Download Private Placements of Public Equity in China

Private Placements of Public Equity in China
G. Nathan Dong*
Columbia University
Ming Gu†
School of Economics and WISE
Xiamen University
Hua He‡
Cheung Kong Graduate
School of Business
March 31, 2017
ABSTRACT
In this study of private equity placements (PEPs) in China, we find that Chinese firms’ PEPs are
issued at a substantial discount and have positive announcement period returns, which is
consistent with previous studies using data mainly from the United States and Europe.
However, there is a long-term outperformance by PEP-issuing firms, and such long-term
abnormal return is even higher when controlling shareholders participate in the deal and the
externally raised capital is allocated to asset restructuring and M&A. We further show that
firms approved for private placements are financially stronger than those rejected by regulatory
authorities. In addition to the benefits accruing to investors, investment efficiency is improved
after private placements, especially in firms that had financial constraints to begin with. Overall
the evidence suggests that the policy preferences of market regulators influence the allocation of
capital to the corporate sector.
Keywords: private placements, Chinese stock market, regulatory intervention, long-term
performance
JEL Code: G14, G15, G18, G20, G32
___________________________________________
*Dept. of Health, Policy & Management, Columbia University ([email protected]). †School of Economics and
WISE, Xiamen University ([email protected]). ‡Cheung Kong Graduate School of Business ([email protected]).
We thank Sirio Aramonte, Daniel Beltran, Yin-Wong Cheung, Gonul Colak, Bora Durdu, Zuzana Fungacova, Jennifer
Huang, Ergys Islamaj, Xiaoyang Li, Bibo Liu, Neil Pearson, Jun “QJ” Qian, Yiming Qian, Frank Song, Zhongzhi Song,
Hefei Wang, Wentao Wu and participants at the Financial Intermediation in Emerging Markets Conference (Cape
Town), Conference on China’s Financial Markets and the Global Economy (Bank of Finland), FMA Annual Meeting
(Orlando), Georgetown Center for Economic Research Biennial Conference, Conference on Financial Development
and Economic Stability (Durham University), National University of Singapore Annual Risk Conference, Summer
Institute of Finance (CKGSB), Cheung Kong Graduate School of Business, and Renmin University of China for
helpful comments. All remaining errors are ours.
I. INTRODUCTION
Private placements of public equity securities, more commonly known as private equity
placements (PEPs), are shown to have benefits that are related to certification and monitoring
by well-informed large, often institutional, investors because their willingness to invest in a
firm’s equity shares serves as a signal of firm value (Leland and Pyle 1977) as well as an
indication of reduced agency costs given that institutional investors have the expertise and
capacity to monitor management at low cost (McConnell and Servaes 1990). Much of the
attention and research has been devoted to understand how the costs and benefits of PEPs are
perceived and reflected in both short- and long-term stock performance. For example, private
placements of equity are associated with positive announcement returns (Hertzel and Smith
1993; Wruck 1989); however, the long-run stock returns of PEP-issuing firms are negative
following private placements (e.g., 3-year negative abnormal return in Hertzel et al. 2002). It is
important to emphasize that, unlike initial and seasoned public offerings (i.e., IPOs and SEOs)
in the U.S., equity securities that are issued and sold via private placements to large investors
do not need to be registered with the Securities and Exchange Commission (SEC),1 and hence
the issuers are not required to (and often do not) publicly disclose information about their PEP
issues.
But what if we let the government to be deeply involved in the review and approval
process of private placements? The rationale behind the rule that allows unregistered offerings
in private placements in the U.S. is that large and often sophisticated investors have the
knowledge and the resources to independently evaluate investment opportunities of the
PEP-issuing firms (Habib and Johnsen 2000). However, in the rest of the developing world, the
sophistication and capacity of institutional investors can be very limited, if not non-existent. An
interesting question, perhaps, is what if the policy preferences of market regulators can
influence the allocation of capital to the corporate sector not in terms of reducing adverse
selection in private placements, but rather through providing pre-screening mechanism to
single out promising investments and investors with the regulatory emphasis placed on
promoting a limited number of “winners”.2 If the approval of PEPs can serve as a confirmation
1 The only requirement is that unregistered private placements of equity cannot be resold in the open market,
except under provisions of the SEC’s rule 144 (the Security Act of 1933). Only after a minimum two-year holding
period, these investors holding privately placed equity can sell them to the public (Silber 1991).
2 This could well be motivated by pro-growth and pro-development considerations. The effects of financial market
liberalization on long-run economic growth have been extensively studied in the prior empirical literature. For
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that better informed investors with the right incentives and ability to monitor managers have
been identified, then the impact on business operations will gradually take place and we will
expect firm performance to improve over time.
Compared to the developed markets, PEPs in China are highly regulated by requiring
regulatory approval on the basis of a range of criteria including limited number of participating
investors and different lock-in periods for different investor categories along with other
undisclosed factors, often influenced by preferential economic policies that favor certain
industrial sectors and public enterprises (Song 2014; Lin and Tan 1999); at the same time,
stringent rules and regulations in emerging markets like China are commonly associated with
weak legal protection of minority shareholder rights (La Porta et al. 1998; La Porta et al. 2002).
Firms and large investors under the influence of low government quality often engage in
rent-seeking from government (Fyre and Shleifer 1997; Shleifer and Vishny 1998; Fisman, 2001),
and this can potentially add a further perverse incentive in favor of asset appropriation by large
shareholders (Johnson et al. 2000; Friedman et al. 2003; Cheung et al. 2010; Fan et al. 2011).
These institutional features provide a unique opportunity to examine the real effect of
government intervention in resource allocation on firm performance. Specifically, we raise and
address the following questions that relate to private placements of public equity securities in
China: Are the short- and long-term effects of private placements in China similar to those of
other markets (monitoring/certification hypothesis)? Does government appear to “cherry-pick”
amongst the large number of PEP applications and to approve those with a high probability of
success (pre-screening hypothesis)? And who actually benefited from these highly regulated
private placements transactions (self-dealing hypothesis)?
Using detailed data of PEP transactions in China during the period from 2006 to 2012, we
find that, consistent with existing studies using data mainly from the United States and Europe,
Chinese firms’ PEPs are issued at a substantial discount and have positive announcement
period (short-term) returns. This deep discounts offered to controlling shareholders provides
some evidence of self-dealing that arises when managers and large shareholders take advantage
of their private information to appropriate minority investors’ wealth. Additionally, in contrast
instance, a decline in the cost of capital that is caused by market liberalization led to an investment boom (Henry
2000), and an increase of one percentage point in average GDP growth can be attributed to stock market
liberalization (Bekaert et al. 2005). Although financial liberalization leads to faster economic growth, it also causes
occasional crises. However, over the long run, the pro-growth effects of greater financial deepening and more
investment outweighs the detrimental effects of financial fragility and market crisis (Ranciere et al. 2006).
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to previous studies, PEP-issuing firms exhibit above-average long-term stock market
performance subsequent to the private placements. Both buy-and-hold abnormal returns and
calendar-time portfolios returns of PEP-issuing firms are significantly higher than that of
non-issuing firm in one, two and three years following PEPs. The outperformance is more pronounced when controlling shareholders participate in the deal and the externally raised
capital is allocated to asset restructuring, and mergers and acquisitions, apparently supporting
the monitoring/certification hypothesis. We further investigate the sample of all firms that have
applied for PEP issuance, including firms whose PEP applications were approved and others
whose applications were rejected by Chinese regulatory authorities. Indeed, consistent with the
pre-screening hypothesis, we find that firms approved for private placements are financially
stronger than those rejected by regulatory authorities. In addition to the benefits accruing to
investors, investment efficiency is improved after private placements, especially in firms that
had financial constraints to begin with.
The remainder of the paper is organized as follows. Section II reviews the relevant prior
research on private placements and describes the market regulation of PEPs in China. Section III
presents the sample data and empirical method. Section IV evaluates the results, Section V
discusses the further analysis, and Section VI concludes.
II. INSTITUTIONAL BACKGROUND AND LITERATURE REVIEW
2.1 Prior Literature on PEPs
Private equity placements (PEPs) are non-underwritten stock offerings sold directly to a single
investor or a small group of investors. In the United States, it is exempt from registration with
the Securities and Exchange Commission (SEC) due to the fact it does not involve any public
offering, and information about private placement transactions is often limited (Carey, Prowse,
Rea and Udell 1994). The market discounts and announcement effects associated with private
placements have long been the hot issue in recent corporate finance literature. Previous studies
on private placements of equity suggest that, in most markets, private placements have market
discounts (Wruck, 1989; Hertzel and Smith, 1993; Wu et al. 2005), as well as positive
announcement effects (Hertzel and Smith, 1993; Kato and Schallheim, 1993; Renneboog et al.
2007), although there are significant variations across countries. The literature attributes the
discounts and abnormal announcement returns of private placements to the monitoring effect,
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asymmetry information, managerial entrenchment, and investor over-optimism. For example,
Wruck (1989) shows that the announcement of a private sale of equity is accompanied by a
4.41% average abnormal return and suggests that changes in ownership concentration can
partially explain the positive announcement effect. This phenomenon can be interpreted as the
“monitoring effect” that private placements are purchased by investors who can ensure efficient
resource allocation and enhance firm value by actively monitoring management. Several other
US studies argue private placement discounts and stock price reactions also reflect illiquidity
(Silber 1991), resolution of asymmetric information about firm value (Hertzel and Smith 1993).
This is consistent with the “certification effect” that informed investors agreeing to purchase a
large block of stock via private placements is like putting their stamp of approval on the
market’s valuation of the firm.
Several studies confirm the positive short-term market reaction to the PEP announcement
in markets outside the U.S., including the Japanese market (e.g., Kato and Schallheim 1996; and
Kang et al. 1999), Hong Kong market (Wu et al. 2005), and U.K. market (Renneboog et al. 2007).
Recent two studies, Lu et al. (2011) and Fonseka et al. (2014), show that the positive market
reaction to PEPs is also evidenced in the Chinese stock market. The non-negative stock-price
reaction associated with PEP issues evidenced in the U.S. and international markets support the
view that PEPs are viewed by investors as a positive signal regarding the firm’s future
prospects. One of the puzzling aspects of PEP issuance is the long-term underperformance
documented in the U.S. (e.g, Hertzel et al. 2002; Krishnamurthy et al. 2005; Barclay et al. 2007;
Brophy et al. 2009; and Chen el at. 2010) and Japanese market (Kang et al. 1999). For instance,
Hertzel et al. (2002) show that positive announcement period returns are followed by
abnormally low post-announcement stock price performance, with -23.8 percent three-year
buy-and-hold abnormal returns relative to a size and book-to-market matched sample of control
firms in the U.S., and the authors attribute this phenomenon to investor over-optimism. One
alternative explanation for the fact that shareholders no longer view private placements as
favorable hence the negative long-run return can be managerial entrenchment. For example,
managers who want to enhance their control of the firm can place large blocks of stock with
passive investors (Barclay et al. 2007).
It is also worth noting that private placements financing arrangements are often associated
with detailed contractual agreements and restrictions between the issuer and the buyer to a
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greater extent than would be found in public offerings (Monahan 1983). This clearly lowers the
liquidity of privately placed securities; however, this problem is mitigated by the clientele effect:
The investors of PEPs are mostly long-term institutional investor (Amihud and Mendelson
1986). Krishnamurthy et al. (2005) examine the relation between stock price performance and
the identity of investors buying equity privately. They show that the long-term abnormal
returns to the affiliated investors outperform those to unaffiliated investors. However, the
institutional buyer of the placements can become active in firm affairs following the placements,
especially in cases when the PEP participant was affiliated with, can exert a strong influence on,
or was a member of the top management team prior to the placements (Barclay et al. 2007). Although it is possible that some affiliated investors, mainly insiders, possess favorable
information regarding the firm that is not fully disclosed at the time of a corporate action, and
can consume or appropriate corporate resources (Allen 2001; Holderness and Sheehan 1988),3
other investors holding majority blocks of stock in publicly traded companies often engage in
monitoring effort (Shleifer and Vishny 1986). Even for large investors that are considered
outsiders (e.g., transient investor), they can still gather costly information about the firm’s
fundamental value by actively trading the firm’s equity and induce managers to undertake
efficient real investment with the voting rights associated with their holding (Edmans 2009).
Following the argument in Pagano and Roell (1998) that the incentive to issuing equity is closely
related to the amount of external funding required, the participation in PEPs by large affiliated
shareholders signals both the need of capital to finance the firm’s operation and the investors’
intention to exert governance and urge better performance, and in turn, minority investors will
perceive a change in the firm’s strategic priorities.
It is very likely that the controlling shareholders that participate in private placements are
better informed about the firm’s operating efficiency and capital investment that characterize
the strategic position of the firm. Hertzel et al. (2002) have shown that private placements tend
to follow periods of relatively poor performance. Given the relatively poor pre-issue operating
performance, investors are anticipating an improvement in future operating performance.
However, whether a turnaround will actually happen depends critically on the capability and
In an attempt to answer the question why some investors benefit more from the transactions of equity issuance
and M&A, Bae et al. (2002) find that large shareholders increase their wealth by increasing the value of other group
firms. Such phenomenon can be attributed to managerial entrenchment (Barclay et al. 2007) and self-dealing
(“tunneling”) of affiliated shareholders because they have strong incentives to transfer resources out of the firm to
benefit themselves (Johnson et al. 2000; Bertrand et al. 2002; La Porta et al. 2002).
3
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willingness of the PEP participants to play a proactive role in monitoring corporate
management to enhance the return of the firm’s existing assets in place. The selection or
screening nature of the regulatory approval process through a tournament-like competition
among the PEP-issuing firms and PEP-participating investors is likely to reduce the number of
approved PEP deals to those most likely to be the fittest. On the one hand, the applications with
PEP-issuing firms paired with participating investors who are best informed and positioned to
monitor are likely to be approved. On the other hand, these firms and investors face strong
incentives to compete for regulatory approval.
Finally, to some extent, the current research is related to the research on policy impacts in a
financial market that is to prone to market failure (monopoly, imperfect information, scarcity
rent, destructive competition, etc.). Specifically in this study we are focused on a financial
regulation policy that was enacted in China to protect investors and serve the public interest by
ensuring fair and orderly markets. It is well documented in previous studies that IPO issuance
is subject to the risk that equity issuers will sell bad securities to the public (La Porta, Lopez-De-Silanes and Shleifer 2006). According to Carpentier, Cumming and Suret (2012), the
appropriate level of regulatory requirements and IPO-issuing firms’ commitment to regulation
reduce information asymmetry and heterogeneity of expectations and hence mispricing.
Carpentier et al. (2012) also study the economic effect of stricter regulatory oversight in Canada
and evidence a strong effect of the IPO disclosure and listing mode on firm value. In contrast to
other financing instruments (e.g., IPOs, SEOs), PEPs have some advantages. For example, listed
firms can raise sufficient external capitals from controlling shareholders and institutional
investors and using non-public offering; controlling shareholders can inject quality assets into
listed firms through private equity placements to enhance the sustainable profitability of listed
firms; lower regulatory disclosure of PEPs can also reduce the refinancing cost and save the
time and auditing resources.
2.2 PEP Issuance and Regulation in China
The stock market in China is one of the largest markets in the world. The market capitalization
of Shanghai Stock Exchange and Shenzhen Stock Exchange combined is almost five trillion U.S.
dollars, more than half as much as the GDP of that country in 2014; however, the Chinese
government has maintained a variety of restrictions on its financial markets, including the size
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of the stock market, the pace and timing of equity issues, and the allocation of resources (Gao
2012; Gordon and Li 2003). Compared with its western counterparts, private placement of
equity in China has shorter history, different characteristics, and more stringent regulation. On
May 8, 2006, the China Securities Regulatory Commission (CSRC) issued “The Administration of
the Issuance of Securities by Listed Companies”. Since then, private equity placements have become
the primary method of equity refinancing for listed firms in China. The figure 1 shows the
development of PEPs in the Chinese stock markets. In 2014, the completed PEPs has raised
666.573 billion in RMB (Renminbi or Chinese Yuan), which accounts for 97.71% of total
refinancing RMB amount of that year in China.4
[Insert Figure 1 Here]
Private equity placements in China are highly regulated and have some unique features.
For example, in China, 1) PEPs require mandatory approval from the CSRC. Once the listed
firms receive the result of whether the application is approved or not by the CSRC, they should
publicly announce the result the next trading day; 2) PEPs can be sold to a maximum of 10
investors who belong to any type of investor category, including controlling shareholders,
institutional investors, wealthy individuals, and other legal investment organizations; 3) The
newly issued PEP stocks are not allowed to be sold within next 12 months irrespective of the
category of the investor. If the stocks are bought by the controlling shareholders or any other
firm owned by the controlling shareholders, they cannot be resold within the next 36 months.
Besides the requirements on issuing target and resale block period, the CSRC also regulate the
PEP issuing amount, issuing price, issuing purpose, and many others.
However, Chinese policy makers are facing a dilemma. On the one hand, more financial
market participation and investment are better than less, because the equity market has become
an important source of external funding and effective platform for restructuring the
state-owned entities (SOEs). The privatization of SOEs through shareholding subjected them to
financial constraints and market disciplines, forcing managers to act in the interests of
shareholders rather than those of themselves or the state. In other words, it is believed, at least
Before 2008, the CSRC report did not separate the total RMB amount of private offering from public offering. From
2008, the CSRC started reporting the detailed RMB amount of PEP issues. To obtain the first two points in the figure 1,
we consider all available PEPs in 2006 and 2007 from Wind dataset, and calculate their total RMB issuing amount
deflated by total equity refinancing RMB amount. (Source: http://www.csrc.gov.cn/pub/newsite/sjtj/).
4
8
by policy makers, that the stock market can enhance corporate governance and in turn improve
management, accountability, transparency, and corruption (Groenewold, Wu, Tang and Fan
2004). Therefore, the policy goal of financial market regulation in China is to increase the
opportunities and ability of the companies to obtain financing through public or private
placements and, at the same time, lower transaction costs including regulatory costs. This is
evidenced by the fact that private placements have become the major method of equity
refinancing for publicly traded firms in China. On the other hand, the country does not yet have
the necessary institutional infrastructure, including formal and informal rules, distribution of
rights, and systems of enforcement, to make equity financing work effectively and efficiently.
As a result, the protection of shareholder rights is still poor, insider trading and fraudulent
dealing are rampant, and public companies do not intend to maximize shareholder value (Liu
2006; Tam 2002). Thus, it is understandable that extensive regulation is needed in this relatively
new and underdeveloped private placements market in China to reinforce the effects of
monitoring (Wruck 1989), certification (Hertzel and Smith 1993) and reduce information
asymmetry and heterogeneity of expectations and hence mispricing (Hertzel et al, 2002),
possibly over a longer period of time.
III. DATA AND METHOD
3.1 Sample Description and Event Study
From the Wind Dataset, we identify all A-share listed firms that had private equity placements
from 2006 to 2012. Because the CSRC placed the regulatory constraints on PEPs in 2006, our
sample period starts from that year. We require at least one year of post-announcement data for
most of our analyses and we only consider the transactions that A-share listed firms issue
A-share. The initial sample includes 846 firm-year observations with successfully completed
PEPs (675 firms). We then impose the following criteria on our sample of issuing firms: 1) we
eliminate the offerings by utility and finance firms (CSRC industry codes D and I), and Chinese
firms dual-listed in Hong Kong; 2) we eliminate the multiple issues in the same month, and
observations where the firm has a previous private placement in the last three years; 3) we
eliminate firms with insufficient data to calculate other measures discussed in the latter section.
The final sample includes 580 firm-year observations (544 firms) that have successfully
completed PEPs from 2006 to 2012. Panel A of Table A1 in the appendix reports the detailed
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sample selection procedure. Panels B and C show the distribution of sample firms across year
and industry. There are more PEPs in the recent years, and in the manufacturing and real estate
industry groups.
We obtain the stock returns data and accounting information about the firms from China
Stock Market Accounting Research (CSMAR) database from 2006 to 2014. The definitions of the
variables are reported in Appendix Table A2. For PEP related variables, PROCEEDS is the total
RMB value of the private offering; FRACTION is calculated as the ratio of shares placed to
shares outstanding after the issue; DISCOUNT is the market discount of private equity
placements and it is computed by (closing price of 10th day after announcement − placement
price)/closing price of 10th day after announcement. We also take several firm characteristics,
investment efficiency variables and corporate governance variables into considerations.
We define CAR (-3, 0) as the 4-day interval of cumulative abnormal return around the
announcement date. We estimate a market model over a 190-day period starting 250 days prior
to the announcement of the private placements and cumulate the average abnormal returns
over 4 days around the announcement. The discount-adjusted abnormal return CAR (-3, 0)-Adj
employs the definition in Wruck (1989) and Hertzel and Smith (1993) as follows:
CAR(-3, 0)-Adj= [1/(1 - a)][CAR(-3, 0)] + [a/(1 - a)][(Pb - Po)/Pb]
(1)
where CAR(-3, 0) is the abnormal stock return, a is the ratio of shares placed to shares
outstanding after the placements, Pb is the market price at the end of the day prior to the event
window, and Po is the placement price.
[Insert Table 1 Here]
Panel A of Table 1 shows that the sample mean value of market equity is RMB 4290.16
million, and book-to-market ratio is 0.64. The average year value between IPO date and private
equity placements announcement date is 8.34 year. The average proceeds raised from the
private placements in our sample is 1165.88 million in RMB. The average fraction of new shares
issued as a percentage of total shares outstanding after the issue is 29.75 percent, slightly higher
than the percentage in the U.S. studies. The private placements in our sample are sold at a mean
discount of 23.21 percent, measured relative to the share closing price of 10th day after
announcement date. The discount is relatively smaller than Lu et al. (2011), because we include
10
the more recent PEPs and we find the issuing discount decreases in the recent years. Panel A
also reports that the mean value of four-day (-3, 0) announcement period returns and four-day
discount-adjusted abnormal returns are 2.05 percent and 12.44 percent, significant at the one
percent level. These findings are consistent with previous studies as summarized in the
appendix Table A3, that private placements are associated with positive announcement period
returns and are issued at a substantial discount. An examination of the Pearson correlation
matrix (Panel B of Table 1) indicate that issuance size (PROCEEDS) is strongly correlated with
both the issuing firm’s equity size (SIZE) and the tradable issues (FRACTION) with the
coefficients of 0.47. FRACTION is also highly correlated with DISCOUNT with the coefficient of
0.40.
3.2 Measurement of Long-Term Abnormal Stock Price Performance
Following Hertzel et al. (2002), we employ two basic approaches to measure long-term
abnormal stock price performance following private equity placements. First, we consider the
approach of Barber and Lyon (1997) and Lyon et al. (1999), and use an individual control firm
for each firm in our sample (buy-and-hold abnormal returns). Fama (1998) and Mitchell and
Stafford (2000) point out that buy-and-hold abnormal returns methodology may be problematic
because it does not adequately account for potential cross-sectional dependence in returns.
Following their suggestions, we also estimate abnormal returns using the calendar-time
portfolio approach used by Mitchell and Stafford (2002).
Similar to Krishnamurthy et al. (2005), we define the buy-and-hold returns to the existing
shareholders not participating in the private placements for firm i from the announcement day
(t=0) to n days subsequent to the announcement as:
t n
BHRi ,n  [ (1  Rit )]  1
(2)
t 0
where Rit is the raw return for firm i on day t . The buy-and-hold abnormal return (BHAR) for
firm i from day 0 through day n is defined as:
BHAR (0, n )  BHRi ,n  BHRcontrol _ i ,n
(3)
where BHRcontrol _ i ,n is the contemporaneous buy-and-hold return on firm i’s control firm. The
matched sample of control firms is created by matching on size and book-to-market ratio as
described in Krishnamurthy et al. (2005). Specifically, we select the control firms that are in the
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same size decile as the sample firm and are closest in book-to-market ratio to the sample firm. In
addition, the feasible controls include only firms that did not issue equity in the prior three
years. The average abnormal buy-and-hold return for a sample of firms is the arithmetic mean
of the individual abnormal buy-and-hold returns.
The participating investor returns are calculated by compounding the non-participating
investor returns BHAR(0, n) and the returns from the offer price to the closing price of the
announcement day. We focus the long-term analysis in one-, two-, and three-year holding
periods because the PEP resale restrictions in China specify different resale lock-in periods for
different investors.
We examine the post-issue long-term stock price performance of equity-issuing firms on a
risk-adjusted basis using calendar-time regressions. For each month, we form equally- and
value-weighted portfolios of all firms that issue equity privately in the previous 36 months.
R pt  R ft     m MKTt   s SMBt   h HMLt   t
(4)
where the dependent variable R pt  R ft in the Fama–French regressions is the return in each
month on these portfolios in excess of the monthly risk-free rate. The intercept in regression
measures the risk-adjusted abnormal performance of PEP-issuing firms. MKT, SMB, and HML
are monthly returns of Fama-French (1993) three factors extracted from CSMAR.
IV. RESULTS
4.1 Long-Term Performance after the Private Placements
Table 2 reports the buy-and-hold abnormal returns over one-, two-, and three-year holding
periods following the private placements announcements. The results show the positive
long-term abnormal returns following private equity placements announcements, controlling
for size and book-to-market ratio. The findings are different from studies in the U.S. market
(Hertzel et al. 2002) and Japanese market (Kang et al. 1999).5
[Insert Table 2 Here]
Panel A suggests that existing shareholders who do not buy the shares in the private
We also examine the results across size matched controls, book-to-market ratio matched controls. Since the results
are similar to size and book-to-market ratio matched controls, we only report the size and book-to-market matched
results in our tables.
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placements (i.e., non-participating shareholders) earn positive abnormal returns over one-, two-,
and three-year holding periods following the private placements. Over the three years (one year)
following the private placements, the shareholders earn a mean return 10.24 percent (2.13
percent) above the control firms. Panel B reports the average size and book-to-market adjusted
returns to the investors buying the shares in the private placements. The participating investor
returns are calculated by compounding the non-participating investor returns and the returns
from the offer price to the closing price of the announcement day. These participating
shareholders earn, on average, 26.85 percent, 31.38 percent, and 38.99 percent over one-, two-,
and three-year holding periods following the private placements. The returns to participants are
substantially higher than the returns to non-participants because private placements are sold at
a mean discount of 23.21 percent on average. The t-statistics of the abnormal returns to
participants in the private placements are statistically significant. The evidence that
participating shareholders benefit more than non-participating shareholders from long-term
stock returns clearly indicates the existence of self-dealing and wealth appropriation by these
large institutional investors. Interestingly, the return differentials to participating and
non-participating investors have been decreasing over time as shown in Figure 2, and this may
suggest that the effects of the managerial entrenchment and large shareholders appropriation
are gradually diminishing.
[Insert Figure 2 Here]
Following Fama and French (1993) and Kang et al. (1999), we examine the post-issue
long-term performance of equity issuing firms on a risk-adjusted basis using calendar-time
regressions. In Table 3, we present the Fama–French three-factor time-series regression results
for the portfolio of PEP-issuing firms. For each month, we form equally- and value-weighted
portfolios of all firms that issue equity privately in the previous 36 months. The intercept (alpha)
of the regression measures the risk-adjusted abnormal performance of issuing firms. For the
equally-(value-) weighted portfolios, the intercept is 0.36% (0.42%), which indicates that the
private placement firms exhibit the average abnormal returns of 0.36%(0.42%) per month over
the 36-month period following the private placements announcement. The equally-(value-)
weighted portfolios regression coefficients are statistically significant and economically large,
13
with t-stat=1.82 (t-stat=2.35). This coverts to a three-year return of approximately 13.69% [(1 +
0.0036)36 - 1] for the equally-weighted portfolios, and 16.16% [(1 + 0.0042)36 - 1] for the
value-weighted portfolios.
[Insert Table 3 Here]
4.2 Compare PEP-approved and PEP-rejected Firms
Before jumping to the conclusion that PEP-issuing firms generally perform better following
private placements than those non-issuing firms, it is important to know that PEP-issuing firms
can be “selected” by the regulatory agency to obtain the permission to place equity privately. It
is very likely that the CSRC may not approve applications from firms that do not have a good
chance of eventually becoming successful. In other words, the observations in our sample of
PEPs only represent the “good” firms that have applied for PEP issuance, received approval,
and completed transactions.
In this subsection, we include 580 firm-year observations that have received approvals and
completed private placements (PEP-approved) plus additional 325 firm-year observations of
firms whose applications were rejected by the CSRC or withdrawn by themselves (PEP-rejected),
and compare the characteristics of PEP-approved firms with that of PEP-rejected firms in Table
4.
[Insert Table 4 Here]
Panel A of Table 4 reports the differences in means between the two groups. We find that
PEP-approved firms have larger size, younger age, lower financial leverage, higher ROA (ROE)
ratios, and higher past 12-month stock returns than PEP-rejected firms; the differences between
these two groups in SIZE, AGE, Leverage, ROA, ROE, and Past_ret12 are at least significant at the
10% level; the differences in book-to market ratios (BM), and earnings management (Accruals)
are insignificant.
In addition to the aforementioned financial ratios, we also investigate the differences in
corporate governance (measured by ownership structure) and financial constraints (proxied by
14
bankruptcy and delisting risks) between these two groups in Panel A. We define Top1 as the
stake of the largest shareholder (Bai, et al 2002), Institution as total shareholding percentage
owned by institutions, and Coverage as the number of EPS forecasting agencies. We find that
firms with PEP approvals have significantly higher level of ownership by institutional investors
and the largest shareholder, and more analyst coverage. The dummy variable Distress is equal
to one if ROE is less than 0 or Altman-Z score (1968) is less than 1.8 in the year before PEP
applications, or there is debt restructuring within 3 years before PEP applications; the dummy
variable Violation is equal to one if firms received warnings from the CSRC, Shanghai stock
exchange or Shenzhen stock exchange within 3 years before PEP application. To examine
whether the PEP regulatory policies award preferential treatment to public enterprises (e.g.,
SOEs) we also create a dummy variable SOE with value one for firms belonging to state-owned
entities. We find that firms with approvals are more likely to be the state-owned entities (SOEs),
have less financial constraints, and received fewer warnings from the regulators before PEP
applications.
We construct the calendar-time portfolios returns of all firms that have applied for PEP
issuance in Panel B of Table 4 and the portfolio strategy is the same as the one in Table 3 with
Fama–French three-factor time-series regressions. For each month, we form equally-and
value-weighted portfolios of firms that succeeded in or failed in issuing PEPs in the previous 36
months. The intercept (alpha) of the regression represents the risk-adjusted abnormal
performance of PEP-issuing firms. This panel reports the portfolios returns and the differences
in returns between the two groups. The equally- (value-) weighted return differences of two
groups portfolios regression coefficients are statistically significant at the 10 percent level, with
t-stat=1.84 (t-stat=1.98). These results show that PEP-approved firms significantly outperform
PEP-rejected firms, consistent with the findings reported in Table 2 and Tables 3.
Overall, the evidence is generally consistent with the pre-screening hypothesis that
regulators in China select firms with better financial performance or investment opportunities
to proceed with issuing PEPs and this can potentially help eliminate “wasteful” capital
expenditures of low-quality firms. Unfortunately, there is no publicly available document that
details the policy direction and goals of the government with respect to the review and
approval of PEP applications. What we do know, at least based on the findings of the present
study, is that state-owned enterprises are more likely to receive regulatory approval, which to
15
some extent supports the “Helping Hand hypothesis” that shareholders in firms with close ties
to government gain from political connections (Fisman 2001; Faccio 2006; Sapienza 2004; Faccio
et al. 2006).
4.3 The economic consequence of PEPs
The next question to ask is about the role of firm investment efficiency in the PEP review
process and it has two parts: first, whether investment efficiency of the applying firm is part of
the consideration for granting permission and more importantly, second, whether firms are
made better off with regard to improvement in investment efficiency following private
placements. We define the underinvestment and overinvestment according to Biddle et al. (2009)
and Chen et al. (2011) for investment inefficiency as follows:
Investmenti ,t   0  1 SalesGrowthi ,t 1   i ,t
(5)
where Investment is calculated as the sum of research and development expenditure, capital
expenditure, and acquisition expenditure less cash receipts from sale of property, plant, and
equipment, scaled by lagged total assets. SalesGrowth is the percentage change in sales from the
previous year to current year. The investment efficiency equation (5) is estimated
cross-sectionally in each industry-year. We measure the positive residuals from equation (5) as
Overinvestment, and negative residuals as Underinvestment. To ease exposition, we multiply the
underinvestment variable by —1 so that a higher value represents a more severe
underinvestment.
[Insert Table 5 Here]
Table 5 presents the comparison of investment efficiency between PEP-approved and
-rejected firms. The firm-year observations include Year T−1, Year T+1, and Year T+2, relative
to year T when firms filed for PEP application. Panel A is the comparison of underinvestment
measures, and Panel B is the comparison of overinvestment measures. In panel A, the difference
is not significant in underinvestment between PEP-approved firms and PEP-rejected firms
before the PEP application (at T-1) or one year after the PEP application (at T+1). However, it is
significant (-0.67) between the two groups at T+2. As for the time-series difference within each
group, PEP-approved firms have significant improvement in underinvestment from T-1 to T+2,
16
but the improvement is weak for PEP-rejected firms. In particular, the underinvestment of
PEP-approved firms significantly declines from 4.90% at T-1 to 4.24% at T+2, while the
underinvestment of PEP-rejected firms increases from 4.73% at T-1 to 4.91% at T+2. The
difference-in–difference (DiD) between two groups from T-1 to T+2 is -0.84, significant at the 1%
level. These results imply that PEP-approved firms use the obtained capital to investment in
more efficient projects over time.
When we turn to the investment efficiency measured by overinvestment in Panel B, we
notice that either the cross-sectional difference between two groups or the time-series difference
within each group is quite small. The difference-in–difference between the two groups from T-1
to T+2 is -0.48, significant at the 10% level. The effect of PEPs on reducing overinvestment is not
as significant as the effect on improving underinvestment. Because the previous DiD tests do
not take into consideration the variation of firm characteristics, we conduct the following
multivariate regression:
InvEff i ,t 1     PEPi ,t   Controlsi ,t   PEPi ,t  Distressi ,t   i ,t
(6)
where InvEff is defined as the excess investment (underinvestment or overinvestment), which is
the absolute value of the residual of the investment efficiency model (5). The dummy variable
PEP is equal to 1 if firms whose PEP applications is approved in that year. The control variables
include size, book-to-market ratio, age, leverage ratio, ROA, cash ratio, tangibility ratio and
industry fixed effects. We also include the dummy variable Distress to proxy for the firm’s
financial constraints. Appendix Table A2 describes the definition of these variables. The
firm-year observations include Year T−1 and Year T+2, relative to year T when firms file for
PEP application. Standard errors are clustered at the year and firm levels in all specifications.
[Insert Table 6 Here]
Table 6 reports the regression results for the relation between private placements and
investment efficiency, in which columns 1 and 2 (3 and 4) employ the underinvestment measure
(the overinvestment measure) as the dependent variable. For example, the coefficient of PEP is
-0.61 (t-stat=-3.25) in column 1, indicating a significant reductions in underinvestment for firms
completed PEPs after controlling for firm characteristics. The coefficient of PEP is -0.59
(t-stat=-1.75) in column 3, showing the reductions in overinvestment for firms completed PEPs
17
is marginally significant. When we add the interaction term PEP*Distress in the regression, we
find that the coefficients of PEP*Distress are -0.76 (t-stat=-2.07) in column 2, and -0.83
(t-stat=-1.24) in column 4, respectively. The significantly negative coefficient of PEP*Distress in
column 2 implies that the reduction in underinvestment is more pronounced for firms that had
a higher degree of financial constraints to begin with.
In summary, the results of both DiD tests multivariate regressions indicate that, firm
investment efficiency is not an important factor in the selection choices; however, in the long
run, PEP approvals can help firms raise much needed capital but also improve investment
efficiency over time, especially in the underinvestment case and for firms that were highly
financially constrained. This finding can be attributed to the “monitoring effect” that private
placements are issued to large investors who can actively oversee management and ensure
efficient resource allocation. Unfortunately, for other firms whose PEP applications are rejected
by the regulator, they are left with a higher level of investment inefficiency.
V. FURTHER ANALYSIS
In the previous section, we show that PEP-issuing firms perform better than non-issuing firms
following private placements in the long run and we attribute this finding to the “enhanced”
monitoring which in turn improves firm investment efficiency. To understand the underlying
economic channels through which private placements may enhance monitoring by large
shareholders, we conduct additional tests to relate long-term firm performance to the types of
investor that participate in PEPs and the use of capital raised from these investors.
5.1 Does investor identity matter?
PEPs in China can be issued to any type of investor, including controlling shareholders,
institutional investors, natural persons, and other legal investment organizations, subject to
different resale lock-in periods. We are interested to know whether PEP-participating investor
identity matters for long-term post-announcement performance as Krishnamurthy et al. (2005)
suggest that the long-term abnormal returns to the affiliated investors are higher than those to
the unaffiliated investors. In order to answer this question, we analyze the long-term abnormal
returns by separating the private placements in our sample into those whose shares are bought
by controlling shareholders and those whose shares are bought by non-controlling shareholders
18
of the issuing firms.
We collect the investor identity information from the WIND database and indentify
investors as controlling shareholders, firms controlled by the controlling shareholders,
institutional investors, natural persons, and other legal investment organizations. Out of 580
private placements in our sample, we classify 108 observations as the PEPs issued only to
controlling shareholders of the issuing firms (Investor 1). The remaining 472 placements include
191 observations as the PEPs issued to both controlling shareholders and non-controlling
shareholders (Investor 2), and 281 observations as the PEPs issued only to non-controlling
shareholders (Investor 3).
[Insert Table 7 Here]
Table 7 reports the PEP issue- and firm-specific characteristics partitioned by participating
investor type (Investors 1 to 3), and Panel A is their summary statistics before the PEP
announcements. We find that firms that issued PEPs to controlling shareholders (Investor 1)
have a substantially larger issue size, higher book to market ratio, older age, lower institutional
ownership, and higher probability of government ownership than those issued to
non-controlling shareholders (Investor 3) at the 5 percent level, and lower analyst coverage and
higher degree of financial constraints at the 10 percent level. Although the differences in issue
size, firm age, and government ownership are insignificant compared to the mixed issues
(Investor 2), the mixed issues still have a larger issue size, older age, higher leverage, and higher
probability of government ownership than those to non-controlling shareholders (Investor 3) at
the 5 percent level.
Panel B reports the summary statistics of issue and firm characteristics around the PEP
announcements. The mean values of issue size, fraction of new shares to total shares
outstanding, and offer discounts for PEPs issued to controlling shareholders (Investor 1) are
significantly higher (1864 million RMB, 33 percent, and 42 percent) than the other two cases
(Investor 2 and Investor 3). The average announcement period reaction measured in CAR (2.84
percent) of PEPs where only controlling shareholders participate (Investor 1) is significantly
higher that of PEPs where only non-controlling shareholders participate (Investor 3), and the
adjusted market reaction of 19.95 percent is higher than the both types of participation (Investor
2 and Investor 3). These results suggest that while there is some degree of insider self-dealing in
19
the form of deeper discounts offered to controlling shareholders, overall PEPs issued to
controlling shareholders are generally considered a positive signal about the firm’s future
prospects.
Panel C of Table 7 reports the long-term abnormal returns (BHAR) following private
placements partitioned by participating investor type. The abnormal returns to both
PEP-participating and non-participating investors, ranging from a 5.6 percent 1-year return to
non-participating investors to a 61 percent 3-year return to participating investors, are higher
when firms issued PEPs to controlling shareholders (Investor 1) than the other two participation
types (Investor 2 and Investor 3). The substantial difference in returns between
PEP-participating and non-participating investors is not surprising because the return to
participating investors is the sum of stock price return and the return from the discounted offer
price to the closing price of the announcement day.
Overall, the long-term outperformance of PEP-issuing firms is largely driven by the
participation of controlling shareholders. Their participation signals both the need of capital to
finance the firm’s operation and these controlling investors’ intention to exert governance and
urge better performance, and in turn, minority investors perceives a change in the firm’s
strategic priorities, which is generally consistent with the monitoring/certification hypothesis.
To what extent the use of capital raised through private placements matters for regulatory
review and approval and its long-effect on firm performance is another interesting question and
we will address it in the next section.
5.2 Subsamples based on PEP objectives
To examine the relation between long-term firm performance and the use of externally raised
capital, we collect the PEP issue objectives information from the WIND database. While these
objectives reflect the “proposed” use of capital raised through private placements, firms
generally comply with the requirement by sticking to their originally proposed plan because
any violation of securities laws will certainly jeopardize their ability to raise capital in the future.
We partition the full sample into five objective groups: “inter-company asset restructuring”
(Objective 1), “whole group listings” (Objective 2), “assets acquisitions” (Objective 3), “asset
injection” (Objective 4), and “project financing” (Objective 5). There are other four purposes in
the sample, including “supplementing working capital”, “shell company restructuring”,
20
“supporting financing”, and “introducing strategic investors”; however, due to the limited
number of observations for each of there four investment objectives, we decided to drop them
from the sample.
[Insert Table 8 Here]
Table 7 reports the PEP issue- and firm-specific characteristics partitioned by issuing
objectives (Objectives 1 to 5), and among these five groups, the use of capital in Objective 5 is
mainly for project financing and it contains 351 firm-year observations. The other uses
(Objectives 1 to 4) are related to asset restructuring and M&A and it has 194 firm-year
observations. Panel A reports their summary statistics before the PEP announcements.
Compared to other four groups of investment objectives, the firms issued PEPs to finance new
projects (Objective 5) have relatively higher ROA and ROE, lower past stock returns, higher
institutional ownership, lower degree of financial constraints, and of younger age.6
Panel B reports the summary statistics of issue and firm characteristics around the PEP
announcements. For PEPs issued for project financing (Objective 5), the mean values of issue
size, offer discount, and fraction of new shares to total shares outstanding are substantially
smaller (778.50 million RMB, 19 percent and 23 percent) than those of other uses of capital. We
also find a substantially lower announcement period reaction of 1.64 percent and adjusted
market reaction of 9.08 percent in this group. Panel C reports the long-term abnormal returns
following PEPs partitioned by issuing objective. Again, the long-term abnormal returns to both
participating and non-participating investors are lower when PEPs are issued for project
financing (Objective 5) compared to those of other issuing objectives. The results in this section
clearly suggest that the “proposed” use of capital to be raised through PEPs, especially for asset
restructuring and mergers and acquisitions, is indeed taken into consideration by regulatory
authorities.7
5.3 Gambling Behavior of Investors
Test statistics are omitted for brevity.
In an un-reported table, we use the type of offerings to break down our sample. In China, issuing firms can choose
either the fixed price or the auction price to issue the equity privately to certain investors. We find that more than
95% of our observations choose the fixed price mechanism. Our results in the previous sections hold if we exclude the
observations that use auctions to offer PEPs.
6
7
21
A limitation of using the event study approach to assess the overall impact of private
placements on firm value is that it is unclear how much of the information about the potential
benefits and costs of PEPs is capitalized into the stock price. The positive short-term
announcement returns reported in this paper may be driven by country-specific characteristics
that are associated with both a high short-term market return and excessive risk taking. For
example, retail investors with gambling preferences often trade stocks of firms involved in any
corporate actions much like the way they buy lottery tickets. It is hard to imagine that it could
not be the case given the turbulent Chinese stock market and limited investment opportunities
for individual investors in China (Wharton 2015; Morck et al. 2008). Gamblers prefer a lottery
ticket in spite of being aware of the negative-sum nature of the game. It has been shown in the
literature that investors who exhibit gambling behavior often trade stocks with payoff
distributions resembling those of lottery tickets. In other words, these positively skewed
securities (i.e., a large positive payoff with a small probability or a small negative payoff with a
large probability) can be overpriced and earn negative average excess returns (Barberis and
Huang 2008). We follow the technique used in Xiong and Yu (2011) to test whether the stocks in
our sample behave like lottery tickets. For the daily stock returns of PEP-issuing firms in one
month subsequent to PEP announcements (t+1, t+30), the average skewness of returns is not
significant (mean of 0.0023 and p-value of 0.9363). The lack of evidence of positive skewness in
stock returns helps rule out gambling behavior as a possible confounding factor.
VI. DISCUSSION AND CONCLUSION
In this paper, we study both short- and long-term performance of PEPs of publicly traded
companies in China and compare and contrast our results with those of previous studies using
data mainly from the United States and Europe where regulation of PEP issuance is broadly
absent. Firms in China are required to submit proposals prior to issuing PEPs, and their
applications are subject to review and approval by the central regulatory authority. The final
decision is based on a set of clearly defined and rather stringent criteria including the number
of participating investors and resale restrictions and largely influenced by preferential
economic policies that favor certain industrial sectors and public enterprises. We are interested
in how the policy preferences of authorities affect the market not only in terms of reducing
22
adverse selection but also through providing pre-screening mechanism, and we find that
Chinese firms’ PEPs are issued at a substantial discount and have positive short-term returns.
However, we also find long-term outperformance by PEP-issuing firms subsequent to private
placements. Both buy-and-hold abnormal returns and calendar-time portfolios returns of
PEP-issuing firms are significantly higher than those of non-issuing firm in one, two and three
years following PEPs. The long-term outperformance can be attributed to many factors, for
example, investment efficiency of issuing firms improve over time and the externally raised
capital is used for asset restructuring and M&A. The most important reason appears to be the
government interference in the allocation of market capital to the corporate sector. We present
evidence that firms approved for private placements are financially stronger than those
rejected by regulators.
Some degree of self-dealing is evidenced by the deep discounts offered to controlling
shareholders, suggesting that managers and institutional shareholders engage in wealth
appropriation by taking advantage of their private information. On the other hand, the fact
that more SOEs received approvals than non-SOE firms and the long-term abnormal return to
minority shareholders is higher when controlling shareholders participate in the deal may
support the “Helping Hand hypothesis” that shareholders in firms with close ties to
government gain from political connections, for example, borrowing on preferential terms
from state-owned banks and government-sponsored bailouts (Fisman 2001; Faccio 2006;
Sapienza 2004; Faccio et al. 2006); however, it lacks evidence from cross-sectional analysis.
23
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http://knowledge.wharton.upenn.edu/article/whats-behind-chinas-stock-market-gamble/
Wruck, K.H., 1989, Equity Ownership Concentration and Firm Value: Evidence from Private
Equity Financings, Journal of Financial Economics 23, 2–38.
27
Wu, X.P., Z. Wang, and J. Yao, 2005, Understanding the Positive Announcement Effects of
Private Equity Placements: New Insights from Hong Kong Data, Review of Finance 9, 385–414.
Xiong, Wei and Jialin Yu, 2011, The Chinese Warrants Bubble, American Economic Review 101,
2723–2753.
28
Appendix Table A1. Sample Description
Panel A. Private equity placements sample selection procedure
We consider the cased that A-share listed firms only issue
A-share from year 2006 to 2012.
Initial sample:
846 firm-year observations
We eliminate the offerings by utility and finance firms and
Chinese firms dual-listed in Hong Kong.
We eliminate the multiple issues in the same month and
observations where the firm had a previous private placement in
the last three years.
We eliminate firms with insufficient data to calculate other
measures discussed in the latter section.
91 firm-year
755 firm-year
observations deducted
observations
121 firm-year
634 firm-year
observations deducted
observations
54 firm-year
observations deducted
29
Final sample:
580 firm-year
observations
Panel B. Distribution of sample firms over time
Year
firm-year observation
2006
40
2007
97
2008
69
2009
77
2010
100
2011
120
2012
77
Total
580
30
Panel C. Distribution of sample firms across industry
Industry
firm-year observation
Agriculture
10
Mining
26
Manufacturing
368
Construction
18
Transportation
18
Information Technology
31
Wholesales and Retails
30
Real Estate
51
Service
19
Media
6
Conglomerate
3
Total
580
31
Appendix Table A2. Description of variable
Variable Name
Descriptions
PEP-related Variables
PROCEEDS(million)
Total RMB value of the private offering in millions
FRACTION
Ratio of shares placed to shares outstanding after the issue
DISCOUT
Market discount of private equity placements and it is computed by (closing price of 10th
day after announcement − placement price)/closing price of 10th day after announcement.
CAR(-3, 0)
4-day interval of cumulative abnormal return around the announcement date; we estimate
a market model over the period beginning 250 days prior to the announcement of the
private placement and cumulate the average abnormal returns over 4-day window around
the announcement.
CAR(-3, 0)-Adj
Discount-adjusted abnormal returns CAR(-3, 0)-Adj using the definition in Wruck (1989)
and Hertzel and Smith (1993);
CAR(-3, 0)-Adj= [1/(1 - a)][CAR(-3, 0)] + [a/(1 - a)][(Pb - Po)/Pb]
where CAR(-3, 0) is the 4-day abnormal stock return, a is the ratio of shares placed to
shares outstanding after the placement, Pb is the market price at the end of the day prior
to the event window, and Po is the placement price.
Buy-and-hold abnormal return (BHAR) for firm i from day 0 through day n is defined as:
BHAR(0, n)
BHAR (0, n )  BHRi , n  BHRcontrol _ i , n
,
BHRcontrol _ i , n
where
is the contemporaneous buy-and-hold return on firm i’s size and
book-to-market ratio matched controls
BHAR(0,250)
Average buy-and-hold one-year abnormal return after the private equity placements
BHAR(0,500)
Average buy-and-hold two-year abnormal return after the private equity placements
BHAR(0,750)
Average buy-and-hold three-year abnormal return after the private equity placements
Firm Characteristics
SIZE
Market value of equity (in millions) at the end of the month prior to the private equity
placements announcement date
BM
Ratio of book value of equity to market value of equity of the fiscal year end prior to the
announcement date
AGE
Years between IPO date and private equity placements announcement date
ROA
Ratio of net income to total assets
ROE
Ratio of net income to total equity
Leverage
Total debt scaled by total assets of the previous fiscal year end
Accruals
Earning minus cash flows, scaled by total assets of the previous fiscal year end
Past_ret12
Cumulative past 12-month stock returns before the PEP announcement, adjusted by size
and book-to-market ratio
Distress
Distress =1 if ROE is less than 0 or Altman-Z score (1968) is less than 1.8 in the year before
PEP application, or there is debt restructuring within 3 years before PEP application;
otherwise Distress =0
Violation
Violation =1 if firms received warning from the CSRC, Shanghai stock exchange or
Shenzhen stock exchange within 3 years before PEP applications; , otherwise Violation =0
32
Investment Efficiency Variables
Investment
The sum of research and development expenditure, capital expenditure, and acquisition
expenditure less cash receipts from sale of property, plant, and equipment, scaled by
lagged total assets
SalesGrowth
The percentage change in sales from the previous year to current year
InvEff
A measure of investment efficiency, which is measured as the absolute values of the
residuals from the investment efficiency model: Investmenti ,t   0  1SalesGrowthi ,t 1   i ,t
The investment efficiency model is estimated cross-sectionally in each industry-year
Overinvestment
Positive residuals (multiplied by 100) from the investment efficiency model
Underinvestment
Absolute value of the negative residuals (multiplied by 100) from the investment
efficiency model
Cash
The ratio of cash to total assets
Tangibility
The ratio of property, plant, and equipment to total assets
Corporate Governance Variables
Top1
The stake of the largest shareholder
Coverage
The number of EPS forecasting agencies in firms’ annual reports
Institution
Total shareholding percentage owned by institutions in firms’ annual reports
SOE
SOE=1 is equal to one when the listed firms belong to the state-owned entities;
otherwise SOE =0
33
Appendix Table A3. Comparison of short-term abnormal returns in the literature
Paper Citation
Sample Country
Sample Period
Measure
Mean Return
Wruck (1989)
USA
1979-1985
CAR(-3, 0)
4.41%
Hertzel and Smith (1993)
USA
1980-1987
CAR(-3, 0)
1.72%
Hertzel et al. (2002)
USA
1980-1996
CAR(-3, 0)
2.40%
Krishnamurthy et al. (2005)
USA
1983-1992
CAR(-3, 0)
2.21%
Chen et al. (2010)
USA
1997-2003
CAR(-3, 0)
3.41%
Average =
2.83%
Lu et al. (2011)
China
2006-2009
CAR(-3, 0)
5.40%
Fonseka et al. (2014)
China
2006-2010
CAR(-3, 0)
1.20%
This paper
China
2006-2012
CAR(-3, 0)
2.05%
Average =
2.88%
34
Table 1. Description of sample variables
The sample contains 580 firm-year observations that issue equity privately during the period 2006 to 2012. SIZE is
defined as the market value of equity at the end of the month prior to the private equity placements announcement
date. BM is defined as the ratio of book value of equity to market value of equity of the previous fiscal year end prior
to the announcement date. AGE is calculated as the year value between IPO date and private equity placements
announcement date. PROCEEDS is the total RMB value of the private offering. FRACTION is calculated as the ratio
of shares placed to shares outstanding after the issue. DISCOUNT is the market discount of private equity placements
and it is computed by (closing price of 10th day after announcement − placement price)/closing price of 10th day
after announcement. CAR(-3, 0) is the 4-day window of cumulative abnormal return around the announcement date.
CAR(-3, 0)-Adj is the discount-adjusted abnormal returns. Panel A reports the sample characteristics of the private
placements and the private placements firms. Panel B reports the Pearson correlations between these characteristics.
The correlation coefficients are bold if significant at 10%.
Panel A. Sample characteristics of the private placement and the private placement firms
Mean
Median
25 percentile
75 percentile
4290.16
2726.31
1424.09
5361.07
BM
0.64
0.65
0.43
0.86
AGE
8.34
8.17
4.38
11.96
1165.88
638.24
395.37
1377.22
FRACTION(in percentage)
29.75
26.62
15.33
40.24
DISCOUNT(in percentage)
23.21
22.96
6.43
38.88
CAR(-3, 0) (in percentage)
2.05
1.00
-2.00
4.75
CAR(-3, 0)-Adj (in percentage)
12.44
8.91
1.65
24.35
SIZE(million)
PROCEEDS(million)
Panel B. Pearson correlations
SIZE
BM
AGE
BM
AGE
PROCEEDS
FRACTION
DISCOUNT
CAR(-3, 0)
CAR(-3, 0)-Adj
-0.14
0.15
0.47
-0.31
-0.01
-0.01
-0.11
-0.15
-0.01
0.16
0.17
0.05
0.17
0.23
0.11
0.03
0.09
0.11
0.47
0.06
0.03
0.23
0.39
0.06
0.61
0.12
0.73
PROCEEDS
FRACTION
DISCOUNT
CAR(-3, 0)
0.46
35
Table 2. Buy-and-hold abnormal returns after the private equity placements
The table reports the buy-and-hold abnormal returns over one-, two-, and three-year holding periods following the
private placements announcements. The buy-and-hold abnormal returns are adjusted by size and book-to-market
ratio. The sample contains firms that issue equity privately during the period 2006 to 2012. The t-statistics of
coefficient estimates are displayed in parentheses.*, ** and *** indicate the significance level at the 10%, 5% and 1%
levels, respectively.
We define the buy-and-hold abnormal return (BHAR) to the existing shareholders not participating in the private
placement as BHAR(0, n )  BHRi , n  BHRcontrol _ i , n . The participating investor returns are calculated by compounding the
non-participating investor returns and the returns from the offer price to the closing price of the announcement day.
Period
Obs
BHAR Mean (%)
t-stat
BHAR Median (%)
Panel A: Returns to non-participating investors
(0, 250)
580
2.13
(0.90)
-0.86
(0, 500)
548
5.95*
(1.69)
2.14
(0, 750)
466
10.24**
(2.41)
7.19
Panel B: Returns to participating investors
(0, 250)
580
26.85**
(2.02)
18.57
(0, 500)
548
31.38***
(4.10)
20.95
(0, 750)
466
38.99***
(5.52)
29.78
36
Table 3. Calendar-time portfolios returns after the private equity placements
The sample contains firms that issue equity privately during the period 2006 to 2012. For each month, we form
equally- and value-weighted portfolios of all firms that issue equity privately in the previous 36 months. The
dependent variable R pt  R ft in the Fama–French regressions is the return in each month on these portfolios in excess
of the monthly risk-free rate.
R pt  R ft     m MKTt   s SMBt   h HMLt   t
The intercept alpha in regression measures the risk-adjusted abnormal performance of PEP-issuing firms. MKT, SMB,
and HML are monthly returns of Fama-French (1993) three factors extracted from CSMAR. The Implied 3-year AR [(1 +
Intercept)36 - 1] is the estimated average buy-and-hold return from earning the intercept return every month for 36
months. The t-statistics of coefficient estimates are displayed in parentheses.*, ** and *** indicate the significance level
of intercept at the 10%, 5% and 1% levels, respectively.
Equally- Weighted
Value-Weighted
Alpha
MKT
SMB
HML
Alpha
MKT
SMB
HML
coefficient
0.36%*
1.08
0.52
-0.32
0.42%**
1.14
0.14
-0.48
t-stat
(1.82)
(18.93)
(7.62)
(-3.78)
(2.35)
(19.86)
(2.16)
(-5.09)
Implied 3-year AR
13.69%
16.16%
37
Table 4. Sample including all firms that have applied for PEP issuance
This table investigate the characteristics of all firms have applied for PEP issuance, including firms whose PEP
applications got approved, and firms whose applications were rejected by the CSRC. The sample contains firms that
have applied for PEP issuance during the period 2006 to 2012. The t-statistics of coefficient estimates are displayed in
parentheses. *, ** and *** indicate the significance level at the 10%, 5% and 1% levels, respectively.
Panel A investigates the characteristics of all firms in PEP-approved and PEP-rejected groups, and the differences in
means between two groups. Appendix Table A2 describes the detailed description of characteristics. Panel B reports
the calendar-time portfolio returns of each group, and return differences of two groups. The portfolio strategy is the
same as Table 3.
Panel A. Sample characteristics of all firms have applied for PEP issuance
PEP-approved
Variable
PEP-rejected
PEP-approved minus -rejected
N
Mean
N
Mean
Difference in Means
t-stat
SIZE (million)
580
4290.16
325
3389.44
900.72*
(1.95)
BM
580
0.67
325
0.65
0.02
(0.25)
AGE
580
8.34
325
9.75
-1.41***
(-5.46)
Leverage
580
0.46
325
0.48
-0.02**
(-2.02)
ROA
580
0.03
325
0.01
0.02***
(5.93)
ROE
578
0.09
324
0.07
0.02***
(4.64)
Accruals
580
-0.01
325
-0.02
0.01
(1.52)
Past_ret12
580
0.25
325
0.22
0.03*
(1.69)
Top1
580
0.38
325
0.35
0.03***
(3.54)
Institution
543
0.14
308
0.10
0.04***
(5.24)
Coverage
463
7.05
265
5.50
1.55***
(2.67)
SOE
575
0.62
317
0.55
0.06**
(1.98)
Distress
580
0.12
325
0.28
-0.16***
(-5.77)
Violation
580
0.05
325
0.10
-0.05***
(-3.15)
Panel B. Calendar-time portfolio returns of all firms that have applied for PEP issuance
PEP-approved
PEP-rejected
PEP-approved minus -rejected
EW-Alpha
VW-Alpha
EW-Alpha
VW-Alpha
EW-Alpha
VW-Alpha
coefficient
0.36%*
0.42%**
0.08%
0.03%
0.28%*
0.39%**
t-stat
(1.82)
(2.35)
(0.37)
(0.21)
(1.84)
(1.98)
38
Table 5. Investment efficiency of all firms that have applied for PEP issuance
The table presents the comparisons of investment efficiency between firms whose PEP applications got approved,
and firms whose applications were rejected by the CSRC. The investment efficiency variables proxied by
underinvestment and overinvestment are the residuals of the investment efficiency model in Appendix A2. We use
the absolute value of the residuals for underinvestment. The sample contains firms that have applied for PEP
issuance during the period 2006 to 2012. The sample firm-year observations include Year T−1, Year T+1, and Year
T+2, relative to the year T when firms file for PEP application. *, ** and *** denote statistical significance at 1%, 5%
and 10% based on t-tests for means.
Panel A. The comparison of underinvestment
underinvestment
PEP-approved
PEP-rejected
PEP-approved minus -rejected
N
Mean
N
Mean
Difference in Means
T-1
367
4.90
215
4.73
0.17
T+1
357
4.40
229
4.64
-0.24
T+2
355
4.24
220
4.91
-0.67**
Difference in Means
Difference in Means
Difference-in-Difference
(T+1) - (T-1)
-0.50**
-0.09
-0.41**
(T+2) - (T-1)
-0.66**
0.27
-0.84***
PEP-rejected
PEP-approved minus -rejected
Panel B. The comparison of overinvestment
overinvestment
PEP-approved
N
Mean
N
Mean
Difference in Means
T-1
213
7.33
110
7.29
0.04
T+1
223
7.21
96
7.18
0.03
T+2
225
6.84
105
7.28
-0.44*
Difference in Means
Difference in Means
Difference-in-Difference
(T+1) - (T-1)
-0.12
-0.11
-0.01
(T+2) - (T-1)
-0.49*
-0.01
-0.48*
39
Table 6. OLS regressions explaining the long-term abnormal returns
This table reports the regression results for the relation between private placements and investment efficiency. The
estimation model is follows:
InvEff i , t 1     PEPi , t   Controli , t   PEPi , t  Distressi , t   i , t
where InvEff is defined as the excess investment (underinvestment or overinvestment), which is the residual of the
investment efficiency model. We use the absolute value of the residuals for underinvestment. The dummy variable
PEP is equal to 1 if firms whose PEP applications got approved in that year. The control variables include size,
book-to-market ratio, age, leverage ratio, ROA, cash ratio, tangibility ratio and industry fixed effects. We also include
the dummy variable Distress to proxy for the financial constraints. Appendix Table A2 describes the detailed
description of variables. The sample contains firms that have applied for PEP issuance during the period 2006 to 2012,
including firms whose PEP applications got approved, and firms whose applications were rejected by the CSRC. The
sample firm-year observations include Year T−1 and Year T+2, relative to the year T when firms file for PEP
application. Standard errors are clustered at the year and firm levels in all specifications. The t-statistics of coefficient
estimates are displayed in parentheses. ***, ** and * indicated significance at the 1%, 5% and 10% levels.
Dependent Variable:
PEP
Underinvestment
(1)
(2)
(3)
(4)
-0.61***
-0.45**
-0.59*
-0.54
(-3.25)
(-2.04)
(-1.75)
(-1.42)
Distress
PEP*Distress
log(SIZE)
log(BM)
log(AGE+1)
Leverage
ROA
Cash
Tangibility
Industry fixed effects
Adj. R-Square
Overinvestment
0.38
0.79
(1.47)
(1.38)
-0.76**
-0.83
(-2.07)
(-1.24)
-0.21**
-0.21**
-0.38***
-0.40***
(-2.34)
(-2.21)
(-2.71)
(-2.83)
-0.06
-0.06
-0.31
-0.34
(-0.39)
(-0.37)
(-0.97)
(-1.04)
0.31
0.31
-0.37
-0.37
(1.63)
(1.62)
(-1.06)
(-1.06)
0.89**
0.79*
0.63
0.52
(2.18)
(1.92)
(0.72)
(0.57)
-7.75
-7.16***
-11.39***
-10.05**
(-4.06)
(-3.50)
(-3.09)
(-2.52)
0.47
0.47
2.31
2.32
(0.59)
(0.60)
(1.46)
(1.46)
0.68
0.70
1.63
1.53
(1.22)
(1.25)
(1.91)
(1.81)
Yes
Yes
Yes
Yes
0.201
0.205
0.144
0.149
40
Table 7. Subsample analysis according to PEP investor identity
The table separates the private placements sample into three subsamples. The first subsample contains private
placements where shares are bought only by controlling shareholders of the issuing firms; the second one contains
those where shares are bought by both controlling shareholders and non-controlling shareholders; the third one
contains those where shares are bought only by non-controlling shareholders of the issuing firms:
Investor 1 represents PEP participation by only Controlling Shareholders.
Investor 2 represents PEP participation by both Controlling Shareholders and Non-Controlling Shareholders.
Investor 3 represents PEP participation by only Non-Controlling Shareholders.
Panel A reports the subsample characteristics of firms before the PEPs. Panel B reports the subsample characteristics
of the private placements around the PEP announcement, and Panel C reports the long-term abnormal returns
following private placements of equity sorted by participating investor type. T-tests of the differences in means
among subsamples are reported with *, ** and *** indicating the significance level at the 10%, 5% and 1% levels,
respectively. The sample contains firms that issue equity privately during the period 2006 to 2012.
Panel A. The means and differences-in-means of sub-sample firm characteristics before the PEP announcements
Investor 1
(N = 108)
(1)
Investor 2
(N = 191)
(2)
Investor 3
(N = 281)
(3)
Difference in
Means
(1) ‒ (2)
Difference in
Means
(1) ‒ (3)
Difference in
Means
(2) ‒ (3)
4878.85
4677.58
3800.56
201.27
1078.29**
877.02**
BM
0.71
0.67
0.65
0.04**
0.07***
0.02
AGE
9.60
9.19
7.27
0.41
2.34***
1.93***
Leverage
0.46
0.48
0.43
-0.02
0.03
0.05**
ROA
0.03
0.03
0.04
0.00
-0.01*
-0.01*
Variable
SIZE (million)
ROE
0.08
0.09
0.10
-0.01
-0.02*
-0.01
Accruals
-0.02
-0.02
0.00
0.00
-0.02*
-0.02*
Past_ret12
0.26
0.23
0.25
0.03
0.01
-0.02
Top1
0.39
0.36
0.37
0.02
0.01
-0.01
Institution
0.09
0.13
0.15
-0.03**
-0.06***
-0.02*
Coverage
5.90
7.29
7.32
-1.39*
-1.42*
-0.03
SOE
0.66
0.72
0.52
-0.06
0.13**
0.20***
Distress
0.17
0.11
0.09
0.06*
0.08*
0.02
Violation
0.07
0.06
0.03
0.00
0.04*
0.03*
Panel B. The means and differences-in-means of sub-sample PEP characteristics
Investor 1
(N=108)
(1)
Investor 2
(N=191)
(2)
Investor 3
(N=281)
(3)
Difference in
Means
(1) ‒ (2)
Difference in
Means
(1) ‒ (3)
Difference in
Means
(2) ‒ (3)
1863.51
1364.44
756.00
499.07***
1107.51***
608.44***
Fraction
0.42
0.30
0.25
0.12***
0.17***
0.05***
Discount
0.33
0.21
0.21
0.12***
0.12***
0.00
CAR(-3, 0) (%)
2.84
2.18
1.66
0.66*
1.18**
0.53
CAR(-3, 0)-Adj %
19.95
12.02
9.83
7.93***
10.12***
2.19
Variable
Proceeds (million)
41
Panel C. The means and differences-in-means of long-term abnormal returns following the PEP announcements
Investor 1
Variable
BHAR to non-participating
investors (0, 250)
BHAR to non-participating
investors (0, 500)
BHAR to non-participating
investors (0, 750)
BHAR to participating
Investors (0, 250)
BHAR to participating
Investors (0, 500)
BHAR to participating
Investors (0, 750)
Investor 2
Investor 3
(1)
(2)
(3)
5.59%
0.18%
2.13%
(N = 108)
(N = 191)
(N = 281)
10.37%
3.41%
5.83%
(N = 108)
(N = 173)
(N = 267)
15.60%
6.53%
9.94%
(N = 108)
(N = 138)
(N = 220)
47.74%
22.77%
21.47%
(N = 108)
(N = 191)
(N = 281)
52.40%
27.48%
25.28%
(N = 108)
(N = 173)
(N = 267)
61.14%
34.53%
30.90%
(N = 108)
(N = 138)
(N = 220)
42
Difference in Difference in Difference in
Means
Means
Means
(1) ‒ (2)
(1) ‒ (3)
(2) ‒ (3)
5.42%**
3.46%*
-1.95%
6.96%**
4.54%*
-2.42%
9.06%**
5.65%*
-3.41%
24.97%***
26.27%***
1.30%
24.92%***
27.12%***
2.20%
26.61%***
30.24%***
3.63%
Table 8. Subsample analysis according to PEP issuing objectives
The table separates the private placements sample into subsamples based on issuing objectives. We identify the
purposes for the money raised by PEPs into the follows five objective groups:
Objective 1: inter-company asset restructuring
Objective 2: whole group listings
Objective 3: assets acquisitions
Objective 4: asset injection
Objective 5: project financing.
Note that there are four other purposes (supplementing working capital, shell company restructuring, supporting
financing and introducing strategic investors); however each of objective groups has a limited number of
observations. Therefore, we drop these four PEP issuing objectives from this sample.
Panel A reports the subsample characteristics of firms before the PEPs. Panel B reports the subsample characteristics
of the private placements around the PEP announcement, and Panel C reports the long-term abnormal returns
following private placements of equity sorted by issuing objectives. The sample contains firms that issue equity
privately during the period 2006 to 2012.
Panel A. The means of sub-sample firm characteristics before the PEP announcements
Variable
SIZE (million)
Objective 1
(N = 45)
Objective 2
(N = 63)
Objective 3
(N = 52)
Objective 4
(N = 34)
Objective 5
(N = 351)
2791.10
6030.41
4537.50
3413.64
4191.06
BM
0.59
0.65
0.59
0.68
0.65
AGE
9.69
10.04
8.08
9.80
7.56
Leverage
0.40
0.50
0.44
0.43
0.45
ROA
0.01
0.02
0.04
0.01
0.04
ROE
0.06
0.08
0.09
0.06
0.10
Accruals
-0.01
-0.02
-0.03
-0.04
0.00
Past_ret12
0.32
0.25
0.26
0.27
0.24
Top1
0.33
0.38
0.41
0.38
0.37
Institution
0.13
0.12
0.14
0.08
0.14
Coverage
5.47
6.00
8.44
5.77
7.34
SOE
0.68
0.68
0.68
0.53
0.59
Distress
0.18
0.13
0.12
0.26
0.09
Violation
0.12
0.06
0.00
0.09
0.03
43
Panel B. The means of sub-sample PEP characteristics
Variable
Proceeds (million)
Objective 1
(N = 45)
Objective 2
(N = 63)
Objective 3
(N = 52)
Objective 4
(N = 34)
Objective 5
(N = 351)
1614.59
2373.67
1166.72
1705.71
778.50
Fraction
0.43
0.44
0.30
0.46
0.23
Discount
0.20
0.33
0.25
0.30
0.19
CAR(-3, 0) (%)
3.05
2.74
2.43
2.70
1.64
CAR(-3, 0)-Adj %
16.61
18.51
14.96
19.06
9.08
Panel C. The means of long-term abnormal returns following the PEP announcements
Variable
Objective 1
Objective 2
Objective 3
Objective 4
Objective 5
9.35%
4.61%
0.70%
5.34%
0.36%
investors (0, 250)
(N = 45)
(N = 63)
(N = 52)
(N = 34)
(N = 351)
BHAR to non-participating
10.62%
11.78%
7.35%
10.75%
3.68%
investors (0, 500)
(N = 42)
(N = 61)
(N = 47)
(N = 31)
(N = 335)
9.76%
17.32%
6.92%
15.41%
8.90%
investors (0, 750)
(N = 31)
(N = 54)
(N = 41)
(N = 30)
(N = 280)
BHAR to participating
40.62%
59.16%
27.89%
48.74%
15.79%
Investors (0, 250)
(N = 45)
(N = 63)
(N = 52)
(N = 34)
(N = 351)
BHAR to participating
45.53%
66.96%
35.23%
60.40%
19.12%
Investors (0, 500)
(N = 42)
(N = 61)
(N = 47)
(N = 31)
(N = 335)
BHAR to participating
47.60%
81.18%
36.87%
64.05%
26.70%
Investors (0, 750)
(N = 31)
(N = 54)
(N = 41)
(N = 30)
(N = 280)
BHAR to non-participating
BHAR to non-participating
44
Figure 1. The development of private equity placements in China
The bar shows the RMB amount (in billions) of PEPs in China by year. The line shows the percentage of private
equity placements (PEPs) RMB value accounting for total equity refinancing issuing each year. The annual summary
data of PEP amount and total equity re financing amount are available from the report from China Securities
Regulatory Commission (CSRC).
(Source: http://www.csrc.gov.cn/pub/newsite/sjtj/).
45
Figure 2. Long-term stock returns of PEP-issuing firms
The blue bars show the 3-year (750 days) BHAR (buy-and-hold abnormal stock return) to investors of the firms
issuing PEPs but did not participated in the transactions, whereas the red bars show the 3-year BHAR to investors of
the same firms but participated in the placements. The year on the horizontal axis indicates the calendar year when
PEPs were first announced.
80.0%
70.0%
60.0%
50.0%
40.0%
Returns to non‐participating investors (0, 750)
30.0%
Returns to participating investors(0, 750)
20.0%
10.0%
0.0%
2006
2007
2008
2009
2010
46
2011