An Evaluation of The Impact of Stock Market Reforms On IPO Under-Pricing in China The Certification Role of Underwriters

International Review of Financial Analysis 28 (2013) 20–33
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International Review of Financial Analysis
An evaluation of the impact of stock market reforms on IPO under-pricing in China:

The certification role of underwriters☆
Chen Su a,⁎, David Brookfield b, 1
a
Newcastle University Business School, 5 Barrack Road, Newcastle upon Tyne, NE1 4SE, UK
b
University of Liverpool Management School, Chatham Street, Liverpool, L69 7ZH, UK
a r t i c l e i n f o a b s t r a c t
Article history: We examine how stock market reforms in China impact the certification role of underwriters in reducing sub-
Received 12 August 2011 stantial IPO under-pricing. In a broad strategy for economic growth, stock market development is seen as crucial
Received in revised form 28 June 2012 but such is the scale of IPO under-pricing in China that it calls into question the continued growth in the period
Accepted 14 January 2013
leading up to the turn of the century. Following the important 2001 IPO system reforms, however, underwriting
Available online 31 January 2013
activities grow and it is our contention that this facilitates the substantial growth in the stock market and wider
JEL classification:
economy thereafter. To show how and why underwriter activity is and continues to be important, we examine
G15 the experience of a near-population sample of Chinese IPOs over the period 1995 to 2007 using an approach that
G24 comparatively analyses the underwriting process pre- and post-reforms. In particular, we focus on underwriter
G32 reputation and, in this neglected area, discover that reputational impact is important when reforms open the list-
ing process to ‘market’ solutions to increase both market liquidity and depth. We demonstrate that the outcome
Keywords: has been successful and which has important policy implications for stock market reform generally and IPO sys-
Underwriter reputation tem reform specifically.
IPO under-pricing
© 2013 Elsevier Inc. All rights reserved.
IPO system reform
China stock market
1. Introduction The benefits of a developing financial sector for an economy are

many. The financial sector develops and income per capita grows when
There is an extensive literature on the relationship between eco- financial reforms are implemented in conjunction with improvements
nomic growth and financial liberalisation and the general consensus is in the institutional environment (Levine, 1999, 2005). Developing stock
that economic growth is positively related to financial market develop- markets provide a channel for the profitable use of domestic savings, im-
ment (Arestis & Demetriades, 1997). There is, however, no consensus prove investment productivity by efficiently allocating funds based on a
on the specific causality of development of stock market activities in market mechanism, and increase effective corporate governance through
the nexus of relations between the financial sector and its impact on market oversight (Singh & Weisse, 1998). An effective and active IPO
the economy (Liang & Teng, 2006). With uncertain theoretical determi- market is a pre-condition for the development of a nascent stock market,
nation as to the causal relationship between economic growth and a fact which the experience of China has unequivocally demonstrated.
stock market development, further empirical work is called-for to un- However, there is a puzzle at the core of the Chinese experience in that
derpin wider theoretical development. In this respect, the economic de- it appears to run counter to the generally accepted view that institutional
velopment of China and the reforms that have taken place in relation to supports in terms of an effective legal and judicial environment encour-
the financial sector provide a potentially illuminating empirical case to age greater financial transparency and better corporate governance
further inform a number of key aspects of the academic debate. (Castaneda, 2006). In terms of both the number of listings and, crucially,
stock market liquidity, China has developed a sizable stock market
faster and with greater market depth than every other transition econ-
omy in spite of having a weak legal system that does not fully support
☆ The paper was previously circulated entitled ‘A comparative study of the certification
property rights and having a significant proportion of non-tradable
role of underwriters in underpricing before and after IPO allocation system reform’. The au-
thors wish to thank Ian M. Dobbs, Robert S. Hudson, an anonymous reviewer, and the shares of listed firms (Yao & Yueh, 2008).
editors, Brian M. Lucey and Lance A. Nail, for their valuable comments and suggestions There are two possible perspectives that might explain this puz-
in the revision process. Chen Su appreciates the financial support from the Faculty zle. First, it is important to be alert to the distinction between legal
Research Fund for Early Career Researcher, Autumn/2012 (OSR/0372/FREF/0019), infrastructure and administrative infrastructure operating in key as-
Newcastle University.
⁎ Corresponding author. Tel.: +44 191 208 1656.
pects of the China stock market operations. Pistor and Xu (2005)
E-mail addresses: chen.su@ncl.ac.uk (C. Su), d.brookfield@liv.ac.uk (D. Brookfield). argue that the listing arrangements surrounding the issue of shares
1
Tel.: +44 151 795 3502. to the market are, in fact, administratively based and, so, not amenable
1057-5219/$ – see front matter © 2013 Elsevier Inc. All rights reserved.
http://dx.doi.org/10.1016/j.irfa.2013.01.006
C. Su, D. Brookfield / International Review of Financial Analysis 28 (2013) 20–33 21
solely to analysis by legal review. This view is supported by the exclu- list to be approved directly for offer to the public if they satisfy list-
sion of China from a comprehensive review of the effectiveness of IPO ing conditions. This removes approval by regulatory examination
regulation and legislation reported in La Porta, Lopez-De-Silanes, and and facilitates a greater role for underwriters (and issuers) in deter-
Shleifer (2006). The administrative perspective in China is, in fact, mining an IPO price (Cheung, Ouyang, & Tan, 2009). Crucially in its
explained by the role of the China Securities Regulation Commis- effect on underwriter reputation, the verification and approval sys-
sion (CSRC), which is an effective share allocation regime and which tem better enables the offer price to be based on a process of book
would have been an appropriate non-market share allocation mech- building whereby underwriters seek to assess market demand and
anism for a nascent stock market when market-based mechanisms thereby become more able to set an IPO price closer to what the
would have struggled (Du & Xu, 2009). The struggles of developing market might expect. This process is part of the well-recognised pre-
stock markets to deal simultaneously with transparent pricing, pric- and post-issue underwriter activities that are apparent in more devel-
ing volatility, depth, liquidity, predatory takeover behaviour, and so oped markets. In the post-issue case, underwriter support of the stock
on, lead some researchers to conclude that, alternatively, bank-based price is a method by which shareholder confidence in the newly issued
financial systems – as the situation was in China prior to the reforms stock is maintained by underwriter market activities thus reinforcing
reported below (Chan, Fung, & Thapa, 2007) – are the best vehicle by and enhancing confidence in the underwriting process. If the under-
which corporate funding is provided to support economic growth writer is to provide post-issue support then investors are likely to
(Singh & Weisse, 1998). Notwithstanding these claims, China pro- perceive ex ante that the issue price is fairly priced in the post-issue mar-
gresses with stock market reforms through the development of the ket (Aggarwal, 2000). The whole process demonstrates that underwrit-
quota system (explained below) and latterly through to the more ing is actually a collection of sequenced but integrated activities that
market-orientated reform known as the verification procedure of enable a smooth transition between initial offerings and seasoned equity
stock offering (hereafter referred to as the verification and approval offerings (Logue, Rogalski, Seward, & Foster-Johnson, 2002). It also sup-
system) in 2001, an assessment of the effectiveness of which is the ports the view that the IPO market is not segmented and not subject to dif-
purpose of this study. The quota system was formally abandoned ferent market forces than are apparent for seasoned stocks. In this
since it would not sustain long term stock market development, a re- context, reputation looks to be built as part of a continuing process
flection of a policy approach that was well recognised in wider eco- that extends some time before and some time following an initial offer-
nomic reforms in China and referred to as ‘grow out of the plan’ ing. Whilst book building is evident in China the chance of post-issue
(Naughton, 1996). prices falling beneath offer prices is unlikely (Chang, Chen, Chi, &
Second, Allen, Qian, and Qian (2005) argue that the importance of rep- Young, 2008). Hence, post-issue support is, in a practical sense, not re-
utation and relationships goes some way to offering a coherent, non-legal quired although there is some evidence for post-issue activities. Post-
explanation for the China situation. They report, in their survey evidence, issue support will continue to have limited relevance as long as post-
that one of the key reasons executives seek a public listing is concerned issue ownership by government continues at a high level. In Cai, Liu,
with ‘reputation increase’ for the business. Allied to a Confucian-based so- and Mase (2008), post-issue high levels of government ownership can
cial and cultural system that reinforces trust and reputation at the core of be taken as a signal to market participants that the newly listed compa-
relationships, it would appear that reputation, which is the focus of this ny continues to have good prospects.
paper, underpins key aspects of corporate governance and also the Our object of attention is the certification role of underwriters and our
wider nexus of business and public relationships (Greif, 1994). Our view method of analysis is market-based. Our arguments rest crucially on the
is that this key, under-researched aspect helps explain stock market de- influence of underwriter reputation in reducing investment risk and in fa-
velopment in terms of stock listing and the role of underwriters and the cilitating stock liquidity, both of which provide a more comfortable risk
task we set ourselves is to measure and demonstrate its impact. environment for investors. We argue that the role of underwriter reputa-
The de-regulation of the stock markets in April 2001 has allowed tion is under-researched and its place within the economic develop-
an increased role for underwriters and this has been reflected in a ment of China is not sufficiently recognised in existing work. In
closer scrutiny of their reputation by which investors determine a investigating this under-researched area, our research looks to pro-
level of trust in the companies they invest in. At a basic level, it is vide a more detailed picture of the nature of causality that involves
relatively easy to identify the impact of reputation in economic underwriter reputation in the nexus of economic relations that has
growth: as stock markets expand, so do underwriting activities so far eluded researchers and has held back theoretical development.
(Arestis, Demetriades, & Luintel, 2001), and increasing underwriter Specifically, we identify the impact that underwriter reputation has on
competition facilitates more effective underwriting activities. Un- reducing substantial IPO under-pricing and relate this directly to a key
derwriters trade on their reputation since their reputation is the stock market de-regulation event in China. We develop proxies for un-
source by which the value of underwriter firm is increased (Nanda derwriter reputation that are consistent with known theories of eco-
& Yun, 1997). Reputation is a reflection of evaluation standards, a nomic development as related to financial sector expansion and
process by which firm value in an IPO is arrived-at (Chemmanur & empirically demonstrate how reputation is nurtured and rewarded for
Fulghieri, 1994). The better the evaluation standards, the closer is underwriting firms and, in turn, which benefits investors by lowering
the firm value to its fair (market) value. The evaluation of this is a number of important risks surrounding the China IPO processes. In
measured by the degree of mis-pricing of the IPO with a closer undertaking this task, the following section briefly reviews the litera-
issue price to post-issue market price being a reflection of better un- ture and its relationship to the IPO system in China. Section 3 describes
derwriter evaluation standards. Reputation is built-up over a period data and methodological approaches. Section 4 presents our empirical
of time and is a reflection of the trust that investors have in underwriter results and analysis. The final section concludes this study.
evaluation standards, attested by underwriter success in minimising
IPO under-pricing. Reputation is not driven exclusively by investors 2. Literature review and empirical setting
but is also a reflection of the trust that firms have in their choice of un-
derwriters with lower under-pricing being desirable by issuing firms The China stock market has experienced fast-growing development
(Fernando, Gatchev, & Spindt, 2005). Moreover, underwriter firms pay since the establishment of the Shanghai Stock Exchange (SHSE) in
attention to reputation since higher fees are associated with more strin- December 1990 and the Shenzhen Stock Exchange (SZSE) in April 1991.
gent evaluation criteria (Fang, 2005). The total number of listed firms on both exchanges reached 1604
Thus, the extent of influence of underwriters grows with the impor- (864 on the SHSE and 740 on the SZSE) by the end of 2008. The rapid
tant IPO system reforms: the verification and approval system, which increase in the number of IPOs has created substantial demands for in-
has been effective since April 2001, allows companies wishing to vestment banking services, while the central government remains in
22 C. Su, D. Brookfield / International Review of Financial Analysis 28 (2013) 20–33
tight control of the financial services industry. 2 Before April 2001, the by ownership structure, whilst their effects are likely to be exacerbated
IPO process was characterised by a quota system in order for the central by the lockup risk. Ownership structure is important in the development
government to control the capacity and stability of the stock market. of a stock market. The privatisation of state assets, for example, is known
The annual IPO quota is determined by the CSRC on behalf of the central to be associated with the reduction of political risk for a country (Perotti
government and then allocated to each province, according to the as- & Pieter, 2001). Lockup risk is essentially a liquidity and value issue. Sub-
sessment of regional industrial structures and the balance of regional scribers are exposed, for the duration of lockup, to both grabbing and
development. Gaining more quotas for the region and being able to fulfil tunnelling risks and also to changes in economic circumstances that
them are, hence, viewed as regional government officials' political might make the expected value of their investment alter as new informa-
achievements and a sign of superior capability (Li & Zhou, 2005). On tion arrives during which they are unable to respond. It is related to li-
the other hand, the failure to meet current year's quota will result in the quidity since, without a subscription discount, investors lose time value
reduction of future quota, which adversely undermines regional authori- when shares are subscribed-for but there is no liquidity until floatation.
ties' political reputation. Therefore, the quota system inevitably results in Our broad contention is that an analysis of the impact of underwriter
rent-seeking activity and inefficient allocation of resources. For example, reputation will shed light on the under-pricing experience in China which
to maximise the quota allocation and to avoid negative political implica- we argue interact significantly with market reforms and the particular
tions of a failed IPO, regional governments either directly assist candi- risks apparent in the China stock market. Our particular attention on the
dates in earnings manipulation through financial subsidies, or assign China stock market, therefore, is further motivated by two major consid-
underwriting tasks to their acquiescent securities firms that are more erations which highlight our detailed contributions. First, although the
willing to cover up for them (Chan, Menkveld, & Yang, 2008). In April significant effect of underwriter reputation on IPO under-pricing has
2001, the quota system was replaced by a verification and approval sys- been observed in a number of developed markets,4 it may be infeasible
tem, under which qualified securities firms can recommend firms to the to expect such a measurable impact in emerging markets since, compared
CSRC for issuing and listing without constraints on the supply of IPOs, with developed markets, emerging markets exhibit a much lower level of
though the CSRC still does the final verification. The negative implication information efficiency and more severe information asymmetry
of a single failed IPO is attenuated and its impact on regional officials' ca- (Chan et al., 2008; Harvey, 1995). As a result, it takes longer for in-
reer outlook has diminished. Meanwhile, with gradual improvement in formation to be fully reflected in asset prices, which can cause the
the overall regulatory environment, it becomes more difficult and costly certification role of underwriters in emerging markets to be differ-
for regional governments to collude with securities firms and issuers re- ent from that reported in developed markets. However, the existing
siding in their jurisdictions.3 With such reforms in place, the setting was literature has paid little attention to the relationship between un-
established for a more significant role for underwriters and the develop- derwriter reputation and IPO under-pricing in emerging markets.
ment of their reputation in the market place to crystallise. This study thus attempts to fill that gap by providing further evi-
Generally, underwriters attest information through their evalua- dence from one of the largest and most important emerging markets
tion standards and help resolve the information asymmetry problem in the world, the China stock market where institutional settings and
that listing firms and their investors face. The information asymme- trading practices are different from and independent of those in de-
try problem is a part reflection of exposure to promoter risk: that is, veloped markets. For example, the China stock market is dominated
owners of a firm that requires a listing have incentives to maximise by individual investors as mutual fund industry is in its nascent stage. 5
funds raised to enhance their wealth. In the face of moral hazard, Also, the ownership structure of Chinese listed firms has some unique
promoters may over-state firm value and such activity may become features not found in developed markets due to the existence of a ma-
widespread in an environment, such as China, where legal remedy is jority of non-tradable shares held by the government and other legal
weak or weakly enforced (La Porta et al., 2006). The paradox for entities, 6 and which has been extensively criticised as an indicator of
China is that such an environment has not hindered development
4
and other factors, such as administrative oversight and the role of In examining various samples of IPOs issued in the 1980s, Carter and Manaster (1990),
Megginson and Weiss (1991), and Carter, Dark, and Singh (1998) report a negative relation-
reputation, have arguably compensated. Other risks are specifically
ship between underwriter reputation and initial returns of IPOs and attribute the lower level
apparent in China which may help focus attention as to just how rep- of under-pricing to the superior certification benefit provided by more prestigious under-
utation ameliorates the effect of a weak legal environment. With refer- writers. Studies by Beatty and Welch (1996) and Loughran and Ritter (2004), however, doc-
ence to IPOs, Tian (2011) identifies ‘grabbing’ risk, ‘tunnelling’ risk, and ument that the negative relationship was reversed in the 1990s. Loughran and Ritter (2004)
‘lockup’ risk as potentially significant. Grabbing risk relates to the expro- argue that such positive relationship reflects a structural change as a result of a boom in high-
tech related new issues in the Internet bubble period, during which more prestigious invest-
priation of assets by government and regulatory officials and is associated ment banks tend to relax their underwriting standards and begin to underwrite younger,
with over-bearing bureaucracy and corruption, supported by a weak legal more uncertain and unproven new issues that they avoid in the 1980s, thus leaving huge
system (Friedman, Johnson, Kaufmann, & Zoido-Lobaton, 2000). Tunnel- amounts of money on the table. The mixed relationship between underwriter reputation
ling risk is the same as grabbing risk but is conducted by insiders, includ- and IPO under-pricing has also been observed in other developed markets (see, e.g.,
Beckman, Garner, Marshall, and Okamura (2001) and Kirkulak and David (2005)
ing both employees and existing shareholders (Johnson, La Porta,
for the Japanese market; Dimovski and Brooks (2004) and Dimovski et al. (2011)
Lopez-de-Silanes, & Shleifer, 2000). Both grabbing and tunnelling risks for the Australian market).
are underpinned by a significant lockup risk which is the time difference 5
By the end of 2008, the total numbers of individual and institutional investors in
between listing and flotation which can run into years in China (Chan, the China stock market are 139.95 million and 0.57 million, respectively.
6
Wang, & Wei, 2004). Both grabbing and tunnelling risks are influenced The ordinary shares of a typical Chinese listed firm can be generally classified into two
categories: tradable shares and non-tradable shares. Tradable shares include A-shares, B-
shares, H-shares, and N-shares, etc., while only A-shares and B-shares are traded on the
2
The Securities Law enacted in 1 January 1999 classifies all securities firms into two cat- SHSE or SZSE. A-shares are denominated in the Chinese currency (RMB) and issued to
egories: comprehensive securities firms and brokerage securities firms, but only the for- (and traded only by) Chinese citizens, while B-shares are exclusively designed for over-
mer is allowed to engage in equity underwriting. A comprehensive securities firm is seas investors and denominated in US dollars on the SHSE or HK dollars on the SZSE.
required to meet the following criteria: 1) the securities firm must have a minimum reg- Non-tradable shares include: 1) state-owned shares held by state authorised investment
istered capital of RMB500 million; 2) senior managers and officials must possess appro- departments or institutions with state assets; 2) state-owned legal person shares held by
priate professional qualifications for employment in the securities industry; 3) the other state-owned enterprises; 3) legal person shares held by corporate enterprises or
securities firm must have established business premises and satisfactory trading facilities; public institutions and social bodies; and 4) employee shares held by employees and ini-
and 4) the securities firm must have a sound management system and standardised sep- tially prohibited from trading for a certain time period until they become tradable A-
arate administrative systems to deal with operations on its behalf and in its brokerage op- shares. Thus, although the total market capitalisation of all A-shares and B-shares on both
erations. The criteria of a brokerage securities firm are similar to those of a comprehensive exchanges was RMB12,136.64 billion (RMB9725.19 billion for all shares on the SHSE and
securities firm except for the minimum registered capital of RMB50 million. RMB2411.45 billion for all shares on the SZSE) by the end of 2008, the total market
3
More institutional features and IPO allocation procedures in the China stock mar- capitalisation of tradable shares is only RMB4521.39 billion (RMB3230.59 billion for all
ket are discussed in Sun and Tong (2003) and Su and Bangassa (2011). shares on the SHSE and RMB1290.80 billion for all shares on the SZSE).
bureaucratic control and operating inefficiency (Chan et al., 2004). The initial return, and aggregate gross proceeds. The gross proceeds are ad-
China stock market therefore provides a unique environment to test justed using the Consumer Price Index (CPI; 2005=100).10 The annual
whether underwriters help improve the efficiency and transparency total number of IPOs in our sample ranges from a low of 13 in 1995 to a
of information in the IPO process in an emerging market context. high of 168 in 1997. In 2000, the CSRC prepared to set up a Small and Me-
Second, although severe IPO under-pricing has been well reported in dium Enterprises (SMEs) Board on the SZSE, resulting in a three-year sus-
the China new issue market (see, e.g., Mok & Hui, 1998; Chen, Firth, & pension of IPOs on the SZSE from 2001 to 2003. Panel A further shows
Kim, 2004; Guo & Brooks, 2008), previous studies generally ignore the that the mean market-adjusted initial return of 1148 IPOs is 124.83%,
explanatory power of underwriter reputation. Two recent Chinese stud- consistent with well known evidence on severe under-pricing in the
ies explore the relationship between underwriter reputation and IPO China new issue market. The mean market-adjusted initial return of
under-pricing by simply introducing dummy variables of underwriter 477 IPOs issued during the verification and approval system from April
reputation in their regressions. For example, Gannon and Zhou (2008) 2001 to December 2007 (hereafter NEW system period) is 117.77%,
label the top 10 underwriters by market share in 2003 as prestigious which is significantly lower than that of 671 IPOs issued during the
underwriters and further propose an expanded model in attempts to quota system period from January 1995 to March 2001 (hereafter OLD
capture the additional effect from the underwriter side, while they system period), 129.86%, at the 5% level (t-stat=2.25; Kruskal–Wallis
find an insignificantly positive relationship between underwriter repu- χ2 =10.50),11 suggesting that the level of IPO under-pricing is substan-
tation and IPO initial returns using the 2003 data. Guo and Brooks tially reduced with the IPO system reform.
(2008) divide all underwriters into three ranks according to the average To check the influence of the size effect on IPO under-pricing, we cat-
market share based on the assumption that the underwriters with first egorise all 1148 IPOs into size quintiles based on the gross proceeds, ad-
rank are the most prestigious. According to an investigation of 286 IPOs justed using the CPI (2005 =100). Panel B of Table 1 clearly shows a
over the period March 2001 to 2005, they report that the level of short monotonically negative relationship between initial returns and the
run under-pricing of IPOs managed by more prestigious underwriters is gross proceeds. Specifically, IPOs in the Small size group with the gross
comparatively low within the first 30 trading days, while the t-statistics proceeds of less than RMB178.90 million shows an average initial return
are insignificant. of 158.19%, while IPOs in the Big group with the gross proceeds of more
than RMB580.97 million show an average initial return of 80.57%. Com-
3. Data and methodology pared with the average gross proceeds of RMB369.02 million raised by
IPOs on the SZSE, average gross proceeds of RMB1359.12 million raised
3.1. Sample description by IPOs on the SHSE are significantly higher at the 1% level (t-stat=4.69;
Kruskal–Wallis χ2 =50.27).
Our sample consists of all IPOs on the SHSE or SZSE over the period
January 1995 to December 2007, excluding those not underwritten by 3.2. Methodology
investment banks.7,8 The final sample is comprised of 639 IPOs on the
SHSE and 509 IPOs on the SZSE (a total of 1148), covering 94.95% of all Several proxies have been developed to measure underwriter rep-
A-share IPOs that went public during the whole sample period. Data on utation. Specifically, the relative positions of investment banks in
the offering price, gross proceeds, number of tradable shares, total shares stock offerings ‘tombstone announcements’ have been used in Carter
outstanding, number of days between the listing and issuing dates, and and Manaster (1990) to assign a discrete reputation ranking variable
number of seasoned equity offerings (SEOs) of each IPO firm are collect- 0–9 where a 9 (0) represents the most (least) prestigious. Johnson
ed from the GTA database.9 We use listing prospectuses of each IPO firm and Miller (1988) modify the Carter and Manaster (1990) measure
and official websites of the SHSE (http://www.sse.com.cn) and the SZSE with the use of a four-tier measure by assigning each investment
(http://www.szse.cn) to double-check these data for accuracy. Other bank a discrete reputation ranking variable 0–3 where a 3 (0) repre-
data, such as the first trading day closing price and total daily return sents the most (least) prestigious. Megginson and Weiss (1991) use
index for each IPO, as well as the SHSE and SZSE A-Share Indices are col- the relative market share of all IPOs managed by each investment
lected from DataStream. The total daily return index is adjusted for stock bank as a proxy for its reputation.
splits, stock dividends, and rights offerings. Due to the lack of a transparently convincing ranking system of un-
The market-adjusted initial return is computed as the percentage derwriter reputation in China, this study develops two alternative proxies
difference between the first trading day closing price and the offering for underwriter reputation based on relative market share and the num-
price for IPOs on the SHSE or SZSE, relative to contemporaneous return ber of all IPOs managed by each underwriter.12 Importantly, we lag the
on the SHSE or SZSE A-Share Index, respectively. The market-adjusted impact of our reputation measures to account for the fact that reputation
initial return is computed as follows: is accumulated in an observable manner based on the history of IPO per-
formance of the underwriters. That is, if an underwriter performs well in
IRi ¼ P i;1 =P i;0 − Ii;1 =Ii;0 ; ð1Þ a previous period, reputation will be enhanced and measurable in the
subsequent period. Its measurable impact is on under-pricing and, by so
where IRi is the market-adjusted initial return of IPO i; Pi,1 and Pi,0 are structuring our analysis in this manner, we are explicitly stating that rep-
the first trading day closing price and the offering price of IPO i, respec- utation causes reduced IPO under-pricing. Also, in a departure and exten-
tively; Ii,1 and Ii,0 are the corresponding market index at the end of the sion from previous approaches to measuring the impact of underwriter
first trading day and at the issuing day of IPO i, respectively. reputation which are based on the assumption that underwriter rep-
Panel A of Table 1 presents the distribution of IPOs by the year of issu- utation remains constant during the whole sample period (see, e.g.,
ing from 1995 to 2007, in terms of the number of IPOs, market-adjusted Megginson & Weiss, 1991; Kirkulak & Davis, 2005; Dimovski, Philavanh,
& Brooks, 2011), our analysis allows for reputational changes. We take
7 numerous merger and acquisitions (M&As) occurring during the
The standard deviation of IPO under-pricing is 823.53% from January 1992 to De-
cember 1994, 83.94% from January 1995 to March 2001, and 94.87% from April 2001
10
to December 2007. The pre-1995 period is too volatile and, now, perhaps too chrono- The historical data on annual Consumer Price Index (CPI; 2005 = 100) are collected
logically distant to be of much use in either challenging or supporting our research from the National Bureau of Statistics of China (NBSC).
11
questions. For that reason, we have dropped this particular period from our analysis The Kruskal–Wallis nonparametric test does not require equal sample sizes and it
and the cleaner period is from January 1995 to December 2007. is robust to departures from normality.
8 12
In this paper, we use the terms ‘underwriter’, ‘investment bank’, and ‘securities firm’ The most popular Carter and Manaster (1990) measure based upon ‘tombstone an-
as synonymous. nouncements’ to create the ranking of underwriters is not used in this study, because
9
Guo Tai An (GTA) Information Technology Co., Ltd. ‘tombstone announcements’ are inapplicable in the China IPO market.
Table 1
Distribution of IPOs by the year of issuing and the gross proceeds.
Whole market SHSE SZSE
N IR Gross proceeds N IR Gross proceeds N IR Gross proceeds
Panel A: Year of issuing

1995 13 59.58 3180.42 7 96.74 1888.35 6 16.22 1292.07
1996 162 105.36 26,708.96 79 94.33 12,466.65 83 115.87 14,242.31
1997 168 145.21 64,047.72 73 147.92 26,152.66 95 143.12 37,895.06
1998 93 134.08 39,694.22 47 133.93 21,377.16 46 134.23 18,317.06
1999 77 120.38 44,985.23 38 115.54 22,651.42 39 125.10 22,333.81
2000 129 152.52 84,168.92 93 154.90 63,276.83 36 146.36 20,892.10
2001 67 138.37 60,034.17 67 138.37 60,034.17 – – –
2002 69 125.70 55,281.41 69 125.70 55,281.41 – – –
2003 66 71.72 47,939.96 66 71.72 47,939.96 – – –
2004 98 72.44 37,744.29 59 73.20 24,156.78 39 71.29 13,587.52
2005 15 48.95 5763.07 3 76.32 2854.54 12 42.10 2908.53
2006 70 81.79 154,548.77 14 38.52 136,972.42 56 92.61 17,576.35
2007 121 193.57 432,211.40 24 126.50 393,424.33 97 210.16 38,787.07
OLD system period 671 129.86 283,258.88 366 129.78 168,286.48 305 129.94 114,972.40
NEW system period 477 117.77 773,049.67 273 100.06 700,190.20 204 141.46 72,859.47
Panel B: Gross proceeds

Small 230 158.19 29,008.42 128 148.60 18,158.36 102 175.37 11,642.26
2 230 137.48 50,346.35 128 134.49 32,318.93 102 136.76 19,252.24
3 228 128.15 71,073.13 127 129.98 45,484.77 101 127.67 26,547.32
4 230 119.81 104,884.12 128 105.62 65,711.50 102 125.12 38,777.90
Big 230 80.57 800,996.54 128 66.83 706,803.13 102 107.80 91,612.14
Full sample 1148 124.83 1,056,308.55 639 117.09 868,476.68 509 134.56 187,831.87
Panels A and B present the distribution of IPOs by the year of issuing and the gross proceeds, respectively, in terms of the number and initial returns of IPOs as well as aggregate
gross proceeds. The sample consists of 1148 IPOs issued over the period 1995 to 2007. The initial return (IR) is computed as the percentage difference between the offering price
and the first trading day closing price, relative to corresponding return on the market benchmark. The SHSE and SZSE A-Share Indices provide the benchmark for IPOs on the SHSE
and SZSE, respectively. The value of IR is presented in percentage, while the aggregate gross proceeds are presented in millions of RMB, adjusted using CPI (2005 = 100). US$1 was
approximately RMB8.07 on 31 December 2005. The final two rows in Panel A report the distribution of 671 IPOs issued during the OLD system period (January 1995 to March 2001)
and 477 IPOs issued during the NEW system period (April 2001 to December 2007).
sample period into account and thus segment the period 1992 to of all control variables). The cross-sectional OLS regression is presented
2007 into five sub-periods: 1992–1994, 1995–1997, 1998–2000, as follows:
2001–2003, and 2004–2007, in attempts to capture the dynamic
changes on underwriter reputation. In each of the five sub-periods, we IR ¼ α þ β1 ½REP1 or REP2 þ β2 LNSIZE þ β3 SEO þ β4 FLOAT þ β5 STD
calculate reputation measure of REP1 as the ratio of total gross proceeds þ β6 MARKET þ β7 TECH þ β8 LNLAG þ ε: ð2Þ
raised by each underwriter to the total gross proceeds raised in the mar-
ket, and reputation measure of REP2 as the number of all IPOs managed The descriptive statistics and Pearson correlation coefficients for
by each underwriter in the market during each sub-period.13 The use of all variables presented in Panels A and B of Table 2, respectively,
both proxies allows us to account for different attributes of underwriters. show some interesting evidence. For example, the larger size and
The first reputation measure of REP1 assumes that the greater the rela- more established IPO firms are relatively less risky, as measured by
tive market share of all IPOs managed by the underwriter, the more pres- the standard deviation of raw returns, and they offer a lower propor-
tigious the underwriter, while the second reputation measure of REP2 is tion of tradable shares. In addition, firms prefer to offer new issues in
based on the assumption that if an underwriter has managed more IPOs, a relatively good market state. 14
it is much better known by investors and possesses higher reputation
(Dimovski et al., 2011; Megginson & Weiss, 1991). To help future studies 4. Empirical results and analysis
on the impact of underwriter reputation on IPO price performance in the
China stock market, we provide a complete list of both reputation mea- 4.1. IPO performance categorised by two reputation measures
sures for 115 Chinese securities firms that managed or co-managed at
least one IPO over the period 1992 to 2007 (see Appendix I). We first divide all IPOs into high and low reputation groups where
The cross-sectional ordinary least squares (OLS) regressions are run IPOs within the high (low) reputation group are managed by more
to formally examine the certification role of underwriters in initial (less) prestigious underwriters, based on the median values of the
under-pricing of Chinese IPOs. The dependent variable of market- lagged reputation measure of REP1 in each sub-period (see the final
adjusted initial return (IR) is regressed on two alternative reputation row in Appendix I). Panel A of Table 3 shows that during the OLD sys-
measures of REP1 and REP2, separately, which are lagged to allow tem period, the mean market-adjusted initial return of 128.93% for
for reputational impact to be measured as a cumulative process of IPOs in the high reputation group is very close to that of 130.71% for
success or failure in previous listings. To assess the marginal impact IPOs in the low reputation group. Both parametric and nonparametric
of the reputation measure, the regression model includes seven ad- test statistics show that the difference in the mean initial returns be-
ditional control variables, generally used in previous IPO studies, to tween the high and low reputation groups is statistically insignificant
proxy for apparent risk of IPOs (see Appendix II for the definitions
14
To test the potential influence of multicollinearity in the regression analyses, we al-
so calculate the variance inflation factors (VIFs). VIF is defined as 1/(1 − R2), where R2
is obtained from the regression of the variable on all other regressors specified in the
13
If two underwriters co-manage one IPO, we equally divide the gross proceeds of regression model. All of multiple regressions yield a value of VIF of less than 2.0, much
the IPO between them. Similarly, if three underwriters jointly manage one IPO, the smaller than the commonly accepted threshold of 10 (Neter, Wasserman, & Kutner,
one-third of the gross proceeds raised is allocated to each of them. 1985), indicating no evidence of multicollinearity in this study.
(t-stat = 0.27; Kruskal–Wallis χ 2 = 0.05). However, during the NEW and (4), during the NEW system period. The coefficients for REP1 and
system period, we find significantly higher mean initial return for REP2 are insignificant in Regressions (1) and (2), respectively, but signif-
IPOs in the low reputation group compared with that for IPOs in the icantly negative in Regressions (3) and (4), respectively. Consistent with
high reputation group, at the 1% significance level (t-stat = 3.28; empirical evidence shown in Table 3, our OLS regression results confirm
Kruskal–Wallis χ 2 = 14.91). Panel B of Table 3 reports consistent re- that underwriter reputation has no significant impact on the level of IPO
sults when using the median values of the lagged reputation measure under-pricing during the OLD system period, but a significantly negative
of REP2 to segment the whole sample into two reputation groups. impact during the NEW system period. Such mixed relationships be-
Finally, we compare the mean market-adjusted initial returns between underwriter reputation and IPO under-pricing support our view
tween IPOs managed by underwriters with high and low reputation, in that the change in policy regime had a significant impact in opening-up
terms of the year of issuing. Based on the reputation measures of REP1 the stock market to important market-based influences such as under-
and REP2, Fig. 1a and b, respectively, illustrates consistent evidence of writer reputation. Our result helps explain some of the mixed evidence
no significant differences of initial returns between IPOs managed by previously reported regarding the certification role of underwriters.
more and less prestigious underwriters in each year during the OLD sys- We extend our analysis to examine the potential impact of exchange
tem period, but higher (lower) initial returns for IPOs managed by less of listing. Our premise is that the two exchanges serve different clientele
(more) prestigious securities firms during the NEW system period, the and may therefore exhibit different reputational effects. Specifically, the
results of which highly rule out the concern that our results presented SZSE is specially designed for young and high-tech related small and
in Table 3 might be due to the extreme performance in a specific year. medium size firms whilst the SHSE characteristically features more
established firms. As such, the two exchanges may have different risk
4.2. Cross-sectional OLS regression results profiles which may feature in the degree of under-pricing of IPOs. As
shown in Table 1, IPOs on the SZSE have significantly smaller market
Empirical results in Table 3 suggest that although underwriter repu- capitalisation and exhibit more severe under-pricing compared with
tation has no significantly impact on the level of IPO under-pricing dur- those on the SHSE. In order to eliminate potential bias on the exchange
ing the OLD system period but that there is a significantly negative of listing, we repeat all tests in Panel A of Table 4, exclusively using a
relationship between underwriter reputation and IPO under-pricing dur- sub-sample of all IPOs on the SHSE. The results shown in Panel B of
ing the NEW system period. We further examine the mixed relationships Table 4 are qualitatively similar to those presented in Panel A: no
using the cross-sectional OLS regression model of Eq. (2) based on the significant relationship between IPO under-pricing and underwriter
whole sample of IPOs on the SZSE or SZSE. reputation during the OLD system period, but significantly negative
In Panel A of Table 4, empirical results of cross-sectional OLS regres- relationship during the NEW system period.
sions with reputation measure of REP1 or REP2 are shown in Regressions Motivated by Dimovski et al. (2011), we also replicate all tests in
(1) and (2), during the OLD system period as well as in Regressions (3) Panels A and B of Table 4 using a sample with 53 outliers removed.
Table 2
Descriptive statistics and Pearson correlation coefficients among major variables.
IR REP1 REP2 SIZE SEO FLOAT STD MARKET TECH LAG
Panel A: Descriptive statistics

OLD system period
Mean 129.86 5.49 1.07 422.14 0.46 25.84 3.15 8.11 0.06 40.73
Median 116.99 5.55 1.03 301.13 0.00 25.64 2.98 4.94 0.00 23.00
Max 820.50 15.27 2.60 8369.81 2.00 65.42 8.04 55.70 1.00 1292.00
Min −130.14 0.07 0.03 42.03 0.00 0.88 1.11 −20.55 0.00 0.00
St. dev. 83.85 3.92 0.66 520.58 0.51 8.68 1.03 15.27 0.23 88.70
NEW system period
Mean 117.77 3.29 0.85 1620.65 0.35 26.98 3.15 3.77 0.07 23.91
Median 90.40 1.12 0.57 320.99 0.00 26.66 3.04 1.18 0.00 15.00
Max 525.75 27.77 2.91 62,846.93 2.00 57.77 6.12 53.50 1.00 3385.00
Min −5.72 0.02 0.04 89.15 0.00 1.36 1.28 −17.60 0.00 0.00
St. dev. 93.84 5.73 0.76 6109.68 0.52 9.29 1.05 14.58 0.26 148.18
IR REP1 REP2 LNSIZE SEO FLOAT STD MARKET TECH LNLAG
Panel B: Pearson correlation coefficients

Correlation matrix for 671 IPOs issued during the OLD system period in the upper triangle
IR 1 −0.031 −0.027 −0.214 0.080 −0.104 0.162 0.135 0.017 0.096
REP1 −0.101 1 0.749 −0.156 0.033 −0.146 0.076 0.074 0.019 0.011
REP2 −0.095 0.764 1 −0.086 0.049 −0.144 0.065 0.087 0.007 0.025
LNSIZE −0.115 −0.149 −0.016 1 −0.013 0.076 −0.137 −0.106 −0.055 −0.161
SEO 0.097 0.045 0.068 −0.019 1 0.073 −0.150 −0.063 0.011 0.072
FLOAT −0.058 −0.168 −0.136 −0.041 0.161 1 −0.180 −0.017 −0.031 −0.134
SD 0.142 0.051 0.026 −0.129 −0.199 −0.141 1 0.129 0.009 −0.159
MARKET 0.159 0.049 0.089 −0.143 −0.176 −0.035 0.115 1 −0.019 −0.143
TECH 0.023 0.020 0.007 −0.041 0.049 −0.042 0.083 0.013 1 −0.026
LNLAG 0.067 −0.048 −0.021 −0.176 0.099 −0.110 0.159 −0.117 −0.006 1
Correlation matrix for 477 IPOs issued during the NEW system period in the lower triangle
Panels A and B of this table presents descriptive statistics and Pearson correlation coefficients of the market-adjusted initial returns, two reputation measures, and seven control
variables. The sample consists of 671 IPOs issued during the OLD system period (January 1995 to March 2001) and 477 IPOs issued during the NEW system period (April 2001
to December 2007). The market-adjusted initial return (IR) is computed as the percentage difference between the offering price and the first trading day closing price, relative
to corresponding return on the market benchmark. The SHSE and SZSE A-Share Indices provide the benchmark for IPOs on the SHSE and SZSE, respectively. The reputation measure
of REP1 is proxied by the ratio of total gross proceeds raised by each underwriter to the total gross proceeds raised in the market in each of five sub-periods: 1992–1994, 1995–1997,
1998–2000, 2001–2003, and 2004–2007. The reputation measure of REP2 is proxied by the number of all IPOs managed by each underwriter in each sub-period. Both REP1 and
REP2 are lagged to allow for reputational impact to be measured as a cumulative process of success or failure in previous listings. SIZE represents gross proceeds from the offering
in millions of RMB, adjusted using CPI (2005 = 100), and expressed as a natural log of gross proceeds (LNSIZE). USD1 was approximately RMB8.07 on 31 December 2005. The values
of IR, REP1, FLOAT, STD, and MARKET are displayed in percentage. All control variables are as defined in Appendix III.
Table 3
Underwriter reputation and market-adjusted initial returns of IPOs.
Reputation OLD system period NEW system period

measures
N Mean Median St. dev. N Mean Median St. dev.
Panel A: Reputation measure of REP1

Low 348 130.71 117.11 85.39 251 130.85 97.98 103.22
High 323 128.93 116.39 82.14 226 103.24 83.54 79.70
t-Stat (0.27) (3.28)***
2
Kruskal–Wallis χ (0.05) (14.91)***
Panel B: Reputation measure of REP2

Low 344 131.27 119.21 85.57 240 127.15 96.40 101.09
High 327 128.37 114.88 81.97 237 108.26 85.30 84.83
t-Stat (0.45) (2.21)**
2
Kruskal–Wallis χ (0.22) (7.94)**
Full sample 671 129.86 116.99 83.85 477 117.77 90.40 93.84
Panels A and B of this table present descriptive statistics for the market-adjusted initial returns. The sample consists of 671 IPOs issued during the OLD system period (January 1995 to
March 2001) and 477 IPOs issued during the NEW system period (April 2001 to December 2007), categorised by two reputation measures of REP1 and REP2. The reputation measure
of REP1 is proxied by the ratio of total gross proceeds raised by each underwriter to the total gross proceeds raised in the market in each of five sub-periods: 1992–1994, 1995–1997,
1998–2000, 2001–2003, and 2004–2007. The reputation measure of REP2 is proxied by the number of all IPOs managed by each underwriter in each sub-period. Both REP1 and REP2
are lagged to allow for reputational impact to be measured as a cumulative process of success or failure in previous listings. The median values of REP1 and REP2 in each sub-period
are used to divide the sample into high and low reputation group. The market-adjusted initial return is the percentage difference between the offering price and the first trading day clos-
ing price, relative to corresponding return on the market benchmark. The SHSE or SZSE A-Share Index provides the benchmark for IPOs on the SHSE or SZSE, respectively. The
market-adjusted initial returns and the standard deviation of returns are displayed in percentage. Both parametric test statistics (t-stat) and nonparametric test statistics (Kruskal–Wallis
χ2) are employed to test differences in sub-sample average returns. ** and *** denote statistical significance at the 5 and 1% levels, respectively.
Outliers are identified as being over 3.5 standard deviations from the listing prospectuses as well as address information of all underwriters
mean. The results presented in Panels A and B of Table 5 do not qual- from the Securities Association of China (SAC). 16 We use the Google
itatively alter our conclusions. The results are not reported for the Map of China (http://ditu.google.com) to measure the geographical dis-
sake of brevity, but available on request. 15 tance between each listed firm and each underwriter and confirm the
closest underwriter to each IPO firm.17
4.3. Tests for the problem of endogeneity The first-stage regression includes the instrumental variable (IV)
of the rank of the closest underwriter to each listed firm, which is
Habib and Ljungqvist (2001), Ljungqvist, Jenkinson, and Wilhelm measured by the relative market share of all IPOs managed by each
(2003), and Fernando et al. (2005) argue that underwriter reputation underwriter at the moment when the firm went public, and other
is an endogenous variable. Notwithstanding the fact that we lag rep- control variables to estimate the lagged reputation measure of REP1.
utation in relation to IPO under-pricing we test for the potential prob- The first-stage regression is presented as follows:
lem of endogeneity which could possibly lead to bias the estimates in
REP1 ¼ α þ β1 IV þ β2 LNSIZE þ β3 SEO þ β4 FLOAT þ β5 STD
our regression analyses in Table 4. To confirm the validity of our con- þ β6 MARKET þ β7 TECH þ β8 LNLAG þ ε: ð3Þ
clusions, we apply a two-stage least squares estimation approach,
where rather than using the reputation measures developed in Sub-
section 3.2, we use the estimated reputation rank from a first-stage In the second-stage regression, we replicate Regressions (1) and (3)
regression. We construct an instrumental variable of the reputation in Table 4, replacing the variable of the reputation measure of REP1 with
of the closest underwriter to each IPO firm. We believe that the un- the estimated value ^ of REP1 obtained using coefficients of the first-stage
derwriter with the shortest geographical distance to the IPO firm is regression, as follows:
more likely to get the mandate to manage the IPO due to the lower in- IR ¼ α þ β^1 REP1 þ β 2 LNSIZE þ β 3 SEO þ β 4 FLOAT þ β 5 STD
formation costs. For instance, if an IPO firm is close to CITIC Securities, þ β6 MARKET þ β7 TECH þ β8 LNLAG þ ε: ð4Þ
a more prestigious underwriter, it is more likely for the firm to choose
the underwriter with high reputation. On the contrary, if an IPO firm is Panel A of Table 6 presents the results of two-stage regressions, using
close to New Times Securities, a less prestigious underwriter, it is more the whole sample of all IPOs on the SHSE and SZSE during the NEW sys-
likely for the firm to choose the underwriter with low reputation. This tem period. The first-stage regression result shows that the instrumental
type of spatial-criteria choosing is within the spirit of the important variable of IV is positively related to underwriter reputation at the 10%
role that relationships play in business in China and our premise is level (t-stat=1.80).18 Also, the McFadden R2 of 25.87% implies the rela-
that closer relationships are more likely to be forged when close in tively strong explanatory power of these variables on the choice of under-
terms of geographic proximity. Thus, we obtain address information writers. The second-stage regression result of a significantly negative
of the headquarters of all listed firms when they went public from ^ at the 5% level (t-stat=−2.08) in Regression (17)
coefficient of REP1,
is consistent with our earlier evidence that underwriter reputation has
15
We examine the distribution of market-adjusted initial return and find that they a significantly negative impact on IPO under-pricing during the NEW sys-
are not normally distributed. The market-adjusted initial returns (IR) have a coefficient
tem period.
of skewness of 1.58 and a coefficient of kurtosis of 5.07. A Shapiro–Wilk test also rejects
the normal distribution of IR. Although the non-normal distribution still produces un-
16
biased and consistent estimators, we, like Carter et al. (1998), also use the Box and Cox Since the SAC just provides a contemporary snapshot of the location of investment
(1964) transformations of dependent variables to rule out any potential bias that banks and some investment banks frequently change the location of their headquarters,
might affect our results. For example, we transform the dependent variable of IR such we track address information of each investment bank at the moment when they led the
that IRλ = ((1 + IR)λ − 1)/λ. The value of λ that we employ to transform the data is 0.1, IPO by double-checking the official listing prospectus of each IPO firm, so we ensure that
which produces a transformed IR with a coefficient of skewness of 0.38 and a coeffi- the geographical distance reflects the true proximity when the listed firm went public.
17
cient of kurtosis of 0.25. A Shapiro–Wilk test also confirms that the transformed IR is If an IPO was co-managed by two or more underwriters, we measure the geo-
normally distributed. The regression results based on this transformed variable are graphical distance between the listed firm and its leading underwriter.
18
qualitatively similar to our original results reported in Tables 4 and 5. The results are The unreported insignificant correlation coefficient of less than 0.1 shows that the in-
not reported for the sake of brevity, but available on request. strumental variable of IV is not correlated with the residual from the regression of interest.
Fig. 1. a: Market-adjusted initial returns of all IPOs managed by underwriters with high and low reputation proxied by REP1, in terms of the year of issuing. b: Market-adjusted initial
returns of all IPOs managed by underwriters with high and low reputation proxied by REP2, in terms of the year of issuing. The market-adjusted initial return is the percentage difference
between the offering price and the first trading day closing price, relative to corresponding return on the market benchmark. The SHSE and SZSE A-Share Indices provide the benchmark
for IPOs on the SHSE and SZSE, respectively. The reputation measures of REP 1 and REP2 are proxied, respectively, by the market share and number of IPOs managed by each underwriter in
each year during the OLD system period (January 1995 to March 2001) and the NEW system period (April 2001 to December 2007). Both REP1 and REP2 are lagged to allow for reputa-
tional impact to be measured as a cumulative process of success or failure in previous listings. The median values of REP1 and REP2 in each sub-period are used to segment all IPOs into two
reputation groups including IPOs managed by securities firms with high and low reputation in each year of issuing. 1995–96 and 2005–06 refer to the results of IPOS issued in both 1995
and 1996 together and IPOs issued in both 2005 and 2006 together, due to the limited number of 13 and 15 IPOs, respectively, issued in 1995 and 2005. In addition, 2000a and 2002a refer
to the results of IPOs issued during January 2000 to March 2001 together and IPOs issued during April 2001 to December 2002 together, respectively.
We also re-examine the exchange of listing effect and take the conser- investor perceptions in the IPO listing process. In particular, our focus
vative decision of only considering IPOs on the SHSE when repeating the on underwriter reputation helps explain the impact of the reforms
two-stage least squares regressions in Panel A of Table 6. The two-stage that took place in relation to the de-regulation of listing requirements
regression results presented in Panel B do not alter our conclusions.19 in April 2001. This watershed event, we suggest, opened-up the possi-
bility for a measured assessment of reputational impact of underwriters
5. Conclusions in relation to the severe IPO under-pricing that has been observed in the
China new issue market. Our context, analysis, and approach reveal that
We set out to examine the role of underwriter reputation in the con- the 2001 IPO system reform has facilitated development of market
text of regulatory reforms relating to firms seeking a listing on the characteristics in China akin to those observed in developed markets
Chinese stock exchanges. Against a background of a weak legal frame- and has created a new ameliorated risk environment that has assisted
work, as understood from a Western perspective, we seek to provide stock market development and economic growth more widely.
some answers to the paradox of rapid economic and stock market de- To this end, our empirical examination is comprehensive on the basis
velopment in China that runs counter to the received wisdom about of a near-population sample over a period straddling key stock market
how economies develop in relation to financial sector growth. We reforms. That is, we specifically compare the differences in impact of
argue that the rapid development, in terms of both liquidity and the certification role of underwriters in IPO under-pricing between the
depth, of the China stock market could be part-attributed to the impor- OLD and NEW system periods. We support our analysis by developing
tance of underwriter reputation and is related to how this might impact two proxies for underwriter reputation that allow also for the accumula-
tion of reputation, a feature not previously considered in existing re-
19
The results presented in Panels A and B of Table 6 are robust to the use of the
search, measured independently over five sub-periods that facilitates a
lagged reputation measure of REP2 as the independent variable in the first-stage re- re-benchmarking of reputation in each sub-period: curiously another
gressions. The results are not reported for the sake of brevity, but available on request. feature not previously considered. Our key findings support that the
Table 4
Cross-sectional results of the impact of underwriter reputation on market-adjusted returns of IPOs.
Intercept REP1 REP2 LNSIZE SEO FLOAT STD MARKET TECH LNLAG Adj. R2
Panel A: Using the whole sample of 1148IPOs on the SHSE or SZSE

OLD system period
(1) 1.5529 0.0552 −0.4532 0.2036 −0.3659 0.5369 0.4369 0.5426 0.8154 0.191
(0. 16) (−3.78)*** (0.86) (−2.36)** (3.69)*** (2.43)** (1.15) (3.15)***
(2) 1.5177 0.0474 −0.4563 0.1956 −0.3458 0.6059 0.4214 0.5231 0.7895 0.195
(0.18) (−3.58)*** (0.69) (−2.31)** (3.91)*** (2.44)** (1.10) (2.89)***
NEW system period
(3) 0.9590 −0.1895 −0.2526 0.0102 −0.1570 0.3026 1.0654 0.9145 0.0521 0.269
(−2.25)** (−2.43)** (0.10) (−1.05) (2.34)** (3.56)*** (2.12)** (0.35)
(4) 0.9718 −0.1776 −0.2125 0.0123 −0.1485 0.3178 1.1062 0.8952 0.0495 0.273
(−2.19)** (−2.15)** (0.13) (−1.16) (2.55)** (3.41)*** (2.08)** (0.31)
Panel B: Using the sub-sample of 639 IPOs on the SHSE

OLD system period
(5) 1.5164 0.0719 −0.5659 0.2197 −0.4126 0.4487 0.6589 0.4737 0.4933 0.227
(0.37) (−2.75)*** (0.63) (−3.02)*** (2.82)*** (2.51)** (0.86) (1.97)**
(6) 1.4991 0.0652 −0.5566 0.2110 −0.3981 0.4516 0.6218 0.4870 0.4962 0.222
(0.31) (−2.83)*** (0.57) (−2.97)*** (2.72)*** (2.42)** (0.92) (2.38)**
NEW system period
(7) 0.8961 −0.2212 −0.2036 0.0372 −0.2186 0.2502 1.2668 1.2255 0.2575 0.344
(−2.36)** (−2.19)** (0.25) (−1.18) (2.09)** (3.24)*** (2.23)** (1.15)
(8) 0.9170 −0.1834 −0.2226 0.0329 −0.2152 0.26974 1.2116 1.1530 0.2517 0.335
(−2.03)* (−2.08)** (0.21) (−1.12) (2.21)** (3.15)*** (2.15)** (1.02)
Panels A and B of this table present the results of cross-sectional OLS regressions explaining market-adjusted initial returns with the use of a whole sample of IPOs or with the use of a sub-sample
of IPOs, respectively, during the OLD system period (January 1995 to March 2001) and the NEW system period (April 2001 to December 2007). The sample used in Panel A includes 1,148 IPOs
on the SHSE or SZSE, while the sub-sample used in Panel B includes 639 IPOs on the SHSE. The market-adjusted initial returns, two reputation measures, and other control variables are as de-
fined in Table 2 and Appendix II. The White heteroscedasticity-consistent t-statistics are reported in parenthesis. *, **, and *** denote statistical significance at the 10, 5, and 1% levels, respectively.
impact of reputation increases in the post-reform period compared to related to stock market de-regulation: a finding that resolves some of
the pre-reform period. Our results are robust to using different reputa- the mixed evidence previously reported. We also offer a further piece
tional measures, accounting for the different characteristics of both of the jigsaw to contribute to our wider knowledge of the detailed link-
stock exchanges, and responding to the possibility that reputation, itself, ages between stock market development and economic growth. Reputa-
may indeed be a latent endogenous variable. tion is a requisite to stock market growth that supports liquidity and
Our overall conclusion is that the 2001 IPO system reform has an im- depth in a country where the legal framework is different and relies on
portant impact in opening-up stock markets to enable market character- administrative oversight in combination with reputational support. This
istics to be observed that researchers would typically associate with subtle mixture has not previously been recognised and our results sup-
more competitive and more efficient equity markets, and that this is port the contention that the lack of recognition has been an oversight
measurable in terms of the impact of underwriter reputation. Our key in relation to the growing work on understanding the Chinese economic
contribution is that reputation is empirically important and that this is paradox.
Table 5
Cross-sectional results of the impact of underwriter reputation on market-adjusted returns of IPOs, with outliers removed.
Intercept REP1 REP2 LNSIZE SEO FLOAT STD MARKET TECH LNLAG Adj. R2
Panel A: Using the whole sample of 1095 IPOs on the SHSE or SZSE
OLD system period
(9) 1.5163 0.0334 −0.4124 0.1598 −0.4171 0.4311 0.4195 0.3031 0.6205 0.216
(0.17) (−4.26)*** (0.28) (−2.78)*** (2.38)** (2.12)** (1.05) (2.71)***
(10) 1.5336 0.0312 −0.4167 0.1472 −0.3962 0.4286 0.4137 0.2818 0.6831 0.197
(0.21) (−4.18)*** (0.22) (−2.68)*** (2.31)** (2.04)** (1.01) (2.58)***
NEW system period
(11) 0.7655 −0.2396 −0.2099 0.0297 −0.2872 0.2545 1.0867 1.0184 0.0248 0.296
(−3.01)*** (−2.42)** (0.08) (−1.43) (1.76)* (4.05)*** (2.71)*** (0.29)
(12) 0.7796 −0.1708 −0.1913 0.0190 −0.2602 0.2557 0.9998 1.0641 0.2671 0.293
(−2.03)** (−2.21)** (0.05) (−1.25) (1.72)* (3.95)*** (2.68)*** (0.34)

OLD system period
(13) 1.4399 0.0776 −0.3258 0.1708 −0.4430 0.2998 0.6977 0.3534 0.3910 0.247
(0.89) (−2.68)*** (0.48) (−2.71)*** (1.99)** (2.58)*** (0.59) (2.18)**
(14) 1.4634 0.0356 −0.3576 0.1903 −0.4243 0.2886 0.7110 0.3777 0.3792 0.235
(0.76) (−2.78)*** (0.51) (−2.64)*** (1.86)* (2.62)*** (0.62) (2.08)**
NEW system period
(15) 0.7480 −0.2622 −0.2468 0.0339 −0.1951 0.4225 1.1362 0.8395 0.1408 0.362
(−2.87)*** (−2.24)** (0.10) (−0.89) (2.17)** (2.91)*** (2.01)** (0.98)
(16) 0.7769 −0.1771 −0.2242 0.0303 −0.1937 0.5051 1.1185 0.8269 0.1767 0.367
(−2.14)** (−2.16)** (0.09) (−0.83) (2.24)** (2.76)*** (1.85)* (1.15)
Panels A and B of this table present the results of cross-sectional OLS regressions explaining market-adjusted initial returns with the use of a whole sample of IPOs or with the use of a
sub-sample of IPOs, respectively, issued during the OLD system period (January 1995 to March 2001) and the NEW system period (April 2001 to December 2007). The sample used in
Panel A includes 1095 IPOs on the SHSE or SZSE, while the sub-sample used in Panel B includes 618 IPOs on the SHSE. A total of 53 outliers (21 on the SHSE and 32 on the SZSE) are iden-
tified as being over 3.5 standard deviations from the mean. The market-adjusted initial returns, two reputation measures, and other control variables are as defined in Table 2 and
Appendix II. The White heteroscedasticity-consistent t-statistics are reported in parenthesis. *, **, and *** denote statistical significance at the 10, 5, and 1% levels, respectively.
Table 6
Test for the problem of endogeneity using the two-stage least squares regressions during the NEW system period.
Intercept IV ^
REP1 LNSIZE SEO FLOAT STD MARKET TECH LNLAG Adg.R2
Panel A: Using the whole sample of 1148 IPOs on the SHSE or SZSE
First-stage regression
0.5128 0.4078 0.8965 0.1625 −0.8788 0.5270 0.3934 0.2642 0.1492 0.259
(1.94)* (2.79)*** (1.24) (−2.03)** (1.48) (2.03)** (1.25) (1.44)
Second-stage regression
(17) 0.9489 −0.1523 -0.2711 0.0318 −0.3109 0.3823 0.9861 0.8875 (0.1070) 0.357
(−2.25)** (−2.04)** (0.27) (−1.14)* (2.45)*** (2.87)*** (1.84)* (1.01)

First-stage regression
0.5748 0.5712 0.7896 0.1859 −0.7016 0.4307 0.5106 0.3447 0.1541 0.285
(2.31)** (2.64)** (1.13) (−2.18)** (1.09) (2.01)** (1.34) (1.58)*
Second-stage regression
(18) 0.8698 −0.1760 −0.2371 0.0241 0.3393 0.3301 0.7348 0.7748 0.1113 0.373
(−2.42)** (−1.91)** (0.21) (−1.79)* (2.31)** (1.71)* (1.71)* (0.78)
Panels A and B of this table present the results of two-stage least squares regressions explaining the market-adjusted initial returns with the use of a whole sample of IPOs or with
the use of a sub-sample of IPOs, respectively, during the NEW system period (April 2001 to December 2007). The sample used in Panel A includes 1148 IPOs on the SHSE or SZSE,
while the sub-sample used in Panel B includes 639 IPOs on the SHSE. The market-adjusted initial returns (IR), two reputation measures and other control variables are as defined in
Table 2 and Appendix II. The first-stage regressions use the reputation measure of REP1 as the dependent variable. The instrumental variable (IV) of the rank of the closest under-
writer to each listed firm is measured by the relative market share of all IPOs managed by each underwriter at the moment when the firm went public. The second-stage OLS re-
gressions replicate Regressions (1) and (3) in Table 4 with the use of IR as the dependent variable, replacing the reputation measure of REP1 by the predicted value of REP1 ^ obtained
with coefficients of the first-stage regression. The White heteroscedasticity-consistent t-statistics are reported in parenthesis. *, **, and *** denote statistical significance at the 10, 5,
and 1% levels, respectively.
Appendix I. A list of 115 Chinese securities firms
The appendix provides an alphabetical list of 115 Chinese securities firms based on two reputation measures in five sub-periods:
1992–1994, 1995–1997, 1998–2000, 2001–2003, and 2004–2007. The reputation measure of REP1 is proxied by the ratio of total gross pro-
ceeds raised by each underwriter to the total gross proceeds raised in the market in each of the five sub-periods, while the reputation measure
of REP2 is proxied by the number of all IPOs managed by each underwriter in each sub-period. The appendix also presents the number and
aggregate gross proceeds of all IPOs managed by each securities firm in each sub-period. The value of REP1 is presented in percentage. The
gross proceeds are presented in millions of RMB, adjusted using CPI (2005= 100). USD1 was approximately RMB8.07 on 31 December 2005. The
final two rows report the mean and median ranks of REP1 and REP2, as well as the mean and median aggregate gross proceeds of all IPOs managed
by each underwriter in each sub-period.
Underwriters 1992–1994 1995–1997 1998–2000 2001–2003 2004–2007
REP1 REP2 Gross REP1 REP2 Gross REP1 REP2 Gross REP1 REP2 Gross REP1 REP2 Gross
Proceeds Proceeds Proceeds Proceeds Proceeds
AJ Securities – – – – – – – – – – – – 0.04 1 239.33

Anhui Intl. Trust & Inv. Corp. 2.32 1 972.27 0.93 4 808.71 0.94 5 1606.32 – – – – – –
Anhui Securities – – – 1.38 5 1196.54 0.84 4 1441.24 – – – – – –
Beijing Securities 1.16 2 486.65 1.37 4 1193.79 2.07 4 3553.52 0.17 1 288.89 0.10 2 653.60
BOCI – – – – – – – – – 1.92 1.50 3214.72 4.65 4.50 29,366.31
Bohai Securities – – – – – – – – – – – – 0.26 4 1635.72
Capital Securities – – – – – – – – – – – – 0.32 2 2018.45
CGWAMC – – – – – – – – – – – – 0.04 1 260.26
CHAMC – – – – – – – – – 0.39 2 650.32 0.04 1 260.67
Changjiang BNP Paribas – – – – – – – – – – – – 0.08 4 533.90
Peregrine Securities
Changjiang Securities – – – – – – 1.20 5 2052.59 0.75 4 1250.49 0.18 2 1150.58
Chengdu Securities 0.14 0.50 57.83 – – – – – – – – – – – –
China Communication Securities – – – – – – 1.51 5 2595.85 1.38 3 2307.76 – – –
China Dragon Securities – – – – – – – – – 0.47 2 783.05 0.02 1 107.87
China Euro Securities – – – – – – – – – – – – 0.47 4.50 2985.95
China Galaxy Securities – – – – – – 0.29 1 496.05 2.22 3 3728.36 13.43 8.83 84,741.07
China Merchants Securities – – – 1.85 8 1610.85 0.17 2 290.38 0.93 3 1565.41 0.60 9 3766.05
China Minzu Securities – – – – – – – – – – – – 0.03 1 184.40
China Securities – – – – – – – – – – – – 1.28 4.50 8048.52
CICC – – – – – – 5.17 2 8872.43 23.97 6 40,218.05 27.77 10.25 175,235.00
Cinda Securities – – – – – – – – – 0.14 1 240.11 3.05 2.33 19,222.69
CITIC – – – 7.13 17 6197.40 9.73 24 16,711.18 11.46 15 19,227.08 17.77 15.75 112,136.73
Citic Wantong Securities – – – – – – – – – – – – 0.15 3 934.01
CJIS – – – – – – –– – – – – – 0.05 1 284.50
CTIC – – – 2.72 12 2363.76 0.49 3 839.62 – – – – – –
Dalian Securities – – – – – – 0.17 1 298.70 – – – – – –
(continued on next page)

(continued)
Appendix I (continued)
Underwriters 1992–1994 1995–1997 1998–2000 2001–2003 2004–2007
Dapeng Securities – – – 1.82 8 1583.78 1.48 6 2541.01 2.26 7 3795.70 – – –

Daton Securities – – – – – – – – – – – – 0.03 1 180.10
Donghai Securities – – – – – – – – – – – – 0.08 2 497.46
Essence Securities – – – – – – – – – – – – 0.08 2 507.30
Everbright Securities – – – 2.64 10 2293.71 3.68 10 6318.78 1.49 7 2497.40 0.47 11 2946.78
Fortune Securities – – – – – – – – – – – – 0.07 2 463.30
Foshan Securities – – – – – – – – – – – – 0.45 6 2812.47
Founder Securities – – – – – – – – – – – – 0.05 2 324.09
Gansu Securities – – – 0.62 2 541.36 – – – – – – – – –
Golden Sun Securities – – – – – – – – – – – – 0.07 2 460.85
Goldman Sachs Gao Hua – – – – – – – – – – – – 2.55 1.33 16,084.92
Securities
Greatwall Securities – – – 0.47 1 404.6 1.00 4 1709.45 0.88 5 1481.82 0.28 3 1771.97
Guangdong Securities 0.31 1 131.48 3.14 9 2733.06 1.33 6 2275.71 0.97 6 1631.26 0.13 3 802.36
GF Securities 0.22 1 90.55 6.30 25 5478.16 6.66 23 11,431.72 4.46 13 7485.34 1.22 17 7729.56
Guangzhou Securities 1.73 3 725.42 0.95 1 822.79 0.16 1 271.06 0.27 1 444.68 0.18 2 1134.80
Guizhou Securities – – – 0.21 1 180.24 – – – – – – – – –
Guosen Securities – – – – – – 5.87 22 10,077.75 2.57 7 4310.56 1.61 26 10,128.63
Guotai Junan Securities – – – – – – 5.90 13 10,130.86 9.42 18 15,802.76 3.31 3.58 20,866.42
Guotai Securities 10.63 4 4461.31 15.27 44 13,274.45 5.78 19 9921.81 – – – – – –
Guoyuan Securities – – – – – – – – – 0.20 1 337.00 0.27 7 1672.90
Hainan Securities 1.69 4 709.47 0.31 2 271.56 – – – – – – – – –
Haitong Securities 5.93 16.50 2488.53 5.55 14 4823.94 8.82 16 15,146.87 1.87 6 3130.39 2.13 11.33 13,458.38
Hantang Securities – – – – – – – – – – – – 0.09 2 551.27
Hebei Securities – – – 0.23 2 195.94 0.16 1 274.30 0.48 3 800.63 – – –
Heilongjiang Securities – – – 0.19 1 162.16 – – – – – – – – –
Henan Securities – – – 0.22 1 193.20 – – – – – – – – –
Hengtai Securities – – – – – – – – – – – – 0.09 2 543.94
Hongyuan Securities – – – – – – 0.33 1 558.57 0.34 1 577.79 0.41 8 2617.71
HuaAn Securities – – – – – – – – – 0.57 4 960.00 0.06 2 403.01
Huafu Securities 0.21 1 88.54 – – – – – – – – – – – –
Hualin Securities – – – – – – – – – – – – 0.04 1 232.16
Huatai Securities – – – – – – 1.02 3 1756.67 2.25 11 3771.91 0.58 9 3667.29
Huaxia Securities 6.16 8 2584.61 5.53 23 4809.12 4.62 14 7941.06 5.43 10 9118.57 0.15 3 975.16
Hubei Securities 0.83 1 350.30 3.46 10 3011.02 0.80 5 1378.18 – – – – – –
Huizhou Securities 0.47 1 195.64 – – – – – – – – – – – –
Hunan Securities 1.08 2 452.49 0.15 1 128.55 0.28 1 472.32 – – – – – –
Industrial Securities – – – 1.56 5 1353.95 0.44 2 753.68 1.84 6 3094.22 0.49 8 3061.16
Jiangsu Securities 2.67 5 1121.34 1.74 6 1508.52 0.55 3 944.35 – – – – – –
Jilin Securities 0.44 1 182.62 0.35 1 604.43 – – – – – –
Junan Securities 2.71 4 1136.14 7.41 29 6438.44 4.25 15 7305.63 – – – – – –
Jutian Securities – – – – – – – – – – – – 0.07 2 458.23
Liaoning Securities – – – 0.23 2 200.17 – – – – – – – – –
Minfa Securities – – – – – – – – – 0.33 2 549.97 0.04 1 223.60
Minsheng Securities – – – – – – – – – – – – 0.02 1 154.70
Nanfang Securities 2.52 6 1056.53 6.16 24 5354.19 9.61 25 16,493.24 7.59 10.50 12,731.60 0.34 3 2171.30
Nanjing Securities – – – – – – – – – – – – 0.03 1 159.75
New Times Securities – – – – – – – – – – – – 0.02 1 132.85
Ningbo Securities – – – 0.18 2 159.54 0.12 1 213.52 – – – – – –
Ningxia Securities – – – – – – 0.38 1 651.80 – – – – – –
Northeast Securities – – – – – – 0.10 1 179.22 0.97 5 1628.14 0.28 7 1755.63
Northwest Securities – – – – – – – – – 0.16 1 267.13 0.03 1 191.99
Orient Securities – – – – – – 0.66 3 1139.57 2.41 4 4046.55 0.24 5 1538.91
PingAn Securities – – – 0.77 2 665.34 0.44 2 747.81 1.49 8 2494.35 1.12 22 7066.30
Qingdao Securities – – – 0.12 1 103.50 – – – – – – – – –
Sealand Securities – – – – – – – – – – – – 0.10 2 624.56
Shandong Securities – – – – – – 1.69 5 2895.60 0.06 1 93.64 – – –
Shanghai Finance Securities 0.15 1 63.16 – – – – – – – – – – – –
Shanghai International 18.47 44 7748.89 – – – – – – – – – – – –
Securities
Shanghai Shenyin Securities 16.22 44 6806.94 3.49 14 3030.89 – – – – – – – – –
Shannxi Securities – – – 0.15 1 131.73 – – – – – – – – –
Shantou Securities 0.54 1 226.58 – – – – – – – – – – – –
Shanxi Securities – – – – – – – – – – – – 0.16 3 1012.33
Shenyin & Wanguo Securities 0.25 1 106.53 9.67 29 8407.94 3.66 13 6280.62 0.29 2 489.32 1.72 4.25 10,825.20
Shenzhen International 4.23 8 1776.19 3.35 7 2914.97 0.28 1 473.85 – – – – – –
Securities
Shenzhen SEZ Securities 14.24 18 5974.31 0.36 2 308.67 – – – – – – – – –
Sichuan Securities 0.27 1 113.27 – – – – – – – – – – – –
Sinolink Securities – – – – – – – – – – – – 0.07 2 440.21
Soochow Securities – – – – – – – – – – – – 0.22 6 1390.99
Southwest Securities – – – – – – 1.88 3 3225.94 0.96 2 1614.26 0.18 4 1160.33
Sun Securities – – – – – – – – – 0.7 4 1176.65 0.03 1 213.83
Three Gorges Securities – – – – – – 0.28 1 486.99 – – – – – –
Appendix
(continued)
I (continued)
Underwriters 1992–1994 1995–1997 1998–2000 2001–2003 2004–2007
Tianjin Securities 0.50 1 207.83 – – – – – – – – – – – –

Tiantong Securities – – – – – – – – – 0.89 5 1488.28 0.20 4 1264.36
Tianyi Securities – – – – – – – – – 0.46 2 768.33 0.06 2 357.53
UBS – – – – – – – – – – – – 9.31 2.83 58,727.72
United Securities – – – – – – 2.05 8 3520.48 2.2 7 3696.84 0.21 5 1317.10
V-Sun Securities – – – 0.15 1 130.68 0.13 1 226.48 – – – – – –
WEST China Securities – – – – – – – – – – – – 0.09 2 597.69
Western Securities – – – – – – – – – 0.12 1 194.84 0.07 1 458.20
Wuhan Securities 1.07 2 447.75 0.37 4 319.10 – – – – – – – – –
Wuxi Securities – – – – – – – – – – – – 0.09 2 593.01
Xiamen Securities – – – 0.21 1 185.26 0.28 2 473.77 – – – – – –
Xiangcai Securities – – – 0.79 3 691.07 2.07 9 3555.05 1.62 6 2710.67 0.09 1 544.95
Xinjiang Securities – – – – – – – – – 0.44 2 739.07 – – –
Yellow River Securities – – – 0.41 1 356.77 – – – – – – – – –
Yunnan Securities 0.66 2 276.00 0.07 1 61.87 – – – – – – – – –
Zhejiang Securities 1.25 3 522.61 0.14 1 122.53 0.34 1 578.08 0.23 1 381.82 – – –
Zhengzhou Securities – – – 0.16 1 138.35 – – – – – – – – –
Zhuhai Securities 0.96 2 403.48 0.09 1 80.69 – – – – – – – – –
Mean 10.93 25.03 4594.85 6.03 19.87 5244.99 4.77 13.91 8182.27 4.15 8.10 7002.33 2.99 9.65 25,511.88
Median 14.24 18.00 5978.31 5.55 23.00 4823.94 4.62 14.00 7941.06 2.22 7.00 3728.36 0.53 8.00 3364.23
Appendix II. Variable definitions
The appendix provides the exact definitions of all control variables included in the cross-sectional OLS regression.
Control Definitions
variables
LNSIZE LNSIZE represents the natural log of the gross proceeds raised from the offering in millions of RMB to control for any systematic influence of offering size on IPO
under-pricing, since compared with large size firms, small size firms publish less information and normally represent more risky and uncertain (Beatty & Ritter,
1986). We, therefore, expect more severe under-pricing for small size IPOs.
SEO SEO is a dummy variable set to 1 if the IPO firm issues SEOs within three years after listing, and 0 otherwise. As Allen and Faulhaber (1989) and Welch (1989)
suggest, IPO under-pricing can be sent as an efficient signal for investors to evaluate the quality of the IPO firms, and issuers would be rewarded by SEOs afterwards.
In this case, we expect SEO to be positively related to the level of under-pricing.
FLOAT FLOAT represents the fraction of tradable shares by total shares outstanding. A majority of state-owned shares and legal entity shares of listed firms on the SHSE or
SZSE are non-tradable in public, making higher agency costs and less liquidity, so the higher level of IPO under-pricing is required to compensate investors for their
increased risk exposures (Chen et al., 2004). Accordingly, we expect a negative relationship between FLOAT and the level of under-pricing.
STD STD represents the standard deviation of returns for each IPO firm, which reflects the risk of future cash flows (Johnson & Miller, 1988), and is estimated from a time
series of daily raw returns using the listing date +1 through the listing date +242. The average annual number of trading days over the period 1995–2007 in the Chinas
stock market is 242. We anticipate a positive coefficient for STD in the regression.
MARKET MARKET represents the weighted average buy-and-hold return of corresponding SHSE or SZSE A-share Index in three months before listing. The weights are
three for the most recent month, two for the next, and one for the third month before listing, based on the assumption that investors' perceptions take the last
three months into account, but give heavier weight to recent periods. Since issuers are more likely to have their IPOs issuing during periods of high market
returns (Derrien & Womack, 2003), a positive coefficient for MARKET is expected in the regression.
TECH TECH is a dummy variable set to 1 if the IPO firm has some high-tech products or services, according to the Industry Classification of Listed Companies issued by the
CSRC as of 2006, and 0 otherwise (see the distribution of all sample IPOs by industry category in Appendix III). Compared with firms in traditional industries,
high-tech firms face greater risk and uncertainty, but they are expected to have much more potential for development in the future (Ritter, 1991). We, therefore,
anticipate a positive coefficient for TECH in the regression.
LNLAG LNLAG represents the natural log of the number of days between the issuing and listing dates. Generally, the long delay increases the uncertainty of the listed
firms and the potential risk for investors (Chen et al., 2004; Chowdhry & Sherman, 1996). So we expect the issuers to price quite lower, leading to a positive
relationship between LNLAG and the level of under-pricing.
Appendix III. Distribution of 1148 Chinese IPOs by the industry category
This appendix presents the distribution of 1148 IPOs issued over the whole sample period January 1995 to December 2007 by industry cat-
egory and the distribution of 723 IPOs classified in the manufacturing industry by industry subcategory, according to the Industry Classification
of Listed Companies issued by the CSRC as of 2006, in terms of the number and initial returns of IPOs as well as aggregate gross proceeds. The
market-adjusted initial return (IR) is computed as the percentage difference between the offering price and the first trading day closing price,
relative to corresponding return on the market benchmark. The SHSE and SZSE A-Share Indices provide the benchmark for IPOs on the SHSE and
SZSE, respectively. The value of IR is presented in percentage, while the aggregate gross proceeds are presented in millions of RMB, adjusted
using CPI (2005 = 100). US$1 was approximately RMB8.07 on 31 December 2005.
Industry sector Whole market SHSE SZSE
N IR Gross proceeds N IR Gross proceeds N IR Gross proceeds
A: Agriculture, forestry, livestock farming, and fishery 36 121.49 13,943.06 23 109.14 9324.75 13 143.33 4618.32
B: Mining 32 102.48 174,706.80 23 92.53 167,395.37 9 127.91 7311.43
C: Manufacturing 723 122.70 300,487.35 367 118.84 170,065.62 356 126.67 130,421.73
C0: Food and beverage 56 135.30 22,684.90 32 126.93 14,216.72 24 146.45 8468.19
C1: Textile, clothes, and fur 55 115.08 20,014.21 30 108.23 12,732.46 25 123.30 7281.74
C2: Timber and furniture 3 54.74 1223.44 2 67.54 1014.28 1 29.13 209.16
C3: Paper making and printing 27 131.69 11,853.56 13 165.06 4814.90 14 100.70 7038.67
C4: Petroleum, chemistry, rubber, and plastic 138 113.63 48,218.53 66 110.03 24,479.10 72 116.94 23,739.43
C5: Electronic 52 152.47 21,477.23 18 147.85 6252.06 34 154.91 15,225.17
C6: Metal and non-metal 119 102.04 74,185.02 62 90.19 50,010.07 57 114.94 24,174.96
C7: Machinery, equipment, and instrument 185 126.20 70,887.70 94 124.10 36,452.79 91 128.36 34,434.90
C8: Medicine and biological products 72 133.30 24,308.41 43 132.69 17,239.14 29 134.19 7069.27
C99: Other manufacturing 16 149.14 5634.33 7 162.45 2854.09 9 138.80 2780.24
D: Electric power, gas, and water production and supply 43 112.85 33,694.03 30 113.20 29,040.69 13 112.02 4653.35
E: Construction 31 107.63 35,266.41 19 81.06 31,016.81 12 149.70 4249.59
F: Transport and storage 53 87.17 101,661.31 43 91.48 94,930.96 10 68.64 6730.35
G: Information Technology 72 158.50 36,497.05 40 134.39 27,110.24 32 188.64 9386.81
H: Wholesale and retail trade 46 130.22 12,722.03 29 130.59 8367.75 17 129.59 4354.28
I: Finance and insurance 18 81.61 310,134.94 17 78.09 306,239.94 1 141.39 3895.00
J: Real estate 22 131.49 12,811.05 14 142.20 10,402.88 8 112.74 2408.17
K: Social service 39 165.68 16,175.63 15 138.63 8935.00 24 182.59 7240.63
L: Communication and cultural industry 4 172.97 2541.17 3 194.27 2050.31 1 109.06 490.86
M: Comprehensive 29 180.03 5667.73 16 159.59 3596.36 13 205.19 2071.37
IT 72 158.50 36,497.05 40 134.39 27,110.24 32 188.64 9386.81
Non-IT 1076 122.58 1,019,811.50 599 115.93 841,366.44 477 130.93 178,445.06
Full sample 1148 124.83 1,056,308.55 639 117.09 868,476.68 509 134.56 187,831.87
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An Evaluation of The Impact of Stock Market Reforms On IPO Under-Pricing in China The Certification Role of Underwriters

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International Review of Financial Analysis 28 (2013) 20–33

Contents lists available at SciVerse ScienceDirect

International Review of Financial Analysis

An evaluation of the impact of stock market reforms on IPO under-pricing in China:

1. Introduction The beneﬁts of a developing ﬁnancial sector for an economy are

Whole market SHSE SZSE

N IR Gross proceeds N IR Gross proceeds N IR Gross proceeds

Panel A: Year of issuing

Panel B: Gross proceeds

IR REP1 REP2 SIZE SEO FLOAT STD MARKET TECH LAG

Panel A: Descriptive statistics

IR REP1 REP2 LNSIZE SEO FLOAT STD MARKET TECH LNLAG

Panel B: Pearson correlation coefﬁcients

Reputation OLD system period NEW system period

Panel A: Reputation measure of REP1

Panel B: Reputation measure of REP2

Panel A: Using the whole sample of 1148IPOs on the SHSE or SZSE

Panel B: Using the sub-sample of 639 IPOs on the SHSE

Panel B: Using the sub-sample of 618 IPOs on the SHSE

Panel B: Using the sub-sample of 639 IPOs on the SHSE

Appendix I. A list of 115 Chinese securities ﬁrms

Underwriters 1992–1994 1995–1997 1998–2000 2001–2003 2004–2007

AJ Securities – – – – – – – – – – – – 0.04 1 239.33

(continued on next page)

Dapeng Securities – – – 1.82 8 1583.78 1.48 6 2541.01 2.26 7 3795.70 – – –

Tianjin Securities 0.50 1 207.83 – – – – – – – – – – – –

Appendix II. Variable deﬁnitions

Appendix III. Distribution of 1148 Chinese IPOs by the industry category

Industry sector Whole market SHSE SZSE

N IR Gross proceeds N IR Gross proceeds N IR Gross proceeds

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