THE HONG KONG IPO MARKET: INITIAL PERFORMANCE AND CORNERSTONE INVESTORS

Abstract

Using the Hong Kong IPO market, this research tests for and discriminates between the major IPO underpricing theories. In particular, I refine the analysis on the partial adjustment phenomenon and show that a positive relation between price revision and market adjusted initial return exists only when the offer price is revised upwards. Furthermore, I demonstrate that the hot issues market hypothesis, which does not assume that underwriters can control the level of underpricing, is more robust than the dynamic information acquisition hypothesis in explaining the relation between price revision and market adjusted initial return. Prestigious underwriters are also not found to reduce the exante uncertainty any more than their less prestigious counterparts, which may be due to the highly competitive investment banking environment in Hong Kong. This research is one of the first to examine the effect that cornerstone investors have on initial performance. For strategic investors, I document that their participation acts as a signal of firm quality only for IPOs that experience a downward revision in offer price. As for corporate investors, I find support for the corporate investor rent extraction hypothesis which predicts a positive relation between corporate investors’ participation and market adjusted initial return. Corporate investors extract rent from their participation in the primary market as a form of compensation for reducing underwriting risk. The finding hints at the reciprocating nature in investment banking transactions.