| Firms like to go public instead of private placement. In initial public offerings, stocks are often underpriced. Why firms reward first-day investors with considerable underpricing? In China, underpricing is common. It is difficult for us to understand: if state-owned enterprises are eager to raise money in stock markets, why do they leave so much money on the table?In this paper, we try to study IPOs in three respects: First, why do firms go public? What on earth do they want? Second, why firms reward first-day investors with considerable underpricing? Third, how IPOs perform in the long run?First is the purpose of the IPOs. According to life cycle theories, Black and Gilson(1998) point out that entrepreneurs often regain control from the venture capitalists in venture-capital-backed companies at the IPOs. Thus, many IPOs are not so much exits for the entrepreneur as they are for the venture capitalists. Chemmanur and Fulghieri(1999) develop the more convincing model that IPOs allow more dispersion of ownership, with its advantages and disadvantages. Pre-IPO investors or venture capitalists hold undiversified portfolios, and, therefore, are not willing to pay as high a price as diversified public-market investors. There are fixed costs associated with going public, however, and proprietary information cannot be costlessly revealed—after all, small investors cannot take a tour of the firm and its secret inventions. Thus, venture capitalists want to be paid by IPOs. Early in its life cycle, a firm will be private, but if it grows sufficiently large, it becomes optimal to go public. According to market timing theories, firms avoid issuing in periods when few other good-quality firms issue. The managers may think that high first-day price is a signal that managers can operate firms well so that the price will go up next.There are relationships between the abnormalities of IPOs price and the purpose of IPOs. If the IPOs prices are overpriced so that the first-day investors lose their money, the whole market including the managers of the firm will suspect the future development of the firm. If public valuations turn out to be lower than expected, firms will delay their IPOs or withdraw their IPOs.The purpose of building the stock market in China is to raise capital for state-owned enterprise and we find that the cost for state-owned enterprise to raise capital from stock market is much lower than from banks' loans. In order to IPOs successfully, it is a logical conclusion that stated-owned enterprises reward the first-day investors with considerable underpricing.The second part of this paper is the underpricing of IPOs. There are theories based on information and others. One way of classifying theories of underpricing is to categorize them on the basis of whether asymmetric information or symmetric information is assumed. The former can, in turn, be classified into theories that: if the issuer is more informed than investors, rational investors fear a lemons problem that only issuers with worse-than-average quality are willing to sell their shares at the average price. Investors would not like to buy worse-than-average quality shares at the average price and they think the price should be lower. Therefore, there is reason to believe that any price appreciation would make IPOs fail and would induce entrepreneurs to return to the market for more funding. If the investors are more informed than issuers, for example, about the general market demand for shares, then the issuers face a placement problem. The issuers do not know the price the market is willing to bear. In other words, an issuer faces an unknown demand for its stocks. There are theories based on symmetric information. For example, issuers underprice to reduce their legal liability. An offering that starts trading at a higher price is less likely to be sued if the post-market price is abnormal.We re-explain the abnormalities of IPOs in China from the three respectstoo. First, we find that investors in China do not ca... |
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