IPO price performance and block-trading activities: Evidence from Hong Kong

Pacific-Basin Finance Journal 15 (2007) 276 – 291 www.elsevier.com/locate/pacfin

IPO price performance and block-trading activities: Evidence from Hong Kong☆ Yan-Leung Cheung ⁎, Yang Liu Department of Economics and Finance, City University of Hong Kong Received 12 July 2005; accepted 21 August 2006 Available online 13 November 2006

Abstract This research studies whether the trading behavior of IPO block holders is informative to small investors. The results show that IPOs have more block trades initiated by sellers on the first trading day than seasoned stocks do, and the level of block-trading activities is negatively associated with IPOs' long-term performance. This research also examines the impacts of the change in rules for IPO share allocations – which aimed at realizing a more even allocation between large and small investors – on IPO block-trading activities. The findings support the hypothesis that IPO block holders may have superior information on newly-listed companies. © 2006 Elsevier B.V. All rights reserved. JEL classification: G3; G14 Keywords: IPO; Block trading; Hong Kong

1. Introduction Initial public offerings (IPOs) are generally underpriced in the short run and underperform in the long run. These phenomena have been well documented in most securities markets. Loughran et al. (1994) present the results of research (performed by the authors or others) on short-run underpricing and long-run underperformance in some major markets. Ritter and Welch (2002) provide a detailed review of the theory and evidence of IPO activity. Most of the theoretical literature on IPOs revolves around information asymmetry and adverse selection between the issuers, investors, and investment banks. Recently, much empirical research focuses on IPO ☆ The authors would like to thank an anonymous referee for suggestions that have substantially improved the paper. We also thank Ge Hui for research support. The usual disclaimer applies. ⁎ Corresponding author. Tel.: +852 27887960; fax: +852 27888040. E-mail address: [email protected] (Y.-L. Cheung).

0927-538X/$ - see front matter © 2006 Elsevier B.V. All rights reserved. doi:10.1016/j.pacfin.2006.08.002

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allocations between institutional and retail investors. There are two reasons for this. First, there is a general perception that underwriters make a preferential allocation of IPO shares to institutional investors with the result that retail investors are not fairly treated. Second, institutional investors are different from retail investors in that they are more likely to be better informed and are capable of identifying IPOs with better long-term performance potential. Institutional investors keep IPOs with good prospects as long-term investments and sell IPOs with poor prospects to capture shortterm profits. This study addresses two issues. First, is the trading behavior of IPO block holders informative to small investors? In particular, we study block trades initiated by sellers on the first trading day. In other words, are IPO block-trading activities different from those of seasoned stocks and can the level of IPO block-trading activities relate to the shares' long-term performance? This addresses the issue of whether IPO block traders have superior information on the newly-listed companies that enables them to capture short-term underpricing and keep shares in IPOs with good long-term prospects. Importantly, can small investors use this as a signal for their investment decisions? Second, this study examines the impacts of the regulatory changes introduced in 1997 (changes that aimed at realizing a more even share allocation of IPO shares between large and small investors) on IPO block-trading activities. By allocating fewer shares to large investors, did the rule change impact IPO block-trading? This study considers a sample of all IPOs which were issued during the period from May 1996 to December 2000 on the main board of the Hong Kong Exchanges and Clearing Ltd (HKEx). First, our study finds an underpricing return of 17.96%, which is eliminated on the opening transaction of the first trading day. We also find that these IPOs produce a statistically insignificant buy-and-hold abnormal return of 0.17% one year after listing. The results reveal that there is a negative association between the underpricing and the after-listing IPO performance in that very cold (hot) IPOs present the best (worst) after-listing performance for the first year. Second, our study finds that there are more block-trading activities in IPOs than in seasoned stocks. We also find that the IPO block-trading level is related to its after-listing performance. The buy-and-hold abnormal return of IPOs within the first year of listing is negatively associated with the block-trading level. The higher the IPO block-trading levels on the first trading day, the lower the returns within the first year of listing. Third, the result shows that IPO block-trading activities are even more active after the rule change. This may imply IPO block holders tend to sell their small allocation (because of the new IPO allocation guidelines) if the issues are hot and they cannot acquire more shares at a reasonable price in the aftermarket. This study seems to support the hypothesis that large investors are able to capture short-run underpricing and to keep shares in IPOs with better long-run performance. The rest of the paper is organized as follows. The next section gives a review of previous work. Section 3 describes IPO activity in Hong Kong and the regulatory change. Section 4 describes the data used in this study. Section 5 presents the IPO short-run and long-run performance. Section 6 reports IPO block-trading activities in Hong Kong. Section 7 assesses the robustness of our findings. The final section concludes. 2. Literature review There is a substantial amount of both theoretical and empirical research on IPOs. Established stylized facts include IPO underpricing and long-run underperformance. Most of the theoretical literature on underpricing revolves around information asymmetries between the issuers, investors, and investment bankers who manage the issues. These reasons include: information asymmetries between the issues and their investment bankers (Baron, 1982; Baron and Holmstrom, 1980); the

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“winners' curse” hypothesis (Rock, 1986); avoiding potential legal liability (Tinic, 1988); costly firm quality (Allen and Faulhaber, 1989; Grinblatt and Hwang, 1989; Welch, 1989); “faddish” behavior on behalf of investors (Aggarwal and Rivoli, 1990); investment banker reputation (Carter and Manaster, 1990); “cascades” in the IPO market (Welch, 1992); and regulatory constraints, wealth redistribution and market incompleteness (Mauer and Senbet, 1992). Most of the above models are based on information asymmetries. A detailed review of IPO activities can be found in Ritter and Welch (2002). They give an updated review on the following aspects of IPO activities: why firms go public; why they reward first-day investors with considerable underpricing; and how IPOs perform in the long run. We summarize some of the previous empirical findings on IPO underpricing in the following. Ibbotson and Jaffe (1975) find that IPOs provide abnormally high short-run monthly returns. Ibbotson et al. (1988) find an average daily return of 16.4% for 4,534 IPOs during the period 1977–1987, as computed from the offer price to closing price on the first day of trading. Aggarwal and Rivoli (1990) investigate the price performance of a sample of 1598 IPOs during the period 1977–1987. They find that IPOs are subject to overvaluation or fads in early aftermarket trading. Their results also show that IPOs are profitable investments in the short term but perform quite poorly over a longer period. Ritter (1991) documents that IPO underpricing is a short-run phenomenon. He shows that newly-listed firms underperform a sample of matching firms from the first day of listing to their three-year anniversaries. Several studies have been conducted on Asian markets including Hong Kong, China, and Singapore. McGuinness (1992) investigates 92 IPOs in Hong Kong in the period 1980–1990 and finds that most of the post-listing returns are attained by the close of the first trading day. Cheng et al. (in press) examines the intraday patterns of IPOs in Hong Kong during the period 1995–1998. They find that the underpricing phenomenon occurs only at the opening trading of new issues and vanishes afterwards. Firth and Liau-Tan (1997) develop various signaling models to explain the valuation of unseasoned new issues listed on the Stock Exchange of Singapore from 1980–1993. They use the entrepreneurs' retained ownership, dividend, underpricing, and the reputation of financial advisers as signals in their models. Their study shows that dividends and financial advisers may signal the accuracy of the company valuation. Lee et al. (1999) use application and allocation schedules to explain the phenomenon of IPO underpricing in Singapore. Hameed and Lim (1998) demonstrate the impact of different pricing methods on IPO underpricing in Singapore. They conclude that IPO firms use the tender option to signal superior firm quality. Mok and Hui (1998) find that A-share IPOs in Shanghai are underpriced by 289% compared with a mere 26% underpricing of B-share IPOs. Aharony et al. (2000) find that state-owned enterprise managers' incentives and opportunities for earnings management vary across industries and listing locations. Some recent studies focus on how IPOs are allocated and how shares are traded. The literature shows that investors who subscribe for shares in an IPO at the offer price can capture a huge profit. Thus, more attention has been drawn to the allocation of an IPO between institutional and retail investors because there is a general perception that institutional investors are being treated favorably during the IPO allocation process. There is a body of literature examining the “flipping” behavior of IPO shares. This refers to the immediate sale of an IPO share allocation by institutional investors. Hanley and Wilhelm (1995) report that institutional investors capture a large proportion of IPO short-run profits. Institutional investors are naturally block holders, and are potentially capable of differentiating IPOs with poor future prospects. Thus, institutional investors' trading behavior may be used as an indicator of IPOs with good long-run potential. Aggarwal et al. (2002) demonstrates that institutions do more flipping than individual investors; they also find that hot IPOs are flipped much more than cold IPOs. Aggarwal (2003) finds that hot IPOs are flipped much more than cold IPOs. Krigman et al. (1999) show that “extra-hot” IPOs are

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the worst future performers. They also demonstrate that large traders flip IPOs with the worst future performance. 3. IPO activity in Hong Kong The listing of securities on the Main Board of the HKEx is regulated by the Rules Governing the Listing of Securities on the HKEx, which are administrated by the HKEx. Some basic requirements for listing equity securities on the HKEx are as follows: • A minimum track record of not less than three years. • The profit attributable to shareholders must, for the most recent year, be not less than HK$20 million; and, for the two preceding years, be in aggregate not less than HK$30 million. • The market capitalization must be at least HK$100 million at the time of listing. • The public must hold at least 25% of any class of listed securities. In the case of issuers with an expected market value of over HK$4000 million, the percentage may be lowered to between 10% and 25%. The most commonly used listing method in Hong Kong is the offer for subscription; this is the offer of new securities to the public by the issuer, or by someone on behalf of the issuer. The subscription must be fully underwritten. The underwriter is responsible for distributing to investors a listing document, called the prospectus, which contains information on the company. The issuer must inform the public about the offer through newspapers and other media. The application period usually lasts for three or four days. Investors are required to submit their application form, along with a bank draft, to the underwriter. It takes, on average, five days for the underwriter to process the applications. If the offer is over-subscribed, the underwriter will be responsible for the share allocation. The HKEx must be satisfied that the share allotment procedure is fair so that applications for the same number of securities receive equal treatment. The share allotment result is published in the newspapers and trading in the shares of the newlylisted companies will start on the HKEx shortly afterwards. Table 1 Descriptive statistics of the IPO sample by year of issue All IPOs N = 209

IPOs – 1996 IPOs – 1997 IPOs – 1998 IPOs – 1999 IPOs – 2000 (six months) N = 37 N = 78 N = 28 N = 27 N = 39

Offer price (HK$) 2.3 (1.2) [0.3, 1.2] Shares offered 79.8 (million) (54.6) [7.5, 879.1] Funds raised 1182.4 (HK$ million) (125) [13.4, 43607.7]

4.1 (1.6) [1, 19.8] 74.6 (59.5) [10.5, 250] 732.5 (194.7) [50.0, 4326.3]

Subscription rate

82.1 (29.9) [0.7, 667.0]

61.5 (8.8) [0.2, 1276.0]

2.0 (1.2) [0.9, 12.5] 92.2 (80.0) [14.5, 393.1] 1045.7 (170.7) [50.0, 32665.1] 116.0 (34.1) [0.6, 1276.0]

1.4 1.0 [0.7, 8.0] 77.6 (40) [13.3, 620] 229.4 (70.9) [50.0, 2072.4] 2.9 (1.1) [0.4, 36.5]

2.1 1.2 [0.8, 10.4] 36.0 (30.1) [10.3, 100] 548.7 (113.5) [50.0, 4301.5] 13.4 (3.6) [0.6, 97.0]

1.9 1.0 [0.3, 15.4] 92.4 (21.9) [7.5, 879.1] 3005.6 (79.8) [13.4, 43607.7] 9.6 (2.0) [0.2, 94.0]

This table presents the descriptive statistics of the IPO sample by year of issue. For each variable, the first line presents the mean value, the second line presents the median value, and the third presents the minimum and maximum values.

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A good description of the share allotment method can be found in McGuinness (1999). The allotment method adopted in Hong Kong is quite similar to those adopted in Singapore and the UK (Koh and Walter, 1989; Levis, 1990). For IPOs with relatively low oversubscription ratios, a simple scaling method is applied to all applicants. The proportion of shares received generally declines as the application size increases. With the scaling method, all applicants receive a share allotment. For IPOs with large oversubscription ratios, a combination of the scaling and balloting approach is used. In this, an application ballot is used to ration shares across the small investors (retail investors) and scaling is used for large investors (institutional investors). Under this approach, there is no guarantee that each and every small investor will receive an allotment of shares, while large investors are sure to receive some shares (a portion of the application). Therefore, in oversubscription cases, the share allotment method used in Hong Kong favors large investors. For example, if retail investors apply for the minimum amount of 2000 shares then a portion of them would receive the minimum allotment of 2000 shares and others would receive none. Large investors, on the other hand, will all receive a portion of their applications. For example, if investors apply for 1,000,000 shares, under scaling each one of them could receive a certain percentage of their application. The HKEx instituted new guidelines on 22 May 1997 to ensure that small investors could subscribe for a reasonable proportion of the shares on offer in all IPOs.1 The new guidelines require the underwriter to divide the total number of shares equally into two subgroups; one for applications of less than HK$5 million and the other for applications of more than HK$5 million. The new guidelines favor small investors by ensuring that small investors acquire a reasonable proportion of the shares on offer in all IPOs. One would expect that under these new guidelines, large investors would receive fewer IPO shares, resulting in lower levels of block-trading activity on the first day of trading. 4. Data The total number of IPOs during the period is 222. Of these, 13 were listed by the introduction method.2 As this method does not provide an offer price, we exclude these IPOs from our sample. Our sample therefore consists of 209 IPOs in the stock market (main board) of Hong Kong during the period from May 1996 to December 2000.3 The information on the IPOs is collected from the Fact Book published by the HKEx. 1 “The total number of securities available for public subscription is to be divided into two pools: Pool A and Pool B. The securities in Pool A should be allocated on an equitable basis to applicants who have applied for securities in the value of HK$5 million or less. The securities in Pool B should be allocated on an equitable basis to applicants who have applied for securities in the value of more than HK$5 million and up to the total value of Pool B.” South China Morning Post, p. 2, 23 May 1997). 2 According to the Listing Rules, equity securities may be brought to listing by any one of the methods described below: a) Offer for subscription: An offer for subscription is an offer to the public by or on behalf of an issuer of its own securities for subscription; b) Offer for sale: An offer for sale is an offer to the public by or on behalf of the holders or allottees of securities already in issue or agreed to be subscribed; c) Placing: A placing is the obtaining of subscriptions for or the sale of securities by an issuer or intermediary primarily from or to persons selected or approved by the issuer or intermediary; d) Introduction: An introduction is an application for listing of securities already in issue where no marketing arrangements are required because the securities for which listing is sought are already of such an amount and so widely held that their adequate marketability when listed can be assumed, etc. During our sample period, 54% of IPOs are offered for subscription and placing, 6.3% for subscription and sales, 36% for subscription only, and the others are offered through a mixture of these methods. We find there is no significant difference in both short-term and long-term performance among different methods of introduction. 3 The intraday transaction data set is available from May 1996.

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Table 2 The short-run underpricing of IPOs Time

Mean (%)

Std dev

Minimum

Maximum

Offer-to-open Open-to-close Offer-to-close 2–3 3–4 4–5

17.96 ⁎⁎ − 1.11 16.58 ⁎⁎ − 1.35 − 0.26 − 0.16

32.56 23.32 45.56 7.45 6.04 5.97

− 37.00 − 100.00 − 100.00 − 24.82 − 14.99 − 20.47

233.00 110.00 314.00 38.12 18.24 35.87

The table presents the short-run IPO performance. These include the offer-to-open return, the open-to-close return, the offer-to-close return and the returns on days 2, 3, 4, and 5. The results show that IPO underpricing is eliminated after the market opens on the first trading day. ⁎⁎ Significantly different from zero at the 5% level.

Table 1 presents the descriptive statistics on the 209 IPOs grouped by year of issue. The mean and median offer prices for the whole sample are HK$2.3 and HK$1.2 respectively. The mean and median funds raised by the firms at their offerings are HK$1182.4 million and HK$125 million respectively. And the mean and median subscription rates are 61.5 and 8.8 times respectively, which implies that most of the issues are oversubscribed. We collect the intraday trade and quote data from the Trade Record and Bid and Ask Record CD datasets, both of which are produced by HKEx. We collect the data on market capitalization, daily stock price, and the Hang Seng Index (HSI) from Datastream. 5. Price performance IPO underpricing in the Hong Kong stock market is well documented in the empirical literature (McGuinness, 1992; Cheng et al., 2004). This research extends the existing work by examining the intraday behavior of IPOs over the period from May 1996 to December 2000. The return is computed as the first logarithm difference. For a better understanding of the short-term IPO underpricing, we decompose the offer-to-close return on the first trading day into the offer-toopen and the open-to-close returns. The first transaction price of the IPOs when the market opens is used as the open price. Table 2 shows the short-term performance of IPOs. This shows the average offer-to-close return of IPOs for the first trading days is 16.58% and the offer-to-open return is 17.96%. Both are statistically significant at 5%. However, the open-to-close return is − 1.11%, which suggests that Hong Kong IPOs are underpriced and the underpricing is eliminated after the opening transaction on the first trading day. Table 2 also presents IPO short-term performance for a period of five trading days after listing. The result shows the daily returns during the five-day period are statistically insignificant. The findings are consistent with Cheng et al. (2004) and show that the benefits of underpricing accrue entirely to the IPO's subscribers. This study uses the buy-and-hold strategy to measure long-term IPO performance after listing (Barber and Lyon, 1997). We compare the buy-and-hold strategy of IPOs with the Hang Seng Index (HSI) as the benchmark portfolio.4 The buy-and-hold abnormal return is defined as the 4 The HSI is composed of 33 constituent stocks. The HSI is used as an indicator of the market movement in Hong Kong. The All Ordinary Index (AOI) is composed of all listed stocks in Hong Kong. We repeat our analysis using AOI as the benchmark portfolio. The results are not substantially different from those reported in Table 2.

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Table 3 Long-run IPO performance Holding period (months)

P

t-stat

1 2 3 4 5 6 7 8 9 10 11 12

− 3.08% − 0.65% − 0.51% − 2.44% − 1.46% − 2.10% 0.02% 2.58% 3.44% 1.11% 1.81% − 0.17%

− 1.44 − 0.22 − 0.14 − 0.78 − 0.34 − 0.49 0.00 0.48 0.60 0.22 0.33 − 0.03

BHAR

This table displays the post-listing performance of IPOs during a one-year period. None of the buy-and-hold abnormal P returns are statistically significant. BHAR denotes the average buy-and-hold abnormal return across the sample.

geometrically compounded return on the stock minus the geometrically compounded return on the HSI portfolio: T

T

t¼3

t¼3

BHARt ¼ j ð1 þ rti Þ− j ð1 þ rtbenchmark Þ

ð1Þ

where rti is the raw return on stock i on day t, and rtbenchmark is the return on the matching HSI for day t. BHARt is the buy-and-hold abnormal return for stock i beginning on the third trading day after the IPO, extending for M months.5 The mean buy-and-hold abnormal return is the weighted average of the individual BHARs: n 1 X BHAR ¼ ð BHARi Þ; n i¼1

P

ð2Þ

where n equals the number of stocks. To examine the after-listing performance of the IPOs in the P first year, we calculate BHAR for 12 holding periods from 1 month to 12 months. Table 3 reports the average buy-and-hold abnormal returns for the 12 months after the third day of the IPO. None of the mean buy-and-hold abnormal returns for the 12 holding periods is significantly different from zero. The next question is whether the initial IPO returns can provide any indication of post-listing IPO performance. Ritter (1991) demonstrates that there is a tendency for the new offers with the highest average adjusted initial returns to demonstrate the worst aftermarket performance. Krigman et al. (1999) also shows that extra-hot IPOs provide the worst future performance. We follow the classification method proposed by Krigman et al. (1999) to use the offer-to-open return to classify our sample of IPOs into four categories: very cold, cold, warm, and very hot. There are 69 very cold IPOs with offer-to-open returns on day 1 of zero percent or less. Forty-nine IPOs are considered to be cold, with offer-to-open returns greater than zero percent but less than or equal to 10%. Sixty-seven IPOs are classified as warm with offer-to-open returns between 10% 5

The third trading day is chosen to minimize the impact of IPO underpricing on the first trading day. We also repeat our analysis using the second trading day replacing the third trading day as the base date, and both results are similar.

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Table 4 Post-listing performance for 209 IPOs categorized by initial return Range of offer-to-open return Average offer-to-open return Number of % % IPOs

Average one-year holding period return %

b =0 0 b and b =10 10 b and b =60 N60

6.00 1.79 − 3.66 − 6.90

− 14.55 3.72 28.29 130.76

69 49 67 24

One-way ANOVA test F-value p-value

13.28 0.01

The IPO sample is classified into four subgroups by initial return. IPOs with the highest offer-to-open return are classified as “very hot” and those with the lowest offer-to-open return as “very cold”. The table compares the average one-year buyand-hold abnormal returns among the four subgroups. The lower part of this table reports the results of the ANOVA test on whether the average return of different subgroups are equal.

and 60%, and 24 IPOs are considered to be very hot with the offer-to-open returns greater than 60%.6 Table 4 displays the average initial returns and the average one-year buy-and hold abnormal returns among the sub-groups of IPOs. The result shows that there is a negative association between the initial return and the post-listing IPO performance. The very cold IPOs present the best after-listing performance for the first year and the very hot IPOs have the worst performance for the one-year period after listing. This finding is consistent with the findings in Aggarwal et al. (2002). 6. Block-trading activities IPO block-trading activities include the immediate sale of IPO block allocations in the aftermarket and day traders who buy and sell IPO shares on the first trading day. These block trades may be initiated by either flippers or day traders. We use seller-initiated block trades on the first trading day to measure the level of IPO block-trading activity. The block holders will sell IPOs that they do not have confidence in over the long run, meaning that these IPOs will be traded more often. Large investors will also keep IPOs with good long-term prospects and these IPOs, in turn, will be traded less often. Thus, IPO block-trading activity levels should be informative. In the US, a block trade is defined as a transaction of 10,000 shares or more. In Hong Kong there is no established definition for block trades. Thus, we first examine the size of all IPO transactions on the first trading days and find more than 80% of transactions are for less than 100,000 shares. We use the transaction size of 100,000 shares or more as a proxy for a block trade. Although the definition is arbitrary, our results are not sensitive to the cutoff.7 We classify individual trades as buy or sell orders using the intraday trade and quote data. For every five-second interval, we take the midpoint of the bid-ask spread as a benchmark and classify trades as buy (sell) orders if they are close to the ask (bid). When trades are at the midpoint, if the 6

These cutoffs are consistent with previous literature (see Krigman et al., 1999). We replicate our analysis using 200,000 and 500,000 shares as proxies for block trades. The results are identical to those using 100,000 shares as a cutoff. 7

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Table 5 Descriptive statistics on IPO seller-initiated block trades Variable

Mean

Median

Minimum

Maximum

Trading volume (HK$ million) Block volume (HK$ million) Block percentage (%)

266.80 51.19 19.82

87.78 13.17 20.06

0.43 0.00 0.00

4576.40 1053.92 74.21

This table shows the seller-initiated IPO block-trading activities on the first trading day. A block is defined as the percentage of trading activities generated by the block sell-order made by large investors on the first trading day. The trading volume is the total trading volume of IPOs on the first trading day. The block volume is the total dollar volume of IPO block trades on the first trading day. Block percentage = Block volume / trading volume * 100%.

current trade is higher (lower) than the previous trade, the trade is classified as a buy (sell) order. We define the block-trading level as the ratio of seller-initiated block-trade dollar volume to the total dollar volume traded. Table 5 shows IPO block-trading activities on the first trading day. The block-trading level ranges from a minimum of zero to a maximum of 74.21% with a mean of 19.82%. We examine whether the IPO block-trading level differs from that of seasoned stocks. We construct a matched sample of seasoned stocks by industry and market capitalization. For each IPO, we select a seasoned stock in the same industry and with similar market capitalization. Thus, we compare the block-trading level of the two stocks on the first day of trading for the IPO.8 Appendix A presents the descriptive statistics of the IPO sample and the matched sample in each industry. Table 6 displays the distribution of block-trading levels of the two samples by industry classification. For each industry, we observe a higher level of block-trading activities in the IPO sample than in the matched sample. Almost 90% of IPOs in each industry have block trades, while the percentage of seasoned stocks with block trades is relatively low. This implies that the level of block-trading activities for IPO shares on the first trading day is much higher than that of seasoned stocks.9 With the new IPO allocation guidelines, one would expect that block holders would receive less allocation of new shares while small investors would obtain more shares than they did before the regulatory change. Thus, block holders may be less able to sell block allocations of new shares after the regulatory change because they receive a smaller allocation. This implies there should be less IPO block-trading activities after the change. To examine whether there is any change in IPO block-trading activities after the guidelines were introduced, we divide the IPO sample into two batches, using 22 May 1997 – the guideline's effective date – as the dividing date. IPOs listed before (after) 22 May 1997 are in Batch 1 (Batch 2). Table 7 shows that the mean and median block-trading level of Batch 1 is lower than that of Batch 2. We use both the t-test and the Kruskal-Wallis non-parametric test to examine the difference in mean and median block-trading level between Batch 1 and Batch 2. Both test statistics are not significant, implying there is no significant difference in block-trading activities after the regulatory change. The results suggest that the change, which aimed for a more even allocation of shares between large and small investors, has no impact on the level of IPO blocktrading activity. We would expect the implication of the rule change would be a reduction in the block allocation of IPO, in turn reducing the IPO block-trading activities. However, we find that 8 We compare the one-year performance between the IPO sample and the matched sample. The result is similar to that reported in Table 3. We do not find any significantly difference in one-year performance between the IPO sample and the matched sample. 9 We also examine block trading activities of the newly-listed companies during the period from the second to the fifth trading day. There is very little block trading activity during the four-day period.

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Table 6 Comparison of seller-initiated block-trading activities between the IPO sample and the matched sample Industry

Finance Utilities Properties Consolidated enterprises Industries Hotels Others All

The IPO sample

The matched sample

Percentage of stocks with block-trading activities (%)

Average number of block-trading transactions

Average blocktrading dollar volume (HK$ million)

Percentage of stocks with block-trading activities

Average number of block-trading transactions

Average blocktrading dollar volume (HK$ million)

92.3 100.0 94.4 89.1

113.0 247.0 133.4 124.6

43.6 (32%) 173.2 (15%) 80.3 (35%) 89.0 (10%)

15.4 40.0 16.7 36.3

2.0 3.0 12.3 6.1

0.3 1.3 3.6 5.4

(3%) (1%) (4%) (1%)

95.5 100.0 40.0 87.3

95.8 156.0 231.0 157.3

36.4 (12%) 32.2 (13%) 147.3 (15%) 86.0 (20%)

24.1 0.0 40.0 24.6

14.5 0.0 4.5 6.1

3.9 0.0 0.5 2.1

(0.5%) (0.2%) (0.1%) (2%)

The IPO sample consists of 209 IPOs listed on the HKEx from May 1996 to December 2000. The matched sample is constructed by market capitalization and industry classification of the IPO firm. The two samples are both categorized by industry. The table compares seller-initiated block-trading activities of the IPO sample and the matched sample on the IPOs' first trading days. The figures in parenthesis give the percentage of block-trading activities relative to the total volume of trading.

the regulatory change does not have any significant impact on IPO block-trading activities in the post-issue market. Assuming that block holders are well informed, we examine whether they are capable of identifying IPOs with better long-term performance. We rank and partition all IPOs into tertiles according to the block-trading level. Fig. 1 plots the one-year buy-and-hold abnormal returns by block-trading level and illustrates that a portfolio of IPOs in the lowest block-trading tertile achieves higher buy-and-hold abnormal returns over the one-year holding period. The IPOs in this tertile outperform the market in the first year after listing, while the IPOs in the middle and highest block-trading tertile underperform the market in the first year after listing. Table 8 provides the mean buy-and-hold abnormal returns of one-month, six-month, and oneyear holding periods in each block-trading tertile. IPOs with the lowest block-trading level (L1) have the highest mean buy-and-hold abnormal returns while IPOs with the highest block-trading Table 7 The effect of new rationing guidelines

The number of IPOs The number of IPOs with seller-initiated block trades Block-trading (%) Mean Median S.D.

Batch 1

Batch 2

67 65 20.83 20.50 9.43

142 134 23.25 23.14 13.67

Test statistics for differences between Batch 1 and Batch 2 t-test (t-statistic) Kruskal-Wallis (X2 statistic)

1.26 1.13

The effect of new rationing guidelines instituted on 22 May 1997 on seller-initiated IPO block-trading activities. Batch 1: IPOs before 22 May 1997. Batch 2: IPOs after 22 May 1997.

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Fig. 1. The one-year buy-and-hold abnormal returns by block-trading level. The sample is partitioned using the blocktrading level of IPOs on the first trading day. Level 1 (L1) is the lowest tertile, level 2 (L2) is the middle tertile, and level 3 (L3) is the highest tertile of block trading. The figure plots the relationship between IPOs' one-year buy-and-hold abnormal returns by block-trading level.

level (L3) have the lowest mean buy-and-hold abnormal returns. This tendency can also be observed in Fig. 2, which plots the mean buy-and-hold abnormal returns of different holding periods and block-trading levels. Table 8 also presents the results of the ANOVA test. The results provide statistical evidence that the abnormal returns in different block-trading tertiles are significantly different. The block-trading level is negatively related to the abnormal return. In each group of one-month, six-month and oneyear buy-and-hold returns, the average abnormal return of the highest block-trading level IPOs is lower than the average abnormal return of the medium block-trading level IPOs, which is lower than the average abnormal return of the lowest block-trading level IPOs (all statistically significant at the 1% level). The negative relationship between the block-trading level and after-listing performance of IPOs implies that block traders may have the ability to distinguish good IPOs from bad ones. Table 8 The comparison of one-month, six-month, and one-year buy-and-hold abnormal returns among IPOs with different blocktrading activities

1-month

6-month

1-year

Block-trading level

Count

Mean

Median

S.D.

F-value

p-value

L1 L2 L3 L1 L2 L3 L1 L2 L3

70 70 69 70 70 69 70 70 69

0.010 − 0.033 − 0.062 0.074 − 0.068 − 0.12 0.191 − 0.095 − 0.160

− 2.95% − 6.14% − 10.55% − 7.61% − 12.88% − 26.07% − 4.33% − 20.24% − 24.47%

0.332 0.281 0.325 0.476 0.448 0.444 0.866 0.586 0.829

12.41

0.01

13.28

0.01

12.75

0.01

This compares the means of one-month, six-month, and one-year buy-and-hold abnormal returns, categorized by sellerinitiated block-trading levels. Level 1 (L1) is the lowest tertile, level 2 (L2) is the middle tertile, and level 3 (L3) is the highest tertile in block-trading initiatives.

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287

Fig. 2. Post-listing Performance by block-trading tertile. The sample is partitioned using the block-trading level on day 1. Level 1 (L1) is the lowest tertile, level 2 (L2) is the middle tertile, and level 3 (L3) is the highest tertile of blocktrades. The buy-and-hold abnormal return is plotted against the duration and block-trading level.

We examine the factors that affect the IPO block-trading level on the first trading day. We select four variables: 1) Underwriter reputation. Underwriters play an important role because they know the IPOs well and are also responsible for the allocation of new shares. We measure the reputation of each underwriter against their market share in terms of IPO proceeds raised (Megginson and Weiss, 1991; Beatty and Ritter, 1986). 2) Offer-to-open return of IPOs. Some investors want to pocket a quick profit on the first trading days: this creates more block-trading activities. 3) Market capitalization. A large IPO may attract more participation from block holders, and this in turn may generate more block-trading activities. 4) Date. A dummy variable captures the effect of new IPO allocation guidelines; Date = 0 (= 1) for IPO listed before (after) 22 May 1997. We estimate the following specification using ordinary least squares to investigate the relationship between the block-trading activities and the three factors10: Block ¼ c0 þ c1 Return þ c2 lnðMktcapÞ þ c3 Rank þ c4 Date þ e

ð3Þ

where Block is the percentage of sell-signed dollar volume executed in trades of 100,000 shares or more to the total dollar volume transacted on the first trading day; Mktcap is the total market 10

When estimating the regression, we also include other independent variables such as the subscription rate, funds raised, and year of issue. However, these variables do not have a significant effect on block-trading activities. We also test the multicollinearity between initial return, market capitalization and sponsors’ ranking by examining their correlation coefficients, and find that the coefficients are insignificant.

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Table 9 Factors affecting IPO block-trading activities

Intercept Return Log of Mktcap Rank Date Adj. R2

All

Hot issues

Cold issues

0.101 (0.071) 0.023⁎⁎ (0.03) 0.042⁎⁎ (0.04) −0.020⁎⁎ (0.009) −0.058 (0.112) 0.342

0.135 (0.230) 0.034⁎⁎ (0.01) 0.042⁎⁎ (0.05) − 0.030⁎⁎ (0.02) 0.105⁎ (0.09) 0.321

0.032 (0.051) 0.003 (0.30) 0.015 (0.15) − 0.090 (0.20) 0.029 (0.45) 0.234

⁎ Statistically significant at the 10% level. ⁎⁎ Statistically significant at the 5% level. The sample consists of 209 firms that completed an IPO between May 1996 and December 2000. The dependent variable in the regression is the seller-initiated block-trading level, defined as the ratio of the first-day seller-initiated block-trade dollar volume to total dollar volume traded on the first day. Independent variables include the log of market capitalization of the firms, a ranking for the underwriters, and the offer-to-open return on the first trading day. The table contains the parameter estimates from OLS estimations and p-values in brackets.

capitalization of the firm at the time of the IPO; Rank is the ranking of underwriter; Return is the percentage change from the offer price to the opening trade price; and Date is the dummy variable to measure the effect of new guidelines. The first column of Table 9 presents the regression result. We find the Return variable has a positive and significant coefficient indicating that the higher the offer-to-open return, the heavier the block-trading activities. This indicates that block holders are more likely to trade IPOs to earn higher initial returns. The coefficient of Mktcap is positive and statistically significant at the 5% level, implying that large IPOs are more likely have block trades. The coefficient Rank is negative and statistically significant, implying a negative relation between block-trading activities and sponsors' reputation. The results support the hypothesis that the signal of a good IPO in the form of good underwriter reputation results in a low block-trading level. Block holders trade more shares if the IPOs have high initial returns, large market capitalization, and lower underwriter reputation: these IPOs tend to be the future bad performers. A dummy variable (Date) is added to the regression model to examine whether the introduction of the new IPO allocation guidelines affects the IPO block-trading activities on the listing day. The results show there is no significant difference in the IPO blocking trading activities before and after the new guidelines. We argue that block holders sell their IPO holdings on the first day because they have superior information about the long-term prospect of the IPOs. There is another possibility: that block holders may not be allocated the full amount requested, especially in heavily oversubscribed issues, so they may increase their holdings by buying additional shares in the secondary market to reach their desired holding quantity. However, if the IPO is hot, the first-day trading may push the aftermarket IPO price to a level that is beyond the block holders' reservation price for the stock. The block holders may dispose of their holding by selling what they were allocated at the IPO. To examine this possibility, we further separate all IPOs into two groups: hot and cold issues. We combine IPOs with offer-to-open return higher (lower) than 10% to be hot (cold) issues. The new classification combines the “very hot” and “warm” IPOs into “hot” issues and the “cold” and “very cold” IPOs into “cold”

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Table 10

Intercept Seller-initiated block-trade Rank Return Log of market capitalization Pre-listing market Date Adjusted R2

Model I

Model II

0.421 − 1.378⁎⁎ − 0.236 − 0.157 0.069 0.024

0.545 −1.575⁎⁎ −0.152 −0.092 0.032 0.019 0.052 0.23

0.27

⁎ Statistically significant at the 10% level. ⁎⁎ Statistically significant at the 5% level. This table presents the results of regression models using one-year post-listing returns as the dependent variable and the seller initiated block-trading activities, underwriter reputation, offer-to-open return, market capitalization, pre-listing market condition, hot issue, and the date of rule change as independent variables. A dummy variable “Hot Issue” is used to capture the IPO performance on the first-day trading. Hot Issue = 1 ( =0) when the offer-to-open return N0 (b0). The pre-listing market consultation is the cumulative 15-day Hang Seng index return before the listing of new issues. The date variable is a dummy variable of the date of rule change in share allocation, where DATE= 0 (=1) before (after) the rule change.

issues. This enables us to examine the IPO block-trading activities among the hot and cold issues. The results are presented in the second and third columns of Table 9 and that show IPO block trading is active in the “hot” issue subgroup, but not in the “cold” issue subgroup. The effect of rule change is only significant in the “hot” issue subgroups. The result shows that IPO block-trading activities are more active after the rule change. This may imply that IPO block holders tend to sell their small allocations (because of the new IPO allocation guidelines) if the issues are hot and they cannot acquire more shares at a reasonable price in the aftermarket. 7. Robustness This section assesses the robustness of our findings. Section 7.1 investigates the negative relationship between the IPO block-trading activities and its aftermarket performance. Section 7.2 replaces the seller-initiated block trades of the first day by those which occur during the first 5-minute trading session. 7.1 We construct the following model to examine the negative relation between the IPO blocktrading activities and its aftermarket performance. The model uses the one-year post-listing IPO return as the dependent variable and the seller-initiated block-trading volume, underwriter reputation, market capitalization, offer-to-open return, and pre-listing market condition11 as control variables. The first column of Table 10 shows that a statistically significant negative relation is found between the seller-initiated block-trading volume and post-listing performance with the inclusion of control variables. This negative relation remains unchanged after the introduction of new IPO allocation guidelines and the result is shown in the second column of Table 10. 7.2 The IPO seller-initiated block trades of the first trading day include block holders who successfully subscribe to the new shares in IPOs and those who trade the new shares on the first day. We propose using the seller-initiated block-trading activities during the first five 11

The pre-listing market condition is defined as the cumulative Hang Seng Index return during a period of 15 days before the listing of the IPO. The definitions of other variables can be found in Section 6.

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minutes as a proxy for the successful subscribers of IPOs. There are two trading sessions in HKEx. The morning session runs from 10:00 am to 12:30 pm and the afternoon session from 2:30 pm to 4:00 pm. There are 48 five-minute trading intervals. On average, the seller-initiated block trades during the first five-minute interval account for 12% of the daily total. This implies that most of the seller-initiated block trades occur during the first five-minute interval. 8. Conclusions Using intraday transactions, this research studies block-trading activities of newly-listed stocks. The issue that we attempt to address is whether investors can use seller-initiated block trades of IPOs as an indicator for future performance. The rationale is that IPO block holders may have superior information about the newly-listed companies and they keep shares in IPOs with good long-term prospects. The results show that IPOs have more seller-initiated block trades on the first trading day. We also find that IPOs have, on average, more seller-initiated block trades than the matched seasoned stocks do. These seller-initiated block trades are related to the IPO post-listing performance. The buy-and-hold abnormal return of IPOs within the first year of listing is negatively associated with the block-trading level. The higher the IPO block-trading levels on the first trading day, the lower the returns within the first year of listing. Furthermore, the result shows that IPO block-trading activities are more active after the rule change. This may imply that IPO block holders tend to sell their small allocations (because of the new IPO allocation guidelines) if the issues are hot and they cannot acquire more shares at a reasonable price in the aftermarket. In summary, this study supports the hypothesis that block holders may have superior information about newly-listed companies. They are able to sell IPOs with “bad” long-term prospects to capture short-term profits and keep those with “good” long-term prospects. Appendix A. Descriptive statistics of the IPO sample and matched sample The IPO sample consists of 209 IPOs listed from May 1996 to December 2000 on the HKEx. The matched sample is constructed by market capitalization and industry classification of the IPO firm. Industry

Finance Utilities Properties Consolidated Enterprises Industries Hotels Others

Number of stocks

Market capitalization of the IPO sample (HK$ million)

Market capitalization of the matched sample (HK$ million)

Mean

Min

Max

Mean

Min

Max

13 5 18 55 112 1 5

616.89 4379.25 3767.64 9271.66 1279.80 541.80 8075.83

98.12 805.69 238.00 155.44 131.20 541.80 252.80

2475.54 8630.14 17549.98 20469.13 25841.94 541.80 21274.70

651.89 4188.41 3825.96 10038.13 1142.41 507.96 7863.15

192.24 643.98 262.40 235.41 117.19 507.96 396.15

2467.43 7104.04 20019.24 23078.15 26373.62 507.96 19723.62

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