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IPO underpricing or the indirect cost of going public is extremely high in China. We hypothesize that government control over the corporate economy underlies this puzzle. Specifically, bureaucratic managers in state-owned firms as well as regulatory authorities have incentives to underprice. Using a sample of a new stock market in China, we find evidence supporting this hypothesis. Underpricing is higher for state-owned firms and for IPOs before the reform making IPO prices less affected by the regulator. Furthermore, we find that the reduction in underpricing or indirect cost by the reform more than offsets the increase in direct costs for compensating underwriters‟ higher efforts. Overall, the reform making IPO process more market-oriented is beneficial to Chinese firms going public.

Government control and the higher costs of going public: Evidence from a new stock market in China