Empirical studies of political connections, private equity and disproportionate ownership: evidence from Chinese IPO markets

Initial public offerings (IPO) are an important topic which has attracted tremendous attention in corporate finance research over the last decades. Quite different from other mature markets, the Chinese IPO market is characterized by a weak legal system and poor governance standards. As part of a transition economy, the Chinese IPO market is also severely regulated by government and subject to intervention by a rigid authority. This unique institutional setting enables us to investigate the effects of institutional features of Chinese firms, such as political connections, the involvement of different private equity and disproportionate ownership structure, on the IPO process of Chinese non-state-owned enterprises (Non-SOEs). First, this thesis examines the value of political capital in the Chinese IPO market. I find a positive relationship between a politically connected executive and the probability of IPO approval of Non-SOEs. I further identify that shareholders value those connections, and give a market premium to the connected firms after the firms go public. This study also provides evidence that other types of political connections through external sources, such as politically connected sponsors and PE investors, also bring benefits to the firms in their IPO approval, and these connections substitute the effect of the executive’s political connections on IPO approval, but they are not endorsed by minority shareholders. Therefore, I argue that in emerging markets where government intervention is still prevalent, political capital does create value and Non-SOEs usually build political capital to facilitate their access to the IPO market, although other types of political capital do not bring further benefits into the post- IPO market. Given that the involvement of PE investors facilitates firms accessing the IPO market (as shown in chapter 2), I argue that PEs are able to do so because of their political connections, however no direct evidence is provided. Therefore I tried to investigate how PEs’ political connections/reputation impact the IPO process of Chinese Non-SOEs. Through my empirical studies, I find that although PEs’ reputation offers some explanation of the IPO approval rate of Chinese Non-SOEs, its marginal effect is less than PEs’ political connections, indicating that PEs’ role in helping firms to access the IPO market is mainly driven by its political connections rather than reputation. In addition, I document that PEs’ reputation rather than political connections is acknowledged by minority shareholders in the secondary market. I provide further evidence that foreign PEs are more likely to monitor managerial behavior by taking seats in the board, which is welcomed by the post-IPO market. The findings of this study support the institutional view of the PE industry. Particularly, politically connected PEs reduce the information asymmetry between regulators and firms through their political connections, but foreign PEs are more reputable and play a certification role which reduces the agency conflicts between controlling and minority shareholders. Finally, an important feature of Chinese listed firms is the wide existence of a disproportionate ownership structure, which has been found to facilitate the exploitation of minority investors by controlling shareholders, especially in emerging markets where the protection of minority shareholders is weak. However, there is no evidence from the IPO market about whether firms with disproportionate ownership underperform or outperform other IPOs. Using a large sample of Chinese newly listed Non-SOEs, this study provides evidence that a disproportionate ownership structure facilitates the exploitation of minority investors by controlling shareholders. The findings show that IPOs with disproportionate ownership structure underperform those without on three-year post-IPO buy-and-hold returns (BHAR) and cumulative abnormal returns (CAR), respectively, and IPOs with disproportionate ownership structure experience greater declines in operating performance post IPO. This underperformance is robust to various accounting-based performance measures and different holding horizons. I also identify that the underperformance of IPOs with disproportionate ownership structure are partly driven by their higher likelihood of undertaking value-destroying related party transactions than those without. The results further indicate that initial return of IPOs with disproportionate ownership structure is significantly lower than those without. The evidence suggests that in a non-state-owned firm with disproportionate ownership structure, minority shareholders face a high likelihood of expropriation by ultimately controlling shareholders in IPOs, resulting in a discount in market valuation of the IPOs with disproportionate ownership structure. Overall, this thesis examines the effects of institutional features of Chinese firms, including political connections, the involvement of different private equity and disproportionate ownership structure, on the IPO process of Chinese Non-SOEs. This thesis provides evidence that, due to the heavy government intervention in the Chinese IPO market, politically connected executives, politically connected sponsors and PE investors have a significantly positive effect on IPO approval. Although the political connections of domestic PEs play a more important role in the IPO process than the reputable PEs, reputable PEs reduce information asymmetries and mitigate agency problems for their portfolio firms better than their domestic equivalents do by providing a closer monitoring service. The empirical evidence also indicates that in emerging markets where the investor protection system is still weak, ultimately controlling shareholders of newly listed Non-SOEs with disproportionate ownership structure usually expropriate the interests of minority shareholders