Bulletin Spring‧Summer Autumn‧Winter 1999

economi s ts and business academics. The Business Administration Faculty, as the largest and best-known business school i n Hong Kong, has launched a broad-based research effort to investigate the subject, an effort that is under-pinned by CUHK 's unique access to China's stock market databases. The Shanghai Stock Exchange, the Shanghai International Securities Co., and the Shenzhen Stock Exchange have all agreed to p r ov i de stock data and company i n f o r ma t i o n of their respective ma r ke ts to C U H K researchers. W i t h these advantages, CUHK is emerging as a wo r ld leader i n this area of research. One such project is undertaken by Dr. Henry M . K . M o k of the Depa r tment of Dec i s i on Sciences and Managerial Economics at CUHK, i n collaboration w i t h Dr. Y.V. H u i of the City Polytechnic of Hong Kong. The project examines the underpricing of new issues and their volatility i n China's stock markets, and w o n an ea rma r k ed g r ant of HK$150,000 f r om the Research Grants Council i n 1993. Why Are New Shares Underpriced? One of the most striking phenomena that cries out for exami na t i on and theoretical understanding is the underpricing of initial public offerings (IPO), and the huge volatility that it generates. When a private company goes public, the original proprietors w i l l offer shares i n the company for sale to the public. There are several advantages to such share offerings. From the point of v i ew of society as a whole, the stock ma r k et he l ps to d i v e rt savings f r om consumption to l ong - t e rm investment. For the original proprietors, it offers access to capital and hence the oppo r t un i ty to grow. It also allows start-up entrepreneurs to recoup their investments on the basis of expected rather than realized profits. When state-owned enterprises are converted into share-holding companies, their management and operations become ma r ke t - d r i ven and market-responsive. The investors on the other hand get the opportunity of achieving a somewhat higher rate of return than is available f r om the bank — at the cost of some financial risk. Society as a whole also gains by spreading financial risk around. Economic theory holds that each party i n any transaction acts to ma x i m i ze his o w n benefits. Thus the issuers, as the seller, wo u l d wan t to set the price of IPOs as h i gh as the market w i l l bear 一 especially since there is always a limit to the number of shares to allot, e need not suppress price to drive up volume. If IPOs are priced at close to eventual market valuation, the offering wo u l d see only a very small rise (possibly even a small fall) soon after the offering, w i t h longer-term gains driven by the success of the enterprise. Yet IPOs are often underpriced, as evidenced by sharp rises very soon after public offer. I n developed markets, the underpricing ranges f r om a few per cent to nearly 50 per cent. Why should the issuers i n effect sell below market price? This poses a challenge to economic theory, and has been cited (Brealey and Myers, 1991) as one of the ten Dr. Henry M. K. Mok graduated with distinction from Hong Kong Bapist College. He earned his MA in economics from the University of Toronto, Canada, and the degrees of Master of Urban and Regional Planning, Master of Social Work and Ph.D. in economics from the University of Hawaii at Manoa. He joined CUHK in January 1988 and is now lecturer in the Department of Decision Sciences and Managerial Economics. Dr. Mok is currently director of the Center for Financial Research on China and director of research development at the Asia-Pacific Institute of Business. Research 22