Dueling IPOs

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Analyzing the differences between the U.S. and Chinese financial markets.
Nasdaq. Dow. S&P 500. Just turn on a TV, radio, computer or smart phone, and you can find updates on the performance of stocks, as well as bonds and commodities. The dynamic nature of the U.S. stock market is a well-known element of the free market system. Chances are you’re impacted by market fluctuations even if you don’t personally invest, because your retirement plan is likely investing on your behalf.

When a corporation decides to go public, the anticipation of significant stock appreciation lures investors to the company’s initial public offering (IPO) on its first day of trading, as evidenced by the hype over Facebook’s IPO launch. That hype, followed by an unexpected poor performance, only served to magnify the disappointment of Facebook’s IPO.

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Unlike Facebook’s IPO performance, however, the average first-day return on IPOs in the U.S. is around 20 percent, according to Congsheng Wu, Ph.D., Professor of International Finance. Wu contrasts this with Chinese company IPOs, which typically experience up to a 200 percent first-day return in China. The distinction is interesting by itself, but becomes even more so when comparing the IPO first-day return of a Chinese company in China, versus the same company’s IPO first-day return in the Hong Kong and U.S. markets. This dichotomy of performance is the focus of Wu’s ongoing research.

The conditions are complex, Wu admits, since China’s market is much newer and the Chinese government imposes numerous regulatory constraints on Chinese companies. However, while these conditions might prompt a Chinese company to pursue listings first in Hong Kong and the U.S., they cannot account entirely for the dramatic difference in the IPO’s domestic and overseas performance. Wu believes his study is the only one to research this comparison.

With initial support from a UB Seed Money Grant and subsequent support from the Shanghai Stock Exchange as a visiting senior financial expert, Wu has been able to collect and analyze data on Chinese companies that went public both overseas and in China. His research compares three sets of Chinese IPOs completed between 1990 and 2007.

The first set consists of more than 1,500 domestic-only IPOs, which demonstrated an average first-day return of about 200 percent. The second set is comprised of 51 Chinese companies that first went public in Hong Kong (in the form of H-shares), with an average first-day return of 11.6 percent, and later, in China, where the price jumped on average by 96 percent on the first day.

The final set consists of 10 Chinese companies that first listed their shares in the U.S. and Hong Kong simultaneously, and later, went back to China. These 10 Chinese IPOs made in the U.S. (in the form of ADRs) demonstrated an average first-day return of 5.8 percent in the U.S. market, compared with an average first-day return of 105 percent in China.

Further, Wu notes that the phenomenon of greater underpricing for the IPO made in China was the same, whether or not a company first went public overseas or only in China, and concluded that when a Chinese company goes public in the U.S., it behaves more like a U.S. IPO, and when it goes public in China, it behaves more like a Chinese IPO. Wu’s comparison of first-day performance for domestic-only versus cross-listed IPOs refutes the conventional theory of IPO underpricing.

Wu’s analysis reveals that, while conventional theories suggest that homecoming IPOs experience less underpricing when compared with Chinese companies that only go public in China, the difference in underpricing between them is not statistically significant in regression analysis.

As he continues to research the IPO behavior of Chinese companies in their domestic and overseas markets, Wu draws on a Chinese proverb that is used to illustrate the role of environmental influences. The tangerine trees that grow south of a river produce tangerines but the tangerine trees that grow on the north side of the same river produce oranges. How can two different fruits come from the same type of tree? The answer lies in the soil and environment.

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Likewise, in the case of the Chinese company’s IPOs, how can the same company’s first-day returns differ so dramatically in various markets? Wu concludes that just as the same tree produces different fruit when planted in different soil with different nutrients according to the Chinese proverb, so a Chinese company’s IPO performance will be influenced by the local conditions. Wu hopes to eventually identify those conditions and develop an analytical framework that can explain these differences in the first-day returns of Chinese companies’ cross-listed IPOs, which will become more important as China’s influence in the world’s financial markets continues to grow.

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