SEO underpricing in China's stock market: a stochastic frontier approach

Abstract

This article studies a sample of 225 Chinese A-share Seasoned Equity Offerings (SEOs) from 1999 to 2007. We compare a novel underpricing measure with a Stochastic Frontier Approach (SFA) as in Koop and Li (2001) to the conventional measure based on the difference between primary market price and secondary market price. We find that SEO underpricing exists in China's stock market, but there is a vast discrepancy between the magnitudes under the two different measures. Also, our empirical results show that the main determinants of the underpricing are associated with high asymmetric information among underwriters, issuers and investors, which is unsurprisingly pronounced in emerging markets such as that of China.

Keywords:

• equity issuance
• SEO underpricing
• stochastic frontier approach
• China's stock market

JEL Classification::

• G30
• G32

Acknowledgement

This work was supported by the new faculty research program 2012 of Kookmin University in Korea.

Notes

College of Business Administration, Kookmin University, Seongbuk-gu, Seoul 136-702, Korea.

¹ The conventional calculation of SEO underpricing follows the same line of thought but there is a lack of consensus regarding the benchmark day, whose closing price is to be compared with the offer price.

² Such lack of interest in SEO underpricing could be attributed to the evidence that SEO underpricing is not as significant as that of IPO. For example, Corwin (2003) reports an average underpricing of 2.2% for US SEOs during the 1980s and 1990s.

³ In China, A shares refer to the specialized shares that are traded in Renminbi (RMB). In comparison, B shares are those traded in foreign currencies (mainly USD and HKD), while H shares are the shares of the firms incorporated in mainland China but are listed in the Hong Kong Stock Exchange. A shares are the most studied among the three.

⁴ Before the reform, many firms were considered state-owned and their shares nontradable. The reform started the privatization of these state-owned firms.

⁵ Growth Enterprise Board, sometimes called the second board, is a stock market established to help the growth of young firms to raise equity capital. It has lower requirements for listing and thus is more risky than the main board, which is the primary stock market. Small-and-Medium-Sized Enterprise Board has the same listing requirements as the main board, but as its name suggests, it only serves relatively small firms.

⁶ Because of the irregularities inherent in the data, we winsorize our data at 5% and 95% levels.

⁷ China's stock market is also younger compared to that of the US.

⁸ These are second and above SEOs conducted by firms which have issued seasoned equities before.

⁹ In Koop and Li (2001), underpricing factors are called misvaluation factors because they use the total market valuation of the offered stocks as the dependent variable, as opposed to the log offer price we use here. We believe the prefix ‘under-’ is more appropriate than ‘mis-’ as the error term is one-sided.

¹⁰ Some underpricing factors documented in the literature on underpricing may turn out to be pricing factors in other contexts. Eckbo et al. (2007) survey a wide range of topics related to security offerings, including the offering process, flotation method choice and costs. They comprehensively summarize the determinants of IPO and SEO underpricing based on issuer characteristics, offer characteristics, market conditions and share ownership.

¹¹ ASSET, QUANTITY and PROCEEDS (a total value of SEO) are heavily skewed to the right while PRICE and PPRICE20 are skewed to the left. Thus, we use the natural logarithm form of such variables to correct for the skewness and to estimate our empirical models.

¹² We find the significant correlation coefficient of 0.65, based on the Pearson correlation test.

Additional information

Notes on contributors

C. Y. Chung

College of Business Administration, Kookmin University, Seongbuk-gu, Seoul 136-702, Korea.