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The role of ‘cornerstone’ investors and the Chinese state in the relative underpricing of state- and privately controlled IPO firms

In recent years, China has partially privatized some of its most important state-owned enterprise companies. Hong Kong has been host to the largest of these issues and during the five-year period, 2005–2009, more initial public offering (IPO) funds were generated through this market than any other. A key development in this market has been the emergence of ‘cornerstone’ investor agreements, which earmark stock allocations to privileged investor parties in the immediate run-up to prospectus release. This study offers a number of important contributions. First, after assessing the characteristics of such agreements, multivariate results point to some evidence of a positive association between the presence of such agreements and initial IPO returns. Second, the Perotti (1995) model contention of increased initial returns in state-controlled entities fails to garner support. Third, as an extension of work on the ‘political connections’ of Chinese A-share issuers (Fan et al., 2007; Francis et al. 2009), the political importance of issuers in the Hong Kong market-place is assessed. This study finds little evidence to support the notion that China's most politically important (strategic) issuers face lower underpricing levels than other issuers. Fourth, IPOs pitched between the incipient phase of the Global Credit Crunch (November 2007) and the Lehman Brothers’ Collapse (September 2008) generated significantly weaker initial returns than issues in other periods. Fifth, IPO clustering, underpricing rates on concurrently positioned offerings and an issuer's price-to-earnings ratio also function to explain initial returns. This last area supports the contention that offer prices fail to fully impound publicly available information (Bradley and Jordan, 2002; Loughran and Ritter, 2002).