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Introduction to ChiNext

Question:

Discuss about the Chinext IPO Initial Under-Pricing-The Impact Of Risk Explored In The IPO Prospectus.

ChiNext was founded in the year 2009 in the month of October in order to help the high growing, innovative and private organizations to have accessibility in the capital market in China. The focus of ChiNext on the privately associated organizations is considerably different from the partial privatizations that look to govern the Chinese Main board. In order to provide accessibility of the private high-growth companies to the capital markets, ChiNext reduces the requirements of listing on the profitability and the size of the company in comparison to the main board (Deng & Zhou 2015). The differences in the characteristics of the company as well as the regulatory environments that is likely to create differences in the initial public offerings under-pricing and the long-run performance for ChiNext in comparison to the SME Board and the Main Board. This paper looks to analyse the ChiNext IPO under-pricing, the performance in the long-run and the elements and undertakes a comparison with the main board and the SME.

The analysis have discovered that the IPOs in the Chinese main Board experiences an increasing level of under-pricing and the underperformance is kind of modest with respect to the IPOs that are functioning in the developed markets. There have been debates that such unique characteristics of the performance of IPO in the Chinese Main Board and are related to their nature of partial privatization, the lack of opportunities of investment in China, separation of equities in the listed organizations and the firm regulations of the government in the IPO process (Deng & Zhou 2017). The effect of these features is likely to fundamentally less for the IPOs of ChiNext provided that they are not significantly not partial privatisations of the assets owned by the government faces lower level of regulatory restrictions when listing as well as ChiNext itself giving out the investors an added set of opportunities for the purpose of investment (Christofi et al., 2015). In this circumstances, it can be expected that the IPO under-pricing and the long run performance for the ChiNext listings in order to differ considerably from the Main Board IPO. The paper has been constructed based on the sample of 629 IPO firms that have been listed within 2014 to 2017 and this paper has looked to discover the initial aggregate adjusted by the abnormal return on ChiNext. This paper would therefore with the help of the literature review and the methodology would look to determine the interim proposal for the IPO under pricing in ChiNext.      

Comparison with Main Board and SME

There have been several researches on the under pricing of the IPO globally. Gao, (2014) has provided a synopsis of the aggregate initial returns on the IPOs in various countries and reveal that the extent of under pricing changes significantly across the countries with the aggregate returns usually higher in the developing markets that the underdeveloped ones.

During past few decades, under pricing of the IPO has influenced a significant body of the literature looking to define the issuers are looking to leave the money on their table. The information asymmetry framework advises that the equilibrium offer price that is inclusive of a limited discount is essential in order to attract and compensate the trading that is uninformed for trading against the advanced information. Lee et al., (2017) have debated that under pricing of the IPO is rational in nature and has been defined as a premium indecision that encloses the value of the new issues.    

The impact of exposure to risk and its effect on the initial returns on IPO can be investigated from the two various aspects of the literature namely the impact of risk on the level of return and the advantage of information disclosure on the IPO share valuation. The fact that most of the investors are risk hesitant, the relationship among the initial return and the risk related to the IPO is anticipated to remain positive (Carpenter & Whitelaw 2017). The investigations on the Chinese IPO markets have disclosed that the investors are in the idea of looking forward to increased returns by investing in IPO shares that much more riskier. Due to this effect, an increased level of risk for the IPO by the underwriters will create an extensive discount on their offer price, which would create an extensive error in pricing and gradually increased initial return (Li & Zhou 2016). Conversely, there is existent of a gap in the current literature about the fact that what the perceived level of risk is. The research questions that have been framed from the literature are given as follows:

Q1. Does the information included in the prospectus of the IPO would assist in mitigating conventional information asymmetry that the IPO companies face from the prospective investors and the underwriters?           

Q2. What is the relationship among the disclosed factors of risk in the prospectus of the IPO and the initial return of the IPO?

This paper mainly looks to answer these two questions.

Under Pricing of IPO Globally

Cumming & Zhang (2016) have explained that the tone and the text disclosed in the prospectus of the US based IPOs have priceless and significant information that can be utilised in order to proxy for the uncertainties that are available in the ChiNext IPOs. The uncertainty in this respect generates increased initial returns. Hence, the factors of risk that have been disclosed in the prospectus of the ChiNext IPOs should incorporate added uncertainties and this as a result should have an impact on the initial return of the IPO.


Xu et al., (2017) are among the first researchers who were to recommend several factors why the risk litigation is a naturally reasonable and economically precise factors for the under pricing of an IPO. The Securities Act of 1933 provides the investors with the power to sue the issuers of the IPO and even the underwriters if the value of the share falls below the offer price because of omission of materials in the IPO prospectus. In this aspect of an uncertainty environment related to the IPO, especially the probable reputational losses that are related with the lawsuit, the issuers of the IPO and the underwriters who are worried about the probable legal actions may look to hedge the risk of lawsuit by under pricing the IPO.

Bhattacharya, (2017) examine the impact of the risk of lawsuit by assessing the variations in the initial returns among the IPOs that have been sued by the investors and IPOs that have not been sued. There are no direct proof that under pricing lowers the incidence of legal actions. Wang & Li (2015) on the other consider the endogeneity of primary returns and the incidence of legal actions and look to discover the assistance for the impact of avoidance and insurance as projected by the theories related to lawsuit risks. Their outcomes recommend that risk associated with litigation can seriously have an impact on the initial returns of the IPO.

The assumptions that are underlying in the present examinations of the lawsuit risk is that the losses in the share market are adequate to bring in legal penalties. In practicality, the two significant scenarios must be met for undertaking prospective successful litigations (Feng & Johansson 2016). Firstly, the investors must have gone through injuries that are in the form of economic or investment value. Secondly, the investors must be able to discover evidence of a material omission in the declaration of the IPO firms that are existent during the time of their primary investments. In order to restrict such potential legal actions, the IPO companies and the underwriters may look to lower their level of profitability with respect to omission of material by improving the declarations given in the prospectus of the IPO. Hence, it can be anticipated a direct connection among the declaration of risk in the prospectus of the IPO and the initial return of the IPO, which this proposal has looked to assess.

Impact of Exposure to Risk on Initial Returns

As explained earlier, one of the factors why the IPOs of ChiNext has been selected has been that all the IPOs of ChiNext are needed to abide a template that is in nature standardized with respect to their prospectus. By looking at the current literature of IPO pricing, the paper has chosen several control variables from the company, economy and the offer distinct features during the primary screening (Nassr & Wehinger 2016). All the controlled variables are handpicked and have to be listed. 

A descriptive statistics for the collected control variables with respect to the three various measures of the initial returns of the IPOs of ChiNext namely MPR, OPR and CPR are documented. As the subscription ratio that is in this aspect offline in nature explains the demand in the market for the new shares from the institutional investors and in this scenario a large number recommends that new shares for ChiNext is increasingly high with respect to the total number of shares that have been offered or given to the investors. The data is collected from the 320 IPOs in ChiNext with the help of their disclosed prospectus. It has been viewed that subscription from the individual and the organizational investors are the key factors that contributes to the increased degree of initial returns for the IPOs of ChiNext.   Offer size is even a key factor as it looks to assess the offer size of the IPOs and thereby looks to obtain the impact of size in the initial under pricing in the ChiNext IPOs (Yao, 2016).

In the process of risk factor process of gathering, there have been observations of three precise trends. Primarily, the IPOs that are from the same sector have the tendency to document similar kinds of factors of risk (Su & Brookfield 2013). Secondly, there are specific risks factors that are always going hand in hand. These are even known as cross listings. Finally there is a widespread of organization specific risk factors and few of them have very limited frequencies of disclosure.

The key job has been to recognise the risk factors and that have an impact on the initial returns. This tends to have an impact on the underperformance of the IPO firms (Chen, 2016). Therefore various statistical tools are used additionally with the special variable mitigating features in order to eliminate unimportant control variables to the initial returns until all the framework converges and brings forth the same key control variables. By maintaining these key variables as the control variables in the framework, a repeated assessment by making use of all the risk factors are undertaken in order to ascertain whether and how declaring the precise factors of risk in prospectus of the IPO of ChiNext has any key and extra effect on their initial returns (Guo et al., 2017).

Research Questions

In the research process, one of the major steps is methodology. This method is considered as the systematic and theoretical analysis of the research methods. There is not any exception of this fact in case of this particular research program. As per the research methodology, there are three steps in data analysis (Bouzouita, Gajewski & Gresse, 2015). In the first step, the screening of all 13 variables will be done with the help of the technique of SPSS variable reduction in order to filter out those variables having the p-value > 0.05. In the second step, all the 54 risk factors will be added into the particular model. After that, it is needed to apply the same approach in order to filter out the risk factors having the p-value > 0.05. In the third step, for the improvements in the specification of model, the researcher will further impose the models of GARCH-M model with an ARMA (1, 1) and this will be imposed in residuals.

More specifically, at first, regression (1) will be run with 13 control variables after the arrangement of 355 IPOs based on their listing dates. The regression will be run on the OPR with the models of Enter, Backward, Forward and Stepwise in order to remove the control variables that do not have significant statistical value having p-value > 0.05 on at a time until the coverage and return of all the four models have the same significant variable that is p-value 0.05. After that, the researcher will report the results of final regression in Panel A of Table 4 (Hanley & Hoberg, 2012). In addition, by using the significant variables identified as control variables from the regression process (1), there will be the inclusion of all the 54 risk factors listed in Table 3 and the researcher will also run regression (2) with the help of same techniques for variable reduction. This process will be done for the removal of all the significant risk factors so that they can be reported in the results in the Panel B of Table 4.

In addition, regression (3) will be run by taking into consideration all the significant variables identified in regression (2) in order to improve the fitness of the model so that the result can be reported in Panel C of Table 4. There will be repetition in CPR and MPR and the result will be reported in Panel A, B and C in Table 5 and 6 respectively.

Factors of Risk Disclosed in the Prospectus of ChiNext IPOs

The area of interest of the researcher will be in the magnitude and signs of the regression coefficients that has association with all the risk factors identified in regression (2) and (3) (Zhou & Lao, 2012). With the help of different retune measures like OPR, CPR and MRP as the regression’s dependable variable; the researcher will be enabled to check that whether the various identified risk factors have different kind of impact on the measurement of different initials. This particular process can contribute to the different implications and conclusions of the research program (Bansal & Khanna, 2012).


It needs to be mentioned that different tables show the different results for regression. From Table 4, the researcher will get the final regression results for the OPR. Panel A will be able to show different impotent factors of the research; they are ratio of offline subscriptions from the institutional investors, the ratio of online subscriptions from the individual investors, the condition of the stock market, the IPO issue size and the dominant as well as significant control variable of OPR (Zaremba & Zmudzinski, 2014). The regression coefficient will help the researcher in the determination of the strong market demand of individual and institutional investors for the new shares of ChiNext IPO. In this context, it needs to be mentioned that there is a positive and significant impact of SZSE composite index return on the OPR; at the same time, the associated coefficient of offer size is significant and negative. On the other hand, the large size of the IPOs will fetch lower rate of initial returns (Chen & Strange, 2012). It can be seen that there are four types of major variables in this particular research. However, the process of changing policies and the growth of profit are also play a significant part in this research.  However, it needs to be mentioned that they contribute less in the fitness of the overall model. It can be said that the value of R2 for the final model is 0.56.

The researcher will be able to go to the significant findings from the comparisons of OPR. It has been seen from the research that the contribution of oversubscription from the institutional inventors are 0.32 towards the adjusted R2. In addition, The value of standardization beta is 0.51. This particular method shows the dominant effect of beta towards OPR. It can also be seen that Panel B of the research reports all the results from regression (2) and all the risk factors are incorporated with it (Daugherty & Jithendranathan, 2012). For this particular research program, there will be immense importance of the research findings. This particular process indicates the fact that for the IPO firms that take into consideration the litigation or lawsuit as risk factors, the OPR of those firms are higher. On the other hand, as per the suggestion of positive coefficient, the underwriter prices the litigations based on the bidding prices and others. In this case, it needs to be mentioned that the effects of under pricing is significant for both the companies and the investors. It needs to be mentioned that due to the under pricing process, more number of investors are attracted towards the companies and they become willing to bid for higher openings for the new shares of the companies. In this process, it needs to be mentioned that there is an association of standardized beta with the ongoing litigations or lawsuits of the companies (Akyol et al., 2014).

Effect of Risk Litigation on IPO under Pricing

Conclusion

In this proposal, the scope of past work in understanding the effect of the informational details that is available in the prospectus of the IPO with respect to the initial returns. By taking the benefit of the generalised format of the prospectus of the Chinext IPOs, an exclusive set of data with several factors of risk are prepared and evaluation of the data with the help of numerous statistical and econometric frameworks with special characteristics are undertaken. After managing and assessing the market, the offer specific features and the company that are effectively reported in the pricing literature of the present IPO, with the considerations of the probable time series and the correlations that are cross sectional in nature in the pricing errors in the IPO and the correlation among the initial returns of the IPO and their volatility in the conditional return there have been recognition of four risk factors that have key impacts on the IPOs of ChiNext with respect to their initial returns. The risk factors are transformations in the policy on the taxation of the government subsidy, increased amortization and depreciation because of recommended capital expenses, ongoing lawsuit and law actions and infringement of trademarks.

There have been worries with respect to the existing legal actions has been a key factor as it has an impact on the CPR and the OPR in a positive manner which indicates the risk compensation with the help of deepened under pricing of the underwriters. Hence, the underwriters are willing to provide a higher bidding price at the open economy during the day when the risk of the IPO is out in public. Hence, risk exposure in the prospectus of the IPO firms in ChiNext play a crucial part.

References

Akyol, A. C., Cooper, T., Meoli, M., & Vismara, S. (2014). Do regulatory changes affect the underpricing of European IPOs?. Journal of Banking & Finance, 45, 43-58.

Bansal, R., & Khanna, A. (2012). IPOs underpricing and money “left on the table” in Indian market”. Int. J. Res. Manage. Econ. Commer, 2(6), 106-120.

Bhattacharya, A. (2017). Innovations in new venture financing: Evidence from Indian SME IPOs. Global Finance Journal.

Bouzouita, N., Gajewski, J. F., & Gresse, C. (2015). Liquidity benefits from IPO underpricing: ownership dispersion or information effect. Financial Management, 44(4), 785-810.

Carpenter, J. N., & Whitelaw, R. F. (2017). The Development of China’s Stock Market and Stakes for the Global Economy?. Annual Review of Financial Economics, 9(1).

Control Variables for the ChiNext IPOs

Chen, J., & Strange, R. (2012). Political economy of IPO underpricing: the evidence from China. Journal of Chinese Economic and Business Studies, 10(2), 111-129.

Chen, X. (2016). The impact of political connections on Chinese listed firms: a thesis presented in fulfilment of the requirements for the degree of Doctor of Philosophy in Finance at Massey University, Palmerston North, New Zealand (Doctoral dissertation, Massey University).

Christofi, A., Bailey, B., & Carroll, M. (2015). IPO Pricing Using the Implied Growth Rate in Cash Flow Valuation. Journal of Business & Economic Studies, 21.

Cumming, D., & Zhang, Y. (2016). Alternative investments in emerging markets: A review and new trends. Emerging Markets Review, 29, 1-23.

Daugherty, M. S., & Jithendranathan, T. (2012). Underpricing of IPOs of US family controlled businesses. Journal of Finance and Economics.

Deng, Q., & Zhou, Z. G. (2015). Offline oversubscription, issue size, and market momentum: the driving forces for ChiNext IPOs’ initial underpricing. Chinese Economy, 48(2), 114-129.

Deng, Q., & Zhou, Z. G. (2017). IPO Pricing Efficiency in China: A ChiNext Board Focus. Frontiers of Economics in China, 12(2), 280.

Feng, X., & Johansson, A. C. (2016). Judging a Book by Its Cover: Analysts and Attention-Driven Price Patterns in China’s IPO Market (No. 2016-39). Stockholm China Economic Research Institute, Stockholm School of Economics.

Gao, J. (2014). Earnings management, underpricing and post-issue stock performance of SME IPOs in the PRC (Doctoral dissertation).

Guo, Y., Wang, T., Jia-Lang, S., & Hung, S. S. (2017). The Effect Of Disclosure Patterns Of Risk Factors In Prospectus On The Relation Between Strategic Alliances And Underpricing Of Biotechnology IPOs. Journal of Applied Business Research, 33(3), 509.

Hanley, K. W., & Hoberg, G. (2012). Litigation risk, strategic disclosure and the underpricing of initial public offerings. Journal of Financial Economics, 103(2), 235-254.

Lee, C., Qu, Y., & Shen, T. (2017). Reverse Mergers, Shell Value, and Regulation Risk in Chinese Equity Markets.

Li, G., & Zhou, H. (2016). The Systematic Politicization of China’s Stock Markets. Journal of Contemporary China, 25(99), 422-437.

Nassr, I. K., & Wehinger, G. (2016). Opportunities and limitations of public equity markets for SMEs. OECD Journal: Financial Market Trends, 2015(1), 49-84.

Su, C., & Brookfield, D. (2013). 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, 20-33.

Wang, L., & Li, B. (2015). Venture Capital: Research Status and Prospects of the Future (Note 1). Journal of Economics and Public Finance, 1(1), 60.

Xu, R., Chow, Y. L., & Ooi, J. T. (2017). A Relook into the Impact of Divestitures in the Presence of Agency Conflicts: Evidence from Property Subsidiary Sell-Offs in China. The Journal of Real Estate Finance and Economics, 55(3), 313-344.

Yao, C. (2016). Chinese Regulation of Issuer Earnings Forecasts: Recommendations for an Ex Ante Legal Framework. Wm. & Mary Bus. L. Rev., 7, 459.

Zaremba, A., & Zmudzinski, R. (2014). IPO initial underpricing anomaly: The election gimmick hypothesis. Copernican Journal of Finance and Accounting, 3(2), 167.

Zhou, J., & Lao, L. J. (2012). Analysis of influencing factors of IPO underpricing in ChiNext. Physics Procedia, 33, 846-851.

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