‍Broker reputation, institutional investor’s shareholdings and IPO underpricing

ZHAO Yan1 SUN Wenchen2

(1.Business School of Jilin University, Changchun, Jilin Province, China 130012)
(2.Lingnan (University) College of Sun Yet-Sen University, Guangzhou, Guangdong Province, China 510275)

【Abstract】Initial public offering (IPO) is an essential way for companies to obtain external capitals and raise brand awareness. A successful IPO can enable companies to attract suitable investors. In this way, the company finds it easier to raise the necessary capitals and enhance the visibility of the enterprise, the staff’s sense of identity and the enterprise system. But at the same time, improper operation of the IPO will bring more serious negative impact on the companies. In this case, the enterprise cannot raise the needed capitals, and may also be examined and dealt with by China Securities Regulatory Commission and other relevant authorities. IPO underpricing refers that the IPO issue price is lower than the market price of the initial market situation. In the actual process, whether it is the Western developed capital market or the emerging financial markets, the IPO underpricing is widespread. In the case of IPO underpricing, the new shares will receive the excess return. As a phenomenon contrary to the efficient market hypothesis, IPO underpricing means that the actual amount of capital raised by the enterprise is lower than the expected value. So the issuing companies bear the expensive hidden cost. This not only makes the issuing companies fail to hit the expected funding target, but also leads the investors to pursue the excess returns of IPO underpricing. This will lead to the capital mismatch between the primary market and the secondary market, and reduce the operational efficiency of the capital market. High underpricing will lead to insufficient supply of capitals of the secondary market and lower share price. In view of the adverse effects of IPO underpricing and the general degree of IPO underpricing in capital market, the formation mechanism of IPO underpricing phenomenon has been a hot issue in the field of IPO theory. The institutional investors have become an important signal to measure the maturity of the financial market. Compared with individual investors, the institutional investors tend to adhere to the concept of value investment. They focus on the company’s intrinsic value of rational investment rather than speculative profit. And after the success of obtaining IPO shares, they will not be sold in the short term. This behavior is conducive to the long-term stable performance of the company after IPO. In addition, institutional investors have more private information about the market demand for new shares compared with the broker and the issuing company. Brokers use book-building mechanism to get the advantage of institutional investors’ information, so as to improve the effective information content of the stock price, which will promote the success of pricing. Since the second half of 2016, China Securities Regulatory Commission has further strengthened the management of brokers. They pointed out that the brokerage agencies failed to play the role of market gatekeeper during abnormal fluctuations of stock market in 2015. China Securities Regulatory Commission pays more and more attention to the role of brokerage in the securities market. By the specialty of the underwriting business, brokers play an important role in the public release process. Brokers assume the intermediary role of the underwriting, which needs to compile the prospectus and take a road show. The securities firms also need to accurately assess the value of company in order to develop a reasonable issuing price. In order to ensure the success of the IPO, high quality and experienced brokers are widely favored by the issuing company. Reputation can be seen as a signal of brokerage business capabilities. For institutional investors, their private information must be through the broker’s book-building process to be able to get play. The broker with high reputation has excellent ability to control the market demand and the capabilities of information conversion. They are able to more fully extract and analyze the effective information in the hands of institutional investors to adjust and modify the IPO pricing. In this way, the high reputation of brokers can indirectly inhibit the IPO underpricing. Based on the background of Chinese IPO market, using data of A-share listed companies in Shanghai Stock Exchange and Shenzhen Stock Exchangeduring 2003–2015 in China, we investigated the relation among underwriter reputation, institutional shareholdings and IPO underpricing. We also analyzed the time effect of IPO underpricing. In the part of the empirical design, we take the market-adjusted first day stock returns as the proxy variable to measure IPO underpricing. The result showed that the more institutions hold, the lower IPO underpricing is when controlling other factors. Besides, when the key underwriter has higher reputation, the significant impact of institutional shareholdings on IPO underpricing is stronger. We proved the moderator role of underwriter reputation in the relation between institutions and IPO underpricing. Thus, we provided some empirical evidence backing the crucial role of institutions in financial markets as well as some policy suggestions on how to regularize the behavior of institutions after the establishment of registration system for IPOs.

【Keywords】 broker reputation; institutional investor’s shareholdings; IPO underpricing;


【Funds】 General Project of National Natural Science Foundation of China (71371084) Major Project of Key Research Base for Humanities and Social Sciences, the Ministry of Education (15JJD790011) Project of Humanities and Social Sciences Research, the Ministry of Education (16YJC790096)

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(Translated by ZHANG Shuo)


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This Article


CN: 11-1047/F

Vol 38, No. 12, Pages 112-131

December 2016


Article Outline


  • 1 Introduction
  • 2 Literature review
  • 3 Theoretical analyses and assumptions
  • 4 Empirical research design
  • 5 Empirical analysis
  • 6 Major conclusions and policy recommendations
  • References