Research Of IPO Price And Extreme Returns Based On Underpricing And Overpricing

Along with the promoting of the economic system reform and development ofcapital market, security market has played an important role in national economicdevelopment and the reform of financial system. But the excessive supervision ofgovernment not only reduces the allocative efficiency of capital market, but also affectsthe stability and development of secondary market. Recently, the phenomenon of highissue price, high P/E ratio and super raised funds draw wide attention in domestic andabroad. They proposed lots of theoretical hypotheses based on the typical institutionbackground. In their results, the CSRC is blame for lack of pricing efficiency whichled to a long-standing extreme IPO return, which is also one of the most important keydrivers for CSRC to promote IPO market reforms such as inquiry system etc. However,the implement of the bookbuilding system did not eliminate the extreme IPO returns ofChina as the former literature expected, which make the IPO initial return become focusagain. Then, what is the primary cause of Chinese long-standing excessive IPO returns?Why bookbuilding system run well in abroad, but failed in domestic? This paperattempts to study Chinese stock markets systematically and comprehensively from theangle of institutional economics and behavioral finance. And we also would to explainand demonstrate the reason of those phenomenons. The discussion of these issues willprovide a microeconomic foundation for the further reform and innovation of IPOsystem.First of all, this paper discusses the formation mechanism of Chinese IPO pricingand extreme IPO returns from the aspect of gaming of the market participators. Thenbased on the theory of “paradox of incentive”, I conduct gaming model between issuers,sponsor and underwriter, underwriter and institutional investors, supervisor, underwriterand sponsor respectively. Through equilibrium solution, I find that separatingequilibrium only occurs when the performance of the optimal company is better than thepoor company under information asymmetry. This means that the quality of companycan be distinguished by underwriters and investors. On contrast, the pooling equilibriumoccurs and the underwriter will underwrite all the IPOs. The uninformed investors’misjudgment of the prior probability will lead to IPO underpricing. What’s more, thesupply restriction of the government will result in the only pooling equilibrium andextreme IPO returns inevitably. In additional, the supervisor should reduce the regulatory cost, improve the success ratio of supervise, strengthen the dynamics ofpunishment, ease the regulatory approval and turn to strengthen the informationdisclosure system. Therefore, the problems of Chinese markets can be eliminatedfinally.Secondly, this paper empirically measures the bookbuilding efficiency byemploying two-tier stochastic frontier model. Using the characteristic that IPO price isdetermined by the bargaining of issuers, underwriters, inquiry institutions and otherobjects under the bookbuilding system, this paper employs the two-tier stochasticfrontier model to measure the IPO pricing efficiency of our country by combiningunderpricing effect and overpricing effect. The results indicate that the underpricingeffect cause the average price of whole IPO companies lower than its intrinsic value12.0%during2006to2010. And the overpricing effect leads the IPO price exceed itsoptimal price5.5%. The average underpricing ratio of IPO companies is6.4%due tothe net effect of those two elements. Although the empirical results supported theformer underpricing theory, the bookbuilding efficiency is pretty high and the issuersare willing to price their IPOs near the optimal boundary.Thirdly, this paper decomposes the Chinese extreme IPO returns from the aspectsof supply and demand. Taking IPO supply constraints and rigid demand into account,this paper decompose Chinese IPO returns into issuer intentional underpricing,institutional overpricing and secondary market overpricing by describe the productivemechanism of IPO underpricing. In the empirical section, this paper contrasts amotivation test model to examine the motivation of each components and the validity ofthe regulatory policy changes. The results show that the supply and frequencyrestriction of government lead the IPO price exceed its optimal value55.6%, which is78.2%of the initial returns. But the secondary market overpricing and intentionalunderpricing can only interpret2.6%and12.9%of the initial returns respectively. Atlast, the robustness test indicate that the reform of the IPO system indeed reduced theIPO returns, which demonstrate the government regulation is the main reason ofextreme IPO returns.Finally, this paper explores the long-term IPO performance by using BHAR, CAR,Fama-Frech and CAPM models. The results show that long-term underperformance isobserved at least in one year period, and then turn to superior performance gradually.Therefore the robustness of the conclusion that Chinese extreme IPO returns is mainlycaused by secondary market overpricing and regulatory overpricing rather than the lack of pricing efficiency is proved.To sum up, the primary contribution of this paper is that it studies the actionstrategies of all the market participators, IPO pricing efficiency, IPO initial returns andlong-term performance systematically. The results prove that the primary reason of IPOinitial returns is supply restriction and the lack of information disclosure and socialresponsibility. The reform of the market should focus on abolishing the approval systemof IPO and SEO and improving the information disclosure mechanism. Besides thosepolicies, any partial and technical changes will be a drop in the bucket and gone foreverlike cattle made of mud falling into the sea.