INITIAL PUBLIC OFFERING (IPO) UNDERPRICING PUZZLE: AN EMPIRICAL STUDY OF THE CHINESE MARKET

Abstract

Since its inception, the Chinese stock market has been characterised with extreme IPO underpricing. My paper studies the impacts of the 2014 IPO reform whose objective was to create a more market-oriented IPO system. I find that the average IPO underpricing increased significantly from 61% to more than 280% after the reform. The huge increase in underpricing is attributed to both lower primary market pricing and higher secondary market valuation of new issuances. The primary market pricing, IPO P/E, seems to follow an ‘unofficial pricing limit’ of 22.99 regardless of industries or listing boards, thereby becoming less informative for secondary market valuation. Furthermore, the secondary market valuation seems to be less related to firms’ financial fundamentals. The secondary market valuation of IPO stocks is nearly 30% higher than that before the reform, and 80% higher than the industry average. My findings suggest that the 2014 reform did not achieve its intended purpose, resulting in a less market-oriented IPO system.