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The overseas listing puzzle: Post-IPO performance of Chinese stocks and ADRs in the U.S. market Yongli Luo a,∗, Fang Fang b, Omar A. Esqueda c a b c

Wayland Baptist University, Plainview, TX 79072, United States The University of Texas-Pan American, Edinburg, TX 78541, United States Tarleton State University, Stephenville, TX 76402, United States

a r t i c l e

i n f o

Article history: Received 12 December 2011 Accepted 22 June 2012 Available online 2 July 2012 JEL classification: G12 G15 G24 G32 Keywords: American depositary receipts Initial public offerings Cross-listing Chinese stocks

a b s t r a c t The “China concepts stock” in the U.S. has attracted a great deal of attention among international investors due to the fast growth in Chinese economy. This paper examines the aftermarket performance and the motivations to list in the U.S. for Chinese firms over 1993–2010 by considering the great impact of split-share structure reform in China. We find that the Chinese firms in the U.S. generally underperform the benchmark and industry peers in the post-IPO period of 3 years. The Chinese cross-listing ADRs show superior performance relative to the single-listings in the long run. It seems that more stringent listing requirements and accounting standards help to improve the corporate governance and operating performance of the Chinese firms. The evidence also supports that the Chinese issuers are motivated to cross-list in the U.S. due to overinvestment incentives, leverage effects or free-cash-flow signaling, which is consistent with agency theory and signaling hypothesis. © 2012 Elsevier B.V. All rights reserved.

1. Introduction The “China concepts stock” in the U.S. market has attracted a great deal of attention among international investors due to the fast growth in Chinese economy. The “China concepts stock” is a set of stock issued by companies whose assets or earnings have significant activities in Mainland China. Investments in these stocks are considered as one of the purest investment plays on China’s longterm economic growth outside of foreign direct investment. Claessens et al. (2006) document that a ∗ Corresponding author at: Wayland Baptist University, School of Business, 1900 West 7th Street, CMB #252. Plainview, TX 79072, United States. Tel.: +1 956 534 3596. E-mail address: [email protected] (Y. Luo). 1042-444X/$ – see front matter © 2012 Elsevier B.V. All rights reserved. http://dx.doi.org/10.1016/j.mulfin.2012.06.008

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country with better economic fundamentals such as higher growth opportunities and income level is associated with more internationalization of the firms including listing, trading and capital raising in international exchanges. Since 1993, increasing numbers of Chinese firms have cross-listed in the U.S. market, and many international investors buy shares in these companies in order to participate in the spectacular growth of the Chinese economy (Cheung et al., 2009). As of 2011, 243 Chinese firms have listed in the U.S. in the form of initial public offerings (IPOs) and American Depository Receipts (ADRs), and the market share of Chinese firms accounts for 73.33% of the market share among all the foreign listings in the U.S. market (Ritter, 2011). Initially, a majority of the Chinese firms were traded in the U.S. in the form of ADRs and served as a vehicle to signal the quality of state owned enterprises (SOEs).1 According to the logic of the Chinese government—“Let the most beautiful daughter marry first”, the Chinese ADRs are selected by the government or dominated by SOEs and their issuances are primarily determined by political relations, not by the firms’ desire to find growth opportunities or expand foreign sales (Hung et al., 2008). Thus, the Chinese ADRs typically have more professional boards of directors, use greater accounting conservatism, and exhibit higher investment efficiency than their domestic counterparts. In addition, Chinese companies traditionally have separate, restricted share classes for domestic residents and foreigners.2 Very few studies have examined the difference between domestic shares and foreign shares issued by Chinese firms. For example, Eun and Huang (2007) show that Chinese investors value local A-shares more highly if the firm has corresponding B- and H-shares available to foreign investors. Yang and Lau (2006) document that there are differences between Chinese firms listed as H-shares in Hong Kong and ADRs in the U.S., and they suggest that the Hong Kong market may offer a better information environment for Chinese firms compared to the U.S. market. Fernald and Rogers (2002) document that the foreign shares were sold intentionally low with deep discounts to attract global investors, and these shares are identical other than who is allowed to own them, but foreigners have generally paid only about one-quarter the price paid by domestic residents. The “China concepts stock” has faced great challenges since a split-share structure reform occurred in China and many overseas-listed Chinese companies have tainted by fraud scandals in recent years. Due to historical reasons, a large amount of non-tradable shares exist in Chinese stock market and this causes severe agency problems. Starting from 2005, the CSRC launched a split-share structure reform aimed at eliminating all non-tradable shares and transferring non-tradable shares into tradable shares. This mandatory institutional change has resulted in significant changes in the IPO issuance and firm liquidity, and the domestic Chinese markets for new issuances were frozen in 2005. Since then, a remarkable increase in overseas listings has been observed as more and more Chinese firms seek to cross-list in the U.S. exchanges. However, many of these companies seek to list in the U.S. through reverse mergers or backdoor IPO listings. According to the Public Company Accounting Oversight Board (PCAOB), more than 150 Chinese companies have backdoored their way onto the U.S. since 2006 by using old shells of listed U.S. companies (the total market capitalization of such firms is over 12.8 billion U.S. dollars in 2010). Because these types of listings become public by merging with the U.S. publicly traded shell companies without the regulatory rigors involved in a traditional IPO, many of them are found to be less regulated or have been accused of fraud or shoddy accounting. This attracted a great deal of attention from the U.S. Securities and Exchange Commission (SEC) and the SEC started investigating them as well as the network of U.S. auditors and public relations firms who marketed such companies to the U.S. market. As a result, many international investors suffered huge losses and encountered difficulties in understanding the value and institutional features of these Chinese firms.

1 Mr. Daojong Zhou, the former chairman of the China Securities Regulatory Commission (CSRC) talked to the CEOs of foreign listed firms and said: “Overseas-listed companies are all outstanding enterprises that are representatives of their respective industries to an extent. I hope you can also be the models of listed companies. The behavior of an overseas-listed company is not only the company’s own business, it relates to our country’s image of reform and openness (May 26, 1995, CSRC web news).” 2 There are five types of Chinese shares: (1) government shares, which are held by the State Assets Management Bureau (SAMB); (2) legal entity shares (or C shares), which are held by other state-owned enterprises; (3) employee shares, which are held by managers and employees; (4) ordinary domestic individual shares (or A-shares), which can be purchased only by Chinese citizens on the Shanghai (SHSE) or the Shenzhen (SZSE) stock exchange; and (5) foreign shares, which can be purchased only by foreign investors in Mainland China (B-share), in Hong Kong (H-share), or in the U.S. (N-share). The first three types of shares are not tradable in the official exchanges, although employee shares are allowed to be listed three years after the IPO.

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Fig. 1. Average first-day returns on European and non-European IPOs. (A) Average first-day returns on (mostly) European IPOs. (B) Average first-day returns on non-European IPOs. Data source: Ritter’s website at http://bear.warrington.ufl.edu/ritter/ipodata.htm.

This study is compelling because the motivations for Chinese firms to list overseas differ from their counterparts in the European or non-European countries in many ways.3 First, China is among the most common countries that list IPOs and ADRs in the U.S., and the short-run Chinese domestic IPO underpricing is extremely high (Loughran et al., 2011). Fig. 1 illustrates that the average first-day return on Chinese domestic IPOs is 137.4% (Chen et al., 2009), which is far above the average first-day returns on most of the European IPOs (less than 30%) and the average first-day returns on non-European IPOs (less than 40% except for Korea, Malaysia and India). Comparing to the average first-day return on the domestic U.S. which is only 16.8% (Ibbotson et al., 1994), the short-run abnormal return on Chinese domestic IPOs is so high that calls for further investigation. However, extant literature mostly focuses on the short-run effects of Chinese domestic IPOs, providing little evidence on the long-run market performance of the Chinese cross-listings. Second, the remarkable economic growth in China leads to strong incentives for Chinese firms to seek for international capital via overseas listings. Due to data availability, previous studies mainly focus on the long-run IPO performance for H-shares that are listed

3 Karolyi (2006) conducts a detailed review of the cross-listing literature and empirical findings; Bianconi and Tan (2008) also provide a thorough investigation of the motivations for overseas listings.

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on the Stock Exchange of Hong Kong (SEHK); however, as more and more firms cross-listed in the U.S. market, the number of Chinese listings in the U.S. became greater than the number of the listings in Hong Kong. In addition, the Chinese domestic A-share and overseas listed H-shares or N-shares are segmented (Jia et al., 2005). Therefore, it is important to examine how Chinese firms make decisions to list abroad and what are the determinants of their post-IPO performance. In addition, literature suggests that the aftermarket performance for both IPOs and ADRs varies across markets. For example, Li et al. (2006) state that the returns on Chinese A-share and H-shares are significantly different, and Chinese ADRs and H-shares have advantages to B-shares. Wang et al. (2004) also study the effects of going public for Chinese SOEs and confirm the previous findings that the overseas listed shares are traded with deep discounts and the return differentials can be explained by their risk premiums. Third, China is the only country in which the government controls the size of the stock market, the pace of issue and the allocation of resources (Zhang and King, 2010). Zhang and King (2010) show that the average length of time for Chinese firms to list on a domestic exchange is 5 years. Gao (2002) also shows that the Chinese government represents an extreme case in terms of setting strict regulations for initial public offerings. Moreover, the privatization of government-owned banks takes away the cheap and easy access to bank loans, limiting the sources of capital for Chinese firms (Luo and Jackson, 2012). Therefore, to avoid the long and cumbersome process to list on domestic exchanges, the issuers are motivated to list overseas in order to meet their urgent capital needs. On the other hand, most European domestic capital markets are well established and therefore regarded as efficient, while the Chinese domestic stock markets are not efficient and the market prices of equity have strong intervention by the government and generally do not reflect the firms’ market performances (Chen et al., 1997; Zhang and Zhou, 2001). In addition, the Chinese domestic market is considered to be highly speculative and full of unexpected risks. For an investor seeking better investment environment and long-term market returns, the Chinese domestic exchange is not an ideal choice. Moreover, the Chinese domestic market is dominated by retail investors rather than institutional holders. In the U.S. and European economies, institutions and foreign investors account for over 60% of the market capitalization, while the holdings of institutions and foreign investors in China are less than 25% (Gao, 2002). Due to the risk-aversion nature of retail investors, the Chinese stock market is very volatile and sensitive to rumors and inside information, which results in very unstable supplies of capital and uncertain long-run uncertainties for investors. Our study has important implications for international investors, the major contributions can be summarized as follows. First, this is the first empirical study to comprehensively examine the motivations and the longrun performance of Chinese firms in the U.S. market. As of December, 2011, China is ranked as the second largest country in the number of stocks and ADRs listed on the U.S. exchanges, and the total number of listings in the U.S. exceeded that of the listings in Hong Kong. However, due to language barriers, geological preference, and the costs of offering, Hong Kong and Singapore are the first choices for Chinese issuers (Sarkissian and Schill, 2004). The Chinese corporations account for 6% of the total value and 15% of total turnover in the Singapore Exchange, and 46% of total value and 56% of total turnover in the Hong Kong Exchange (Cheung et al., 2009). However, the reasons for Chinese firms to list in the U.S. and European markets are quite different. Sarkissian and Schill (2004) point out that the U.S. and European markets are attractive due to the market size and liquidity rather than regional preference or cultural similarity. Second, our study has important implication for international investors to better understand the institutional features of the “China concepts stock” in the U.S. market. Initially, N-shares are issued at deep discount relative to the local shares to attract global investors. However, the goal of our study is to see whether China’s privatization program, as a whole, can leverage on the U.S. market to improve the SOEs’ performance. Hence, we use a unique sample of Chinese firms in the U.S. over 1993–2010. Particularly, we compare the market performance between cross-listed ADRs and single-listings in the U.S., while previous studies mainly focus on the studies of H-shares or domestic A-shares. For example, Sun and Tong (2003) and Wang et al. (2004) study the going public process and success of Chinese A-shares by observing the stock behaviors of the SOEs. Zhang and King (2010) compare the sample of issuers that list outside of China with those that list on domestic exchanges. Our study, on the other hand, focuses on Chinese shares listed on the U.S. exchanges and compares the firm

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performance relative to their U.S. benchmarks or industry peers. Specifically, we use different conventional proxies for form benchmarks (such as firm size, book-to-market ratio, and equally weighted or value-weighted industry portfolios). Therefore, our study provides further insights for international investors into the understanding of the long-run investment opportunity and firm value in Chinese firms. Third, we examine the impacts of split-share structure reform on overseas listings in China. We want to see how this institutional change is related to the motivations to list overseas and long-run firm performances of the Chinese ADRs and IPOs in the U.S. market. At the early stage, the main target of overseas listing of Chinese firms was to raise foreign capital. “Crossing the river through touching stones”, which is a Chinese saying that means doing things by trial and error, and this is also the approach that China is following with overseas listings (Jia et al., 2005). Mr. Zhou, the former chairman of the CSRC also mentioned that “Recommending medium-to-large SOEs for overseas listing is useful in raising necessary foreign capital; but more importantly, it prods SOEs to learn from the successful experiences of overseas companies, helping them to match international standards, and making it possible for them to compete in the international market (July 26, 1995, CSRC web news).” Cheung et al. (2009) also find that there are significant differences in information disclosure between China and the neighboring Hong Kong market. Propped up firms are more likely to have foreign shareholders (such as B-shares, H-shares and ADRs) compared to firms subject to tunneling listed on the Chinese domestic markets. Thus, this paper examines the post-IPO performance deviations between the two types of listings (single-listings and cross-listed ADRs), and provides further insight into the understanding of the great impacts of institutional changes on firm value. Last and most importantly, we broaden the scope of the existing literature by examining the listing decisions of Chinese firms from various stems of previous hypotheses based on agency theory, signaling hypothesis and corporate governance theory. Zhang and King (2010) recently demonstrate that the motives of Chinese companies to list abroad differ by the types of issues and by the market location. Cross-listing issuers are motivated by the legal and accounting standards of the foreign markets, as well as the demands for external capital and foreign expertise. In this paper, we simultaneously investigate the motives for Chinese firms to list abroad by incorporating the new risk factors summarized in Karolyi (2006) and other factors unique to Chinese companies. We study the importance of firm leverage, manager’s overinvestment and corporate governance on the long-run performance of the Chinese cross-listed firms in the context of liquidity hypothesis, signaling hypothesis and bonding hypothesis. The results reveal that the Chinese firms in the U.S. generally underperform the U.S. benchmark and industry peers within the first 3 years horizon after their initial public offerings. The difference in market performance between cross-listing ADRs and single-listings is significant and weakly supported in the long run, and cross-listing ADRs typically outperform those single-listings due to more stringent listing requirements and accounting standards which help to improve the corporate governance and operating performance of Chinese ADRs in the United States. The firms’ operating performances could hardly interpret the holding period abnormal returns relative to their benchmarks, implying that the Chinese ADRs are dominated by SOEs and their issuances are primarily determined by political relations, not by the firms’ desire to find growth opportunities or expand foreign sales (Hung et al., 2008). Importantly, we find that Tobin’s Q and capital structure changes provide significantly predictive information about the aftermarket performance of the Chinese firms. The results show that Chinese overseas listings are driven by over-investment incentives, leverage effects, and free-cash-flow signaling, which is consistent with agency theory and signaling hypothesis. Our results have important implications for international investors, suggesting that international investors need further investigation of the types of listings and institutional features of the Chinese firms in the U.S. rather than simply speculating the “China concepts stock.” The rest of the paper is structured as follows. Section 2 presents the literature and hypotheses. Section 3 discusses the data and provides descriptive statistics. Section 4 constructs the methodologies and presents the empirical analyses, and Section 5 concludes.

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2. Literature review and hypotheses Earlier research based on market segmentation or risk premium hypothesis states that firms seek cross-border issuance in order to overcome barriers and gain access to more international investments (Black, 1974; Solnik, 1974; Errunza and Losq, 1985; Merton, 1987; Foerster and Karolyi, 1998, 1999). Simultaneously, the liquidity theory claims that cross-listing firms can benefit from a lower cost of capital in the sense that the greater the liquidity, the lower the spreads (Fanto and Karmel, 1997; Pagano et al., 2002; Burns, 2004; Tolmunen and Torstila, 2005). The existing literature along the dimension of liquidity theory states that globalization improves the firms’ opportunities to raise capital, and thus significantly increases the firms’ liquidity and lowers the firms’ leverage. Sarkissian and Schill (2004) examine the market preferences of firms listing abroad and find that geographic, economic, cultural, and industrial proximity is the main determinant of the choice of overseas listing exchange. On the other hand, the U.S. and European markets are attractive alternatives when one considers market size and liquidity. Existing literature typically agrees that cross-listed firms obtain a short-term positive abnormal return and a long-run negative abnormal return (Jayaraman et al., 1993; Miller, 1999; Foerster and Karolyi, 1999; Benos and Weisbach, 2004). Foerster and Karolyi (1999) show that ADRs earn an abnormal return of 19% during the prelisting year, an additional 1.2% during the listing week, but incur losses of 14% during the year following listing. They conclude that the results can be partially explained by the subsequent increases in liquidity and the amount of capital raised at the time of cross-listing. Similar to Foerster and Karolyi (1999), Miller (1999) analyzes the stock price in response to cross-listing events and confirms the short term gains. Moreover, Mittoo (2003) points out that the effects of liquidity and market segmentation vary over time, he finds that Canadian firms underperform a benchmark index by 13–30% during a 3-year period after cross-listing in the U.S., which is consistent with the results of Alexander et al. (1988). Mittoo (2003) also documents a deterioration of operating performance during the 3 years following the cross-listing event. Sarkissian and Schill (2009) use a longer period of up to 10 years before and after the cross-listing event to study the stock performance of cross-listed firms and they find little evidence of a permanent effect on stock returns for firms that list abroad. The economic rationale for this liquidity effect has been well documented in Jensen and Meckling’s (1976) seminal work. The agency theory states that an overseas listing contributes to corporate value by increasing the firms’ free cash flow and reducing the firms’ leverage. There are two reasons. First, free cash flow implies a strong information effect for both IPOs and ADRs listed in the U.S. market over the long run. It not only depends upon agency considerations, but also has different information effects on different firms. Jensen (1986) predicts that the availability of free cash flow in a firm can affect managers’ investment decision, and the ability to invest over time is constraint with the level of earnings or debt. Second, the capital structure indicates that pure leverage changes have a strong announcement effect for the short-run market return as well as long-run operating performance. These predictions are also consistent with the differential information effects observed by Howe et al. (1992) and Denis et al. (1994) that the reduction in the agency costs provides a different rationale for increases in earnings because reducing firm leverage is perceived as good news for over-investing firms. In addition, previous event studies have investigated the impact of debt-for-equity exchanges on long-run stock performance and confirm that the leverage changes have significant effects on the aftermarket performance of publicly listed firms (Jensen, 1986; Stulz, 1999). Therefore, free cash flow and capital structure policies interact to provide significant predictive information about future abnormal stock returns. Thus, we propose an agency-based hypothesis stating that the abnormal returns of overseas listed firms are associated with firms’ leverage due to liquidity effects. Other theories in support of signaling effects claim that globalization of capital markets affects firm values because cross-listing signals market participants about the firm’s quality and long-run profitability (Tinic and West, 1974; Amihud and Mendelson, 1987; Werner and Kleidon, 1996; Smith and Sofianos, 1997; Domowitz et al., 1998; Foerster and Karolyi, 1998, 1999; Miller, 1999). The signaling theory hypothesizes that the overseas-listing decision is driven by top management, and thus the long-run stock performance is substantially affected by the managers’ over-investment strategies. Loughran and Ritter (1995) present evidence that companies successfully time their offerings for periods when valuations are high, with investors receiving low returns in the long-run. The

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Chinese government wished to use foreign listings as means of improving the quality of SOEs and of making them role models for locally listed SOEs, especially in the early days. However, Chinese SOEs that listed overseas went through a process that was not necessarily based on the economic merits of the firms. There were stories circulated about favoritism and the misuse of funds raised by the listed firms. In this paper, we argue that over-investment strategies exhibit a stronger information effect for Chinese-listed firms for the following reasons. First, the Chinese domestic market is relatively under-developed as the security markets were established only in the early 1990s. The domestic capital market is unable to digest large and continuous IPO pressure; therefore, diverting large IPOs to overseas markets eases the issuing pressure in the domestic market. Both Subrahmanyam and Titman (1999) and Megginson et al. (2004) find evidence to support the view that overseas IPOs facilitate the development of domestic stock markets. Second, the overseas listings are traded intentionally at a heavy discount relative to the domestic market price. This phenomenon is interpreted as a scale of economy and availability of information (Pagano et al., 2002; Saudagaran, 1988). Pagano et al. (2002) show that firm size is one of the major factors that can explain a firm’s decision to cross-list in both the U.S. and European markets. In fact, the offering price of Chinese IPOs is always set far below the market level by the CSRC to stimulate the incentives of domestic investors for a successful subscription. Third, the ownership structure of a Chinese publicly listed firm is very unique. For the majority of the publicly listed firms, the predominant groups of shareholders are the state or other legal entities that own a large portion of shares that are not tradable. Before the split-share structure reform was launched in 2005, the majority shares of the public firms are controlled by the state or legal-person entities, and these shares are not tradable. Therefore, the individual and institutional investors can only purchase the tradable shares, which are approximately one-third of the total number of common shares. As a result, the new issues typically represent a small portion of the tradable public shares, while the majority of other shares are not allowed to be traded by public investors. In this paper, we borrow Lang and Litzenberger’s (1989) method by using Tobin’s Q as an indicator of over-investment. We use Tobin’s Q to differentiate information effects for over-investing firms (with Tobin’s Q less than one) from all other firms. Tobin’s Q is defined as the market value of firm assets divided by the repurchase value of firm assets indicates whether a company’s valuation level is higher than the repurchase value of its assets. In another words, a company with a Tobin’s Q exceeding one creates value by combining its resources, whereas a company with a ratio below one should be acquired or liquidated. Accordingly, companies with a high Tobin’s Q seem to have desirable resources and could be an attractive prey for asset appropriation. In turn, asset appropriation should reduce Tobin’s Q in the future, as essential resources disappear, which lowers value creation potential. The existing studies overwhelmingly confirm the valuation effects of overseas listings in the U.S. market (Doidge et al., 2004). The widely accepted belief is that the U.S. exchanges provide unique gains to foreign firms due to more stringent listing requirements and accounting standards of the U.S. market which help to improve the corporate governance and operating performance of the overseaslisted firms. Sanger and McConnell (1986), McConnell and Sanger (1987), and Dharan and Ikenberry (1995) all report abnormal returns around changes in domestic equity listing, especially for new equity offerings (Asquith and Mullins, 1986; Ritter, 1991; Loughran and Ritter, 1995). A large body of empirical studies find abnormal returns around global equity offerings as well (Foerster and Karolyi, 2000; Henderson et al., 2006). Specifically, Foerster and Karolyi (1999) find a 28% drop in the local market beta across all foreign firms cross-listed in the United States, while Errunza and Miller (2000) report that foreign firms listed in the U.S. experience an 11.4% decline in their cost of capital. Sarkissian and Schill (2004) conduct similar research and also find some evidence supporting the conclusion that firms listed in markets that require greater information disclosure, on average, achieve higher abnormal returns. Unlike previous research that favors the liquidity hypothesis as the reason for the value increase, Doidge et al. (2004) relate cross-listed firms’ gains to an increase in shareholder protection, referred to as the bonding hypothesis (Stulz, 1999). They suggest that overseas listed firms become bonded to the stricter regulations existing in the U.S. and thus they are likely to have better visibility and coverage in the financial press which may lead them to expropriate less. Doidge et al. (2004) further claim that firms with weak investor protections (such as Chinese A-share firms) tend to benefit the most from cross-listing on exchanges with better shareholder protections. Therefore, we hypothesize that overseas listed firms tend to have better operating performance subject to more

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stringent corporate governance, and the government-backed ADRs tend to have relatively superior performances in contrast to those of the single-listed Chinese IPOs in the U.S. market. In addition, much evidence has been assembled in support of the corporate governance hypothesis because globalization improves corporate governance and thereby lowers the cost of capital (Foerster and Karolyi, 1993, 1999; Jayaraman et al., 1993; Alexander et al., 1988; Errunza and Miller, 2000; Kaul et al., 2006; Hail and Leuz, 2009). It assumes that a firm’s value depends heavily on its corporate governance system due to “information asymmetry” and “bonding” hypotheses; hence, firms often make a decision to list on foreign markets with more rigorous corporate governance procedures because of the poor domestic disclosure or transparency standards. Changes in corporate governance and firm characteristics convey information to the stock market about the future performance of the firms. The legal system is an effective external mechanism to protect minority shareholders. Many studies posit that the Chinese stock market institution is very unique and quite different from that of the U.S. stock market. In China, all shares have the same voting and cash flow rights by law, but in reality, the stock market is segmented, as Chinese listed shares can be classified according to the residency of their owner as domestic (A-shares) or foreign (B-, H-, and Nshares). A-shares are available exclusively to Chinese domestic investors, and are denominated in the Chinese currency, while foreign shares are only available for trade by non-residents. Huang and Song (2005) studied the pre- and post-listing financial and operating performance for a complete sample of H-shares between 1993 and 2000. One of the surprising findings is that the performance of newly listed private firms declined more than that of the state-owned H-firms. The authors attribute such an anomaly to the positive privatization effect that offsets the negative IPO effect for the H-firms. Kao et al. (2009) focus on two sets of IPO regulations: pricing regulations and penalty regulations. They find that Chinese IPO firms that report higher pricing-period accounting performance have engaged in more income-increasing earnings management. On the other hand, penalty regulations have deterred IPO firms from making over-optimistic earnings forecasts and therefore have a positive impact on the behavior of IPO firms. Tian (2011) finds that the extreme Chinese IPO underpricing is principally caused by government intervention with IPO pricing regulations and the control of IPO share supplies. In this study, we use the industry peers from the home country as a benchmark,4 assuming that the goal of Chinese firms cross-listing in the U.S. is to achieve better corporate governance and higher permanent valuation gains; thus, we hypothesize that the aftermarket performance of single-listed ADRs or stocks will be distinct relative to those cross-listed ADRs due to more stringent legislative institutions and accounting standards which help to improve the corporate governance and operating performance of the overseas-listed Chinese firms. 3. Data The Chinese stock market was established in the early 1990s. The Shanghai Securities Exchange (SHSE) was opened in 1990, followed by the establishment of the Shenzhen Stock Exchange (SZSE) in 1991. From May 2004, SZSE formally established a Small and Medium Enterprise (SME) board for growing firms. Meanwhile, the Chinese stock market was made partially accessible to foreign investors. In 2005, the CSRC introduced a split-share structure reform. Under this framework, non-tradable shares eventually become limited-tradable shares and in a longer horizon, the limited-tradable shares will become regular tradable shares until they can trade without limit. Most Chinese firms choose to cross-list in Hong Kong. SEHK provides a main listing board for major companies with a record of consistent operation and profit as well as a Growth Enterprise Market (GEM) that was established on November 25, 1999. In recent years, there is a growing body of Chinese firms that list stocks or ADRs in the U.S. markets, including AMEX, NYSE and NASDAQ. As of December 31, 2010, a total of 1955 A-shares and 108 B-shares were listed on Mainland China domestic markets (including both SHSE and SZSE) with a total tradable market capitalization

4

It would be interesting to construct a new study by using the Chinese domestic benchmarks to further investigate this specification. In this study, using the U.S. benchmarks is more appropriate rather than using the domestic industry peers because 80% of our sample firms is only listed in the U.S. markets in the forms of ADRs and stocks.

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Table 1 Descriptive statistics of different types of Chinese shares listed on both domestic and overseas markets. Domestic listings (SHSE + SZSE) Overseas listings A-share

Total number of shares Market capitalization

1955 3981.94

B-share

108 38.17

H-shares

N-shares

Main board

GEM

NYSE

NASDAQ

165 672.95

29 0.59

63 10.01

180 10.50

The data are collected and calculated as of December 31, 2010 from the following data sources: China Securities Regulatory Commission (http://www.csrc.gov.cn/pub/newsite/sjtj/), Hong Kong Exchanges and Clearing LimitedChina Dimension (http://www.hkex.com.hk/eng/stat/smstat/chidimen/cd hmb.htm), New York Stock Exchange–Listing Directory (http://www.nyse.com/about/listed/lc all region 7.html?country=2), and NASDAQ-Company lists in China (http://www.nasdaq.com/screening/companies-by-region.aspx?region=Asia&country=China). This table reports the total number of shares and market capitalization for different types of Chinese shares listed in both domestic and overseas markets. A-shares are those shares that can only be purchased by Chinese citizens on the SHSE or the SZSE in Mainland China, while B-shares are foreign shares listed on the SHSE or the SZSE that can be purchased by foreign investors. H-shares are issued by Mainland Chinese firms but listed or cross-listed on the Hong Kong Stock Exchange (SEHK), which provides a main listing board for major companies with a record of consistent operation and profit as well as a Growth Enterprise Market (GEM). N-shares are those stocks or ADRs issued by Chinese firms in the U.S. capital market, which includes NYSE and NASDAQ. The market capitalizations are reported in billions U.S. dollar. The local currencies are converted to the U.S. dollar as of the exchange rate on December 31, 2010 (1USD = 7.77249 HKD, 1USD = 6.60231 CNY).

of Chinese yuan 265,422.59 billion (equivalent to 4020.15 billion U.S. dollar). According to the CSRC overseas listing statistics, a total of 165 H-shares were issued, among which 136 H-shares were listed on the main board of SEHK with market capitalization of HK$ 5,230.48 billion (equivalent to 672.95 billion U.S. dollar), and 29 stocks were listed on GEM with a market capitalization of 0.59 billion U.S. dollar. Moreover, 63 Chinese firms listed their stocks or ADRs on NYSE and 180 Chinese firms listed their stocks or ADRs on NASDAQ and the market capitalization for each exchange is around 10 billion U.S. dollar. A detailed statistical summary of the Chinese shares on both domestic and overseas markets is reported in Table 1. Table 2 reports the market share of Chinese and foreign companies among the U.S. listings over 1993–2011. The statistics shows that Bermuda, Canada, China, Greece, Israel, the Netherlands, and the United Kingdom are the most common countries for IPOs that list in the United States. Before 2001, the number of Chinese IPOs constituted only a very small portion of the foreign issuance (less than 10%), while after 2001, the number of Chinese IPOs jumped to more than 20% with a peak of 75% in 2009 among all the foreign IPOs in the U.S. market. During the past two decades, the number of Chinese ADRs listed in the U.S. have increased remarkably as well. After 2001, about 50% of the foreign ADRs in the U.S. were issued by Chinese firms. Particularly, during the time of recent financial crisis, more than 90% of the new ADR issuances are from China as indicated by the number of Chinese ADRs over foreign ADRs with 100% in 2008, 77.78% in 2009, 94.12% in 2010 and 91.67% in 2011. The sample consists of 73 Chinese firms that issued either stocks or ADRs in the U.S. during the period 1993–2010. The Chinese ADRs are typically listed before 2005, while the Chinese stocks or single-listings are mostly issued after 2005. Among all the ADR listings, we only choose type II and type III ADRs and exclude all the ADRs that are traded via over the counter (OTC) or under 144A. We also exclude those firms that do not have continuously available trading history for at least 12 months. The final sample consists of 73 firms including 59 single-listing ADRs/stocks and 14 cross-listing ADRs.5 The market and financial data are retrieved from China Center for Economic Research (CCER), Mergent online, DataStream and the Center for Research in Security Prices (CRSP) database.

5

A single-listing ADR is an ADR whose underlying share is not publicly traded in the issuer’s home market. It is listed and traded only in the ADR market, and its cancellation will not result in delivery of a locally listed ordinary share. In this study, we redeem the single-listing ADRs as the same as single-listed stocks in the U.S. markets.

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Table 2 The market share of Chinese and foreign companies among the U.S. listings 1993–2011. Year

Number of IPOs Total (1)

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Domestic (2)

Number of ADRs Foreign (3)

Chinese (4)

% Chinese/foreign (4)/(3)

Foreign (5)

Chinese (6)

% Chinese/foreign (6)/(5)

528 421 474 707 506 297 504 420 84 68 65 191 173 172 191 25 50 126 93

488 386 432 643 428 258 451 335 74 63 59 161 143 138 138 18 38 81 71

40 35 42 64 78 39 53 85 10 5 6 30 30 34 53 7 12 45 22

1 3 1 1 4 2 1 7 2 1 2 9 8 9 29 4 9 33 13

2.50% 8.57% 2.38% 1.56% 5.13% 5.13% 1.89% 8.24% 20.00% 20.00% 33.33% 30.00% 26.67% 26.47% 54.72% 57.14% 75.00% 73.33% 59.09%

19 18 17 32 33 13 28 40 5 2 3 17 13 15 31 4 9 34 12

1 2 1 1 3 1 0 4 2 1 2 9 8 7 27 4 7 32 11

5.26% 11.11% 5.88% 3.13% 9.09% 7.69% 0.00% 10.00% 40.00% 50.00% 66.67% 52.94% 61.54% 46.67% 87.10% 100.00% 77.78% 94.12% 91.67%

1993–2011 5095

4405

690

139

20.14%

345

123

35.65%

This table reports the market share of foreign companies among the U.S. listings over 1993–2011, including all the ADRs as well as other IPOs. The statistics excludes IPOs with an offer price below $5.00 per share, unit offers, REITs, closed-end funds, partnerships, banks and S&Ls, and IPOs not listed on CRSP within six months of the offer date. Bermuda-domiciled companies are included as foreign, irrespective of the main country of operations. The authors have deleted those listings that can be found in “SDC Corrections” on Ritter’s IPO Data page) from the IPO counts. The count for Chinese IPOs does not include those from Hong Kong, and excludes “reverse mergers” and best efforts IPOs. The data are obtained from Ritter’s website at http://bear.warrington.ufl.edu/ritter/IPOs2011Foreign1912.pdf.

4. Methodology 4.1. Measuring the long-run aftermarket performance of Chinese stocks and ADRs It is a general belief that IPO firms typically experience a significant under-performance relative to their benchmarks in the subsequent 3–5 years after issuance (Ritter, 1991; Loughran and Ritter, 1995). Such a phenomenon has been widely observed in the U.S. market as well as other international exchanges.6 Since the Chinese firms have a relatively short trading history in the U.S. market, we examine the long-run Chinese IPOs and ADRs performance by constructing the buy and hold abnormal returns relative to the benchmark of different conventional proxies from 1 to 3 years after the issuances. Previous studies suggest that the measure of long-run performance for IPOs is sensitive to the benchmark used. Barber and Lyon (1997) show that when long-run performances are calculated, the test statistics are negatively biased. This bias is, however, not present when abnormal returns are calculated as the return of a sample firm less the return of a single control firm matched on size or book-to-market (B/M) ratio. Moreover, the size and B/M characteristics have been documented extensively as important determinants of stock returns in previous literatures (Lakonishok et al., 1994; Loughran and Ritter, 1995; Daniel and Titman, 1997; Davis et al., 2000; Daniel et al., 2001). Following Ritter’s (1991) procedure, we construct three forms of benchmarks: size and B/M matching by industry, equally weighted portfolio matching by industry and value-weighted portfolio matching by industry. 6

The results have been recently challenged by the study of Megginson et al. (2000). They examined the long-run (1–5 years) performance of 158 share issue privatizations from 33 countries (including Chinese SOEs that are listed on the SEHK) and found statistically significant positive excess returns relative to a variety of benchmarks.

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To control for both size and B/M effects, each sample firm is matched with a firm that has the closest B/M ratio and the same size quintiles in the preceding year. In addition, the matching firms have to be listed for at least 3 years and have the necessary market value at the end of the issuing calendar month. The procedure for matching firms by size and B/M is based upon their market capitalization and SIC code. Except for retrieving the book value for each matching firm from the annual accounting report, we chose to compute the market value by multiplying the total share of outstanding and the market price at the end of the issuing month for each firm. Since the total shares outstanding for each firm vary over time, B/M is defined as the previous year’s book equity divided by the total market equity. If the matching firms cannot be achieved by utilizing the 4-digit SIC code, we match the firms with the 2-digit SIC code and the closest B/M ratio. The alternative measure to find matching firms is to form a portfolio by industry with the same 4-digits SIC code. After obtaining the matching firms, we retrieve the market data for each firm from CRSP and calculate the stock returns over the same sample period. The industry benchmark portfolio return is formulated in two ways: equally weighted and value-weighted. We also use other popular matching techniques for robustness check and the results are essentially consistent for different measures of matching firms. To measure the long-run performance, we define the buy and hold return (BHR) for each stock i as the geometric average rate of return over the time periods t. In this paper, t is the relative month up to 36 months after the IPO or ADR issuing month. Specifically, t = 12, 24, and 36 denoting the first, second and third year BHR for each stock i. Specifically, it is expressed as the following equation: BHRi,t =

T 

(1 + reti,t ) − 1

(1)

t=1

The buy and hold abnormal return (BHAR) for each stock i is defined as the geometric average rate of return over the time periods t of stock i relative to the benchmark. In specific, BHAR is the BHR of stock i relative to the return on the matching firms by size and B/M; EWAR is the BHR of stock i relative to the equally weighted benchmark portfolio return of the same industry (by 4-digits SIC code); VWAR is the BHR of stock i relative to the value-weighted benchmark portfolio return of the same industry (by 4-digits SIC code); correspondingly, the BHAR can be expressed in the following equation: BHARi,t =

 T 

  T 

t=1

t=1

(1 + reti,t ) − 1

−



(1 + retB,t ) − 1

(2)

where retB,t is the formulated benchmark (or portfolio) return at time t. Table 3 presents the summary of descriptive statistics for BHR and BHAR over the sample period. Although the mean buy and hold abnormal returns for different periods of ADRs and IPOs relative to their benchmarks are overwhelmingly positive, the median BHARs for the proxies over most of the sample periods are negative. Further examination shows that the positive means are largely driven by outliers.7 The BHARs for IPO and ADR firms are lower than their matching firms during the first year and the following second and third years. During the first year, the median BHAR return for the sample firms is −14% over the benchmark matched by size and B/M, −5.5% and −5.0% over the equally weighted industry-matched benchmark and value-weighted industry-matched benchmark respectively. During the second and third years after IPO, the median BHAR returns still remain negatively between −11.1% and −19.5%. The distributions of monthly abnormal returns are skewed with high kurtosis, and the accumulative volatilities of the returns increase consistently over time. The assumptions of normal distribution of the returns are overwhelmingly rejected by Jarque–Bera (1980) test. Generally, the Chinese ADRs and IPOs underperform their matching firms for all different holding periods. The results are consistent with the findings of Zhang and King (2010) that the stock returns after the listing events are generally negative for Chinese ADRs and foreign IPO stocks.

7 After controlling for outliers, we did the non-parametric one-way tests showing that the mean BHARs for different periods of ADRs and IPOs relative to their matching firms are consistent with the median BHARs.

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Table 3 Descriptive statistics of buy and hold abnormal returns over different sample periods.

First year BHR BHAR EWAR VWAR Second year BHR BHAR EWAR VWAR Third year BHR BHAR EWAR VWAR

Mean

Median

Max

Min

SD

Skewness

Kurtosis

J–B test

N

0.968 0.014 0.062 0.265

0.879 −0.140 −0.055 −0.050

2.847 1.774 1.777 1.852

0.135 −0.760 −0.970 −0.752

0.660 0.565 0.553 0.582

1.155 1.456 1.268 0.921

3.995 4.838 4.545 3.441

19.235*** 36.068*** 26.828*** 10.918***

73 73 73 73

1.114 0.149 0.074 0.404

0.669 −0.195 −0.111 −0.146

5.291 3.942 3.758 4.144

0.046 −1.006 −1.444 −0.930

1.034 0.889 0.832 0.897

1.459 1.621 1.748 1.544

5.437 6.519 7.742 6.306

39.755*** 62.970*** 95.463*** 56.287***

66 66 66 66

1.274 0.262 0.129 0.371

0.773 −0.146 −0.281 −0.140

5.233 4.030 3.994 4.348

0.059 −0.971 −1.205 −0.886

1.267 1.202 1.109 1.165

1.313 1.343 1.586 1.572

3.977 4.050 5.251 5.119

14.059*** 14.898*** 27.098*** 25.764***

43 43 43 43

This table depicts the summary of descriptive statistics of BHR, BHAR, EWAR and VWAR for 73 Chinese stocks and ADRs listed in the U.S. in the first year, the second year and the third year after an initial public offering. BHR is the buy and hold return for each stock i which is defined as the geometric average rate of return over the time periods of t. BHAR is the BHR of stock i relative to the return on the benchmark matched by size and book-to-market ratio in the same industry; EWAR is the BHR of stock i relative to the equally weighted benchmark portfolio return of the same industry (by 4-digits SIC code); VWAR is the BHR of stock i relative to the value-weighted benchmark portfolio return of the same industry (by 4-digits SIC code). N is the total number of observations. J–B test is the Jarque–Bera (1980) test under the null of normal distribution. *** denotes 1% significance level.

4.2. Examining the abnormal returns differences between IPOs and ADRs Table 4 reports the summary of two-sample t-test of the equality of the means and Pearson Chisquare test of the equality of the medians of the BHAR for the Chinese cross-listings vs. single-listings in the U.S. in the first, second and third year as well as the overall sample period after initial public offering. Panel A reports the two-sample t-test for different periods of Chinese stocks and ADRs relative to their matching firms. Although the single-listings seem to underperform the cross-listed ADRs for all different holding periods, the mean differences of abnormal returns between these two groups are not likely to be statistically significant in the first year. Panel B reports the Pearson Chi-square test of the equality of medians for all the cross-listing ADRs and single-listings relative to their benchmarks. The Pearson Chi-square test has the advantage of making no assumption about the distribution of data. Technically speaking, it is non-parametric and distribution free, while the t-test is not robust enough to handle this highly non-normal data with small sample size. As we can see in Panel B, over the long run (24 or more months after the event date), the difference of BHAR returns between cross-listings and single-listings appears to be significant by using more stringent benchmarks. The differences in medians between cross-listing ADRs and single-listings matched by size and B/M in the same industry are statistically significant in the second and third years, and the results are also partially supported by the portfolio-matched benchmarks. The results imply that the aftermarket performance of cross-listed ADRs is superior to that of the single-listings over time. The cross-listed firms generally outperform those single-listings because they are subject to more stringent listing requirements and accounting standards which help to improve the corporate governance and operating performance. However, the evidence in support of the corporate governance theory and bonding hypothesis varies over time and differs with the methodologies used to form benchmarks. 4.3. Testing hypotheses and selecting determinants of the abnormal returns The stylized facts illustrate that firms choose to list their equity in foreign markets and subsequently realize substantive valuation gains. Such gains are generally attributed to a reduction of the super-risk premium associated with the barriers or disadvantaged characteristics of the particular home equity

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Table 4 Two-sample t-test and Pearson Chi-square test of the equality of buy and hold abnormal return for cross-listing ADRs vs. single-listing ADR/stocks. N Panel A: two-sample t-test of the equality of the means Single-listing 59 First year Cross-listing 14 t-test Single-listing 54 Second year Cross-listing 12 t-test 34 Single-listing Third year 9 Cross-listing t-test Single-listing 147 Overall 35 Cross-listing t-test Panel B: Pearson Chi-square test of the equality of the medians 59 Single-listing First year Cross-listing 14 Chi-square 54 Single-listing Second year 12 Cross-listing Chi-square 34 Single-listing Third year 9 Cross-listing Chi-square Single-listing 147 Overall Cross-listing 35 Chi-square

BHAR

EWAR

VWAR

−0.006 0.101 −0.750 −0.043 1.011 −3.152*** 0.063 0.919 −1.984** −0.004 0.632 −3.263***

0.104 −0.117 1.662 −0.033 0.324 −0.988 0.053 −0.076 0.280 0.041 0.040 0.008

0.299 0.122 1.142 0.253 0.861 −1.687 0.213 0.459 −0.528 0.262 0.472 −1.060

−0.204 −0.034 5.389** −0.243 0.778 10.185*** −0.341 0.451 5.064** −0.232 0.399 16.760***

−0.011 −0.223 1.553 −0.188 0.132 4.660** −0.313 −.347 0.056 −0.132 −0.111 0.127

0.188 −0.044 1.282 −0.048 0.567 7.704*** −0.159 0.188 1.142 0.023 0.281 2.032*

This table reports the summary of two-sample t-test and Pearson Chi-square test of the equality of buy and hold abnormal return for the Chinese cross-listing ADRs vs. single-listing ADRs (or stocks) in the U.S. in the first year, second year, third year and the overall sample period after the initial public offering. BHAR is the BHR of stock i relative to the return on the benchmark matched by size and B/M ratio in the same industry; EWAR is the BHR of stock i relative to the equally weighted benchmark portfolio return of the same industry (by 4-digits SIC code); VWAR is the BHR of stock i relative to the value-weighted benchmark portfolio return of the same industry (by 4-digits SIC code). ***, **, * denote 1%, 5%, and 10% significance level respectively.

market. On the other hand, the overseas listing is costly, thus there must be some compelling reasons for Chinese firms to take a more costly route to raise capital in the U.S. market. In this study, we use the return-on-equity (ROE) ratio to measure the firms’ operating performances. For robustness check, we also introduce two accounting performance ratios, return-on-asset (ROA) ratio and cash-flow-toequity (CFE) ratio, to measure a firm’s profitability. To test the signaling hypothesis, we employ Tobin’s Q (TOBIN) ratio that is defined as the market value of a company divided by the replacement value of the firm’s assets. Moreover, we use the total debt-to-equity (LEV) ratio to measure the leverage changes for each firm. The following step describes the explanatory variables that are used in the model and summarizes the statistical features over the first, second and third year horizons. Table 5 shows that the mean and median values of Tobin’s Q and leverage are overwhelmingly larger than 1 with non-normality distributions. All the CFE ratios are around 15–20%, implying the possibility of free-cash-flow effects. The market performance represented by ROE are 19.9% on average in the first year, but drops to 8.6% in the following year, and increases slightly to 11.3% in the third year. The changes in ROE suggest a potential market timing effect. In addition, the high leverage and low ROA ratio suggest that the Chinese overseas-listed firms typically have sufficient funds but poor operating efficiency. In general, the descriptive statistics seems to support the long-run IPO underperformance hypotheses and signaling theory. To further diagnostically check the relationships between the abnormal returns and the explanatory variables, we report the correlation matrix in Table 6. It illustrates that the buy and hold abnormal returns matched by different proxies are highly correlated. The correlation between BHAR and EWAR

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Table 5 Descriptive statistics of the explanatory variables over different horizons.

First year CFE LEV ROA ROE TOBIN Second year CFE LEV ROA ROE TOBIN Third year CFE LEV ROA ROE TOBIN

Mean

Median

Max

Min

SD

Skewness

0.263 3.619 0.132 0.266 2.970

0.230 2.189 0.104 0.196 1.541

1.022 19.046 0.586 1.618 12.851

−0.238 1.182 −0.239 −0.642 1.008

0.232 3.411 0.146 0.319 3.006

1.195 2.384 0.821 1.327 2.023

0.149 7.092 0.087 0.119 3.312

0.127 4.705 0.075 0.110 2.492

0.395 33.421 0.464 0.561 14.837

−0.013 1.132 −0.073 −0.155 0.871

0.108 7.401 0.081 0.111 2.571

0.164 4.569 0.078 0.091 3.222

0.158 3.038 0.063 0.098 1.788

0.426 22.638 0.314 0.428 17.956

−0.041 1.060 −0.054 −0.953 0.852

0.125 4.170 0.087 0.216 3.546

Kurtosis

J–B test

N

5.163 8.986 5.044 7.515 6.538

29.859*** 168.41*** 19.761*** 78.850*** 26.479***

73 73 73 73 73

0.693 2.186 1.705 0.941 2.002

2.625 7.158 9.368 6.385 8.556

4.723* 94.040*** 134.783*** 38.745*** 109.435***

62 62 62 62 62

0.093 2.658 0.827 −3.257 2.832

2.099 11.496 3.455 17.290 11.054

11.128** 142.279*** 4.171* 349.389*** 133.315***

34 34 34 34 34

This table depicts the summary of descriptive statistics of the explanatory variables for 73 Chinese stocks and ADRs listed in the U.S. in the first year, second year and third year after the initial public offering. CFE is cash flow to total equity ratio; LEV is total debt to total equity; ROA is return on asset; ROE is return on equity; TOBIN is Tobin’s Q. N is the total number of observations. J–B test is the Jarque–Bera (1980) test for normality. * ** ***

10% significance level. 5% significance level. 1% significance level.

is 0.92, and the correlation between BHAR and VWAR is 0.91. The high correlations among different firms’ performance measures are also observed in the table. All the abnormal returns are negatively related to the firm’s leverage, but positively associated with firm’s value represented by Tobin’s Q. Moreover, the abnormal returns have a positive but relatively weak relationship with the operating performance measures, such as CFE, ROE and ROA. To check whether these variables are collinear, we perform a variance inflation factor (VIF) test by using BHAR as dependent variable. The VIF indicators are substantially lower than 10, so collinearity should not be a problem.

Table 6 Correlation matrix.

BHAR EWAR VWAR CFE LEV ROA ROE TOBIN

BHAR

EWAR

VWAR

CFE

LEV

1 0.923 0.913 0.115 −0.187 0.103 0.150 0.302

1 0.916 0.001 −0.153 0.059 0.087 0.399

1 0.057 −0.152 0.040 0.085 0.301

1 −0.376 0.539 0.656 −0.053

1 −0.042 −0.186 0.073

ROA

1 0.927 0.303

ROE

1 0.238

TOBIN

VIF

1

1.90 1.27 2.96 2.72 1.19

This table presents the Pearson correlation matrix between each selected variable for 73 Chinese stocks and ADRs listed in the U.S. over the sample period after the initial public offering. BHAR is the BHR of stock i relative to the return on the benchmark matched by size and B/M ratio in the same industry; EWAR is the BHR of stock i relative to the equally weighted benchmark portfolio return of the same industry (by 4-digits SIC code); VWAR is the BHR of stock i relative to the value-weighted benchmark portfolio return of the same industry (by 4-digits SIC code). CFE is cash flow to total equity ratio; LEV is total debt to total equity; ROA is return on asset; ROE is return on equity; TOBIN is Tobin’s Q. VIF is variance inflation factor test for collinearity (by using BHAR as dependent).

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4.4. Empirical results on the determinants of abnormal returns We construct the following model by regressing the BHAR relative to different benchmarks on the firm’s leverage, operating performance, and Tobin’s Q over the first, second and third-year period after the initial public offering. Based on our hypotheses, the testing model is specified as follows in Eq. (3): BHARi,t = ˛ + ˇP × Performancei,t + ˇO × Overinvestmenti,t + ˇL × Leveragei,t + εi,t

(3)

The testing equation can be rewritten as follows in Eqs. (4)–(6): BHARi,t /VWARi,t /EWARi,t = ˛1 + ˇ1 × ROEi,t + ˇ2 × TOBINi,t + ˇ3 × LEVi,t + εi,t

(4)

BHARi,t /VWARi,t /EWARi,t = ˛2 + 1 × ROAi,t + 2 × TOBINi,t + 3 × LEVi,t + εi,t

(5)

BHARi,t /VWARi,t /EWARi,t = ˛3 + 1 × CFEi,t + 2 × TOBINi,t + 3 × LEVi,t + εi,t

(6)

where BHAR is the BHR of stock i relative to the return on the benchmark matched by size and B/M ratio in the same industry; VWAR is the BHR of stock i relative to the value-weighted benchmark portfolio return of the same industry (by 4-digits SIC code). EWAR is the BHR of stock i relative to the equally weighted benchmark portfolio return of the same industry (by 4-digits SIC code); ROE is return on equity; TOBIN is Tobin’s Q; LEV is total debt to total equity ratio; ROA is return on asset; CFE is cash flow to total equity. The results indicate that Tobin’s Q and firm leverage provide significantly predictive information about the long-run market performance of Chinese firms listed in the U.S. market. We use Tobin’s Q with a value less than one as an indicator of over-investment. Table 7 shows that Tobin’s Q is statistically significant at the 1% level to interpret the market abnormal returns for Chinese overseas IPOs and ADRs. We find that one unit of increase in Tobin’s Q tends to increase the buy and hold abnormal returns by 10%. The results show there is a stronger information effect of Tobin’s Q on BHARs, supporting the over-investment hypothesis that changes in Tobin’ Q may convey information regarding a firm’s future market performance.8 The results also demonstrate that the firm’s leverage has a strong information effect for those Chinese firms listed in the United States. The debt-to-equity ratio is statistically significant and negatively correlated with the abnormal returns, one unit of increase in the firm’s leverage tends to reduce the firms’ long-run abnormal returns by 2–3%. It shows that high firm leverage tends to deteriorate the firms’ long-run abnormal returns relative to their benchmarks. Following Stulz’ (1999) arguments, combined with those of Jensen (1986), we conclude that capital structure changes reflect the changes in agency costs. The results imply that free cash flow may be used to fund negative net present value (NPV) projects (Jensen, 1986). Therefore, our results are in support of the agency theory and consistent with free cash flow hypothesis that globalization improves the Chinese firms’ opportunities to raise capital, and thus changes the firms’ leverage and long-run abnormal returns. Table 7 shows that the Chinese firms generally underperform the U.S. benchmark and industry peers in the long run and the issuers experience a significant drop in operating performance in 3 years after IPO. The Chinese firms do not seem to enjoy better net income growth or greater returns in capital expenditure than their industry peers. The holding period abnormal returns have no significant relationship with the firms’ operating performance that is represented by ROA, ROE, and CFE. The results are consistent with the previous findings that the Chinese ADRs are dominated by SOEs and their issuances are primarily determined by political relations, not by the firms’ desire to find growth opportunities or expand foreign sales (Hung et al., 2008). Moreover, since the primary goal of authorization for overseas listing is to raise capital rather than to pursue long-run profitability, the initial price is intentionally issued at a deep discount price relative to the domestic market price. To seek approval for the quotas to be listed abroad, the firms have to suffer extraordinary costs for approval

8 Lang and Litzenberger (1989) argue that, on average, over-invested firms have greater price reactions to changes in the firms’ fundamentals.

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Table 7 Cross-sectional regressions of the determinants of buy and hold abnormal returns. Dependent variables

ROE

Panel B

Panel A

BHAR

EWAR

VWAR

0.203 (0.24)

−0.163 (−0.28)

0.042 (0.07)

ROA

Panel C

BHAR

EWAR

VWAR

−0.303 (−0.25)

−0.742 (−0.66)

−0.657 (−0.55)

CFE TOBIN LEV Constant N R2 Adj. R2

BHAR

EWAR

VWAR

−1.349 (−1.67) 0.135*** (4.65) −0.038** (−2.27) 0.055 (0.24)

−0.691 (−0.80) 0.113*** (3.68) −0.039** (−2.18) 0.337 (1.40)

106 0.21 0.183

106 0.14 0.119

0.103*** (3.27) −0.041** (−2.59) 0.131 (0.70)

0.137*** (4.60) −0.028* (−1.89) −0.218 (−1.40)

0.111*** (3.52) −0.032** (−2.04) 0.180 (1.10)

0.107*** (3.37) −0.042*** (−2.69) 0.173 (0.98)

0.141*** (4.64) −0.028* (−1.89) −0.190 (−1.19)

0.117*** (3.64) −0.032** (−2.06) 0.220 (1.30)

0.240 (0.27) 0.106*** (3.46) −0.039** (−2.20) 0.108 (0.44)

104 0.15 0.126

109 0.19 0.163

109 0.13 0.109

104 0.15 0.126

109 0.19 0.165

109 0.14 0.112

101 0.15 0.123

This table reports the cross-sectional regressions of buy and hold abnormal returns on the explanatory variables for 73 Chinese stocks and ADRs listed in the U.S. over the sample period after the initial public offering. The estimated equation is BHARi,t /VWARi,t /EWARi,t = ˛1 + ˇ1 × ROEi,t + ˇ2 × TOBINi,t + ˇ3 × LEVi,t + εi,t BHARi,t /VWARi,t /EWARi,t = ˛2 + 1 × ROAi,t + 2 × TOBINi,t + 3 × LEVi,t + εi,t BHARi,t /VWARi,t /EWARi,t = ˛3 + 1 × CFEi,t + 2 × TOBINi,t + 3 × LEVi,t + εi,t BHAR is the BHR of stock i relative to the return on the benchmark matched by size and B/M ratio in the same industry; VWAR is the BHR of stock i relative to the value-weighted benchmark portfolio return of the same industry (by 4-digits SIC code). EWAR is the BHR of stock i relative to the equally weighted benchmark portfolio return of the same industry (by 4-digits SIC code); CFE is cash flow to total equity ratio; LEV is total debt to total equity; ROA is return on asset; ROE is return on equity; TOBIN is Tobin’s Q. N is the total number of observations. t-statistics are presented in parentheses. * ** ***

10% significance level. 5% significance level. 1% significance level.

of overseas listings. In sum, the results are consistent with the signaling hypothesis and agency theory, suggesting that Chinese overseas listings and financing policies are driven by over-investment incentives, leverage effects and free-cash-flow signaling. 5. Conclusions The results reveal that the overseas-listed Chinese IPOs and ADRs generally underperform the U.S. benchmark and industry peers within the first 3-year horizon after the initial public offering. The institutional change caused by split-share structure reform has great impacts on the motivations to list abroad for Chinese firms. The long-run abnormal returns between cross-listing ADRs and singlelistings appear to be statistically different over time, and cross-listing ADRs generally outperform single-listings due to the more stringent listing requirements and accounting standards which help to improve the corporate governance and operating performance of the Chinese firms. The results seems to support corporate governance theory and bonding hypothesis, although the evidence is weakly supported in the short run and differs from the methodologies used to form the benchmarks. Subsequent to the listing events, the operating performances that are represented by ROA, CFE and ROE have no significant interpreting power to the holding period abnormal returns of the Chinese firms relative to their benchmarks. The result is consistent with the findings of Hung et al. (2008) that the Chinese ADRs are dominated by SOEs and their issuances are primarily determined by political relations, not by the firms’ desire to find growth opportunities or expand foreign sales. It implies that the Chinese overseas listings are driven by the government for political purpose, and the results

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are consistent with the previous findings that the listing process was not necessarily based on the economic merits of the firms. The results appear to support signaling theory and are consistent with agency theory. Tobin’s Q and firm leverage provide significantly predictive information about the aftermarket performance of the Chinese ADRs and IPOs in the U.S. market. The findings indicate that the Chinese issuers are motivated to cross-list in the U.S. due to over-investment incentives, leverage effects, and free-cash-flow signaling. We suggest that international investors need further investigation of the institutional features of the Chinese overseas listings rather than simply speculating in the “China concepts stock.” The findings have important implications for international portfolio diversification and the understanding of long-run investment opportunities in the Chinese overseas-listed firms. 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