 20.404 20.822 21.422 1.148
ROA 1953 0.149 0.093 0.135 0.186 0.078
Lev 1953 0.482 0.357 0.491 0.602 0.172
Growth 1953 0.197 0.106 0.159 0.234 0.161
Age 1953 10.133 6.000 10.000 14.000 5.446
SOE 1953 0.308 0.000 0.000 1.000 0.462
Top6 1953 0.149 0.000 0.000 0.000 0.356
Big4 1953 0.062 0.000 0.000 0.000 0.241
Days 1953 12.037 9.000 11.000 14.000 3.923
IssueSize 1953 0.011 0.002 0.003 0.005 0.060
Lotte 1953 0.759 0.096 0.442 0.862 1.173
IssuePE 1953 34.454 21.640 26.410 45.060 19.090
Up10 1953 0.504 0.000 1.000 1.000 0.500
Down10 1953 0.204 0.000 0.000 0.000 0.403
VC 1953 0.446 0.000 0.000 1.000 0.497
GDP% 1953 0.139 0.085 0.145 0.188 0.058
PopG 1953 0.016 0.004 0.008 0.016 0.028
Religion 1953 23.886 12.000 21.000 29.000 18.71
Fists 1953 0.392 0.278 0.382 0.501 0.151
Exes 1953 0.228 0.000 0.088 0.478 0.255
Ind 1953 0.327 0.300 0.333 0.333 0.131
Panel B: Univariate comparison of IPO underpricing between firms in high- and low-trust regions
Low trust High trust t-test of difference in mean Wilcoxon-test of difference in median
N Mean Median N Mean Median Diff. Diff.
UnderP 910 0.658 0.440 1043 0.539 0.440 0.119 ⁎⁎⁎

0.000⁎⁎⁎
UnderPadj 910 0.651 0.427 1043 0.532 0.412 0.119⁎⁎⁎ 0.015⁎⁎⁎
IssuePE 910 32.804 24.005 1043 35.893 28.140 −3.089⁎⁎⁎ −4.145⁎⁎⁎
IssuePB 910 7.918 6.217 1043 8.961 6.978 −1.043⁎⁎⁎ −0.761⁎⁎⁎
This table reports descriptive statistics for IPO underpricing measures, buy-and-hold, market-adjusted stock return measures, social trust measures,
and control variables. Panel A reports statistics for the full sample. Panel B presents univariate comparisons of IPO underpricing between firms in
low-trust regions and firms in high-trust regions. We classify regions as high- (low-) trust when the provincial Trust1 is higher (lower) than the
median. In Panel B, t-tests (Wilcoxon z-tests) are conducted to test for differences in means (medians). Here, p-values are reported and *, **, and ***
indicate significance at the 10%, 5%, and 1% levels, respectively. All variables are defined in Appendix A.
regions. This univariate comparison confirms our hypothesis that trust lowers IPO underpricing and motivates our further analysis of
the relation between trust and IPO underpricing.
Panel B of Table 2 also shows the univariate comparison of IPO issuing P/E and P/B ratios between issuing firms in high- and low-
trust regions, where IssuePE is IPO offer price divided by earnings per share in the issuing year and IssuePB is IPO offer price divided
by book value of net asset per share in the issuing year. Both IssuePE and IssuePB are significantly higher for IPO firms in high trust
regions relative to those in low trust regions, indicating that IPO firms in low trust regions tend to provide larger discounts to attract
participation compared to those in high trust regions. This interpretation is consistent with our conjecture of the direct impact of trust
on IPO underpricing, i.e., trust encourages investor participation, hence issuing firms in high trust regions do not need to provide high
discounts and have lower underpricing compared to those in low trust regions.
231
4. Results
4.1. Trust and IPO underpricing
This section tests our first hypothesis by examining the relation between trust and IPO underpricing using multivariate regres-
sions. The baseline regression model is specified as:
Underpricingi = 0 + 1 Trust + j Controlj + i (3)
where, the dependent variable is IPO underpricing, measured by UnderP or UnderPadj. The variable of interest, Trust, captures the
level of regional trust. Controlj is a vector of control variables.10 Hypothesis 1 predicts α1 to be negative if trust reduces IPO un-
derpricing.
Table 3 provides the regression estimates of Eq. (3). Columns (1) and (2) present the regression results with Trust1 as the
independent variable of interest while controlling for firm characteristics, underwriter and auditor quality, and issue characteristics,
which are found to affect IPO underpricing in previous studies, as well as industry-, year- and province-fixed effects. Standard errors
are clustered by province and industry (Petersen, 2009). The significantly negative coefficients on Trust1 support Hypothesis 1 and
suggest that IPO firms located in high-trust provinces tend to have lower underpricing compared to those in low-trust provinces. This
negative impact of trust on IPO underpricing is economically significant. For example, the significantly negative estimate of Trust1 in
Column 1 suggests that, on average, a one standard deviation increase in Trust1 is associated with 5.79%11 lower IPO underpricing.
When the market-adjusted underpricing variable is used as the dependent variable (Column 2), the estimate of Trust1 is still sig-
nificantly negative although smaller in magnitude.
Following Ritter (1984), Tian (2011) and Chen et al. (2015), we include five firm characteristics: size (Size), financial performance
(ROA), leverage (Lev), growth potential (Growth), and firm age before IPO (Age). These firm characteristics measure ex ante un-
certainty and information asymmetry of IPO firms. Chen et al. (2015) show that ownership structure, whether a firm is privately
owned or state owned (SOE), has an impact on IPO underpricing. We therefore include SOE in the analysis to control for the impact of
ownership structure on IPO underpricing. Underwriter and auditor quality are also related to information asymmetry of the IPO firms
and are measured by Top6 and Big4.12
Previous studies (Benveniste and Spindt, 1989; Chowdhry and Sherman, 1996) show that the IPO mechanism has an impact on
IPO underpricing; thus, we include several variables on issue characteristics in our analysis. Days is the number of days between IPO
issue date and the listing date, which measures the IPO waiting period. As documented by Mok and Hui (1998) and Chan et al.
(2004), the longer the IPO waiting period, the higher is the IPO underpricing. IssueSize is the number of shares issued in the IPO,
which measures share supply and therefore is expected to be negatively correlated with IPO underpricing. Lotte is the lottery ratio of
IPO allocation, which is the ratio of shares issued to shares subscribed. This variable measures relative demand for an issue; it is lower
when demand is higher, and hence is expected to be negatively correlated with underpricing. Following Chen et al. (2015), we also
include the IPO issuing P/E ratio (IssuePE) as a control variable.
We also include bull and bear market sentiment dummy variables (Up10 and Down10) to control for the effects of extreme market
conditions on underpricing (Ritter, 1984). Up10 equals 1 if the return of the annual market A-share index return one year before the
IPO is at or above 10%, and zero otherwise. Down10 equals 1 if the return of the annual market A-share index return one year before
the IPO is at or below −10%, and zero otherwise. We expect Up10 to be significantly positive, supporting the “hot issue” argument of
previous studies (Ritter, 1984; Loughran and Ritter, 2002; Boulton et al., 2011; Chen et al., 2015). The control variables mentioned
above are loaded with coefficients that are largely consistent with theoretical predictions and empirical findings from other studies.
Finally, we control for the impact of venture capital investment on IPO underpricing. Megginson and Weiss (1991) and Gompers
(1996) show that VC-backed IPO firms have lower underpricing compared to non–VC-backed IPOs, while some more recent studies
(Francis and Hasan, 2001; Lee and Wahal, 2004; Elston and Yang, 2010) find the opposite result. Wang et al. (2018a) examine a
sample of Chinese IPOs and show that IPO firms backed by government-controlled VCs present higher earnings management in the
IPO year and poorer performance in two years post-IPO. We include an indicator variable, VC, in the baseline regression; it equals 1 if
the IPO firm is VC-backed, and zero otherwise. Table 3 reports a significantly positive association between VC and underpricing,
consistent with the findings of Francis and Hasan (2001) and numerous other recent studies.
Boulton et al. (2011) show that IPO firms in countries with higher quality financial information have less underpricing. Following
their study, we include an additional variable (EM1) to control for financial reporting quality. EM1 is measured as signed non-
operating earnings scaled by total assets one year before IPO, following Chen and Yuan (2004) and Chen et al. (2017b). Consistent
with Boulton et al. (2011), the coefficients on EM1 is significantly positive.
It is possible that other regional economic and formal institutional factors may also affect IPO underpricing, while our trust
10
Details on the control variables are introduced in the following paragraphs when we discuss the results. The definitions of all variables are
presented in Appendix A.
11
A reduction of 5.79% in IPO underpricing is the product of one standard deviation of Trust1 (0.603) and the coefficient on Trust1 (−0.096) in
Column 1 of Table 3.
12
Top6 is an indicator variable that equals 1 if the underwriter of the IPO firm is ranked among the top 6 underwriters by the Securities
Association of China (SAC), and zero otherwise. Big4 is also an indicator variable that equals 1 if the auditor of the IPO firm is ranked among the top
4 auditors, and zero otherwise.
232
Table 3
Trust and IPO underpricing.
(1) (2) (3) (4) (5) (6) (7) (8)
UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj
Trust1 −0.096⁎⁎⁎ −0.082⁎⁎⁎

(−8.15) (−5.06)
Trust2 −0.323⁎⁎⁎ −0.336⁎⁎⁎
(−23.66) (−9.76)
Trust3 −0.074⁎⁎⁎ −0.063⁎⁎⁎
(−8.15) (−5.06)
Trust4 −0.032⁎⁎⁎ −0.031⁎⁎⁎
(−4.11) (−3.70)
Size −0.147⁎⁎⁎ −0.146⁎⁎⁎ −0.148⁎⁎⁎ −0.147⁎⁎⁎ −0.147⁎⁎⁎ −0.146⁎⁎⁎ −0.148⁎⁎⁎ −0.147⁎⁎⁎
(−12.33) (−12.57) (−13.52) (−13.73) (−12.33) (−12.57) (−13.67) (−13.91)
ROA −0.820⁎⁎⁎ −0.831⁎⁎⁎ −0.866⁎⁎⁎ −0.871⁎⁎⁎ −0.820⁎⁎⁎ −0.831⁎⁎⁎ −0.920⁎⁎⁎ −0.927⁎⁎⁎
(−3.79) (−3.67) (−4.03) (−3.88) (−3.79) (−3.67) (−4.32) (−4.14)
Lev −0.082 −0.069 −0.100 −0.086 −0.082 −0.069 −0.107 −0.093
(−0.71) (−0.59) (−0.94) (−0.78) (−0.71) (−0.59) (−1.00) (−0.84)
Growth 0.123 0.125 0.119 0.120 0.123 0.125 0.146 0.148
(0.90) (0.92) (0.89) (0.90) (0.90) (0.92) (1.06) (1.07)
Age 0.002 0.002 0.001 0.002 0.002 0.002 0.001 0.001
(0.99) (1.11) (0.61) (0.72) (0.99) (1.11) (0.48) (0.59)
SOE 0.030⁎ 0.041⁎⁎ 0.045⁎⁎⁎ 0.055⁎⁎⁎ 0.030⁎ 0.041⁎⁎ 0.051⁎⁎⁎ 0.062⁎⁎⁎
(1.76) (2.39) (3.03) (3.81) (1.76) (2.39) (3.25) (3.94)
Top6 −0.005 −0.003 −0.001 0.002 −0.005 −0.003 −0.005 −0.002
(−0.23) (−0.12) (−0.06) (0.10) (−0.23) (−0.12) (−0.25) (−0.10)
Big4 0.150⁎ 0.148⁎⁎ 0.146⁎ 0.144⁎ 0.150⁎ 0.148⁎⁎ 0.135⁎ 0.133⁎
(1.92) (2.05) (1.85) (1.94) (1.92) (2.05) (1.71) (1.78)
Days 0.002 0.001 0.003 0.001 0.002 0.001 0.003 0.001
(1.27) (0.33) (1.51) (0.48) (1.27) (0.33) (1.59) (0.59)
IssueSize −0.150 −0.131 −0.112 −0.094 −0.150 −0.131 −0.089 −0.070
(−1.56) (−1.45) (−1.32) (−1.22) (−1.56) (−1.45) (−1.10) (−0.96)
Lotte −0.036⁎⁎⁎ −0.040⁎⁎⁎ −0.038⁎⁎⁎ −0.041⁎⁎⁎ −0.036⁎⁎⁎ −0.040⁎⁎⁎ −0.037⁎⁎⁎ −0.041⁎⁎⁎
(−9.89) (−11.19) (−9.41) (−10.00) (−9.89) (−11.19) (−9.19) (−9.91)
IssuePE −0.005⁎⁎⁎ −0.004⁎⁎⁎ −0.004⁎⁎⁎ −0.004⁎⁎⁎ −0.005⁎⁎⁎ −0.004⁎⁎⁎ −0.004⁎⁎⁎ −0.004⁎⁎⁎
(−7.77) (−6.52) (−8.91) (−7.22) (−7.77) (−6.52) (−8.90) (−7.18)
Up10 0.686⁎⁎⁎ 0.757⁎⁎⁎ 0.652⁎⁎⁎ 0.727⁎⁎⁎ 0.686⁎⁎⁎ 0.757⁎⁎⁎ 0.599⁎⁎⁎ 0.673⁎⁎⁎
(5.56) (6.33) (7.98) (9.72) (8.75) (10.61) (8.61) (10.49)
Down10 0.206 0.254 0.165⁎⁎ 0.215⁎⁎⁎ 0.206⁎⁎ 0.254⁎⁎⁎ 0.397⁎⁎⁎ 0.419⁎⁎⁎
(0.97) (1.28) (2.07) (2.78) (2.49) (3.13) (6.95) (6.76)
VC 0.046⁎⁎⁎ 0.051⁎⁎⁎ 0.048⁎⁎⁎ 0.053⁎⁎⁎ 0.046⁎⁎⁎ 0.051⁎⁎⁎ 0.045⁎⁎⁎ 0.050⁎⁎⁎
(6.64) (6.01) (7.49) (6.77) (6.64) (6.01) (7.53) (6.88)
EM1 0.044⁎⁎⁎ 0.043⁎⁎⁎ 0.045⁎⁎⁎ 0.044⁎⁎⁎ 0.044⁎⁎⁎ 0.043⁎⁎⁎ 0.046⁎⁎⁎ 0.045⁎⁎⁎
(3.51) (3.52) (3.41) (3.38) (3.51) (3.52) (3.20) (3.14)
GDP% −0.123 −0.179 0.077 −0.005 −0.123 −0.179 0.401 0.325
(−0.33) (−0.48) (0.22) (−0.01) (−0.33) (−0.48) (1.16) (0.97)
PopG 0.134 0.168 0.410⁎ 0.443⁎⁎ 0.134 0.168 0.159 0.180
(0.48) (0.66) (1.96) (2.42) (0.48) (0.66) (0.48) (0.56)
Religion 0.000 0.000 0.000 0.000⁎ 0.000 0.000 0.001⁎ 0.001⁎
(0.57) (0.73) (1.37) (1.75) (0.22) (0.45) (1.78) (1.80)
Constant 3.854⁎⁎⁎ 3.760⁎⁎⁎ 4.481⁎⁎⁎ 4.448⁎⁎⁎ 3.899⁎⁎⁎ 3.798⁎⁎⁎ 3.791⁎⁎⁎ 3.727⁎⁎⁎
(20.16) (18.77) (24.60) (20.82) (29.27) (27.41) (20.09) (20.76)
Industry Yes Yes Yes Yes Yes Yes Yes Yes
Year Yes Yes Yes Yes Yes Yes Yes Yes
Province Yes Yes Yes Yes Yes Yes Yes Yes
N 1953 1953 1953 1953 1953 1953 1953 1953
R2 0.514 0.513 0.503 0.501 0.514 0.513 0.501 0.500
This table reports regression results of the relation between social trust and IPO underpricing. All variables are defined in Appendix A. Industry-,
year-, and province-fixed effects are included as well. The t-statistics reported in parentheses are based on standard errors clustered by province and
industry. All continuous variables are winsorized at the 1st and 99th percentiles. *, **, and *** indicate statistical significance at the 10%, 5%, and
1% levels, respectively.
measure merely picks up those factors. To exclude this possibility, we add several variables to control for local factors documented in
other studies (Chen et al., 2015; Li et al., 2017) on the provincial differences in IPO underpricing or impacts on social trust. The first is
GDP%, which is the annual province-level GDP growth rate and which measures local economic development. PopG is the annual
233
provincial population growth rate. Both variables are obtained from the NBS. We also control for religion (Religion), the number of
religious places13 in the province, obtained from the State Administration for Religious Affairs of the People's Republic of China
website.14 All the above variables are defined in Appendix A. Further, we include industry-, year-, and province-fixed effects in our
regressions and cluster the standard errors by province and industry (Petersen, 2009).
Table 3 also reports the regression results of Eq. (3) using three other alternative measures of provincial trust, Trust2 (Columns
3–4), Trust3 (Columns 5–6), and Trust4 (Columns 7–8), respectively. The negative relation between trust and IPO underpricing
remains significant, which suggests that the impact of trust on IPO underpricing is robust to alternative measures of trust.
4.2. Path analysis of the effect of trust on IPO underpricing
We further examine the economic mechanisms through which trust affects IPO underpricing, using path analysis. As suggested by
Wright (1934), a path analysis may separate the exogenous variables' direct effects on endogenous variables from the indirect effects
on endogenous variables through some mediating variables. Path analysis has been used extensively in many empirical studies (e.g.,
Pevzner et al., 2015). Specifically in our case, path analysis allows us to test whether the negative relation between trust and IPO
underpricing is directly due to trust improving investor participation or indirectly due to trust enhancing financial reporting quality
and better quality reports lowering IPO underpricing subsequently. The mediating variable in the indirect channel is therefore
financial reporting quality.
Following Pevzner et al. (2015), we estimate a structural equation model (SEM) including a regression of IPO underpricing on
trust and a mediating variable (earnings management), and a regression of the mediating variable on trust, with control variables in
both regressions. The SEM is specified as:
Underpricingi = 0 + 1 Trust + 2 EMi + j Controlj + i (4)
EMi = 0 + 1 Trust + j Controlj + i (5)

where all variables are as defined in Eq. (3). We follow the literature on financial reporting quality and use four measures of earnings
management (EM). EM1 is signed non-operating earnings scaled by total assets one year before IPO (Chen et al., 2017b), which
represents the extent of earnings management using non-operating activities. EM2 is the value of discretionary accruals estimated
based on the modified Jones model of Kothari et al. (2005). EM3 is the value of discretionary accruals estimated based on the
modified Jones model of Dechow et al. (1995). EM4 is discretionary accruals estimated based on the Jones model (Jones, 1991). EM2,
EM3, and EM4 all represent the extent of earnings management using operating activities.15 We obtain financial statements one year
before IPO from CSMAR, and then compute EM1, EM2, EM3, and EM4. EM1 can be constructed directly from financial statements
prior to IPO. We compute EM2 in two steps. First, we estimate Eq. (6) cross-sectionally by year and industry.
1
TAit = 0 + 1 + 2( SALESit ARit ) + 3 PPEit + it ,
ASSETSit 1 (6)
where TA is total accruals scaled by lagged total assets. Total accruals equal to net income minus cash flow from operations. ΔSALES
is change in sales scaled by lagged total assets, ΔAR is change in account receivable scaled by lagged total assets, and PPE is net
property, plant and equipment scaled by lagged total assets. Second, we compute EM2 using Eq. (7):
1
EM 2 = TAit 0 1 2( SALESit ARit ) 3 PPEit ,
ASSETSit 1 (7)
where 0 , 1 , 2 and 3 are estimates of α0, α1, α2, and α3 from Eq. (6). Similarly, we construct EM3 by estimating Eqs. (8) and (9), and
EM4 by Eqs. (10) and (11).
1
TAit = 0 + 1 + 2 SALESit + 3 PPEit + it ,
ASSETSit 1 (8)
1
EM 3 = TAit 0 1 2( SALESit ARit ) 3 PPEit ,
ASSETSit 1 (9)
1
TAit = 0 + 1 + 2 SALESit + 3 PPEit + it ,
ASSETSit 1 (10)
1
EM 4 = TAit 0 1 2 SALESit 3 PPEit ,
ASSETSit 1 (11)
The number of observations decrease to 1913 when we require available financial information to calculate EM2, EM3, and EM4.
13
Sites for religious activities, such as a monastery and a temple.
14
http://www.sara.gov.cn.
15
See Kothari et al. (2005) for more details on the differences among the Jones (1991), Dechow et al. (1995) and Kothari et al. (2005) models.
234
Table 4
Path analysis of effects of trust on IPO underpricing.
Panel A: Trust1
Path = EM1 Path = EM2 Path = EM3 Path = EM4
Direct Path
α1: P(Trust1, Underpricing) −0.096⁎⁎⁎ −0.082⁎⁎⁎ −0.087⁎⁎⁎ −0.073⁎⁎⁎ −0.086⁎⁎⁎ −0.073⁎⁎⁎ −0.086⁎⁎⁎ −0.073⁎⁎⁎
(−8.15) (−5.06) (−6.72) (−3.97) (−6.59) (−3.92) (−6.60) (−3.92)
Mediated Path
β1: P(Trust1,Path) −0.037⁎ −0.013⁎⁎ −0.013⁎⁎⁎ −0.012⁎⁎
(−1.89) (−2.27) (−2.96) (−2.67)
Size −0.064⁎⁎⁎ −0.005 −0.008⁎ −0.007
(−3.06) (−1.14) (−1.82) (−1.66)
ROA 0.312 0.296⁎⁎⁎ 0.269⁎⁎⁎ 0.249⁎⁎⁎
(0.53) (5.05) (4.60) (4.24)
Lev −0.431⁎⁎⁎ 0.106⁎⁎⁎ 0.105⁎⁎⁎ 0.099⁎⁎⁎
(−3.68) (3.48) (3.45) (3.41)
Growth 0.381 −0.106⁎⁎⁎ −0.083⁎⁎⁎ −0.076⁎⁎⁎
(0.86) (−3.83) (−2.92) (−2.87)
Age 0.004⁎⁎ −0.001⁎⁎ −0.001⁎⁎ −0.001⁎⁎
(2.48) (−2.49) (−2.43) (−2.37)
SOE −0.022 −0.026⁎⁎⁎ −0.026⁎⁎⁎ −0.023⁎⁎⁎
(−1.24) (−3.14) (−3.15) (−2.85)
Big4 −0.064 −0.012 −0.011 −0.013
(−1.50) (−1.07) (−1.04) (−1.25)
Fists −0.115⁎ −0.023 −0.023 −0.019
(−1.84) (−1.23) (−1.19) (−1.01)
Exes 0.189⁎⁎⁎ 0.011 0.010 0.009
(3.81) (0.94) (0.86) (0.77)
Ind −0.198⁎⁎ 0.004 0.002 0.004
(−2.16) (0.29) (0.16) (0.33)
GDP% −1.045⁎⁎⁎ −0.034 −0.039 −0.033
(−7.91) (−0.33) (−0.38) (−0.33)
PopG −0.569⁎⁎ 0.035 0.022 0.023
(−2.32) (0.24) (0.16) (0.16)
Religion 0.001⁎ −0.000⁎⁎ −0.000⁎⁎⁎ −0.000⁎⁎⁎
(1.94) (−2.29) (−3.13) (−3.10)
Industry Yes Yes Yes Yes
Year Yes Yes Yes Yes
Province Yes Yes Yes Yes
Constant 2.128⁎⁎⁎ 0.108 0.150⁎ 0.131⁎
(4.58) (1.34) (1.99) (1.73)
R2 0.168 0.117 0.116 0.108
α2: P(Path,Underpricing) 0.044⁎⁎⁎ 0.043⁎⁎⁎ 0.098⁎⁎ 0.086⁎ (1.89) 0.103⁎⁎ 0.090⁎⁎ 0.107⁎⁎ 0.114⁎⁎
(3.51) (3.52) (2.23) (2.39) (2.15) (2.38) (2.22)
α2 β1: P(Trust1, Path)*P(Path, −0.002⁎ −0.002⁎ −0.001 −0.001 −0.001⁎ −0.001⁎ −0.001⁎ −0.001⁎
Underpricing) (−1.66) (−1.67) (−1.59) (−1.45) (−1.86) (−1.74) (−1.78) (−1.71)
N 1953 1953 1913 1913 1913 1913 1913 1913
Panel B: Trust2
Direct Path
(−23.66) (−9.76) (−7.12) (−7.94) (−7.17) (−7.99) (−7.15) (−7.97)
Mediated Path
β1: P(Trust2,Path) −0.222 −0.222 −0.049⁎⁎ −0.049⁎⁎ −0.050⁎⁎ −0.050⁎⁎ −0.049⁎⁎⁎ −0.049⁎⁎⁎
(−1.33) (−1.33) (−2.07) (−2.07) (−2.19) (−2.19) (−2.20) (−2.20)
α2: P(Path,Underpricing) 0.045⁎⁎⁎ 0.044⁎⁎⁎ 0.110⁎⁎⁎ 0.097⁎⁎⁎ 0.116⁎⁎⁎ 0.103⁎⁎⁎ 0.119⁎⁎ 0.106⁎⁎
(3.41) (3.38) (3.88) (3.91) (3.01) (2.98) (2.54) (2.55)
α2β1: P(Trust2, Path)*P(Path, −0.010 −0.010 −0.005⁎ −0.005⁎ −0.006⁎ −0.005⁎ −0.006⁎ −0.005⁎
Underpricing) (1.24) (1.24) (−1.83) (−1.83) (−1.77) (−1.76) (−1.66) (−1.67)
N 1953 1953 1913 1913 1913 1913 1913 1913
235
Table 4 (continued)
Panel C: Trust3
Direct Path
(−8.15) (−5.06) (−6.72) (−3.97) (−6.59) (−3.92) (−6.60) (−3.92)
Mediated Path
β1: P(Trust3,Path) 0.009 (0.40) 0.009 (0.40) −0.006 −0.006 −0.006⁎⁎ −0.006⁎⁎ −0.005⁎ −0.005⁎
(−1.35) (−1.35) (−2.00) (−2.00) (−1.76) (−1.76)
α2: P(Path,Underpricing) 0.044⁎⁎⁎ 0.043⁎⁎⁎ 0.098⁎⁎ 0.086⁎ (1.89) 0.103⁎⁎ 0.090⁎⁎ 0.107⁎⁎ 0.094⁎⁎
(3.51) (3.52) (2.23) (2.39) (2.15) (2.38) (2.22)
α2β1: P(Trust3, Path)*P(Path, 0.000 (0.40) 0.000 (0.40) −0.001 −0.001 −0.001 −0.001 −0.001 −0.000
Underpricing) (−1.15) (−1.10) (−1.53) (−1.46) (1.42) (−1.38)
N 1953 1953 1913 1913 1913 1913 1913 1913
Panel D: Trust4
Direct Path
α1: P(Trust4, Underpricing) −0.032⁎⁎⁎ −0.031⁎⁎⁎ −0.033⁎⁎⁎ −0.032⁎⁎ −0.033⁎⁎⁎ −0.032⁎⁎ −0.033⁎⁎⁎ −0.032⁎⁎
(−4.11) (−3.70) (−2.91) (−2.53) (−2.92) (−2.53) (−2.91) (−2.53)
Mediated Path
β1: P(Trust4,Path) −0.027 −0.027 −0.004⁎⁎ −0.004⁎⁎ −0.004⁎ −0.004⁎ −0.003⁎ −0.003⁎
(−1.30) (−1.30) (−2.08) (−2.08) (−1.91) (−1.91) (−1.70) (−1.70)
α2: P(Path,Underpricing) 0.046⁎⁎⁎ 0.045⁎⁎⁎ 0.117⁎⁎⁎ 0.105⁎⁎⁎ 0.124⁎⁎⁎ 0.111⁎⁎⁎ 0.127⁎⁎⁎ 0.114⁎⁎⁎
(3.20) (3.14) (6.27) (7.17) (4.00) (4.14) (3.14) (3.27)
α2 β1: P(Trust4, Path)*P(Path, −0.001 −0.001 −0.000⁎⁎ −0.000⁎⁎ −0.000⁎ −0.000⁎ −0.000 −0.000
Underpricing) (−1.20) (−1.20) (−1.97) (−2.00) (−1.72) (−1.73) (−1.49) (−1.51)
N 1953 1953 1913 1913 1913 1913 1913 1913
This table reports path analysis estimates of the relation between trust and IPO underpricing. We use several trust measures in the path analysis,
Trust1 in Panel A, Trust2 in Panel B, Trust3 in Panel C, and Trust4 in Panel D. For brevity, the full estimation results of trust on IPO firm's financial
reporting quality are only reported for Trust1 in Panel A. The mediating variables are firm financial reporting quality (EM1, EM2, EM3, and EM4).
All variables are defined in Appendix A. Industry-, year-, and province-fixed effects are included as well. The t-statistics reported in parentheses are
based on standard errors clustered by province and industry. All continuous variables are winsorized at the 1st and 99th percentile. *, **, and ***
indicate statistical significance at the 10%, 5%, and 1% levels, respectively.
The direct path of trust on IPO underpricing is measured by α1 in Eq. (4), which is expected to be significantly negative to support
Hypothesis 1. While the indirect path of trust on underpricing is measured by the product of β1 and α2, which is also expected to be
negative and significant if trust indirectly impacts IPO underpricing through improving financial reporting quality.
Panel A of Table 4 shows the path analysis results using Trust1. We find that no matter which underpricing proxy and financial
reporting quality proxy (EM) are used, trust always has a significantly negative impact on IPO underpricing at the 1% significance
level, as evidenced by the direct coefficients of Trust1 on UnderP (−0.096) and UnderPadj (−0.082) with t values above 3. Results
using alternative measures of trust (Panels B, C, and D) are quantitatively and qualitatively similar. This result supports the direct
channel explanation that outside investors are more likely to participate in an IPO firm in high-trust regions so that the issuing firm
does not need to provide a high discount to secure participation.
Panel A of Table 4 also presents the detailed results of trust on IPO firm's financial reporting quality. For brevity, we only report
the results using Trust1. Most of the control variables in Eq. (5) are defined in Eq. (3). Additional control variables are included
following Dechow et al. (2010). Fists is the percentage of shares owned by the largest shareholder. Exes is the percentage of shares
owned by top managers. Ind is the ratio of the number of independent directors over the total number of directors on the board. The
negative and significant coefficients on Trust1 indicate that trust lowers earnings management and enhances firms' financial reporting
quality, which is supportive for the indirect path of trust on IPO underpricing.
However, the indirect effect of trust on underpricing through the mediating variable, financial reporting quality, is much smaller
in magnitudes compared to the direct effect of trust on underpricing. For example, in Panel A of Table 4, the direct coefficient of
Trust1 on UnderP is −0.096, the coefficient of Trust1 on EM1 is −0.037, and the coefficient of EM1 on UnderP is 0.044. Therefore, the
236
indirect effect of trust on underpricing is −0.002, on average. Although it is statistically significant at the 10% level, the economic
magnitude is only 2% of the direct effect.16 This result is relatively weak and sometimes insignificant when other trust and EM proxies
are used in the regressions. These results indicate a weak indirect path explanation that trust lowers underpricing through improving
financial reporting quality. Overall, the path analysis shows that the negative impact of trust on IPO underpricing is mainly due to the
direct path that trust encourages investor participation and hence lowers the IPO underpricing.
4.3. Robustness test
This section presents two robustness tests for the baseline Eq. (3). The first robustness re-estimates the model for some different
sample specifications, while the second test estimates the baseline model using two additional trust measures.
Our first robustness test addresses the concern that our results may be driven by a few provinces with disproportionately large
numbers of IPO firms in the sample. As shown in Table 1, IPO firms are distributed unevenly across provinces; Guangdong, Zhejiang,
and Jiangsu provinces account for 17.9%, 13.3%, and 13.1%, respectively, of the 1953 IPO firms in total from 2001 to 2016. To
address this concern, we estimate the baseline regression model again either with these provinces removed individually or together.
Panel A of Table 5 presents the results, which remain robust using samples excluding these provinces, ruling out the possibility that
the negative impact of trust on IPO underpricing is driven by uneven distribution of IPO firms across provinces. To control for the
possible impact of outliers, we also run a robustness test excluding provinces with the highest two average trust scores, that is,
Shanghai and Beijing. Columns (9) and (10) in Panel A of Table 5 show that the relation between trust and underpricing remains
significantly negative when Shanghai and Beijing are excluded from the sample. We rerun the tests using alternative trust measures
with these provinces removed. The results shown in Panel A of Table 5 remain robust.
The second robustness test addresses the concern that our trust measures are mostly static over our sample period or that our trust
measures are all tied to the IPO firm's home province, which is the potential endogeneity concern that firms may choose their location
region to conduct business and earn first-day returns when they go public, or that IPO underpricing affects social trust in a firm's
location. Specifically, we use charitable contributions (Trust5) and the province-level enterprise trustworthiness score of the firm
CEO's hometown (CEOTrust1) to proxy for trust in the IPO firm. Charitable contributions are made voluntarily by firms, organiza-
tions, and individuals to help others in need. This represents altruism and trust in the social system. Several studies (Putnam, 1995;
Bekkers, 2003; Brooks, 2005; Welch et al., 2005) show that charitable contributions at the provincial level are positively correlated
with local trustworthiness.
Trust5 is calculated as annual province-level charitable contributions (in 100 Yuan) per person. The data span 2001–2014 and are
obtained from the NBS. We use the 2014 data for 2015–2016. While CEOTrust1 is the enterprise trustworthiness score of the CEO's
hometown, it is less likely to be the reason for CEO selection or to be affected by IPO underpricing. Therefore, CEOTrust1 tends to be a
good measure of trust between the issuing firm and outside investors without contamination from local factors or endogeneity
concerns. As shown in Table 2, the annual provincial charitable contribution (in 100 Yuan) per person (Trust5) is 0.525, i.e., 52.5
Yuan per person, on average, with a standard deviation of 0.507, and CEOTrust1 has a mean value of 70.5% and a standard deviation
of 54.1%.
Panel B of Table 5 shows the baseline regression results using two additional trust measures, Trust5 and CEOTrust1. Consistent
with the results shown in Table 3, the coefficients of the alternative trust measures are negative and significant, indicating that the
negative relation between trust and IPO underpricing is robust to selection of the various trust measures used in previous studies and
is less likely due to endogeneity problem.
Overall, our baseline results remain significant after excluding a few provinces with disproportionately large numbers of IPO firms
or excluding provinces with extreme trust scores and are robust to additional measures of trust, lending support to Hypothesis 1 that
trust reduces IPO underpricing.
4.4. Endogeneity correction
Our analysis suggests that social trust has a negative impact on first-day returns of IPOs. However, the negative association
between social trust and a firm's IPO underpricing could also be driven by reverse causality or omitted variables. For example, both
social trust and IPO underpricing may be affected by the same unobservable common variables. Although using CEOTrust1 as the
trust measure (Section 4.3) potentially alleviate the endogeneity concern, we further employ an instrumental variables (IV) approach.
A valid instrument for regional social trust needs to satisfy both the validity requirement, that is, high correlation with social trust,
and the exclusion requirement, that is, no correlation with residuals from the regressions of first-day returns of IPOs on trust and
other control variables.
Following Ang et al. (2015), we instrument regional trust by the number of distinct dialects in a province (Dialects) and the
number of ethnic groups in that province (Ethnic Groups). Previous studies (Easterly and Levine, 1997; Guiso et al., 2009) document
that diversified ethnic and local dialects in a region tend to reduce local social trust. Ang et al. (2015) argue that the diversified
dialects and ethnic groups across Chinese provinces are exogenous factors driving the large variations in regional trust within China.
Table 6 reports the two-stage least squares (2SLS) regression results using an instrumental variables approach. Column (1) shows
that Dialects and Ethnic Groups are highly significantly and negatively correlated with Trust1, which suggest that they satisfy the
16
0.002/0.096 = 0.02.
237
Table 5
Robustness tests.
X. Li, et al.
Panel A: Alternative sample selections
Independent variable = Trust1
Guangdong excluded Zhejiang excluded Jiangsu excluded Guangdong, Zhejiang, & Jiangsu Beijing and Shanghai excluded
excluded
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj
⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎

Trust1 −0.099 −0.083 −0.106 −0.092 −0.097 −0.083 −0.112 −0.097 −0.060 −0.056⁎⁎⁎
(−6.41) (−4.46) (−11.06) (−6.39) (−6.71) (−4.46) (−6.56) (−4.77) (−4.34) (−3.96)
Constant 3.983⁎⁎⁎ 3.894⁎⁎⁎ 3.899⁎⁎⁎ 3.876⁎⁎⁎ 4.322⁎⁎⁎ 4.242⁎⁎⁎ 3.938⁎⁎⁎ 3.847⁎⁎⁎ 4.086⁎⁎⁎ 4.015⁎⁎⁎
(14.01) (15.40) (26.99) (29.10) (27.94) (23.79) (14.61) (15.92) (20.47) (19.44)
Firm-level Controls Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Province-level Controls Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Industry fixed effect Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Year fixed effect Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Province fixed effect Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
N 1604 1604 1692 1692 1696 1696 1086 1086 1631 1631
R2 0.511 0.511 0.551 0.550 0.508 0.507 0.555 0.555 0.498 0.496
238
excluded
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Trust2 −0.388⁎⁎⁎ −0.411⁎⁎⁎ −0.299⁎⁎⁎ −0.317⁎⁎⁎ −0.337⁎⁎⁎ −0.349⁎⁎⁎ −0.349⁎⁎⁎ −0.380⁎⁎⁎ −0.265⁎⁎⁎ −0.280⁎⁎⁎
(−8.94) (−8.95) (−18.98) (−9.35) (−13.16) (−8.78) (−6.24) (−6.81) (−2.94) (−3.09)
Constant 4.747⁎⁎⁎ 4.736⁎⁎⁎ 4.402⁎⁎⁎ 4.462⁎⁎⁎ 4.940⁎⁎⁎ 4.919⁎⁎⁎ 4.607⁎⁎⁎ 4.618⁎⁎⁎ 4.625⁎⁎⁎ 4.592⁎⁎⁎
(14.27) (15.02) (35.62) (28.29) (25.65) (21.24) (16.07) (17.23) (12.99) (12.91)
N 1604 1604 1692 1692 1696 1696 1086 1086 1631 1631
R2 0.498 0.497 0.538 0.537 0.496 0.495 0.536 0.536 0.498 0.497

Table 5 (continued)

X. Li, et al.
excluded
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎

Trust3 −0.076 −0.064 −0.082 −0.071 −0.075 −0.064 −0.087 −0.075 −0.134 −0.130⁎⁎⁎
(−6.41) (−4.46) (−11.06) (−6.39) (−6.71) (−4.46) (−6.56) (−4.77) (−4.40) (−4.34)
Constant 4.029⁎⁎⁎ 3.933⁎⁎⁎ 3.948⁎⁎⁎ 3.919⁎⁎⁎ 4.367⁎⁎⁎ 4.280⁎⁎⁎ 3.990⁎⁎⁎ 3.892⁎⁎⁎ 4.185⁎⁎⁎ 4.113⁎⁎⁎
(14.61) (16.11) (28.69) (30.44) (29.61) (24.58) (15.18) (16.57) (15.58) (15.41)
N 1604 1604 1692 1692 1696 1696 1086 1086 1631 1631
R2 0.511 0.511 0.551 0.550 0.508 0.507 0.555 0.555 0.501 0.499
239
excluded
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Trust4 −0.031⁎⁎⁎ −0.030⁎⁎⁎ −0.028⁎⁎⁎ −0.029⁎⁎⁎ −0.035⁎⁎⁎ −0.034⁎⁎⁎ −0.031⁎⁎⁎ −0.033⁎⁎ −0.033⁎⁎⁎ −0.034⁎⁎⁎
(−10.46) (−4.99) (−4.00) (−3.22) (−2.97) (−2.64) (−4.24) (−2.51) (−4.56) (−4.94)
Constant 3.948⁎⁎⁎ 3.886⁎⁎⁎ 3.666⁎⁎⁎ 3.609⁎⁎⁎ 4.156⁎⁎⁎ 4.105⁎⁎⁎ 3.889⁎⁎⁎ 3.837⁎⁎⁎ 4.083⁎⁎⁎ 4.017⁎⁎⁎
(5.06) (5.13) (30.54) (36.84) (25.54) (23.88) (16.40) (17.76) (17.28) (16.52)
N 1604 1604 1692 1692 1696 1696 1086 1086 1631 1631
R2 0.495 0.494 0.537 0.536 0.494 0.494 0.533 0.533 0.498 0.496

Table 5 (continued)
Panel B: Additional measures of trust

X. Li, et al.
(1) (2) (3) (4)
UnderP UnderPadj UnderP UnderPadj
⁎⁎⁎ ⁎⁎⁎
Trust5 −0.014 −0.014
(−4.18) (−3.09)
CEOTrust1 −0.061⁎⁎ −0.057⁎⁎
(−2.18) (−2.03)
Constant 3.762⁎⁎⁎ 3.699⁎⁎⁎ 3.723⁎⁎⁎ 3.809⁎⁎⁎
(20.65) (20.52) (5.98) (5.73)
Firm-level Controls Yes Yes Yes Yes
Province-level Controls Yes Yes Yes Yes
Industry fixed effect Yes Yes Yes Yes
Year fixed effect Yes Yes Yes Yes
Province fixed effect Yes Yes Yes Yes
N 1953 1953 676 676
R2 0.501 0.499 0.599 0.600
Panel A reports the estimation results using alternative sample selections, excluding Guangdong, Zhejiang, or Jiangsu, one province at a time and then altogether, given the three provinces have
disproportionately large representation in the firm–year observations, and excluding Beijing and Shanghai, given they have extreme trust scores. Panel B reports the baseline estimation results using two
additional measures of social trust, Trust5, measured by the annual province-level charitable contributions (in 100 Yuan) per person for 2001–2014, and CEOTrust1, measured by province-level enterprise
trustworthiness score (Trust1) of the CEO's hometown. The firm-level controls include: Size, ROA, Lev, Growth, Age, SOE, Top6, Big4, Days, IssueSize, Lotte, IssuePE, Up10, Down10, VC and EM1. The
province-level controls include: GDP%, PopG, and Religion. Industry-, year-, and province-fixed effects are included as well. The t-statistics reported in parentheses are based on standard errors clustered by
240
province and industry. All continuous variables are winsorized at the 1st and 99th percentile. *, **, and *** indicate statistical significance at the 10%, 5%, and 1% levels, respectively. All variables are
defined in Appendix A.
X. Li, et al.
Table 6
Endogeneity correction.
First stage Second stage First stage Second stage First stage Second stage First stage Second stage
(1) (2) (3) (1) (2) (3) (1) (2) (3) (1) (2) (3)
Trust1 UnderP UnderPadj Trust2 UnderP UnderPadj Trust3 UnderP UnderPadj Trust4 UnderP UnderPadj
⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎

Dialects −0.037 0.012 −0.129 −0.027
(−10.25) (20.92) (−25.12) (−6.27)
EthnicGroups −0.049⁎⁎⁎ −0.026⁎⁎⁎ 0.006 −0.029⁎⁎⁎
(−8.71) (−29.02) (0.82) (−4.18)
Instrumented Trust1 −0.083⁎⁎ −0.080⁎⁎
(−2.04) (−1.97)
Instrumented Trust2 −0.346⁎ −0.329⁎
(−1.82) (−1.73)
Instrumented Trust3 −0.051⁎ −0.051⁎
(−1.81) (−1.84)
Instrumented Trust4 −0.123⁎⁎ −0.118⁎
(−1.98) (−1.91)
Constant 1.578⁎⁎⁎ 3.840⁎⁎⁎ 3.774⁎⁎⁎ 2.219⁎⁎⁎ 4.190⁎⁎⁎ 4.105⁎⁎⁎ 4.051⁎⁎⁎ 4.028⁎⁎⁎ 3.892⁎⁎⁎ 3.825⁎⁎⁎
(4.66) (11.31) (11.23) (45.34) (7.80) (7.68) (9.89) (9.94) (11.38) (11.26)
241
Firm-level Controls Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Province-level Controls Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Industry fixed effect Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Year fixed effect Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Province fixed effect Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
N 1953 1953 1953 1953 1953 1953 1953 1953 1953 1953 1953 1953
R2 0.516 0.501 0.500 0.529 0.496 0.494 0.610 0.264 0.270 0.495 0.495 0.494
Predictive power of excluded instruments

Partial-R2 0.229 0.454 0.385 0.072
Robust F-statistic (instruments) 128.012 423.532 376.172 47.298
F-statistic p-value 0.000 0.000 0.000 0.000
Test of overidentifying restrictions

Hansen J-statistic 0.694 0.635 2.279 2.077 0.569 0.529 0.862 0.790
p-Value 0.405 0.426 0.131 0.150 0.451 0.467 0.353 0.374
This table reports the results of regression analysis based on the instrumental variable (IV) approach using Dialects and Ethnic Groups as the instruments for trust. The partial R2 and F-statistic test the null
hypothesis of weak instruments. The test of overidentifying restrictions (Hansen J-test) tests the joint null hypothesis that the excluded instruments are uncorrelated with the error term and are correctly
excluded from the second-stage equation. The firm-level controls include: Size, ROA, Lev, Growth, Age, SOE, Top6, Big4, Days, IssueSize, Lotte, IssuePE, Up10, Down10, VC, and EM1. The province-level
controls include: GDP%, PopG, and Religion. Industry-, year-, and province-fixed effects are included as well. The t-statistics reported in parentheses are based on standard errors clustered by province and
industry. All continuous variables are winsorized at the 1st and 99th percentile. *, **, and *** indicate statistical significance at the 10%, 5%, and 1% levels, respectively. All variables are defined in
Appendix A.
validity requirement. The reported robust F-statistic in the first stage is 128, confirming that Dialects and Ethnic Groups are indeed
strong instruments.
In the second stage, we use the instrumented Trust1 from the first stage in the baseline regression and show the results in Columns
(2) and (3) of Table 6. We also conduct the Hansen overidentification test to ensure the number of instruments is larger than the
number of endogenous regressors. The reported Hansen-J-statistics are 0.694 (for UnderP) and 0.635 (for UnderPadj), with p-values of
0.405 and 0.426, respectively, which do not reject the null hypothesis that the overidentifying restrictions are valid (Hansen, 1982).
The coefficient estimates of the instrumented Trust1 remain negative and significant. However, compared to the OLS results in
Table 3, the economic magnitudes of the 2SLS coefficient estimates of Trust1 are smaller than those of the OLS estimates. Specifically,
Table 6 shows that a one standard deviation increase in Trust1 is associated with a 5%17 reduction in the IPO first-day returns after
controlling for endogeneity, while the effect of one standard deviation increase in Trust1 on IPO underpricing is a 5.79% decrease in
the OLS analysis. This observation seems to suggest that the OLS estimates bias the results upwards due to endogeneity, which is
because some omitted variables might lower IPO underpricing, and at the same time, enhance regional trust. Once we use the
instruments to mitigate the endogeneity problem, the coefficient estimates become less negative. Alternatively, we use Trust2, Trust3,
and Trust4 to proxy for regional trust and rerun the 2SLS tests. The results are consistent with the results using Trust1 as the measure
of regional trust.
Overall, the negative and significant coefficients on the instrumented trust measures lend support to the hypothesis that regional
trust reduces IPO underpricing. Table 6 shows a significant negative impact of trust on IPO underpricing after controlling for en-
dogeneity concerns.
4.5. Cross-firm and regional variations in the effect of trust on IPO underpricing
Here we examine the cross-firm and regional variations in the effect of trust on IPO underpricing. To test Hypothesis 2, we
estimate the regression model specified below.
Underpricingi = 0 + 1 Trust + 2 Trust × InfoAsym + 3 InfoAsym + j Controlj + i, (12)
where all variables except the information environment variable (InfoAsym) are defined as in Eq. (3). We use three measures of firm
information environment: firm size, market-to-book, and whether the firm is in a high-tech industry. Prior studies (Zhang, 2006;
Garrett et al., 2014; Pevzner et al., 2015) suggest that small firms, high market-to-book firms, and firms operating in high-tech
industries typically have higher information asymmetry between the firm and outside investors. We measure firm size by total assets.
Specifically, the indicator SmallSize equals 1 if firm size is below the sample median in a given year, and zero otherwise. HighMB is
also an indicator variable; it equals 1 if the firm's market-to-book ratio is above the sample median in a given year, and zero
otherwise. The third indicator variable is Hitech, which equals 1 if the IPO firm is operating in high-tech industries, and zero
otherwise. We obtain firms' operating industries from the CSMAR database. According to Hypothesis 2, the coefficient of interest, α2,
is negative if trust plays a more important role when there is greater information asymmetry between the IPO firms and investors.
We estimate Eq. (12) and report the estimation results in Table 7. While most of the coefficients on trust itself are not significant,
the interaction terms between Trust1 and the measures of high information asymmetry have negative and significant coefficients in
all columns, which suggests the negative effect of trust on IPO underpricing is more prominent for firms with higher information
asymmetry, that is, small firms, growth (high market-to-book) firms, and firms in high-tech industries. Moreover, the sum of α1 and α2
is statistically different from zero, for example, the reported F-statistic of the sum equaling zero is 8.76 in Column (1) of Table 7,
which indicates that the impact of trust on IPO underpricing is statistically significant when firms have high information asymmetry.
This evidence shown in Table 7 is consistent with Hypothesis 2.
We further explore the effect of insider holdings on the relation between trust and IPO underpricing. To test Hypothesis 3, we
estimate the following model.
Underpricingi = 0 + 1 Trust + 2 Trust × InsiderOwn + 3 InsiderOwn + j Controlj + i, (13)
where, all variables except insider ownership (InsiderOwn) are defined as in Eq. (3). We measure insider ownership by two indicator
variables, HighOwn and HighExec. HighOwn equals 1 if the percentage of shares owned by the founders of the IPO firm is above the
sample median, and zero otherwise. HighExec equals 1 if the percentage of shares owned by the top managers of the IPO firm is above
the sample median, and zero otherwise. According to Hypothesis 3, the coefficient of interest, α2, is expected to be significantly
positive if trust plays a less important role when insiders hold a large stake in the IPO firm.
Table 8 reports the estimation coefficients of Eq. (13). All coefficients on Trust1 remain negative and significant, while all
coefficients on the interactions between Trust1 and HighOwn (HighExec) are positive and significant. The results support Hypothesis 3
that the impact of trust on IPO underpricing is less prominent for IPO firms with large insider holdings. The coefficients on both
HighOwn and HighExec are negative, but only significant on HighExec, indicating that high insider ownership does signal the quality of
the IPO firm and lower underpricing, especially when the top managers hold a large stake in the company. Finally, the F-statistics on
whether the sum of α1 and α2 is zero are insignificant or marginally significant, which suggests that the effect of trust on IPO
17
A reduction of 5% in the IPO first-day returns is the product of one standard deviation of Trust1 (0.603) and the coefficient on Trust1 (−0.083)
in Column 2 of Table 6.
242
Table 7
Effect of information asymmetry.
(1) (2) (3) (4) (5) (6)
UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj
Trust1(α1) −0.040 −0.026 −0.048⁎⁎ −0.032 −0.090⁎ −0.076

(−1.57) (−0.89) (−2.19) (−1.11) (−1.92) (−1.62)
Trust1*SmallSize(α2) −0.101⁎⁎⁎ −0.100⁎⁎⁎
(−2.63) (−2.62)
SmallSize 0.076⁎ 0.073⁎
(1.81) (1.79)
Trust1*HighMB(α2) −0.088⁎ −0.091⁎⁎
(−1.95) (−2.02)
HighMB 0.230⁎⁎⁎ 0.225⁎⁎⁎
(4.21) (4.26)
Trust1*Hitech(α2) −0.044⁎⁎ −0.037⁎⁎
(−2.28) (−2.05)
Hitech 0.025 0.018
(1.05) (0.79)
Constant 3.933⁎⁎⁎ 3.855⁎⁎⁎ 3.318⁎⁎⁎ 3.245⁎⁎⁎ 4.295⁎⁎⁎ 4.213⁎⁎⁎
(4.72) (4.77) (23.60) (17.17) (18.18) (17.80)
Firm-level Controls Yes Yes Yes Yes Yes Yes
Province-level Controls Yes Yes Yes Yes Yes Yes
Industry fixed effect Yes Yes Yes Yes Yes Yes
Year fixed effect Yes Yes Yes Yes Yes Yes
Province fixed effect Yes Yes Yes Yes Yes Yes
N 1953 1953 1953 1953 1953 1953
R2 0.516 0.515 0.526 0.524 0.514 0.513
F(α1 + α2 = 0) 8.76 6.21 78.01 92.02 6.56 4.87
P-value 0.003 0.013 0.000 0.000 0.011 0.027
This table reports regression results of the impact of information asymmetry on the relation between social trust and IPO underpricing. Information
asymmetry is proxied by three dummy variables, SmallSize, HighMB, and Hitech. The firm-level controls include: Size, ROA, Lev, Growth, Age, SOE,
Top6, Big4, Days, IssueSize, Lotte, IssuePE, Up10, Down10, VC, and EM1. The province-level controls include: GDP%, PopG, and Religion. Industry-,
year-, and province-fixed effects are included as well. The t-statistics reported in parentheses are based on standard errors clustered by province and
industry. All continuous variables are winsorized at the 1st and 99th percentile. *, **, and *** indicate statistical significance at the 10%, 5%, and
1% levels, respectively. All variables are defined in Appendix A.
underpricing is not significant when firms have high insider ownership.

Hypothesis 4 implies that the negative relation between trust and IPO underpricing is affected by the presence of political
connections. To test Hypothesis 4, we estimate the model specified below.
Underpricingi = 0 + 1 Trust + 2 Trust × PC + 3 PC + j Controlj + i, (14)
where the political connections indicator variable PC equals 1 if the firm's CEO or Chairman was or is an officer of the central
government, local government, or the military, a member of the Committee of the Chinese People's Political Consultative Conference,
or a member of the National Congress of Communist Party of China, and zero otherwise. Hypothesis 4 predicts a significant α2.
Table 9 shows that while the coefficients on Trust1 and PC are significantly negative, the coefficients on the interaction term between
Trust1 and PC are significantly positive. This evidence indicates that while both trust and political connections have negative impact
on IPO first-day returns, investors rely less on trust when the IPO firms have political connections.18 The F-statistics on the zero sum
of α1 and α2 are insignificant, indicating that there is no significant impact of trust on IPO underpricing for firms with political
connections. We interpret this evidence as trust play a less significant role in attracting investor participations for issuing firms with
political connections.
We further test Hypothesis 5 and investigate the role of trust on IPO underpricing across firms with different formal institutional
environments. The estimation model is specified below.
Underpricingi = 0 + 1 Trust + 2 Trust × FormalInst + 3 FormalInst + j Controlj + i, (15)
where FormalInst is an indicator variable and the rest of the variables are defined as in Eq. (3). Specifically, we measure firms' formal
institutional environments by two indicator variables, HighLaw and HighEdu. HighLaw equals 1 if the province-level law institutions
and environment index are above the sample median, and zero otherwise. We obtain the law institutions and environment index for
18
The total effect of PC on underpricing is captured by the sum of the two coefficients on PC*Trust1 and PC. For example, in Column (1) of Table 9,
the coefficient of Trust1*PC is 0.071 and the coefficient of PC is −0.053; since Trust1 has a mean value of 0.896 (Table 2), the effect of PC on
underpricing is 0.071*0.896–0.053 = 0.011. The positive effect of PC on underpricing suggests a “helping hand” role, consistent with Fisman
(2001), Faccio (2006) and Francis et al. (2009), however, we do not examine whether the effect is significant.
243
Table 8
Effect of insider holdings on the relation between trust and IPO underpricing.
(1) (2) (3) (4)
Trust1(α1) −0.117⁎ −0.103⁎ −0.072⁎⁎⁎ −0.066⁎⁎⁎

(−1.95) (−1.75) (−3.97) (−3.74)
Trust1*HighOwn(α2) 0.037⁎⁎ 0.040⁎⁎⁎
(2.08) (2.90)
HighOwn −0.132 −0.133
(−1.35) (−1.49)
Trust1*HighExec(α2) 0.055⁎⁎ 0.046⁎⁎
(2.48) (2.27)
HighExec −0.094⁎⁎⁎ −0.079⁎⁎⁎
(−3.58) (−3.07)
Constant 4.311⁎⁎⁎ 4.234⁎⁎⁎ 3.895⁎⁎⁎ 3.816⁎⁎⁎
(5.63) (5.56) (17.87) (18.25)
N 1953 1953 1953 1953
R2 0.514 0.513 0.503 0.501
F(α1 + α2 = 0) 1.29 0.85 1.77 2.74
P-value 0.258 0.357 0.185 0.099
This table reports the effect of insider holdings on the relation between trust and IPO underpricing. Insider holding is proxied by two dummy
variables, HighOwn and HighExec. The firm-level controls include: Size, ROA, Lev, Growth, Age, SOE, Top6, Big4, Days, IssueSize, Lotte, IssuePE, Up10,
Down10, VC, and EM1. The province-level controls include: GDP%, PopG, and Religion. Industry-, year-, and province-fixed effects are included as
well. The t-statistics reported in parentheses are based on standard errors clustered by province and industry. All continuous variables are win-
sorized at the 1st and 99th percentile. *, **, and *** indicate statistical significance at the 10%, 5%, and 1% levels, respectively. All variables are
defined in Appendix A.
Table 9
Effect of political connections.
(1) (2)
UnderP UnderPadj
Trust1(α1) −0.113⁎⁎⁎ −0.096⁎⁎⁎

(−5.85) (−4.09)
Trust1*PC(α2) 0.071⁎⁎⁎ 0.069⁎⁎⁎
(8.29) (12.16)
PC −0.053⁎⁎⁎ −0.048⁎⁎
(−2.72) (−2.51)
Constant 4.040⁎⁎⁎ 3.938⁎⁎⁎
(27.06) (26.30)
Firm-level Controls Yes Yes
Province-level Controls Yes Yes
Industry fixed effect Yes Yes
Year fixed effect Yes Yes
Province fixed effect Yes Yes
N 1953 1953
R2 0.512 0.510
F(α1 + α2 = 0) 2.53 0.91
P-value 0.113 0.341
This table reports the regression results of the impact of political connections (PC) on the relation
between social trust (Trust1) and IPO underpricing. The firm-level controls include: Size, ROA, Lev,
Growth, Age, SOE, Top6, Big4, Days, IssueSize, Lotte, IssuePE, Up10, Down10, VC, and EM1. The
province-level controls include: GDP%, PopG, and Religion. Industry-, year-, and province-fixed
effects are included as well. The t-statistics reported in parentheses are based on standard errors
clustered by province and industry. All continuous variables are winsorized at the 1st and 99th
percentile. *, **, and *** indicate statistical significance at the 10%, 5%, and 1% levels, respec-
tively. All variables are defined in Appendix A.
244
Table 10
Effect of formal institutions.
(1) (2) (3) (4)
Trust1(α1) −0.120⁎⁎⁎ −0.125⁎⁎⁎ −0.117⁎⁎⁎ −0.113⁎⁎⁎

(−3.08) (−3.32) (−6.60) (−6.05)
Trust1*HighLaw(α2) 0.107⁎⁎⁎ 0.109⁎⁎⁎
(2.85) (2.95)
HighLaw −0.060⁎⁎⁎ −0.052⁎⁎⁎
(−3.32) (−3.02)
Trust1*HighEdu(α2) 0.086⁎⁎⁎ 0.082⁎⁎⁎
(4.38) (3.89)
HighEdu −0.028 −0.023
(−1.38) (−1.12)
Constant 3.803⁎⁎⁎ 3.742⁎⁎⁎ 4.216⁎⁎⁎ 4.166⁎⁎⁎
(16.85) (17.59) (18.76) (19.23)
N 1953 1953 1953 1953
R2 0.503 0.501 0.503 0.502
F(α1 + α2 = 0) 0.19 0.30 6.25 7.67
P-value 0.661 0.585 0.026 0.015
This table reports the regression results of the impact of formal institutions on the relation between social trust and IPO underpricing. Columns (1)
and (2) of this table show the effect of law on the relation between trust and IPO underpricing. Columns (3) and (4) of this table show the effect of
education on the relation between social trust and IPO underpricing. The firm-level controls include: Size, ROA, Lev, Growth, Age, SOE, Top6, Big4,
Days, IssueSize, Lotte, IssuePE, Up10, Down10, VC, and EM1. The province-level controls include: GDP%, PopG, and Religion. Industry-, year-, and
province-fixed effects are included as well. The t-statistics reported in parentheses are based on standard errors clustered by province and industry.
All continuous variables are winsorized at the 1st and 99th percentile. *, **, and *** indicate statistical significance at the 10%, 5%, and 1% levels,
respectively. All variables are defined in Appendix A.
each province in China for the 2001–2014 period from the National Economic Research Institute (NERI), which measures the quality
of law institutions and environment at the provincial level. A higher index indicates a better quality of law institutions and en-
vironment in the province. HighEdu is also an indicator variable; it equals 1 if the province-level ratio of the population with a college
degree and above to the population over 6 years old is above the sample median, and zero otherwise. Hypothesis 5 indicates a
positive and significant α2, suggesting that trust plays a less important role in provinces with stronger formal institutional en-
vironments, such as a stronger legal system and a higher average education level.
Table 10 presents the estimation results of Eq. (15). We find that no matter which underpricing measure is used, the stand-alone
terms of Trust1 continue to have significantly negative effects on the first-day returns of IPOs; also, the interaction terms between
trust and the stronger formal institutional indicators have significant and positive coefficients. This is consistent with Hypothesis 5,
which states that trust plays a less important role in IPO underpricing when firms are located in provinces with stronger formal
institutional environments, suggesting a substitution effect between formal and informal institutions. Moreover, the sum of α1 and α2
is insignificant when HighLaw is used to measure formal institutions, while significant when HighEdu is used. This result indicates that
the impact of trust on IPO seems to vary for firms with high institutional environments depending on the proxy for institutional
environment used.
Overall, we find that the impact of trust on IPO underpricing is more salient for firms with high information asymmetry, less
prominent for IPO firms with large insider holdings and firms with political connections, and less pronounced for firms located in
regions with stronger formal institutional environments.
5. Conclusions
Using several social trust measures and a large sample of China's IPOs from 2001 to 2016, we examine how underpricing of IPOs is
affected by trust, which constitutes part of firms' informal institutional environments. We find that IPO firms located in high-trust
provinces have lower first-day returns compared to those in low-trust provinces. This result is robust after controlling for firm
characteristics, underwriter and auditor quality, issue characteristics, “hot issue” effect, venture capital investments, and industry-,
year- and province-fixed effects. The evidence remains strong using alternative measures of trust and excluding provinces with
disproportionately large numbers of IPOs during our sample period of 2001–2016, and after removing provinces with extreme trust
scores. The negative association between trust and IPO underpricing is also robust after controlling for endogeneity by using in-
strumental variables to proxy for social trust. We interpret our results as showing that trust encourages investors to participate in IPOs
located in high-trust regions. While issuing firms are usually required to provide underpricing to secure investor participation, trust
245
lessens the burden on the issuing firms and leads to lower underpricing.
The impact of trust on IPO underpricing is more prominent for small firms, growth firms, and firms in high-tech industries, less
pronounced for firms with high insider ownership and firms with political connections, and less prominent for firms located in
regions with better formal institutional environments. These cross-sectional variations are consistent with prior theoretical studies
and empirical evidence showing that trust and formal institutions are substitutable, that investors rely less on trust when insiders
signal firm quality with large shareholdings or when firms have political connections. Further, trust plays a more important role in
poor information environments.
This study extends the literature on the role of social trust on economic development and financial market transactions by
examining the relation between trust and IPO underpricing. It contributes to the literature by providing the first evidence that social
trust as part of firms' informal institutions could impact IPO underpricing above and beyond the effects of formal institutions. We
show that, besides formal institutional factors such as legal system and credit market development, trust, an informal institutional
factor, impacts an important capital market phenomenon, that is, IPO underpricing. Along this line, further studies may want to
investigate the role of informal institutions on other capital market activities.
One possible improvement in future study is to find some better time series trust measures instead of relying on the currently
available cross-sectional measures used in this study. Although we try to explore this possibility by including two trust measures with
time series variations, the number of NGOs and annual province-level charitable donations, these measures are not perfect and could
be affected by factors other than regional trust.
Acknowledgements
This study is supported by the National Natural Science Foundation of China (Project Nos. 71572161, 71503283, 71572191),
ZHONGCAI-CSCI Pengyuan Local Finance Investment and Funding Research Institute, the Bo Zhi Shui Tong Award, Fok Ying Tung
Education Foundation (Project No. 161077), and the University of International Business and Economics Fund for Distinguished
Young Scholars (no. 18JQ10).
Appendix A. Variable definitions
Dependent variables
UnderP IPO initial day return after listing. UnderP = (P1-P0) / P0. P1 is the closing price of the first trading day; P0 is the IPO offering price.
UnderPadj IPO initial day market-adjusted return after listing. UnderPadj = (P1-P0) / P0 – (M1-M0)/ M0. P1 is the closing price of the first trading day; P0 is the
IPO offering price; and M0 and M1 are the A-share market index closing prices on the IPO issuing day and the first trading day, respectively.
Social trust variables

Trust1 Enterprise trustworthiness at the provincial level, from a survey conducted by the “Chinese Enterprise Survey System” in 2000 that measures the
trustworthiness of enterprises in China, where a higher index value suggests a more trustworthy enterprise business community in the province.
Trust2 A provincial-level index, from a survey conducted by the “China General Social Survey” in 2003 that measures the degree to which residents trust
strangers. The mean value of residents' opinions in a province is used as a proxy of trustworthiness, where a higher index value suggests residents
in the province have greater trust in strangers.
Trust3 Citizen trustworthiness at the provincial level, in the form of the number of milliliters of blood donated on a purely voluntary basis in 2000 in a
province divided by the population of that province. These data are available from the Chinese Society of Blood Transfusion.
Trust4 Number of non-government organizations in a province per million population. We obtain the data for 2001–2014 from the National Bureau of
Statistics of China (NBS). We use the data for 2014 for 2015–2016 as well.
Trust5 Annual province-level charitable contributions (in 100 Yuan) per person. We obtain the data for 2001–2014 from the NBS. We use the data for
2014 for 2015–2016 as well.
CEOTrust1 Province-level enterprise trustworthiness score (Trust1) of the CEO's hometown.
Firm-level control variables

Size Firm size, calculated as the logarithmic value of the total assets of the IPO firm.
ROA Average returns on assets over the two years preceding the IPO.
Lev Financial leverage, calculated as the average of the total debts/total assets ratio over the two years preceding the IPO.
Growth Growth potential of the firm, calculated as average scaled sales (sales/total assets) over the two years preceding the IPO.
Age Number of years between the listing date and the established date.
SOE Dummy variable that equals 1 if the firm is a state-owned enterprise and 0 otherwise.
Top6 Underwriting quality dummy variable. Top6 is an indicator variable that equals 1 if the underwriter of the IPO firm is ranked among the top-6
underwriters by the Securities Association of China (SAC), and zero otherwise.
Big4 Dummy variable that equals 1 if the firm employs Big Four auditors and 0 otherwise.
Days Number of days between IPO issuing date and listing date.
IssueSize IPO issuing size, defined as the number of issuing shares (in 100 million shares).
Lotte Lottery ratio of IPO allocation. Data are collected from the WIND database.
IssuePE IPO issuing P/E ratio, which is IPO offer price divided by earnings per share in the issuing year. Data are collected from the WIND database.
IssuePB IPO issuing P/B ratio, which is IPO offer price divided by book value of net asset per share in the issuing year.
Up10 Bull market sentiment dummy variable. Up10 equals 1 if the annual market A-share index return 1 year before the IPO is at or above 10%, and 0
otherwise.
Down10 Bear market sentiment dummy variable that equals 1 if the annual market A-share index return one year before the IPO is at or below −10%, and 0
otherwise.
VC Dummy variable that equals 1 for VC-backed IPOs and 0 otherwise.
Fists The percentage of shares owned by the largest shareholder.
Exes The percentage of shares owned by top managers.
246
Ind The ratio of the number of independent directors over the total number of directors on the board.
Instrumental variables
Dialects Number of distinct dialects in the province, obtained from Chinese Academy of Social Sciences (1987), (1990).
EthnicGroups Number of ethnic groups in the province, obtained from NBS.
Province-level control variables

GDP% Annual province-level GDP growth rate. Data are from the NBS.
PopG Annual provincial population growth rate, obtained from the NBS.
Religion Number of religious places in the province, obtained from a 2010 article on State Administration for Religious Affairs of People's Republic of
China's website (http://www.sara.gov.cn/).
Other variables of interest

EM1 Signed non-operating earnings scaled by total assets one year preceding IPO.
EM2 Value of discretionary accruals estimated based on modified Jones model (Kothari et al., 2005) for the year of IPO.
EM3 Value of discretionary accruals estimated based on modified Jones model (Dechow et al., 1995) for the year of IPO.
EM4 Value of discretionary accruals estimated based on Jones model (Jones, 1991) for the year of IPO.
HighOwn Dummy variable that equals 1 if percentage of shares owned by the founders of the IPO firm is above the sample median, and 0 otherwise.
HighExec Dummy variable that equals 1 if percentage of shares owned by top managers of the IPO firm is above the sample median, and 0 otherwise.
SmallSize Dummy variable that equals 1 if firm size is below the sample median and 0 otherwise.
HighMB Dummy variable that equals 1 if market-to-book ratio of the firm is above the sample median and 0 otherwise.
Hitech Indicator variable equal to 1 if a firm is operating in high-tech industries and 0 otherwise. The data are obtained from CSMAR.
PC Dummy variable equal to 1 if the CEO or Chairman was or is an officer of the central government, local government, or the military, a member of
Committee of the Chinese People's Political Consultative Conference, or a member of the National Congress of Communist Party of China, and 0
otherwise.
HighLaw Dummy variable that equals 1 if the law institutions and environment index is above the median and 0 otherwise. The law institutions and
environment index indices of China's 31 provinces in various years, measuring the quality of law institutions and environment at the provincial
level, are obtained from the National Economic Research Institute (NERI), with a higher index indicating a higher quality of law institutions and
environment. NERI's index project was sponsored in conjunction with the China Reform Foundation and conducted by Fan et al. (2016). We use
the 2014 index for 2015–2016 as well.
HighEdu Dummy variable that equals 1 if the ratio of the population with a college degree and above to the population over 6 years old at the province level
is above the median and 0 otherwise. We obtain the data from the NBS.
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Journal of Corporate Finance 56 (2019) 224–248

Contents lists available at ScienceDirect

Journal of Corporate Finance

Trust and IPO underpricing

ARTICLE INFO ABSTRACT

3. Sample and variables

3.2. Measuring IPO underpricing

3.3. Measuring trust

3.4. Sample statistics

Province Number of IPOs Trust1 UnderP UnderPadj

Hainan 9 0.041 0.577 0.540

Panel B: Distribution of sample IPO firms by province and industry

Panel B: Distribution of sample IPO firms by province and industry

Jiangsu 257 0 197 1 7 5 0 17 7 5 6 6 2 3 0 1

Variable N Mean 25th pctl. Median 75th pctl. Std. dev.

UnderP 1953 0.594 0.265 0.440 0.679 0.660

N Mean Median N Mean Median Diff. Diff.

UnderP 910 0.658 0.440 1043 0.539 0.440 0.119 ⁎⁎⁎

4.1. Trust and IPO underpricing

Underpricingi = 0 + 1 Trust + j Controlj + i (3)

UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj

Trust1 −0.096⁎⁎⁎ −0.082⁎⁎⁎

4.2. Path analysis of the effect of trust on IPO underpricing

Underpricingi = 0 + 1 Trust + 2 EMi + j Controlj + i (4)

EMi = 0 + 1 Trust + j Controlj + i (5)

Path = EM1 Path = EM2 Path = EM3 Path = EM4

UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj

Path = EM1 Path = EM2 Path = EM3 Path = EM4

UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj

(continued on next page)

Path = EM1 Path = EM2 Path = EM3 Path = EM4

UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj

Path = EM1 Path = EM2 Path = EM3 Path = EM4

UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj

4.3. Robustness test

4.4. Endogeneity correction

Panel A: Alternative sample selections

Independent variable = Trust1

⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎

(continued on next page)

Independent variable = Trust3

⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎

Independent variable = Trust4

(continued on next page)

Panel B: Additional measures of trust

(1) (2) (3) (4)

UnderP UnderPadj UnderP UnderPadj

⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎ ⁎⁎⁎

Predictive power of excluded instruments

Test of overidentifying restrictions

Underpricingi = 0 + 1 Trust + 2 Trust × InfoAsym + 3 InfoAsym + j Controlj + i, (12)

Underpricingi = 0 + 1 Trust + 2 Trust × InsiderOwn + 3 InsiderOwn + j Controlj + i, (13)

UnderP UnderPadj UnderP UnderPadj UnderP UnderPadj

Trust1(α1) −0.040 −0.026 −0.048⁎⁎ −0.032 −0.090⁎ −0.076

underpricing is not significant when firms have high insider ownership.

Underpricingi = 0 + 1 Trust + 2 Trust × PC + 3 PC + j Controlj + i, (14)

Underpricingi = 0 + 1 Trust + 2 Trust × FormalInst + 3 FormalInst + j Controlj + i, (15)

UnderP UnderPadj UnderP UnderPadj

Trust1(α1) −0.117⁎ −0.103⁎ −0.072⁎⁎⁎ −0.066⁎⁎⁎

Trust1(α1) −0.113⁎⁎⁎ −0.096⁎⁎⁎

UnderP UnderPadj UnderP UnderPadj

Trust1(α1) −0.120⁎⁎⁎ −0.125⁎⁎⁎ −0.117⁎⁎⁎ −0.113⁎⁎⁎

Appendix A. Variable definitions