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Review of Quantitative Finance and Accounting

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15-02-2020 | Original Research

The economic benefits of returned-global Chinese IPOs

Authors: Jerry W. Chen, In-Mu Haw, Jianfu Shen, Pauline W. Wong

Published in: Review of Quantitative Finance and Accounting | Issue 4/2020

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Abstract

On June 6, 2018, China has adopted a new policy that allows overseas-listed Chinese companies to launch secondary listings (hereafter, returned-global Chinese IPOs) in the domestic market. This study examines how the returned-global Chinese IPOs affect financial reporting quality, information environments, and IPO pricing in the domestic market. We find that these newly public companies in China exhibit lower discretionary accruals (and their components), lower stock price synchronicity, and lower first-day underpricing upon IPOs. Our difference-in-differences tests reveal that IFRS convergence in China mitigates overseas listing advantage of the returned-global firms. Overall, this study highlights the economic benefits of overseas listing of the returned-global Chinese IPOs and the impact of the change in financial accounting standards on the IPO market. Our evidence highlights the bright side of the recent regulatory change in China.

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The domestic market is referring to as domestic A-share markets in mainland China. A-shares are shares issued by Chinese companies listed on the Shanghai and Shenzhen Stock Exchanges. A-shares are available only for domestic Chinese investors although foreign investors can invest in A-shares through the Qualified Foreign Institutional Investors (QFII).

We refer those overseas listed Chinese companies (i.e., global Chinese IPOs) that sequentially issue IPOs in the domestic A-share market in mainland China to “returned-global Chinese IPOs,” “returned-global IPOs,” “returned IPOs” or “home-listed IPOs” throughout the paper.

We measure earnings quality based on discretionary accruals and their components. Following prior studies (Morck et al. 2000; Piotroski and Roulstone 2004; Gul et al. 2010), we measure the stock price synchronicity for each firm from the logistic transformation of the R² statistics from market models. IPO underpricing is referred to the common phenomenon of substantially increased share prices of IPOs on the first day of trading. We discuss details in Sect. 3.

We observe that IPO firms in China experience significantly higher discretionary accruals, accounting receivables and inventories (see Table 4). These results are consistent with Aharony et al. (2000), Teoh et al. (1998a, b) and Shen et al. (2014).

Hong et al. (2014) use the rule of law index that represents the degree of confidence of a country’s citizens in the quality of its law enforcement mechanisms. They use a sample of IPOs from 20 countries and compare the impact of the IFRS adoption on IPO pricing between the pre-IFRS adoption period (i.e., 2003–2004) and the post-IFRS adoption period (i.e., 2006–2007). Consequently, their sample excludes Chinese IPOs because China adopted the IFRS convergence in 2007. According to Kaufmann et al. (2007), the rule of law index of China is considerably lower than their sample country median of 1.6, indicating China’s weak implementation credibility. Since their study focuses on the impact of IFRS adoption on IPO pricing, our study extends their work to the consequences of IFRS convergence on financial reporting quality and information environment of Chinese IPOs.

These overseas markets have stronger disclosure requirements and stricter regulations and enforcements to protect stakeholders than emerging markets like mainland China. Those markets also have better market intermediaries like financial analysts and institutional investors that serve as monitoring institutions.

The market capitalization is not less than RMB 200 billion.

The most recent year’s operating income is not less than RMB 3 billion and the valuation is not less than RMB 20 billion or the operating income grows rapidly, having relatively advantaged position in the same industry competition, with independent research and development, and international leading technologies.

The enterprise later on withdrew the CDR application on June 19, 2018.

Another strand of studies reveals that greater scrutiny from regulators and external auditors during the IPO process may help improve earnings quality in the IPO year (e.g., Ball and Shivakumar 2008; Armstrong et al. 2016).

Although there are alternative metrics of earnings quality, e.g., timeliness, conservatism and value relevance, earnings management (measured by the magnitude of discretionary accruals) is the most popular metric in the setting of initial public offerings in the literature.

While performance-matched approach can reduce the noise of estimating discretionary accruals measures from accruals models in the IPO setting, we note different interpretation of the results: if the estimated performance-matched discretionary accruals measures are not different from zero, the implication is not that earnings are not managed, but rather that earnings are not managed any more significantly than in publicly traded firms with similar earnings performance.

Following the study of Hung et al. (2012), we measure post-IPO performances in 3-year period. The period covers 750 (250 × 3) trading dates after the IPO date.

The market models are similar to Eqs. (1), (1a), (1b) and (1c) in Gul et al. (2010). Our sensitivity tests show that our results are not sensitive to exclusion of A–B and A–H share firms in our control sample.

When we include ROA to control for profitability in the logit regression, our main results with PSM-matched sample are qualitatively similar.

One such example is Tsingtao Brewery Co. The company became the first overseas listed Chinese company with its IPO in Hong Kong in July 1993. One month later, the company issued IPO in the domestic A-share market.

Wu (2014) also constructs a sample of returned IPOs from the Chinese listed firms in Hong Kong (A–H cross listed firms) and Chinese ADRs from 1990 to 2007. The sample of returned IPOs is larger in this study. Wu (2014) only explores the impacts of returned listings on IPO underpricing in A-share market. Our paper investigates earnings quality and information quality of the returned IPOs. Also, we examine the benefits of IFRS convergences in A-share market and the impacts on IPOs.

The IPO sample period in Table 2 truncates to Year 2013 for retaining Year + 2 data.

When we use performance-matched measures, results are qualitatively similar.

The regression results for PSM-domestic sample are statistically significant for DΔINV compared to those for the full sample, suggesting that IPO firm-specific characteristics are important factors in affecting managers’ incentives to manipulate earnings through inventory manipulation.

Wu (2014) shows that the coefficients on the dummy variable of returned IPOs are negative but insignificant if firm- and offer-specific variables are controlled in the regressions. The coefficients in our regression remain significant with the firm-level control variables in the full sample.

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Title: The economic benefits of returned-global Chinese IPOs
Authors: Jerry W. Chen
In-Mu Haw
Jianfu Shen
Pauline W. Wong
Publication date: 15-02-2020
Publisher: Springer US
Published in: Review of Quantitative Finance and Accounting / Issue 4/2020
Print ISSN: 0924-865X
Electronic ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-020-00873-1

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