Legal Protection and Underpricing of Ipo

Pacic-Basin Finance Journal 27 (2014) 163187
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Pacic-Basin Finance Journal

journal homepage: www.elsevier.com/locate/pacfin
Legal protection and underpricing of IPOs:

Evidence from China
Jianlei Liu a, Konari Uchida b, Ruidong Gao c,
a
School of Finance, Capital University of Economics and Business, China
b
Faculty of Economics, Kyushu University, Japan
c
Graduate School of Economics, Waseda University, Japan
a r t i c l e i n f o a b s t r a c t
Article history: Chinese data enable investigation of the relationship between

Received 2 August 2013 underpricing of initial public offerings (IPOs) and legal protection
Accepted 20 February 2014 with controlling for time-invariant characteristics of regions. Our
Available online 1 March 2014
investigation of Chinese IPOs between 1997 and 2009 shows that rms
from a province with more developed legal framework experience less
JEL classication:
underpricing after controlling for time-invariant, province-xed effects.
G30
We also nd that the extent of underpricing is decreased by the strength
G32
G38
of legal protection of property rights. Importantly, these tendencies are
K22 evident only after the introduction of a book-building system, which
provides issuers and underwriters with discretion on offering price
Keywords: determination. These results offer robust evidence that legal protection
IPO mitigates ex ante uncertainty regarding property rights protection, and
Underpricing thereby, reduces underpricing.
Legal protection 2014 Elsevier B.V. All rights reserved.
China
1. Introduction
Underpricing of initial public offerings (IPOs), represented by positive and signicant initial returns,
exists in many stock markets. Loughran et al. (1994) conrm the underpricing phenomenon of IPOs in 25
countries, with the degree of underpricing varying across countries. Most of the earlier studies rmly
established the existence of underpricing of IPOs in the U.S. capital market (Reilly and Hateld, 1969;
An earlier version of this paper was presented at the Asian Finance Association Conference. We would like to thank Nobuaki Hori,
Yusuke Kinari, Ghon Rhee (editor), and an anonymous reviewer for their valuable comments. This research has been nancially
supported by JSPS KAKENHI Grant Number 23330107.
Corresponding author at: Graduate School of Economics, Waseda University, 1-6-1 Nishiwaseda Shinjuku-ku, Tokyo 169-8050,
Japan. Tel.: +81 80 5038 1798.
E-mail address: gaoruidong@gmail.com (R. Gao).
http://dx.doi.org/10.1016/j.pacn.2014.02.006
0927-538X/ 2014 Elsevier B.V. All rights reserved.
164 J. Liu et al. / Pacic-Basin Finance Journal 27 (2014) 163187
McDonald and Fisher, 1972; Logue, 1973; Ibbotson, 1975; Ibbotson and Jaffe, 1975; Ritter, 1984; Ritter,
1991). Ritter (1991) conrms that the underpricing of 1526 US IPO companies during the period of 1975 to
1984 is 14.3%. The IPO underpricing phenomenon is also documented in Asian stock markets such as those of
Japan (Beckman et al., 2001; Kirkulak and Davis, 2005), Hong Kong (McGuinness, 1992), Singapore (Saunders
and Lim, 1990), and Korea (Kim et al., 1993). The existence of underpricing still remains a puzzle in nance
research, although numerous works have been devoted to this issue (Beatty and Ritter, 1986; Rock, 1986;
Allen and Faulhaber, 1989; Levis, 1990; Brennan and Franks, 1997; Rydqvist, 1997; Lowry and Shu, 2002).
La Porta et al. (1997, 1998, 2002) argue that legal investor protection highly affects the development of
nancial markets and corporate nancial behaviors. Underpricing of IPOs can be inuenced by the
strength of a country's legal system (Ibbotson, 1975; Hughes and Thakor, 1992; Lowry and Shu, 2002).
Ritter (1984), Beatty and Ritter (1986) and Rock (1986) suggest that information asymmetry is associated
with underpricing. Strong investor protection is likely to mitigate information asymmetry (e.g., strong
disclosure enforcement can resolve problems that are attributable to asymmetric information), and in
turn, decrease underpricing (information asymmetry hypothesis). Engelen and Essen (2010) nd that the
quality of a country's legal framework signicantly reduces the level of underpricing that occurs. On the
other hand, Ibbotson (1975), Hughes and Thakor (1992), and Lowry and Shu (2002) demonstrate that IPO
rms use underpricing to decrease future litigation risk, which is evident especially in countries with
strong legal protection (litigation risk hypothesis). Boulton et al. (2010) and Banerjee et al. (2011) provide
evidence of a positive relationship between the accessibility of legal recourses and IPO underpricing,
which support the litigation risk hypothesis.
We should see these empirical results from cross-country analyses with caveats. Substantial variations are
likely to exist in many unobservable factors across countries and legal protection indices potentially
incorporate non-legal characteristics (e.g., culture, diversity, and degree of risk aversion) (Hofstede, 2001;
Hope, 2003; Chui et al., 2002, 2010). Analyses that use country-level indices also suffer from equal-weight
bias, in which small countries receive the same weight as large countries (Allen et al., 2005). Those previous
studies use legal protection indices, proposed by La Porta et al. (1998), Kaufmann (2004), and Djankov et al.
(2008), which are time-invariant and do not enable investigations of the relationship between legal investor
protection and underpricing with controlling for time-invariant non-legal characteristics. In sum, it is still an
unsolved question whether legal environments affect underpricing.
This paper principally attempts to investigate the relationship between legal environments and
underpricing in a single-country setting. We use the data of Chinese IPOs that provide a valuable
opportunity to address the issue.1 Although Chinese domestic data have less variance in culture and
peoples' characteristics relative to international data, the data exhibit great heterogeneity in legal
environments across provinces for historical and geographical reasons (Qian and Weingast, 1997; Jin et
al., 2005); coastal provinces (eastern region) have experienced more rapid legal developments than the
inland provinces (middle and western regions). Fan et al. (2001, 2011) propose Chinese province legal
protection indices that enable econometric analyses of the relationship between legal protection and
underpricing of IPOs. This creates an appropriate laboratory to address the issue in a more homogenous
environment. Importantly, Chinese legal protection has gone through progressive development, which is
represented by the promulgation of the Company Law in 1993 and Securities Law in 1998. Fan et al.
(2011) present legal protection indices by province and year that allow us to implement province-xed
effects model estimations to investigate the relationship between legal protection and underpricing.
Initial return is determined by noting the offering price and the stock price on the rst trading day.
Empirical research on underpricing typically assumes that the rst day price is efcient and high initial return
is attributable to low offering price. However, it is not easy to accurately investigate whether legal factors
affect offering price rather than the rst day price. It would be noteworthy that the Chinese IPO market has
experienced signicant regulation changes and provides data that help us avoid the problem. In 2004 and
before, an online xed-price offering method was employed in which offering price was determined by
reported earnings multiplied by the assigned P/E ratio (Liu et al., 2012, forthcoming). This system should
make legal protection and various rm characteristics less inuential on underpricing. However, the Chinese
IPO market adopted a book-building system in 2005, and thereafter, underpricing is affected by various
1
Allen et al. (2005) also note that many of previous cross-country studies delete one of the most important developing countries,
China.
J. Liu et al. / Pacic-Basin Finance Journal 27 (2014) 163187 165
factors. We should nd a signicant relationship between legal protection and underpricing only after the
introduction of a book-building system if legal issues are a true determinant of offering price.
We collect a sample of 963 Chinese IPOs that went public on the Shanghai Stock Exchange (SHSE) and
Shenzhen Stock Exchange (SZSE) during the period of 1997 to 2009, and investigate the relationship between
underpricing and legal framework. We nd that the mean market-adjusted initial return of Chinese IPO is
123.02%. Firms from a province with a more developed legal framework have less underpricing, even after
controlling for time-invariant province xed effects. Consistent with Engelen and Essen (2010), the extent of
underpricing is decreased by the strength of legal protection of property rights. Importantly, these tendencies
are evident only for the book-building system, which suggests that the legal framework affects offering price
rather than rst day price. These results provide robust evidence that legal protection affects underpricing by
reducing ex ante uncertainty regarding property rights protection (Ritter, 1984; Beatty and Ritter, 1986; Rock,
1986; Claessens and Laeven, 2003; Cull and Xu, 2005; Berger and Udell, 2006; Engelen and Essen, 2010).
The presented analyses make signicant contributions to the literature. Firstly, we present robust
evidence that legal environments matter in IPOs' underpricing by using a homogeneous data setting that
avoids biases from various cross-region differences. This result implies an important policy implication that
we can signicantly reduce critical costs for IPO rms (underpricing) by strengthening rules of law. We also
argue that the province-xed effects model presents powerful evidence of the legal protection effect that
successfully controls for unobserved time-invariant, cross-region differences. Finally, we present a specic
mechanism through which legal protection affects underpricing (protection of property rights). Put
differently, ex ante uncertainty regarding property rights should be viewed as an important factor associated
with underpricing, which is commonly observed around the world.
The remainder of this paper is organized as follows. Section 2 presents background information. Section 3
presents a literature review. Section 4 explains sample selection and variables. Section 5 presents the
empirical results. Finally, Section 6 is a brief summary of the paper.
2. Background information
The Chinese central government initiated economic reform in 1978, a key aspect of which was the
establishment of SHSE in 1990, followed by SZSE in 1991. The government initially exerted a strong power on
the IPO process. In 1993, the Chinese Government introduced a governance system (Issuance Quota System)
to select companies to go public. Under this system, the China Securities Regulatory Commission (CSRC)
imposed the maximum number of shares that could be issued to local governments each year (Chi and
Padgett, 2005). From 2001 to 2004, CSRC adopted the Channel Restrictions System, in which CSRC allocates
the number of IPO underwritings to each securities rm. During these regulated periods, the most common
method of offering price determination was the online xed-price offering method, which determined the
offering price by the after-tax earnings per share multiplied by an assigned P/E ratio.2 It is less likely that
various rm characteristics (except earnings) and environments affected underpricing during the regulated
period. However, the Chinese central government abolished the unique regulations on the IPO process and
introduced the book-building system in 2005. Since then, the online xed-price offering method was
removed, and thus, issuers and underwriters have more discretion in offering price determination (Liu et al.,
forthcoming). Under the market mechanism-based system, various rm characteristics and environments in
which IPO rms operate will become inuential in offering price (or underpricing).
Sophisticated legal environments potentially boost economic developments. The Chinese government
realizes that the establishment of an effective legal system is important to develop the capital market. China's
formal written rules to protect economic parties have experienced a progressive development since the
establishment of stock markets. A series of legal systems (e.g., professional lawyer service organization) and
judicial authorities (courts) have been established all around the country. By the end of August 2010, China
had enacted 240 constitutional and effective laws, 704 administrative rules and regulations, and more than
8600 local rules and regulations.3 Although any law, administrative and local rules, and regulations are
subordinate to the constitution, local rules and regulations are very important components of the Chinese
2
The P/E ratio was xed at 15 before 1999, but it was increased to 50 in January 1999 and then declined to 20 in 2002.
3
Available from the White Paper published by the state council information ofce of the People's Republic of China on October 27,
2011 (Chinese characteristic socialism legal system): http://www.gov.cn/jrzg/2011-10/27/content_1979498.htm.
legal system. The constitution entrusts the provincial people's congresses and committees with formulation
of local rules and regulations that t the provincial situations.4
Importantly, China has 31 provinces that have different legal systems for investor protection (Qian
and Weingast, 1997; Jin et al., 2005). Coastal provinces (eastern region) have experienced more rapid
economic and legal developments than the inland provinces (middle and western region) due to
historical and geographic reasons.5 China presents a wide heterogeneity in legal protection across
provinces. Taking the protection of intellectual property rights as an example, the city of Shanghai rstly
established the intellectual property pledge appraisal management system in 2010. As a result, 68 enterprises
in Shanghai issued 69 intellectual property mortgage loans, which amount to 1.849 billion RMB, by 2011. The
Municipal Copyright Bureau also released the local copyright industry report and established the Shanghai
Copyright Service Center, the Copyright Dispute Mediation Center, and the Shanghai Copyright Trading
Center. The Shanghai Copyright Trading Center provides nancing, copyright transfer, consulting services,
and other copyright-related services, amounting to 29 billion RMB in total.6 In 2012, the amount of patent
application and authorization in Shanghai reached 82,682 and 51,508, respectively. The courts in Shanghai
tried 3977 civil cases involving intellectual property rights in that year, of which 3968 cases were settled.7
Similarly, Jiangsu Province has considerably improved legal environments on intellectual property rights.8
The Jiangsu Provincial Supreme People's Court established the expert bank of the provincial intellectual
property rights jurisdiction technology in 2009 to enhance the quality of property rights jurisdiction. The
Jiangsu Supreme People's court also promoted establishments of judicial institutions and teams on
intellectual property rights protection. As a result, Jiangsu Province has 16 basic courts with jurisdiction of
intellectual property rights cases, representing one sixth of the total number of courts in the country.9 The
courts in Jiangsu Province tried 9175 civil cases involving intellectual property rights in 2012, and resolved
8526. Jiangsu Province is the top province in the number of patent applications and grants in 2012: 472,656
patent applications (24.72% of the national total); 269,944 patent grants (23.21% of the national total).10
In contrast, the western provinces lagged in intellectual property protection. For Guizhou, a western
province, only 11,296 patent applications were submitted in 2012, of which 6054 were authorized. In the
same year, courts in Guizhou tried only 600 civil cases of intellectual property rights, of which 598 cases were
closed.11
Fan et al. (2001) constructed an index (NERI Indices) that represents the progress of the institutional
transition in 31 Chinese provinces with nancial support from the National Economic Research Institute
(NERI) and the China Reform foundation. The legal environment score is a component of the NERI indices,
which includes the following four sub-components: (1) development of the market intermediary
(service conditions of lawyers and accountants; availability of assistance from Industry Associations;
conditions on technical service and export); (2) protection of producers' property rights (the ratio of the
number of economic crimes to provincial GDP); (3) protection of intellectual property rights (ratios of patent
applications and their acceptance to the number of the scientic and technical people); and (4) protection of
4
Special economic areas were also authorized to issue and implement local rules and regulations.
5
The eastern region includes the following 11 provinces (cities): Beijing, Tianjin, Hebei, Liaoning, Shanghai, Jiangsu, Zhejiang,
Fujian, Shandong, Guangdong, and Hainan. The middle region includes Shaanxi, Jilin, Heilongjiang, Anhui, Jiangxi, Henan, Hubei, and
Hunan (8 provinces). The western region includes 12 provinces (cities): Sichuan, Chongqing, Guizhou, Yunnan, Tibet, Shanxi, Gansu,
Qinghai, Ningxia, Xinjiang, Guangxi, and Inner Mongolia.
6
Available from the White Paper published by the Shanghai Joint Conference Ofce of Intellectual Property on April 20, 2011
(Shanghai Intellectual Property Protection in year 2010): http://www.sipa.gov.cn/gb/zscq/node2/node23/userobject1ai8660.html.
7
Available from the White Paper published by the Shanghai Joint Conference Ofce of Intellectual Property on April 27, 2013
(Shanghai Intellectual Property Protection in year 2012): http://www.sipa.gov.cn/gb/zscq/node2/node26/node253/userobject1ai10019.
html.
8
Guangdong, Shanghai, Beijing, Zhejiang, Jiangsu, and Shandong are the top six provinces in patent applications during the past
10 years.
9
Available from the White Paper published by the Joint Meeting of Intellectual Property of the People's Government of Jiangsu
Province (State of Development and Protection of Intellectual Property of Jiangsu Province in Year 2009): http://www.jsip.gov.cn/
wcm/webpage/zwgk/more.jsp?info_id=12500.
10
Available from the White Paper published by the IP Joint Conference Ofce, Jiangsu Provincial People's Government (IP
Development and Protection Situations in Jiangsu Province 2012): http://www.jsip.gov.cn/wcm/upload/infoopen/upload_8011087.
pdf.
11
Available from the White Paper published by the Guizhou Province Intellectual Property Bureau on May 2, 2013 (Guizhou
Province Intellectual Property Protection in year 2012): http://www.gzsipo.gov.cn/ztxx/display.asp?id=238.
consumers' rights (the ratio of the number of consumer complaints received by the Consumer Association to
provincial GDP). Those indices attempt to take the provincial economic development into account by
normalizing a value by provincial GDP. Fan et al. (2001) construct raw scores of the four sub-components
from rst-hand data for 31 provinces. High scores on the market intermediary and the protection of
intellectual property rights naturally suggest positive developments in legal frameworks. Accordingly, Fan et
al. (2001) calculate the following to construct standardized provincial legal environment scores (PScore) on
the market intermediary and the protection of intellectual property rights:
RScoreRScoremin
PScore 10 1
RScoremax RScoremin
where RScore is the province's raw score on the sub-component; RScoremax is the highest raw score on the
sub-component among 31 provinces for the base year; and similarly, RScoremin is the lowest raw score of
the sub-component for the base year. The year 2001 is used as the base year, and the minimum and
maximum values for each component are specied to be 0 and 10, respectively. Values of each component
in other years are normalized by the base year value.
In contrast, high scores on the protection of producers' property rights and the protection of consumers'
rights (many economic crimes and consumer complaints) imply poor legal environments. Fan et al. (2001)
compute PScore on those components by the following equation:
RScoremax RScore
PScore 10: 2
RScoremax Rscoremin
As a result, PScore is positively related to the development of the legal framework for all of the four
subcomponents. The total legal environment score (legal framework index) is an arithmetic average of
these four standardized scores.
This project has been continued and Fan et al. (2011) present the institutional environment index
during the period of 1997 to 2009. Fan et al. (2011) renewed the computation of producers' property
rights score for 2003 and after. In the new method, the raw score on the property rights protection is
computed by Eq. (1) using results of a survey that asks enterprises to rate local judicial departments and
enforcement agencies' impartiality and efciency. We will discuss potential biases from this calculation
change in the latter part of this paper.
Appendix A presents the time-series mean of Fan et al.'s (2011) legal framework index by province during
the period of 1997 to 2009. The city of Shanghai has the best legal environment (with an index of 11.056);
while Qinghai, located in the western region, has the lowest mean legal score (2.214). Appendix B indicates
that the total legal environment score shows an improvement over time for all regions. As a result, the
nationwide mean of the legal score increased from 2.37 in 1997 to 7.91 at the end of 2009. Importantly, the
eastern region has the highest legal environment score, followed by the middle and west regions. Besides, the
eastern region has experienced the greatest increase in the legal environment score (from 3.15 in 1997 to
12.37 in 2009), whereas the index for the western region only increased by 2.94 during this period. These
ndings are consistent with the conventional notion that Chinese legal protection has experienced a great
development (e.g., establishment of many rules and regulations) while the western and middle regions lag
behind the eastern region. Put differently, Fan et al.'s (2011) index accurately captures the legal environment
of each province. Appendix B also shows the scores of four sub-components separately. It also indicates that
Chinese legal protection has experienced large improvement in all four dimensions, with the eastern region
achieving the fastest development.
3. Literature review
Previous studies have presented information asymmetry-based theories of underpricing. These ideas
assume that at least a part of investors are not well informed about the issuer's quality, and as a result,
issuers need to set a low offering price (Ritter, 1984; Beatty and Ritter, 1986; Rock, 1986; Ljungqvist,
2007). Ljungqvist (2007) suggests that institutional factors also affect the extent of underpricing. Firms
located in regions with effective legal protection will present more transparent information disclosure
and thus mitigate information asymmetry. La Porta et al. (2002) conrm that investors are willing to pay
more for nancial assets when being better protected by the legal system. This idea gives rise to a
prediction that IPO underpricing is negatively related to investor protection. Indeed, the law and nance
literature has shown increased interests in the inuence of legal systems on the extent of underpricing
(Ibbotson, 1975; Hughes and Thakor, 1992; Lowry and Shu, 2002; Engelen and Essen, 2010; Boulton et
al., 2010; Banerjee et al., 2011; Hopp and Dreher, 2013). Engelen and Essen (2010) nd a negative
relationship between underpricing of 2920 IPOs from 21 countries during 2000 to 2005 and the quality of
legal enforcement, which is obtained from La Porta et al. (1998), Kaufmann (2004), Kaufmann et al.
(2005), and Djankov et al. (2008).
In contrast, strong legal protection will increase litigation risk. If an underwriter and issuer overstate the
potential gain and understate the potential loss in the IPO prospectus, the accessibility of legal recourses will
trigger lawsuits against them. Lowry and Shu (2002) estimate that 5.8% of US rms that went public between
1988 and 1995 were sued for various violations relating to the IPO, with the average settlement costs reaching
4 million US dollars (nearly 13% of IPO proceeds).
Because litigation is costly, managers have an incentive to insure against such costs. For this reason, issuers
and underwriters conduct a lot of investigations before going public (e.g., they investigate all aspects of the
rm's business, nances, management and statement in the IPO prospectus). However, it is not easy to
effectively insure against these costs (Lowry and Shu, 2002) and underpricing provides an attractive form of
insurance. Indeed, Boulton et al. (2010) and Banerjee et al. (2011) demonstrate that IPO rms use
underpricing to decrease future litigation risk, especially in countries with strong legal protection (litigation
risk hypothesis). Boulton et al. (2010) investigate underpricing of 4462 IPO rms from 29 countries during
2000 to 2004. They nd a positive relationship between underpricing and the legal enforcement quality,
which is available from La Porta et al. (1998, 2006); Kaufmann (2004); Marshall and Jaggers (2000); Dyck and
Zingales (2004); and Djankov et al. (2008). Banerjee et al. (2011) show a positive relationship between
underpricing of 8776 IPOs from 36 countries during 2000 to 2006 and the quality of legal enforcement, which
is presented in La Porta et al. (1998, 2006) and Djankov et al. (2008).
We should see these empirical results with caveats. Previous studies commonly obtain legal protection
indices from La Porta et al. (1998), Kaufmann (2004), Kaufmann et al. (2005), and Djankov et al. (2008). These
famous indices are almost time-invariant and potentially cause biases, to the extent that the legal protection
indices are correlated with time-invariant, non-legal characteristics of countries. Allen et al. (2005) point out
that small, homogeneous countries (e.g., Jordan and Ecuador) may have more effective legal systems than
large diverse countries (e.g., India) because such systems can be closely adjusted to meet the needs of these
countries. If this is true, it is difcult to distinguish the effects of legal protection on underpricing from those of
country size and homogeneity, as long as we use the time-invariant legal protection scores.
We premise that it is still an unsolved question whether legal environments affect underpricing. As
mentioned, Fan et al. (2011) present time-variant legal protection scores for 31 Chinese provinces. These data
enable us to use province-xed effects model estimations to examine the relationship between legal
protection and underpricing. The single country data also allow us to address the issue in a homogeneous
setting relative to cross-country studies. Chinese data have another important characteristic that enables us to
accurately examine the effect of legal environments on underpricing. Underpricing research is subject to the
difculty of identifying whether underpricing is attributable to low offering prices or to high rst trading day
price. We may present an incorrect conclusion that well-developed legal environments reduce underpricing
when investors bid up IPO stocks from developed legal environments to a disproportionally high extent.12 As
discussed in Section 2, before 2005, offering prices were determined by an online-xed price offering system
in which rm characteristics and environments were less inuential. In such, legal environments should have
more pronounced effects on underpricing after the introduction of the book-building system. If we nd a
signicant relationship between legal protection and initial returns only during the book-building period, we
can rule out the possibility that the rst trading day price is associated with legal protection.
12
This situation will be evident if the stock market overestimates the effect of well-developed legal environments on IPO rms'
growth.
4. Sample selection and variables
4.1. Sample selection
We analyzed Chinese A-share IPOs that went public on the SHSE and SZSE during the period 1997 to 2009.
We obtained the data of IPOs from the China Center for Economic Research Database (CCER Database). As
mentioned, the index for legal framework is available from Fan et al. (2011). This index has been also used by
Chen et al. (2006), Wang et al. (2008), Firth et al. (2009), and Wu et al. (2009). Importantly, Fan et al. (2011)
assign different values to the index of a single province over time, taking the development of the legal
protection into consideration. The higher the score is, the better the legal framework is. Compared with
notable legal protection indices proposed by La Porta et al. (1998), Kaufmann (2004), and Djankov et al.
(2008), the time-variant characteristics of the Chinese provincial legal index allow us to investigate how the
time-series development of legal protection affects IPOs' underpricing.
We hand-collect data of corporate ownership structure and seasoned equity offerings before 1998 from
rms' prospectuses. The sample covers periods during which the Issuance Quota System, Channel Restrictions
System, and Book-building System were executed. This allowed us to investigate the sensitivity of the
relationship between legal environments and underpricing to offering price determination methods. We did
not include B-share IPOs because there were only six B-share IPOs from 2000; furthermore, they are much
smaller in offering size and illiquid compared to A-share IPOs. We eliminate rms for which necessary data
are not available. As a result of those procedures, our sample consisted of 963 companies, of which 403 rms
were listed on the SHSE and 560 rms were listed on the SZSE.
Panel A of Table 1 shows the distribution of our sample by calendar year. Over the span of these thirteen
years, IPO markets were more active in 1997, 2000, and 2007. Panel B presents the distribution of our sample
by regulation regimes. More than half of our sample rms were selected from the xed-price offering period.
Panel C shows the sample distribution by industry and region. Although our industry classication principally
follows that of the National Bureau of Statistics of China, we added the high-technology industry because
previous research suggests high-tech companies are subject to serious information asymmetry, and thereby,
have high underpricing.13 In our sample, 200 rms belong to high technology companies, of which 139
companies (69.5%) are from the eastern provinces. This gure suggests that IPOs in the eastern region are
dominated by technology companies. With respect to other industries, (non-high-tech) manufacturing rms
account for a substantial part of the sample companies, and 55% of manufacturing rms are located in the
eastern region. The middle and western provinces are dominated by agriculture, shing and stockraising,
mining and electricity, gas, and water industries.
4.2. Measures for underpricing
Following previous studies (Mok and Hui, 1998; Chan et al., 2004; Chi and Padgett, 2005; Guo and
Brooks, 2008), we measure the extent of IPO underpricing as the return on the rst day of trading (relative
to the offering price). We adopt the initial return that is adjusted for the market effect:
ADIRi P i1 P i0 =P i0 P m1 P m0 =P m0
where ADIRi is the market-adjusted initial return of the stock i (see Table 2 for denition of variables). The
subscripts i and m respectively indicate rm and market index: Pm is the closing price of SHSE A-share
composite index or SZSE A-share composite index. The subscripts 1 and 0 mean the rst trading day of the
IPO stock and the offering day, respectively.
Summary statistics for the market-adjusted initial return (underpricing) are presented in Table 3. We
nd that the average Chinese IPO is underpriced by 123.02%, which is positive and statistically signicant
at the 1 percent level. All annual averages and medians are also positive and signicant.
13
The high-technology industries include: information chemical manufacturing; pharmaceutical manufacturing; medical
equipment and instruments manufacturing; aerospace and aircraft manufacturing; communications equipment, IT and other
electronic equipment manufacturing, and social services. Our analyses delete these industry rms from other industries
(manufacturing, IT, social services).
Table 1
Sample distribution.
This table shows the sample distribution. Panel A shows the distribution by IPO year. Panel B shows the distribution by offering price
determination method. Panel C presents the distribution by industry and geography. Our sample consists of 963 rms that went
public on the Shanghai Stock Exchange (SHSE) and the Shenzhen Stock Exchange (SZSE) between 1997 and 2009.
IPO year Number of IPOs (%)
SHSE SZSE Total
Panel A: Distribution by calendar year

1997 79 105 184 19.11
1998 50 45 95 9.87
1999 45 51 96 9.97
2000 85 46 131 13.60
2001 72 0 72 7.48
2002 24 0 24 2.49
2003 2 0 2 0.21
2004 0 1 1 0.10
2005 0 0 0 0.00
2006 13 52 65 6.75
2007 23 100 123 12.77
2008 5 71 76 7.89
2009 5 89 94 9.76
Total 403 560 963 100
Panel B: Distribution by offering price determination method

Number of rms that went public under the xed-price offering system 357 248 605 62.82
Number of rms that went public under the book-building system 46 312 358 37.18
Total 403 560 963 100
Panel C: Distribution by industry and geography
Industry Number of IPOs
Eastern Middle Western Whole

region region region country
Agriculture, shing, and stockraising 12 7 8 27

Mining 12 9 5 26
Manufacturing 260 108 104 472
Electricity, gas, and water 14 9 7 30
Construction 16 2 4 22
Transportation and warehousing 34 5 4 43
IT 7 2 2 11
Wholesale and retail 26 6 3 35
Financing and insurance 20 1 1 22
Real estate 21 9 5 35
Social service 12 4 7 23
Media 4 0 0 4
Comprehensive 8 3 2 13
High-technology 139 35 26 200
Total 585 200 178 963
4.3. Control variables
IPO underpricing is explained by some classical models based on asymmetric information, such as the
winner's curse hypothesis (Rock, 1986; Levis, 1990); the ex ante uncertainty hypothesis (Ritter, 1984; Beatty
and Ritter, 1986); and the signaling hypothesis (Allen and Faulhaber, 1989; Grinblatt and Hwang, 1989;
Welch, 1989). Some researchers also examine these models in China (Mok and Hui, 1998; Su and Fleisher,
1999; Chi and Padgett, 2005; Yu and Tse, 2006). In the winner's curse, Rock (1986) assumes that there are two
groups of potential investors in the IPO market: informed and uninformed investors. Informed investors
only bid on attractive IPO rms, while uninformed investors apply for all new issuing rms indiscriminately.
As a result, uninformed investors face the competition for good IPO rms, incurring higher possibilities to
Table 2
Denitions of variables.
Variables Denitions
IR Raw initial return: (closing stock price at the rst trading day offering price)/offering price.
ADIR Market-adjusted initial return.
LEGAL The index of legal framework from Fan et al. (2011).
INTERMEDIARY The index for the development of the market intermediary from Fan et al. (2011).
PROPERTY The index of the protection of producers' property rights from Fan et al. (2011).
INTELLECTUAL The index of the protection of intellectual property rights from Fan et al. (2011).
CONSUMER The index of the protection of consumers' rights from Fan et al. (2011).
BOOKBUILD A dummy variable that takes a value of one for IPOs during the period 20052009 (book-building period) and
zero for others (online xed-price offering period).
LOTTERY The odds of winning the IPO lottery.
SEO A dummy variable that takes a value of one when the rm issues seasoned equity in the subsequent 2 years
and zero for others.
M_RETURN The market return in the period between the offering day and listing day.
AGE Age of the rm at the point of IPO.
UNDERWRITER A dummy variable that takes a value of one for rms underwritten by the top ve underwriters and zero for
others.
SOE A dummy variable that takes a value of one for rms controlled by the state and zero for others.
RETAIN The percentage ownership by the state at IPO year.
P/E Price to earnings ratio.
LNOFFERNUM Natural logarithm of the number of shares offered.
B_SHARE A dummy variable that takes a value of one when the rm issues B-share and zero for others.
HIGHTEC A dummy variable that takes a value of one for rms belong to high-technology industries and zero for others.
HOTMARKET A dummy variable that takes a value of one for rms that went public in year with median ADIR higher than
100% (1997; 1998; 2000; 2001; 2002; 2007) and zero for others.
obtain bad shares. For the sake of ensuring uninformed investors' continued participation in the market, their
initial returns should be high. In our analyses, we adopt the lottery rate in the purchasing process for new
shares (LOTTERY) as a proxy for the winner's curse hypothesis. The lottery rate is predicted to be negatively
associated with underpricing (Guo and Brooks, 2008). Panel B of Table 4 shows that the mean lottery rate for
Chinese IPOs is 0.008%.
Table 3
Descriptive statistics for underpricing.
This table shows the mean and median values of the market-adjusted initial returns (underpricing) by year. T-statistics (z-statistics)
are for the null hypothesis that the mean (median) ADIR is zero. See Table 2 for denitions of the variables.
IPO year ADIR
Mean (%) t-Statistics Median (%) z-Statistics Minimum (%) Standard deviation (%) Maximum (%) N
1997 140.21 25.33 126.74 11.76 3.03 75.08 464.25 184

1998 123.56 13.60 113.42 8.24 130.14 88.57 428.31 95
1999 101.84 10.07 86.48 8.49 3.42 99.06 820.50 96
2000 151.45 20.46 140.74 9.93 19.59 84.70 476.35 131
2001 126.08 11.01 123.33 6.94 158.38 97.14 413.56 72
2002 135.52 7.90 104.07 4.29 40.58 84.09 310.48 24
2003 16.06 1.53 16.06 1.34 5.57 14.84 26.56 2
2004 74.64 74.64 1.00 74.64 74.64 1
2005 0
2006 75.96 12.39 69.26 7.00 1.25 49.41 327.45 65
2007 162.25 17.38 143.27 9.62 27.39 103.51 525.75 123
2008 97.70 11.16 78.11 7.54 15.33 76.35 347.68 76
2009 69.76 16.62 68.76 8.42 5.19 40.69 206.91 94
Total 123.02 43.52 103.80 26.67 158.38 87.72 820.50 963
Signicant at the 1% level.
Table 4
Descriptive statistics.
This table indicates descriptive statistics, except for underpricing measures. Panel A is for dummy variables and Panel B is for
non-dummy variables. See Table 2 for denitions of the variables.
Panel A: Dummy variables
Number of rms that take a value of one Number of rms that take a value of zero
BOOKBUILD 358 605

SEO 214 749
SOE 538 425
B_SHARE 12 951
UNDERWRITER 99 864
HIGHTEC 200 763
Panel B: Non-dummy variables
Mean Standard deviation Minimum Median Maximum N
LOTTERY (%) 0.008 0.014 0.000 0.004 0.137 963

M_RETURN 0.004 0.627 0.935 0.178 4.328 963
Number of offering share(million) 162.338 794.912 10.000 45.000 14950.000 963
P/E 24.531 12.873 0.000 20.580 98.670 963
RETAIN (%) 37.488 29.548 0.000 44.272 86.286 963
AGE 3.677 3.535 0.000 3.000 20.000 963
Ritter (1984) and Beatty and Ritter (1986) argue that underpricing should increase with ex ante
uncertainty surrounding the issue. Following them, we adopt the market return between the offering and
listing day of IPOs (M_RETURN) (Ritter, 1984; Clarkson and Merkley, 1994; Yu and Tse, 2006); rm age (AGE)
at the time of offering (Ritter, 1984; Megginson and Weiss, 1991); and the underwriter's reputation (Beatty
and Ritter, 1986; Carter and Manaster, 1990) as proxies for ex ante uncertainty. The average M_RETURN is
0.4% in our sample (Panel B of Table 4). It is difcult to precisely measure the quality of underwriters for
Chinese IPOs, because all sample rms are underwritten by a Chinese securities company that is controlled by
the government (Chen et al., 2004; Yu and Tse, 2006). Following Francis et al. (2009), we make a dummy
variable that takes a value of one if an IPO rm uses one of the top ve underwriters based on the frequency of
underwriting for the largest 100 IPOs in offering size (UNDERWRITER). Panel A of Table 4 shows that only 99
IPO rms in our sample are underwritten by those underwriters. Allen and Faulhaber (1989), Grinblatt and
Hwang (1989), and Welch (1989) establish the signaling hypothesis of IPO underpricing in which good IPO
rms use the underpricing to distinguish themselves from bad rms so as to maximize the proceeds of
seasoned equity offerings. The signaling hypothesis implies a positive relation between underpricing and the
likelihood of seasoned equity offerings. Su and Fleisher (1999) and Chen et al. (2004) suggest that the
signaling hypothesis also explains the underpricing in Chinese IPOs. In contrast, Yu and Tse (2006) suggest
that the signaling hypothesis cannot explain underpricing of Chinese IPOs. We include a dummy variable that
takes a value of one when the rm issues seasoned equity offerings in the subsequent two years and zero for
others (SEO). Panel A of Table 4 shows that there are 214 (22.22%) rms that issue seasoned equity two years
following the IPO.
Some previous studies also argue that the high underpricing of Chinese IPOs is caused by the unique
characteristics of Chinese stock market (Mok and Hui, 1998; Chau et al., 1999; Su and Fleisher, 1999; Chen et al.,
2004; Chi and Padgett, 2005; Guo and Brooks, 2008; Cheung et al., 2009). Cheung et al. (2009) nd that the
xed-price offering method (xed P/E ratio by the regulators) contributes signicantly to IPO underpricing in
China. This evidence gives rise to a prediction that the underpricing level of IPO decreases after the abolishment
of the xed-price offering method (the introduction of the book-building system). To test this idea, we adopt a
dummy variable that takes a value of one when the rm went public under the book-building system (from
2005 to 2009) (BOOKBUILD). In our sample, there are 358 (37.18%) rms that went public from 2005 to 2009
(Panel A of Table 4).
We also include the P/E ratio (PE) in our analyses and predict that it has a negative impact on
underpricing. We use the amount of offering shares (LNOFFERNUM) to control the effect of the imbalance
supply and demand of new shares (Chi and Padgett, 2005; Guo and Brooks, 2008), which is predicted to have
a negative relation to underpricing. Some other researchers nd that the extent of underpricing increases
with the concentrated ownership structures and control (the equity retention by the state and state-owned
enterprises). We include the equity retention by the state (RETAIN) and a dummy variable indicating
state-owned enterprises (SOE) in our analyses. Panel B of Table 4 shows the mean RETAIN is 37.49%. Mok and
Hui (1998) argue that B-share prospectus usually contains more and detailed information than A-share
prospectus does, which can reduce the underpricing level. We adopt a dummy variable that takes a value of
one for rms that have previously or simultaneously issued B-shares, and zero for others (B_SHARE). We
predict that this variable will be negatively related to underpricing. Finally, we follow previous studies to
employ the hot market dummy (HOTMARKET), which takes a value of one for years with median ADIR
greater than 100% (Ibbotson and Jaffe, 1975; Ritter, 1984).
5. Empirical analyses
5.1. Univariate analyses
To examine whether legal environments affect underpricing, we equally divided the sample rms into
four groups upon the total index of legal environments (LEGAL). Panel A of Table 5 illustrates that there is a
monotonic relationship between the market-adjusted initial return and the level of legal protection strength.
The mean ADIR of Group 1 (the group with the lowest legal protection scores) is 134.76%, while the mean
ADIR of Group 4 (the group with the highest legal protection scores) is 102.23%. The mean difference between
these groups is signicant at the 1 percent level.14 The results suggest that underpricing of IPOs is negatively
related to legal protection.
We premise that issuers and underwriters do not have sufcient discretion in the offering price
determination under the xed-price offering method. Panel B of Table 5 clearly shows that rms that went
public under the book-building system are underpriced signicantly less than those under the xed-price
offering period. This nding is consistent with Cheung et al.'s (2009) nding.
Panels C and D of Table 5 test whether the relation between legal environments and underpricing
differs across the sub-periods. Panel C of Table 5 shows no evidence of monotonic and signicant
relationship between the underpricing and legal protection under the xed-price offering period. In
contrast, we nd that underpricing is negatively related to the strength of legal protection under the
book-building system (Panel D of Table 5). Panel D of Table 5 also presents that the mean ADIR of Group 4
is signicantly lower than that of Group 1. The results are consistent with the idea that legal protection
affects underpricing and rejects the possibility that the relationship between underpricing and legal
protection for the whole sample period (Panel A) is attributable to the potential positive relationship
between listing day price and legal score. Given that non-legal provincial characteristics will be
unchanged between the two sub-periods, this result also suggests that the negative relationship between
the legal framework and IPOs' underpricing is not attributable to non-legal, time-invariant differences
across provinces.
It is often stated that the eastern region has better legal environments than the middle and western
regions do. Upon our hypothesis, this fact predicts that IPOs in the eastern region have lower
underpricing than those in the middle and western regions. Meanwhile, Panels C and D of Table 1 show
that the eastern provinces are dominated by technology rms. Given that previous studies premise that
high-technology companies face high ex ante uncertainty about their prospects, this fact gives rise to the
opposite prediction (higher underpricing for IPOs in the eastern region).15 To address the issue, we
divided the sample rms into the eastern region and others. Panel E of Table 5 shows that the mean ADIR
of rms located in eastern provinces is signicantly lower than that for companies located in the middle
and western provinces at the 1 percent level. Meanwhile, Panel F of Table 5 indicates that the mean ADIR
of high-technology rms is signicantly higher than that of non-high-technology rms. Importantly,
14
In the unreported analysis, we nd similar results for the median difference test.
15
Ritter (1984) argues that underpricing is related to the ex ante uncertainty about the future value of a rm going public.
174
J. Liu et al. / Pacic-Basin Finance Journal 27 (2014) 163187
Table 5
Univariate analyses.
This table indicates the mean of the market-adjusted initial return (ADIR) for subsamples. In Panel A, we equally divide the rms into four groups upon LEGAL (Group 1 is the lowest LEGAL group).
Panel B shows mean ADIR separately for IPO rms that went public under the xed-price offering period (19972004) and the book-building system (20052009). In Panels C and D, we divide
sample rms into four groups upon the legal framework (LEGAL) and separately present mean ADIR: Panel C is for the xed-price offering period (19972004) and Panel D is for the book-building
system (20052009). In Panel E, we present mean ADIR separately for the eastern region and the non-eastern region. Panel F shows the difference on ADIR for high-technology rms and
non-high-technology companies. Panel G compares ADIR between high-technology and non-high-technology companies by region. See Table 2 for denitions of variables.
Panel A: Subsamples upon LEGAL
Group 1 Group 2 Group 3 Group 4 Highest Group versus lowest group

(lowest) (Highest)
Difference t-Statistics
ADIR (%) 134.76 127.50 127.31 102.23 32.54 4.61

N 252 238 227 246
Panel B: Subsamples upon BOOKBUILD
Firms went public under the xed-price Firms went public under the Difference t-Statistics
offering period (19972004) book-building system (20052009)
ADIR (%) 131.55 108.60 22.96 3.95

N 605 358
Panel C: Subsamples upon LEGAL under the xed-price offering period (19972004)

(lowest) (Highest)
ADIR (%) 139.19 123.82 127.85 136.67 2.53 0.26

N 178 168 157 102
Panel D: Subsamples upon LEGAL under the book-building system (20052009)

(lowest) (Highest)
ADIR (%) 137.11 106.34 102.06 91.72 45.39 3.35

N 88 82 82 106
Panel E: Subsamples upon geography
Eastern region Middle and western region Difference t-Statistics
ADIR (%) 114.97 135.48 20.52 3.57

N 585 378

Panel F: Subsamples upon high-technology companies
High-tech companies Non high-tech companies Difference t-Statistics
ADIR (%) 142.18 118.00 24.18 3.49

N 200 763
Panel G: Subsamples upon geography and high-technology companies
ADIR (%) High-tech companies Non high-tech companies Difference t-Statistics
Eastern region 139.90 107.19 32.71 4.00

N 139 446
Middle and western regions 147.36 133.20 14.16 1.13
N 61 317
Difference 7.46 26.00
t-Statistics 0.56 4.10
175
Panel G of Table 5 illustrates that high-technology rms have signicantly higher underpricing than
non-high-technology rms in the eastern region, whereas non-high-technology rms in the middle and
western regions have a higher level of underpricing than non-high-technology rms in the eastern
region. These ndings suggest that two conicting effects exist in the underpricing of IPOs in the eastern
region: high underpricing due to industry composition (many high-technology rms) versus low
underpricing due to well-developed legal environments. The univariate analysis result suggests that the latter
effect exceeds the former.
5.2. Regression results
In this section, we execute regression analyses of ADIR to control for various rm characteristics. The
key independent variable is LEGAL, which is the total legal environment score obtained from Fan et al.
(2011). BOOKBUILD is added to examine whether the increased discretion on offering price
determination directly affects the level of underpricing. We also include LOTTERY, M_RETURN, AGE,
UNDERWRITER, and SEO to control for effects of asymmetric information (the winner's curse hypothesis,
ex ante uncertainty hypothesis, and signaling hypothesis). We employ PE, RETAIN, SOE, LNOFFERNUM,
and B_SHARE to control for unique characteristics of Chinese IPOs. In order to control for the impact of
industry distribution, we also include industry dummies (including a high-technology industry dummy,
which is denoted by HIGHTEC) in our regressions. Table 6 shows no serious correlations among
independent variables.
Model 1 of Table 7 shows OLS regression results for the whole sample period. Throughout the
following analyses, we compute t-statistics for OLS coefcients by using province-clustering standard
errors since error terms for same province observations are potentially correlated. Consistent with the
univariate analysis result, LEGAL has a negative and signicant coefcient, suggesting that a developed
legal framework can reduce underpricing of IPOs. It is likely that some provinces have relatively strong
legal protection during the whole sample period compared to other provinces. The negative coefcient of
LEGAL in Model 1 is potentially attributable to the cross-province difference in legal protection, which is
potentially correlated with unobserved, non-legal, cross-province differences (e.g., culture, ethnicity,
and so on). As mentioned, LEGAL for a single province takes different values over time. To take this
advantage, we implement a province-xed effects model estimation, which controls for unobserved,
time-invariant province characteristics.
Model 2 of Table 7 presents that the province-xed model estimation also engenders a negative and
signicant coefcient on LEGAL (it becomes large in absolute value). The estimated coefcient suggests
that a one standard deviation increase in the total legal environment score (3.07) is associated with an
approximate 18.11 percent reduction in underpricing (3.07 0.059 = 0.1811). Given that the
mean ADIR is 123.02%, the marginal effect of the legal score is economically signicant. This result
suggests important policy implications for regions with less developed legal environments in addition to
providing robust evidence that legal protection reduces underpricing. If the middle and western
provinces improve their legal environments by the one standard deviation, rms in the regions will
decrease IPO underpricing by approximately 77 million RMB (29.1 billion RMB cost reduction in total for
IPO rms from these regions). Given that underpricing amounts to a major cost to IPO rms, an improved
legal environment will substantially decrease the costs that young companies need to incur when going
public.
Although the univariate test result suggests that underpricing signicantly declines following the
introduction of the book-building system, Model 2 of Table 7 engenders a positive and marginally
signicant coefcient on BOOKBUILD. We should see this result with caveats, since BOOKBUILD is
correlated with HOTMARKET in our data (hot market occurred frequently before the introduction of a
book-building system). The coefcient of BOOKBUILD becomes insignicant when we deleted
HOTMARKET from the independent variable. This result suggests that the increased discretion did not
signicantly affect the level of underpricing per se once we control for the effects of the time-invariant
characteristics of a province. Regarding control variables, all models of Table 7 engender a negative and
signicant coefcient on LOTTERY. The result is consistent with the winner's curse hypothesis (Guo and
Brooks, 2008). M_RETURN has a negative and signicant coefcient, which is consistent with the idea
that underpricing is associated with high ex ante information asymmetry. However, the other proxy
Table 6
Correlation matrix.
This table indicates the correlation matrix among independent variables. See Table 2 for denitions of variables.
LEGAL SOE SEO LOTTERY LNOFFERNUM M_RETURN UNDERWRITER B_SHARE AGE PE RETAIN HIGHTEC
LEGAL 1.000
SOE 0.365 1.000
SEO 0.068 0.026 1.000
LOTTERY 0.202 0.158 0.032 1.000
LNOFFERNUM 0.084 0.415 0.032 0.164 1.000
M_RETURN 0.019 0.013 0.059 0.008 0.104 1.000
UNDERWRITER 0.114 0.108 0.033 0.065 0.427 0.017 1.000
B_SHARE 0.057 0.006 0.007 0.049 0.036 0.002 0.038 1.000
AGE 0.376 0.212 0.093 0.128 0.078 0.068 0.058 0.040 1.000
PE 0.311 0.217 0.114 0.163 0.020 0.176 0.077 0.042 0.253 1.000
RETAIN 0.466 0.385 0.003 0.164 0.422 0.025 0.111 0.012 0.387 0.239 1.000
HIGHTEC 0.201 0.179 0.015 0.067 0.227 0.115 0.047 0.057 0.036 0.126 0.186 1.000
177
Table 7
Regression results.
This table shows regression results of ADIR for the entire period. In each regression, observations are deleted from the analysis when
necessary independent variables are not available. Model 1 employs OLS estimation; Model 2 adopts province-xed effects model
estimation. We compute t-statistics for OLS coefcients by using province-clustering standard errors. See Table 2 for denitions of
variables.
Independent variable Model 1 Model 2
Entire period (OLS) Entire period (Province effects)
Coefcient t-Statistics Coefcient t-Statistics
LEGAL 0.035 4.82 0.059 3.61

BOOKBUILD 0.111 1.35 0.227 1.97
LOTTERY 0.067 4.09 0.069 4.11
M_RETURN 0.091 2.40 0.107 2.62
AGE 0.002 0.29 0.004 0.46
UNDERWRITER 0.304 4.78 0.245 3.10
SEO 0.021 0.40 0.008 0.15
PE 0.001 0.17 0.001 0.34
LNOFFERNUM 0.311 10.76 0.327 11.55
RETAIN 0.057 0.32 0.097 0.58
SOE 0.007 0.10 0.043 0.60
HIGHTEC 0.153 1.02 0.169 1.14
B_SHARE 0.942 2.72 0.903 2.49
HOTMARKT 0.477 8.65 0.451 7.95
INDUSTRY Yes Yes
Constant 3.722 13.46 3.946 13.29
Adjusted R2 0.266 0.270
N 963 963
variables for ex ante information asymmetry have an insignicant coefcient. We nd a positive and
signicant coefcient on UNDERWRITER, which is opposite in sign to our prediction.16 We do not nd a
clear relationship between ADIR and AGE. As with Yu and Tse (2006), Table 7 presents no evidence of the
signaling hypothesis in the Chinese IPO market.
Regarding the unique characteristics of Chinese IPOs, we nd that LNOFFERNUM has a negative and
signicant impact on underpricing level for all the models, which is consistent with the ndings of Chi and
Padgett (2005) and Guo and Brooks (2008). Table 7 also shows that rms experience low underpricing if
they issue B-shares to foreign investors (Mok and Hui, 1998). We nd that the coefcients of HIGHTEC are
positive but insignicant once we control for legal environments and other rm characteristics. We do not
nd a clear relationship between ADIR and the other control variables in our regressions.
As mentioned, there should be little discretion in offering price determination under the online
xed-price offering method. Information asymmetry and other factors are less likely to have
considerable effect on offering price during the period, even though those factors potentially affect the
stock price at the initial trading day. We also execute regression analyses of ADIR separately for the
online xed-price offering period (Models 1 and 2 of Table 8) and the book-building system (Models 3
and 4 of Table 8) to accurately investigate whether legal environments affect offering price. Both the OLS
and province-xed estimations suggest that legal protection is not signicantly related to underpricing
of IPOs during the xed-price offering period. In contrast, the legal framework has a signicant impact on
the underpricing under the book-building system. These results present strong evidence that a legal
system affects offering price; the negative relationship between the initial return and legal score is not
mainly attributable to its potential correlation with the listing day price. We also stress that the analyses
control for unobserved, time-invariant province characteristics in two ways: usage of the province-xed
16
As mentioned, it is difcult to measure Chinese underwriters' reputation, since the A-share IPOs are underwritten by domestic
state-owned securities companies (Chen et al., 2004; Yu and Tse, 2006).
Table 8
Regression results: the xed-price offering period versus the book-building period.
This table shows regression results of ADIR for sub-periods. In each regression, observations are deleted from the analysis when
necessary independent variables are not available. Model 1 is OLS results for the xed-price offering period (19972004); Model 2 is
province-xed model results for the xed-price offering period; Model 3 is OLS results for the book-building period (20052009);
and Model 4 shows province-xed effects model results for the book-building period (20052009). We compute t-statistics for OLS
coefcients by using province-clustering standard errors. See Table 2 for denitions of variables.
Independent variable Model 1 Model 2 Model 3 Model 4
Fixed-price offering pe- Fixed-price offering pe- Book-building system Book-building system
riod riod (OLS) (Province effects)
(OLS) (Province effects)
Coefcient t-Statistics Coefcient t-Statistics Coefcient t-Statistics Coefcient t-Statistics
LEGAL 0.014 0.89 0.048 1.19 0.034 2.80 0.047 1.91

LOTTERY 0.046 3.00 0.057 3.40 0.224 2.01 0.269 3.11
M_RETURN 0.326 3.51 0.363 3.47 0.021 0.53 0.031 0.64
AGE 0.042 3.59 0.050 3.08 0.013 1.26 0.016 1.50
UNDERWRITER 0.229 2.08 0.257 1.99 0.175 1.34 0.145 0.92
SEO 0.027 0.46 0.021 0.34 0.008 0.09 0.009 0.10
PE 0.002 0.66 0.002 0.41 0.002 1.31 0.002 1.22
LNOFFERNUM 0.593 7.95 0.583 7.51 0.118 2.89 0.147 3.10
RETAIN 0.282 1.48 0.351 1.72 0.095 0.29 0.078 0.23
SOE 0.018 0.22 0.008 0.11 0.114 0.54 0.102 0.57
HIGHTEC 0.183 1.09 0.225 1.44 0.037 0.14 0.187 0.72
B_SHAREa 0.880 2.58 0.778 2.20
HOTMARKET 0.004 0.03 0.006 0.05 0.794 8.11 0.724 7.38
INDUSTRY Yes Yes Yes Yes
Constant 6.235 10.26 6.220 9.35 2.356 6.00 2.918 4.73
Adjusted R2 0.329 0.321 0.354 0.344
N 605 605 358 358
a
There are no rms that issued B-shares from 2005 to 2009 in our sample. Hence, we delete B_SHARE from the independent
variable of regressions for the book-building period.
effects model and the sub-period analyses. If the negative coefcient on LEGAL is attributable to the
unobserved factor, we should nd the same result for the online xed-price offering period, and the
province-xed effects model should not carry a signicant coefcient on LEGAL. Especially, Models 2 and
4 provide robust evidence that a legal framework affects underpricing by controlling for time-invariant,
provincial characteristics.17
Regarding control variables, M_RETURN, AGE, and UNDERWRITER have a signicant coefcient only for
the online xed-price offering period. LNOFFERNUM is signicantly related to ADIR for both of the
sub-periods, but the coefcient is larger in absolute value for the online xed-price offering period. Given that
offering price was automatically determined by the reported income and the xed P/E ratio during the former
sub-period, it is less likely that those factors affect offering price. A potential interpretation is that those
factors affect the stock price of the initial trading day rather than offering price. LOTTERY has a signicant
coefcient for both of the sub-periods, which is larger in absolute value for the book-building period. This
result serves as evidence of the winner's curse hypothesis in the Chinese IPO market.
17
To prevent non-legal regional characteristics biasing our results, we also implement regression analyses for the eastern region
only. Since the eastern region has various characteristics that are distinctive from the other regions, we can minimize the effects of
the non-legal characteristics by limiting our attention to the eastern region. The xed effects-model estimation carries a negative and
signicant coefcient on LEGAL for the entire sample period, as well as for the book-building period. This result also serves as
powerful evidence that legal environments matter in underpricing. For the middle and western regions, however, LEGAL does not
have a signicant coefcient. This is probably due to the small sample size, especially for the book-building period (46 for the middle
region and 43 for the western region), and small variation in LEGAL within the middle and western regions.
Table 9
Regression results by adopting the sub-indices of legal framework.
This table shows results from regressions of ADIR that employ legal environment scores on subcomponents as a key independent
variable. Province-xed effects models are used for estimation. In each regression, observations are deleted from the analysis when
necessary independent variables are not available. Panel A is for the entire period; Panel B is for the xed-price offering period
(19972004); Panel C is for the book-building system (20052009); and Panel D shows results of regressions for the entire sample
that includes the interaction terms of legal protection variables and BOOKBUILD. The sample size is smaller for Model 1 and 2 than
for others since INTERMEDIARY and CONSUMER are not available for the rst two years of our sample period. See Table 2 for
denitions of variables.
Independent variables Model 1 Model 2 Model 3 Model 4
Coefcient t-stat. Coefcient t-Stat. Coefcient t-Stat. Coefcient t-Stat.
Panel A: Entire sample

INTERMEDIARY 0.101 5.09
PROPERTY 0.062 2.79
INTELLECTUAL 0.016 3.27
CONSUMER 0.026 0.61
BOOKBUILD 0.288 2.92 0.022 0.26 0.121 1.24 0.002 0.01
LOTTERY 0.260 5.77 0.071 4.17 0.064 3.84 0.250 4.87
M_RETURN 0.067 1.20 0.075 1.98 0.111 2.57 0.073 1.38
AGE 0.010 1.06 0.003 0.39 0.004 0.45 0.009 0.93
UNDERWRITER 0.203 2.13 0.263 3.34 0.258 3.51 0.237 2.72
SEO 0.011 0.19 0.014 0.26 0.012 0.23 0.033 0.56
PE 0.004 1.99 0.001 0.31 0.001 0.67 0.004 1.96
LNOFFERNUM 0.273 4.98 0.319 11.31 0.323 11.56 0.255 4.68
RETAIN 0.139 0.69 0.078 0.49 0.098 0.60 0.153 0.72
SOE 0.022 0.21 0.022 0.31 0.048 0.65 0.030 0.28
HIGHTEC 0.004 0.02 0.171 1.06 0.179 1.16 0.038 0.21
B_SHARE 0.875 1.87 0.861 2.49 0.905 2.43 0.970 1.96
HOTMARKET 0.550 8.13 0.508 11.15 0.448 6.90 0.526 8.62
Constant 3.840 7.88 3.820 12.99 3.735 12.72 3.543 5.89
Adjusted R2 0.298 0.258 0.267 0.285
N 684 963 963 684
Panel B: Fixed-price offering period

PROPERTY 0.035 1.33
CONSUMER 0.109 1.24
LOTTERY 0.108 1.77 0.055 3.56 0.056 3.36 0.093 1.58
M_RETURN 0.359 2.31 0.368 3.47 0.367 3.49 0.406 2.52
AGE 0.032 1.47 0.048 3.18 0.050 2.90 0.028 1.33
UNDERWRITER 0.210 1.44 0.263 2.06 0.260 2.08 0.201 1.30
SEO 0.008 0.11 0.022 0.36 0.023 0.39 0.010 0.12
PE 0.014 2.25 0.002 0.51 0.002 0.51 0.015 2.30
LNOFFERNUM 0.685 5.15 0.585 7.87 0.579 7.57 0.674 5.08
RETAIN 0.477 1.90 0.342 1.71 0.342 1.70 0.499 1.90
SOE 0.067 0.53 0.005 0.06 0.004 0.06 0.105 0.74
HIGHTEC 0.167 0.72 0.231 1.42 0.224 1.43 0.150 0.62
B_SHARE 0.850 1.54 0.769 2.17 0.774 2.18 0.997 1.65
HOTMARKET 0.268 1.88 0.008 0.06 0.002 0.02 0.209 1.41
Constant 7.863 5.99 6.208 10.16 6.094 9.29 7.998 5.29
Adjusted R2 0.394 0.321 0.321 0.379
N 326 605 605 326
Panel C: Book-building period

PROPERTY 0.167 2.20
CONSUMER 0.214 1.43
LOTTERY 0.262 2.78 0.293 3.24 0.270 3.09 0.266 2.81
M_RETURN 0.014 0.23 0.007 0.14 0.026 0.55 0.012 0.21
Table 9 (continued)
Independent variables Model 1 Model 2 Model 3 Model 4
Coefcient t-stat. Coefcient t-Stat. Coefcient t-Stat. Coefcient t-Stat.
Panel C: Book-building period

AGE 0.015 1.45 0.019 1.86 0.016 1.50 0.018 1.81
UNDERWRITER 0.138 0.88 0.116 0.74 0.144 0.92 0.135 0.84
SEO 0.027 0.30 0.017 0.20 0.014 0.16 0.011 0.12
PE 0.001 1.02 0.002 1.16 0.002 1.16 0.002 1.54
LNOFFERNUM 0.139 3.06 0.143 3.12 0.145 3.07 0.135 2.88
RETAIN 0.069 0.20 0.073 0.22 0.072 0.21 0.108 0.32
SOE 0.095 0.54 0.119 0.70 0.094 0.53 0.131 0.78
HIGHTEC 0.217 0.92 0.212 0.79 0.184 0.70 0.199 0.79
HOTMARKET 0.768 6.01 0.727 8.63 0.739 7.32 0.764 6.75
Constant 3.551 4.61 3.328 4.37 2.640 4.96 4.434 2.56
Adjusted R2 0.341 0.344 0.343 0.339
N 358 358 358 358
Panel D: Entire period with interaction terms

INTERMEDIARY BOOKBUILD 0.055 1.08
PROPERTY 0.033 1.31
PROPERTYBOOKBUILD 0.081 1.93
INTELLECTUALBOOKBUILD 0.003 0.12
CONSUMER 0.020 0.50
CONSUMERBOOKBUILD 0.101 1.32
BOOKBUILD 0.608 1.54 0.348 1.63 0.112 1.14 0.960 1.20
LOTTERY 0.256 5.61 0.067 3.91 0.064 3.51 0.243 4.85
M_RETURN 0.075 1.38 0.081 2.08 0.111 2.57 0.083 1.61
AGE 0.009 0.96 0.002 0.25 0.004 0.47 0.011 1.09
UNDERWRITER 0.202 2.14 0.249 3.26 0.259 3.65 0.239 2.69
SEO 0.003 0.05 0.005 0.10 0.011 0.22 0.029 0.48
PE 0.004 1.96 0.001 0.59 0.001 0.66 0.003 1.75
LNOFFERNUM 0.269 5.01 0.319 11.31 0.322 11.47 0.261 4.97
RETAIN 0.146 0.73 0.076 0.47 0.097 0.60 0.171 0.81
SOE 0.034 0.31 0.037 0.51 0.047 0.67 0.043 0.40
HIGHTEC 0.005 0.03 0.169 1.07 0.179 1.17 0.025 0.14
B_SHARE 0.939 1.98 0.901 2.50 0.904 2.44 0.953 1.95
HOTMARKET 0.538 8.05 0.487 9.79 0.447 6.91 0.500 8.32
Constant 3.806 7.85 3.755 12.92 3.738 12.80 3.588 6.21
Adjusted R2 0.301 0.262 0.267 0.288
N 684 963 963 684
5.3. Additional analyses
We implement various additional analyses to check the robustness of our results. Firstly, we conduct
regression analyses that replace ADIR (dependent variable) with the raw initial return (IR). The raw initial
return (IR) is calculated as:
IRi P i1 P i0 =P i0 ;
where Pi1 is the closing price of stock i on the rst trading day and Pi0 is the offering price of stock i. The
mean of IR in our sample is 130.75%. Unreported analyses nd qualitatively the same results as those in
Tables 7 and 8; LEGAL has a signicantly negative impact on IR only for the book-building period.
Fan et al.'s (2011) legal protection score suggests that the eastern provinces have better legal
environments than the middle and western provinces (Appendix B). We replicate the OLS estimation by
replacing LEGAL with a dummy variable that takes a value of one for IPOs located in the eastern provinces
and zero for others. Although the time-invariant variable does not have a strong power of test relative to
LEGAL, unreported analyses nd that the coefcient of the new dummy variable is negative and
signicant at the 1 percent level only for the book-building period. As mentioned, high-technology rms
that are shown to have high underpricing in previous studies, occupy a signicant portion of IPOs in the
eastern region. Nevertheless, those IPOs have signicantly lower underpricing due to well-developed
legal environments.
We have so far employed a panel data set to examine the effect of legal protection on underpricing with
controlling for time-invariant province characteristics. Nevertheless, it would be also meaningful to
investigate whether cross-sectional differences in legal protection at a given year are related to the level of
underpricing. We implement single-year cross-sectional regression analyses for years with more than 50
observations available. For four years during the online xed-price offering period (1998 through 2001),
coefcients on LEGAL are all positive and statistically signicant for year 1998 (untabulated). In contrast,
LEGAL has a negative coefcient for three of the four years of the book-building period (2006 through 2009),
becoming statistically signicant for year 2009.
These results suggest that the cross-sectional variation in underpricing is also negatively related to the
cross-sectional difference in legal environments after introduction of a book-building system; results from
Model 1 of Table 7 and Model 3 of Table 8 are at least partly attributable to the cross-sectional relation
between LEGAL and underpricing. Although we should see the result with caveats since cross-sectional
variation in legal environments is potentially correlated with non-legal provincial characteristics, the result
reinforces our argument that developments of legal protection decrease underpricing. We also replicate the
analysis by replacing LEGAL with the eastern region dummy. Consistent with the former nding, untabulated
results suggest that the eastern region dummy has a negative coefcient for three years during the
book-building period and it is statistically signicant for years 2007 and 2009, while the coefcient is positive
for three years of the online xed-price offering period.
As mentioned, Fan et al.'s (2011) legal protection index is composed of four sub-indices: the index
for the development of the market intermediary (INTERMEDIARY); the protection of producers'
property rights (PROPERTY); the protection of intellectual property rights (INTELLECTUAL); and the
protection of consumers' rights (CONSUMER). We replicate the analyses above by replacing LEGAL
with the four sub-indices to further examine what dimensions are effective for legal protection to
reduce underpricing. Claessens and Laeven (2003) show that rms operating under poor, legal
protection of intellectual property rights underinvest in intangible assets, leading to lower rm
growth and lower rm value. In general, weak property rights protection is likely to create more
uncertainty about the future IPO strategies and managerial decisions, which will negatively affect rm
value (Claessens and Laeven, 2003; Cull and Xu, 2005; Berger and Udell, 2006). Engelen and Essen
(2010) argue that better legal protection of investors can reduce ex ante uncertainty and, in turn,
reduce underpricing of IPOs.
Table 9 presents the regression results (province-xed effects model is used). Since there is high
correlation among those legal proxies, we separately employ them in four regression models. Models 1
and 4 have a smaller sample size than the other models because INTERMEDIARY and CONSUMER are not
available for the rst two years of our sample period. Models 1 to 3 in Panel A (results for the entire
sample period) show that underpricing signicantly declines with INTERMEDIARY, PROPERTY, and
INTELLECTUAL. Panels B and C replicate the analysis separately for the online xed-price offering period
and the book-building period. Under the online xed-price offering system, INTERMEDIARY has a
signicant coefcient (Panel B). In contrast, Panel C shows that INTERMEDIARY and PROPERTY have a
negative and signicant impact on underpricing during the book-building period (at the 5 percent
signicance level). Given that rm characteristics and environments are less likely to affect offering price
considerably during the xed-price offering period, these results suggest that legal protection of
property rights reduces underpricing. The estimated coefcient suggests that a one standard deviation
increase in producers' property protection score (PROPERTY) during the book-building period (1.95) is
associated with an approximate 32.6 percent reduction in underpricing (1.95 0.167 = 0.326).
Given that the mean ADIR is 108.60% during the book-building period, the marginal effect is economically
signicant. These results present robust evidence that legal protection of property rights affects
underpricing. On the other hand, it is difcult to assure that INTERMEDIARY affects offering prices since it
has a statistically signicant coefcient in the xed-price offering period as well as in the book-building
period (the coefcient is larger in absolute value for the xed-price offering period). We cannot reject the
possibility that the stock market signicantly appreciates IPOs from high INTERMEDIARY provinces at the
rst trading day.
Panel D of Table 9 shows results of regression analyses for the entire sample that add the
interaction term of BOOKBUILD and the four legal sub-component variables. This analysis conrms
that the relationship between legal protection of property rights (PROPERTY) and underpricing
becomes evident only after the introduction of the book-building system. Once we drop HOTMARKET,
which is correlated with BOOKBUILD, the coefcient of PROPERTY BOOKBUILD becomes signicant
at the 5 percent level. As a robust check, we replace ADIR (dependent variable) by IR and nd
qualitatively the same results as those in Table 9 (unreported).
As mentioned, Fan et al. (2011) adopted a new calculation of protection of producers' property
rights for year 2003 and after. As a robustness check, we replicate the analyses for the period before
2003. Unreported results suggest that PROPERTY did not have a signicant impact on underpricing
before 2003. This result is consistent with our former ndings. Overall, our ndings present a specic
mechanism through which legal protection reduces underpricing. The importance of property rights
protection is consistent with the argument that property rights protection is an important factor that
increases rm value and reduces risk of overinvestment (Ritter, 1984; Rock, 1986; Beatty and Ritter,
1986; Claessens and Laeven, 2003; Cull and Xu, 2005; Berger and Udell, 2006; Engelen and Essen,
2010).
6. Conclusions
Previous studies show that underpricing of IPOs exists widely in many stock markets (Ibbotson, 1975;
Saunders and Lim, 1990; Ritter, 1991; McGuinness, 1992; Kim et al., 1993; Loughran et al., 1994; Mok and Hui,
1998; Su and Fleisher, 1999; Beckman et al., 2001; Chan et al., 2004; Kirkulak and Davis, 2005). The existence of
underpricing of IPOs is one of the puzzles in corporate nance research that has attracted signicant attention
from researchers. Several researchers argue that legal protection of investors affect ex ante information
asymmetry and decrease underpricing (Ritter, 1984; Beatty and Ritter, 1986; Rock, 1986; Engelen and Essen,
2010). On the other hand, Boulton et al. (2010) and Banerjee et al. (2011) provide evidence of a positive
relationship between the accessibility of legal recourse and IPO underpricing, suggesting that IPO rms
intentionally underprice their shares as a form of insurance against future liability. These previous studies
commonly use a country-level legal protection index and we premise that the presented results are potentially
biased due to regional non-legal factors. It is still an unsolved question whether legal protection affects
underpricing of IPOs.
We examine the relation between legal environments and underpricing by using Chinese data that provide a
valuable research opportunity. Chinese domestic data exhibit heterogeneity in legal environments across
provinces, while the data should present less heterogeneity in non-legal characteristics relative to cross-country
data (Qian and Weingast, 1997; Jin et al., 2005). In addition, legal protection in China has gone through a
progressive development and Fan et al. (2011) propose legal protection indices by province and year. These
time-variant legal protection indices allow us to investigate the dynamic relationship between legal protection
and underpricing, which cannot be addressed in cross-country analyses that typically use legal protection indices
from La Porta et al. (1998), Kaufmann (2004), Kaufmann et al. (2005), and Djankov et al. (2008). It would be also
noteworthy that the Chinese IPO market has experienced signicant regulation changes between the online
xed-price offering method and the book-building system. We should nd a signicant relationship between
legal protection and underpricing only after the introduction of the book-building system that provides issuers
and underwriters with discretion in offering price determination, if legal issues are a true determinant of offering
price.
We collect a sample of 963 Chinese IPOs that went public on SHSE and SZSE during the period of
1997 2009 and investigate the relationship between underpricing and legal framework. The analyses
nd that rms from a province with more developed legal framework have less underpricing, even after
controlling for time-invariant, province-xed effects. Importantly, these tendencies are evident only for
the sub-period of the book-building system. These results provide robust evidence that legal protection
reduces underpricing. We also nd that the extent of underpricing is decreased by the strength of the legal
protection of property rights.
The presented analyses make signicant contributions to the literature. Firstly, we present
robust evidence that legal environments matter in IPOs' underpricing by using a research setting
that enables avoidance of biases from various time-invariant, cross-region differences namely,
usage of a single country data, a province-xed effects model, and two sub-period analyses. Given
that underpricing is a critical cost for IPO companies, this result presents an important policy
implication that developments of legal environments signicantly decrease costs that young
companies need to incur when going public. Finally, we present a specic mechanism through
which legal protection mitigates underpricing (protection of property). Put differently, ex ante
uncertainty regarding property rights should be viewed as an important factor associated with
underpricing, which is commonly observed around the world.
We should note a caveat for our results. Compared to the US, China has a relatively underdeveloped
legal environment. In general, Chinese legal protection is weak and may not provide investors with
sufcient legal power. Indeed, Chinese people tend to be conservative about litigation. Although the
threat of civil litigation signicantly affects US rms' behaviors, civil litigation is very rare in China (Chen
et al., 2006). Hence, we cannot reject the idea that the litigation hypothesis is unsupported in this
research due to the characteristics of the Chinese legal environment and aversion to litigation embraced
by most Chinese people. Nevertheless, we stress that it is an important nding that the legal framework
has a signicant impact on underpricing, even after controlling for time-invariant regional effects.
Analyses that address the aforementioned concerns are important work for future research.
Appendix A. The legal framework index by province
This Appendix presents the mean of Fan et al.'s (2011) legal framework index (total legal
environment score) by province during the period of 1997 to 2009 (See Table 2 for denitions of
variables). The legal framework index is an arithmetic average of the scores for the following four
components: (1) development of the market intermediary (service conditions of lawyers and
accountants; availability of assistance from Industry Associations; conditions of technical export
services); (2) protection of producers' property rights (the ratio of the number of economic crimes to
provincial GDP until 2002, and measured by using results of a survey that asks enterprises to comment
on the impartiality and efciency of local judicial departments and enforcement agencies for 2003 and
after); (3) protection of intellectual property rights (the ratio of patent applications and their
acceptance to the number of scientic and technical people); and (4) protection of consumers' rights
(the ratio of the number of consumer complaints received by the Consumer Association to provincial
GDP). Year 2001 is used as the base year, and the minimum and maximum values for each component
are specied to be 0 and 10, respectively. Values of each component in other years are normalized by
the base-year value.
Eastern region Middle region Western region

(11 provinces or cities) (8 provinces or cities) (12 provinces or cities)
Beijing 8.701 Shaanxi 3.879 Sichuan 4.166

Hebei 3.791 Heilongjiang 4.365 Guizhou 2.629
Shanghai 11.056 Jiangxi 3.371 Tibet 2.423
Zhejiang 8.781 Hubei 4.060 Gansu 2.560
Shandong 4.916 Jilin 4.107 Ningxia 3.000
Hainan 3.541 Anhui 3.804 Guangxi 3.322
Tianjin 7.132 Henan 3.615 Chongqing 3.804
Liaoning 5.265 Hunan 3.175 Yunnan 3.185
Jiangsu 7.412 Shanxi 3.366
Fujian 5.233 Qinghai 2.214
Guangdong 8.518 Xinjiang 3.812
Inner Mongolia 3.742
Appendix B. The legal framework index and its subcomponent scores
This Appendix presents the mean legal framework index (total legal environment score) from Fan et al.
(2011) and its subcomponent scores by region and year (See Table 2 for variables' denitions): (1)
development of the market intermediary (service conditions of lawyers and accountants; availability of
assistance from Industry Associations; conditions of technical export services); (2) protection of producers'
property rights (the ratio of the number of economic crimes to provincial GDP until 2002, and measured by
using results of a survey that asks enterprises to comment on the impartiality and efciency of local judicial
departments and enforcement agencies for 2003 and after); (3) protection of intellectual property rights (the
ratio of patent applications and their acceptance to the number of scientic and technical people); (4)
protection of consumers' rights (the ratio of the number of consumer complaints received by the Consumer
Association to provincial GDP). Year 2001 is used as the base year, and the minimum and maximum values for
each component are specied to be 0 and 10, respectively. Values of each component in other years are
normalized by the base-year value.
Region Year
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
The legal framework index

Mean: Eastern region 3.15 3.48 3.68 4.25 5.55 6.01 6.51 6.72 7.83 8.36 9.42 10.53 12.37
Mean: Middle region 1.83 2.08 2.94 3.00 2.96 3.16 3.38 3.69 4.62 4.77 5.18 5.60 6.25
Mean: Western region 1.99 2.08 2.46 2.26 2.28 2.51 2.73 3.05 3.86 3.98 4.38 4.84 4.93
Mean: Whole country 2.37 2.6 3.01 3.16 3.61 3.92 4.24 4.51 5.47 5.74 6.37 7.05 7.91
Market intermediary
Mean: Eastern region N.A. N.A. 2.44 2.79 3.99 4.29 3.76 3.99 6.43 6.43 6.43 6.43 7.34
Mean: Middle region N.A. N.A. 1.49 1.53 1.75 1.80 1.62 1.67 5.41 5.41 5.41 5.41 5.98
Mean: Western region N.A. N.A. 1.16 1.10 1.40 1.40 1.21 1.28 4.26 4.26 4.26 4.26 3.51
Mean: Whole country N.A. N.A. 1.72 1.81 2.41 2.53 2.22 2.34 5.33 5.33 5.33 5.33 5.51
Protection of producers' property rights

Protection of intellectual property rights

Protection of consumers' rights

Mean: Eastern region N.A. N.A. 6.56 7.11 7.87 8.24 8.64 8.99 9.34 9.57 9.91 10.16 10.37
Mean: Middle region N.A. N.A. 5.61 6.15 6.31 6.90 7.58 8.16 8.59 8.98 9.47 9.82 10.1
Mean: Western region N.A. N.A. 3.53 3.83 4.15 4.96 5.69 6.63 7.16 7.72 8.22 8.78 9.22
Mean: Whole country N.A. N.A. 5.20 5.59 6.03 6.62 7.22 7.86 8.30 8.70 9.14 9.54 9.85
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Pacic-Basin Finance Journal 27 (2014) 163187

Contents lists available at ScienceDirect

Pacic-Basin Finance Journal

Legal protection and underpricing of IPOs:

Article history: Chinese data enable investigation of the relationship between

4. Sample selection and variables

4.1. Sample selection

4.2. Measures for underpricing

IPO year Number of IPOs (%)

SHSE SZSE Total

Panel A: Distribution by calendar year

Panel B: Distribution by offering price determination method

Panel C: Distribution by industry and geography

Industry Number of IPOs

Eastern Middle Western Whole

Agriculture, shing, and stockraising 12 7 8 27

4.3. Control variables

IPO year ADIR

1997 140.21 25.33 126.74 11.76 3.03 75.08 464.25 184

Panel A: Dummy variables

BOOKBUILD 358 605

Panel B: Non-dummy variables

Mean Standard deviation Minimum Median Maximum N

LOTTERY (%) 0.008 0.014 0.000 0.004 0.137 963

5.1. Univariate analyses

Panel A: Subsamples upon LEGAL

Group 1 Group 2 Group 3 Group 4 Highest Group versus lowest group

ADIR (%) 134.76 127.50 127.31 102.23 32.54 4.61

Panel B: Subsamples upon BOOKBUILD

ADIR (%) 131.55 108.60 22.96 3.95

Group 1 Group 2 Group 3 Group 4 Highest Group versus lowest group

ADIR (%) 139.19 123.82 127.85 136.67 2.53 0.26

Group 1 Group 2 Group 3 Group 4 Highest Group versus lowest group

ADIR (%) 137.11 106.34 102.06 91.72 45.39 3.35

Panel E: Subsamples upon geography

Eastern region Middle and western region Difference t-Statistics

ADIR (%) 114.97 135.48 20.52 3.57

J. Liu et al. / Pacic-Basin Finance Journal 27 (2014) 163187

High-tech companies Non high-tech companies Difference t-Statistics

ADIR (%) 142.18 118.00 24.18 3.49

Panel G: Subsamples upon geography and high-technology companies

ADIR (%) High-tech companies Non high-tech companies Difference t-Statistics

Eastern region 139.90 107.19 32.71 4.00

5.2. Regression results

Independent variable Model 1 Model 2

Entire period (OLS) Entire period (Province effects)

Coefcient t-Statistics Coefcient t-Statistics

LEGAL 0.035 4.82 0.059 3.61

Independent variable Model 1 Model 2 Model 3 Model 4

Coefcient t-Statistics Coefcient t-Statistics Coefcient t-Statistics Coefcient t-Statistics

LEGAL 0.014 0.89 0.048 1.19 0.034 2.80 0.047 1.91

Independent variables Model 1 Model 2 Model 3 Model 4

Coefcient t-stat. Coefcient t-Stat. Coefcient t-Stat. Coefcient t-Stat.

Panel A: Entire sample

Panel B: Fixed-price offering period

Panel C: Book-building period

Coefcient t-stat. Coefcient t-Stat. Coefcient t-Stat. Coefcient t-Stat.

Panel C: Book-building period

Panel D: Entire period with interaction terms

5.3. Additional analyses

Appendix A. The legal framework index by province

Eastern region Middle region Western region

Beijing 8.701 Shaanxi 3.879 Sichuan 4.166

Appendix B. The legal framework index and its subcomponent scores