Is Disclosure Transparency a Panacea to IPO Underpricing?

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Abstract

Prior research indicates that risk factor disclosure in the IPO prospectus plays an important role in reducing IPO underpricing in the U.S. Other studies in the international context also find that more stringent IPO disclosure requirements are associated with smaller IPO underpricing. This study examines whether disclosure transparency serves as a panacea to the severe underpricing in China’s IPO market where litigation risk is low and political connections play a dominant role in the capital markets. Using China’s domestic IPOs during the period of 2006-2012, we find that on average higher quality risk factor disclosure in the IPO prospectus is negatively associated with IPO underpricing, although the sheer number of risk factors disclosed is not. However, cross-sectional analyses suggest that these findings are driven by firms with political connections. Absent of political connections, high quality risk factor disclosure in IPO prospectus does not seem to matter, even though ex post high quality risk factor disclosure by firms without political connections turns out to be informative about post-IPO return volatility.

Authors

• Yi YAO, NANKAI UNIVERSITY

• Isabel Wang, Michigan State University