Equity Financing and the Pecking Order Hypothesis in the Emerging Market: Evidence from Taiwan's Relocated Firms in China (TRFC)

Abstract

This article examines two datasets of Taiwan's relocated firms in China (TRFC) and discusses the pros and cons of equity financing alternatives as well as cross-sectional heterogeneity and inter-temporal dynamics in the pecking order of capital structure. On-site listing, regardless of the board chosen, appears a sustainable approach for TRFC to expand in the emerging market of the Mainland. The pecking order hypothesis is mostly supported by evidence from moderately leveraged TRFC as variables are kept unscaled by net book assets, and the role of asymmetric information is confirmed from findings using sub-samples specified by firm size.

Keywords:

• Equity financing
• pecking order hypothesis
• emerging market
• Taiwan
• China

JEL CLASSIFICATION::

• G15
• G18
• G32

Acknowledgements

The author acknowledges the financial support of the National Science Council (Research Grant No. 95-2745-H-029-003-HPU) in Taiwan and suggestions from several referees.

Notes

1. Non-tradable shares are held by the State, State legal persons, domestic legal persons including promoters (underwriters), individuals as the internal staff prior to privatization, and foreign-capital legal persons such as original overseas promoters. These shares permit control over key SOEs by the State majority shareholders at the expense of incurring conflict of interest, technical difficulty in issuing derivatives, and a relatively high price-to-earnings ratio by international standard.

2. At the beginning of 2006, the Shanghai Stock Exchange created the New Composite Index covering fully tradable shares, denoted as G-shares.

3. In parallel, qualified foreign institutional investors (QFII) were allowed to issue A-share mutual funds aimed at global investors under capital control in China. The QFII program, introduced in late 2002 and amended in 2006, maintains a quota on cross-border capital flows by the State Administration of Foreign Exchange and People's Bank of China. Compliance risk remains crucial for QFII even though the quota appears less stringent than actually demanded.

4. This trading venue was originally named the Growth Enterprises Board and designed to facilitate fundraising by high-tech companies.

5. Haw et al. (2005) document significant earnings management among IPO-applying firms in China on account of the present listing requirements.

6. This board had the ambition of becoming a well-functioning over-the-counter market but now mainly serves firms whose shares have been delisted from the main board, hence analogous to the US bulletin board.

7. As pointed out in Walter and Howie (2006), Chan et al. (2007), and Fung and Liu (2007), the B-share market was once a provisionary mechanism that aimed to smooth shocks by external capital during transition and is sooner or later to be merged with the A-share main board. As of February 2001, the B-share market was opened to Chinese individuals (but not institutional investors). However, as documented in Yang and Lau (2005), B-shares continued to trade at a large discount.

8. Wu (2007) indicates that offshore listing by large SOEs was mainly encouraged by the CSRC. In 1993, the world-famous beer producer Tsingtao Brewery and a key petrochemical corporation SINOPEC Shanghai, respectively, listed H-shares in Hong Kong and American depositary receipts in New York. Currently, there are more than 150 Chinese SOEs that list H-shares. In addition, this direct overseas listing has been innovated, for instance, with the A-and-H offering programme by the ICBC and CITIC, two leading commercial banks in China, and the A-then-H scheme for effective price convergence between the two markets. Both raise the issue of international dual listing as discussed by Chemmanur and Fulghieri (2006), King and Segal (2009), Lee and Valero (2010), and Boubakri et al. (2010). From a longer-term perspective, a successful overseas IPO, in particular in advanced markets, brings benefit beyond global fundraising for both Chinese SOEs and TRFC.

9. Because listed TRFC amounted to over 50, Mega Securities Hong Kong and Polaris Securities Hong Kong in collaboration with Standard and Poor's compiled two “T-share” indices to track performance. Both in general under-perform the benchmark Hang Seng Index as local institutional investors are less interested in T-shares.

10. Further widening of the band to 0.5% in May 2007 soon broke the symbolic rate of 7 in April 2008. In June 2010, the PBOC released a statement about the intention to further increase the flexibility of the RMB.

11. In Ni and Yu (2008), D _it is represented by the change in current liabilities rather than long-term debt since debt financing by Chinese firms mostly involves short-term borrowing and some informal financing such as pawn shops.

12. In Akhtar and Oliver (2009), capital structure is differentiated between multinationals and domestic firms in Japan. They find that the former exhibit lower leverage than the latter. Although business risks are not significant for the capital structure of local companies, these risks negatively relate to leverage for multinationals. Moreover, there exists a significantly positive leverage effect of foreign exchange risk faced by multinationals.