Summary:
Initial public offerings (IPOs) are an important part of the healthy development of a stock market. IPOs not only allow firms to access capital markets and raise capital at low cost, but also provide investors with new investment opportunities. IPO pricing inefficiency has long plagued China's stock market. This study compares the IPO price efficiency of the market pricing mechanism with that of the window guidance (price cap). We find that IPO pricing mechanisms not only impact stocks' primary market price, but also influence stocks' secondary market price movement immediately after the stocks are issued. Only by examining stock prices in the primary and secondary markets together can we achieve a comprehensive understanding of the IPO mechanism. Our heterogeneous and irrational investor-based theoretical model demonstrates that although a price cap can lower the primary market IPO price, it also amplifies the secondary market trading price immediately after the new shares are issued. When investors are not fully rational and conduct momentum trading, the primary market price cap can align investors' expectations in the direction of stock undervaluation. As irrational investors tend to buy shares of newly issued stocks more aggressively than their rational counterparts, they can drive the stock price to a level even higher than the price level under the IPO market pricing scenario. To empirically test this theory, we collect a sample of 1,950 IPOs in both the market pricing period (from January 2009 to June 2014) and the window guidance period (from July 2014 to June 2018). The persistent price increase after the listing of the firms indicates that the secondary market is still engaged in the pricing process, which is not accomplished in the primary market. Only when the stock price stops increasing and reaches a local maximum is the pricing process completed. To effectively characterize the secondary market pricing of IPO stocks, we introduce a new concept, the extreme price-earnings (EPE) ratio, which is defined as the first local maximal closing price-to-earnings (P/E) ratio after the stock is traded in the secondary market. Consistent with our theory, we find that an IPO price cap leads to an abnormal secondary market price increase after stock issuance. The average industry-adjusted EPE ratio of the IPO stocks reaches 30.4 in the window guidance period, which is significantly larger than the 10.0 average in the IPO market pricing period. This result is very robust even after controlling for firm accounting variables. It clearly demonstrates that instead of alleviating the IPO overpricing problem, the price cap policy exaggerates the overpricing issue. Although the price cap limits overpricing in the primary market, it only moves the problem to the secondary market at the cost of even higher secondary market overpricing. We find three additional pieces of evidence to support our claim. First, the financial performance of IPO firms (e.g., sales growth, ROE, leverage, etc.) is much better in the market pricing period than in the window guidance period, suggesting that the higher industry-adjusted EPE ratio in the window guidance stage is driven not by higher firm quality, but by larger mispricing. Second, IPO stocks in the window guidance period have much lower market-adjusted long-term returns than the IPO stocks in the market pricing period. According to our theory, the price cap drives the secondary market price to an excessively high level, which will lead to much lower returns in the long run. Third, we find that the mispricing effect in the secondary market is stronger for the Growth Enterprises Market (GEM) Board IPO stocks than for the Main Board IPO stocks. As GEM firms are subject to more growth uncertainty and information asymmetry, they are more likely to be chased by irrational investors, thus creating larger mispricing.
张劲帆, 李丹丹, 杜涣程. IPO限价发行与新股二级市场价格泡沫——论股票市场“弹簧效应”[J]. 金融研究, 2020, 475(1): 190-206.
ZHANG Jinfan, LI Dandan, DU Huancheng. Do IPO Pricing Caps Contain New Stock Price？ Evidence from the Secondary Market. Journal of Financial Research, 2020, 475(1): 190-206.
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