Under The Sponsor System: An Empirical Study Of Relationship Between Underwriter Reputation And Ipo Underpricing

Initial excess returns of Initial Public Offerings, or IPO is an anomaly in the capital market. In the nearly six decades, scholars put forward a variety of interpretations on this issue. Among them, taking information asymmetry as a starting point, some researchers explained excess returns of IPO from the perspective of underwriters, focusing on the influence of underwriters’reputation on IPO underprcing.In the process of IPO, underwriters bear the role of "information transmitter" and "quality certification intermediary". Western mainstream financial theory suggests that underwriters with high reputation should be able to reduce IPO underpricing rate by reducing the degree of information asymmetry in the process of IPO. That is, underwriter reputation and IPO underpricing rate should be negatively correlated. Empirical evidences support this theory in the Western developed capital markets. However, the theory does not hold empirically in Chinese stock market.In this paper, taking all the IPOs in Shanghai and Shenzhen A-share markets from February2004(the implementation of sponsor system) to September30,2010as the sample, I used SAS to obtain a series of conclusions through a variety of statistical methods:(1) Underwriter reputation and IPO underpricing rate has a significant positivecorrelation.In other words, underwriters with larger market share lower the price of their new shares, which is contrary to the Western classic asymmetric information theory. Past researches end in this conclusion, but the author hope to further explain this phenomenon. It is susceptible that underwriters take advantage of their dominant position in the securities market in order to place low-cost new shares to their best clients in the purpose of interest transfer. By empirical study, I arrive at two conclusions:(2) The greater market share an investment bank has, the greater the proportion of new shares it places.(3) IPOs with placing to legal person have much better price and volume performance than IPOs without placing in the following12months after the listing, especially before and after the lockup period expires.The conclusions above depict a complete picture:big investment banks take advantage of their dominant position in the stock market to place large numbers of new shares to institutional investors at lower prices. And these stocks have a good volume and price performance before and after the expiration of the lock-up period, facilitate investors’ profit-taking. Of course, these conclusions are only necessary but not sufficient conditions for interest transfer to underwriters’ best clients. We can’t therefore find certain evidence of interest transfers, as needs further researches in the future.The study shows that the Western reputation theory of investment banks doesn’t hold in China’s IPO market. Reputation mechanism is not established for the lack of sanctions to bad underwriters. Reputation of investment banks is not negatively correlated with underpricing rate, as may be related to some system deficiencies in China’s issuing market. This paper also put forward several policy recommendations.