Do initial reserves signal long-term IPO stock performance?

Abstract

This research examines the long-run Initial Public Offerings (IPO) stock performance of a large Chinese sample, and in particular the relationship between initial reserves (capital reserves and revenue reserves immediately after the IPO) and long-run IPO stock performance. In general, Chinese IPOs do not underperform the market/industry benchmarks, but they significantly underperform their size-matched industry peers. More importantly, Chinese IPO firms tend to issue a large amount of bonus shares (also called as a ‘capitalization issue’, i.e. capitalization of the reserves) after the IPO. Consistent with bonus share signaling hypothesis, Chinese IPO firms exhibit increased operating/stock performance subsequent to bonus issues. Interestingly, the size of the initial reserves is positively associated with long-run IPO stock performance. This research adds another piece of empirical evidence to the literature whether IPOs underperform in the long run, by confirming that the choice of performance measures and benchmarks could affect the conclusion on the IPO long-run performance. Further, it discovers that size of initial reserves could signal superior IPO stock performance in the long run.

Keywords:

• IPOs
• long-run stock performance
• bonus issues
• signaling
• China

JEL classifications:

• G12
• G14
• G32

Public Interest Statement

This research is of interest to both academic researchers and public investors, especially those who are interested in the emerging Chinese IPO market. It adds a piece of empirical evidence to the literature whether IPOs underperform in the long term. Contrary to the large body of IPO underperformance literature, which may indicate informational inefficiency and capital misallocation in the IPO market, this study supports that the choice of tests of performance and benchmarks may lead to a different conclusion. Importantly, this research discovers that Chinese IPOs issue a large amount of bonus shares in the post-IPO period, and IPOs with the potential to issue bonus shares (i.e. large initial reserves) perform better in the after-IPO market. So, the research has an investment recommendation for stock investors, as the magnitude of initial reserves could signal superior stock performance in the long run.

Additional information

Funding

Funding. The authors received no direct funding for this research.

Notes on contributors

Peng Cheng

Peng Cheng is a lecturer in accounting and finance at Xi’an Jiaotong-Liverpool University (China). He completed his PhD in 2007 at the University of Surrey (UK), and then moved to the University of Antwerp as a postdoctoral researcher. He has been working for Xi’an Jiaotong-Liverpool University since 2010, and currently he is the Head of Accounting and Finance Group at the Business School. His research interests include finance accounting, corporate governance, and international finance. He has published in a number of academic journals, such as Journal of Accounting and Public Policy, Accounting and Business Research, Corporate Governance: An International Review, Journal of International Financial Markets, Institutions & Money, and so on.