Received: 12 September 2020 Revised: 6 December 2020 Accepted: 5 March 2021

DOI: 10.1002/pa.2676

ACADEMIC PAPER

Institutional quality and initial public offering underpricing:

Evidence from Hong Kong

Haitian Wei1 | Rasidah Mohd-Rashid1 | Waqas Mehmood1 |

Ahmad Hakimi Tajuddin2

1
School of Economics, Finance and Banking,
Universiti Utara Malaysia, Sintok, Kedah, The main objective of this research is to investigate the impact of institutional quality
Malaysia
on the underpricing of IPOs in Hong Kong. Besides, ordinary least squares presented
2
School of Accounting & Finance, Taylor
University, Subang Jaya, Malaysia in the study used quantile regression as a robust technique to investigate the associa-
tion of institutional quality and the underpricing level of 986 IPO from January 2000
Correspondence
Waqas Mehmood, School of Economics, to December 2017 in the Hong Kong stock market. Through research findings, it is
Finance and Banking, Universiti Utara asserted that voice and accountability, regulatory quality, control of corruption and
Malaysia, 06010, Sintok, Kedah, Malaysia.
Email: [email protected] firm size are significantly negatively correlated. Whereas, government effectiveness
and rule of law are significantly positively correlated in influencing the underpricing
of IPO in Hong Kong. Findings are consistent with the quantile regression analysis.
The research is beneficial to the main participants of the market, such as investors,
issuers and regulators.

KEYWORDS
Hong Kong, information asymmetry, institutional quality, IPO, underpricing

1 | I N T RO DU CT I O N average underpricing rate of IPOs in Hong Kong is over 15%, far

below those emerging equity markets, but close to developed equity
Underpricing of initial public offerings (IPOs) has been a common phe- markets (Chong et al., 2010; Deng et al., 2010; Lowry et al., 2017)
nomenon in global markets. However, there are different level of highlighted that basic IPO underpricing patterns mostly are related to
underpricing within emerging markets and developing markets. The ini- the theory of information asymmetry. In better-developed markets
tial performance of new offering from companies from less developed with lower information asymmetry, the companies have less under-
nations or developing nations always surpass those from developed- pricing (Huang et al., 2019). A good institutional quality probably is
market companies (Boulton et al., 2011; Loughran et al., 1994; Song & the reason for the relatively low underpricing level in Hong Kong
Lee, 2012). In emerging countries, underpricing of newly listed compa- stock exchange. The high intensity of voice and accountability, regula-
nies in target countries is from 13.6 to 388%, and in developed markets tory quality and control of corruption can increase information trans-
between 4.2% and 54.4% (Ritter, 2003). As one of the most developed parency and lower uncertainties in the equity market (Wang &
markets, H-shares had more than 2100 listed companies with over HK Jiang, 2019). Autore et al. (2014) found that institutional quality is
$34 trillion in 2017. As shown in Figure 1, listed companies market strongly associated with underpricing of IPO in developed markets,
value to GDP increased from 131% in 1986 to 1053% in 2018. The including H-shares, but a nearly absent relationship in emerging mar-
development of the equity market has become increasingly important kets. Autore et al. (2014) also proposed that political stability, govern-
in Hong Kong. ment efficiency, regulatory burden and corruption control can
Many equity investors have the preference of underpricing of positively affect the underpricing. However, other researchers argue
new offerings because underpricing is a channel as a compensation that there is an unrelated or inversely related association on the qual-
for the risks faced by uninformed investors due to poor transaction ity of institutional and IPO underpricing. If institutions of great quality
information, and underpricing is a signal that issuing companies can reduce investors' alarm by reducing ex-ante uncertainty, institu-
convey their valuable information to the public or institutions. The tional quality may likely associate with IPO underpricing (Engelen &

J Public Affairs. 2021;e2676. wileyonlinelibrary.com/journal/pa © 2021 John Wiley & Sons, Ltd 1 of 12
https://doi.org/10.1002/pa.2676
2 of 12 WEI ET AL.

1400
1200
1000
800
600
400
200
0
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
F I G U R E 1 Market capitalisation of listed domestic companies (% of GDP).
Source: World bank

Van Essen, 2010). Based on the mutually exclusive points of view, precaution against the impact of institutional quality on underpricing
there is no empirical evidence to support the relationship between of IPOs. As a result, this study investigates the influence determinants
the governance index and the underpricing specifically in the Hong of IPO underpricing on the Hong Kong market. By doing so, this anal-
Kong market. Similarly, the results of the overall data of the developed ysis tends to fill the void in IPO research by meeting the following
markets cannot explain the specific characteristics of the single mar- objective:
ket due to the unique regulation of certain developed markets. Fur-
ther, there is insufficient evidence that the interpretations of global • Identify the foremost factors such as, voice and accountability,
IPO underpricing can interpret the underpricing of IPO in H-shares political stability, government effectiveness, regulatory quality, rule
(Chong et al., 2010). Also, it lacks insufficient evidence to interpret of law and control of corruption that affect IPO underpricing in
the specific relation of dimensions of institutional quality with the Hong Kong.
level underpricing of H-shares. Hence, in this paper, we continue to
discuss the determinants, including institutional quality, on the level In the following parts, the second section discusses the literature
underpricing of IPO in H-shares. review and hypotheses development. The third section presents the
In the IPO market, institutional quality information is essential in data and methodology. The fourth section exhibits data analysis and
influencing market sentiment. The government's effectiveness reflects findings. In the last section, conclusion, implication, limitation and
the country's good performance in regulating policy, the rule of law future study will be interpreted.
and better control of corruption, which is beneficial to current
research on the impact of IPO investment. Low government efficiency
leads to information asymmetry, leading to uncertainty. Investors tend 2 | LI T E RA T U R E RE V I E W A N D
to invest in effective markets with high transparency and low informa- HY P O T H E S E S D EV E L O P M EN T
tion asymmetry. Weaker information transparency can cause more
ex-ante uncertainty, hence pushing up IPO underpricing (Beatty & This section discusses the fundamental theory used in this study
Ritter, 1986). This would affect the investors' final decision. There- namely the information asymmetry theory which proposes that high
fore, information reflecting investor sentiment is crucial to investors' IPO underpricing are driven by poor information transparency. Infor-
decision-making. Autore et al. (2014) have suggested the positive mation asymmetry occurs between the pre-IPO owners and new
association of control of corruption with firm-level IPO underpricing investors (Carter & Manaster, 1990; Leland & Pyle, 1977). Company
in developed markets. Thus, strong ability to control corruption will information is mostly held by company insiders including pre-IPO
help increase the stock market performance and reduce underpricing owners. Meanwhile, new external investors have restricted access to
level, as well as reissuing firms must have suitable tactics to encounter company information which only the pre-IPO owners can provide.
country-level governance quality. Issuing firms can list their compa- Although the companies are legally required to disclose relevant infor-
nies in countries which have higher and better in institutional quality mation in the form of accessible prospectuses, pre-IPO owners can
to affirm their sustainability in the market. still potentially provide misrepresented information (Riley, 1979;
Regulators are government agencies which the statutory bodies Spence, 1976). Consequently, investors will reject the presented
and regulatory commissions that are responsible for generating, information and look for other indications of the company's actual
retaining, and enforcing regulatory and sound policies. The positive value (Downes & Heinkel, 1982; Spence, 1976). Uncertainties and
association of regulatory quality with IPO underpricing in developed risks will emerge in financial transactions when one party has less
markets has been proven (Autore et al., 2014). Better regulatory qual- information than the other. Information asymmetry is more prevalent
ity tends to increase the underpricing. Regulatory authorities should with IPOs as the presented prospectuses are the sole source of infor-
pay more attention and has the policy related to individual, business mation for the investors and underwriters. Smaller and newer compa-
entity, interest and professional organisation to take the preventive nies have limited or no trail of public disclosures. Information
WEI ET AL. 3 of 12

asymmetry is also affected by disclosure requirements which are companies. However, less evidence shows that voice and accountability
determined by the security laws of a country. As such, poor institu- significantly affect stock performance (Shaghaghi et al., 2019). Likewise,
tional quality disclosure can lead to market information failures which Hearn (2012) describes negative significant association among voice and
can ultimately decrease information transparency. accountability and IPO underpricing. In terms of emerging markets,
As such the institutional factors are important in the development of Ajide (2014) found that the voice and accountability negative affect the
economy and finance and require policymakers to establish reforms to stock prices in Nigeria market. Boadi and Amegbe (2017) also reveal that
deal with uncertainty (Cherif & Gazdar, 2010). In the case of emerging voice and accountability significantly affect stock market performance by
markets, maintaining political stability, regulating and implementing the analysing 23 markets from emerging countries and developed countries.
law, and managing quality of bureaucracy is vital for the performance of Hence, it hypothesis that;
the capital market (Yartey, 2010). Papaioannou (2009) applied similar
institutional quality indicators to examine the role of an institutional Hypothesis H1. Voice and accountability have a negative influence
factor in international capital mobilisation, demonstrates that well- on IPO underpricing.
functioning institutions are vital and a dynamic force of international
bank flows. Shaghaghi et al. (2019) interpreted that government can
improve the development of the capital market by strengthening the 2.2 | Political stability and absence of violence/
institutional quality due to the positive relationship of market stock index terrorism
and institutional quality. Asongu (2012) determined a positive and signifi-
cant connection of institutional quality and equity market performance Political stability assesses political instability expectations of politically
on developing countries; the results have proposed that countries with motivated crime, including terrorism (Kaufmann et al., 2009).
improved institutional quality framework assure high market value, trad- Yartey (2010) asserted that the overall performance of capital market
ing volume, optimistic turnover ratio. Greater governance index has posi- depends on the political stability, quality management of bureaucra-
tive and negative aspects for companies aiming to obtain external funds cies, implementation and legal regulation. However, in countries with
through share offerings (Boulton et al., 2010). They also found that when higher uncertainty and political risks, Stulz (2005) predicted that IPO
a company is listed in a nation with sound regulations to protect inves- activities would be weaker because those listed companies could be
tors, its share price is more undervalued, and ownership is more dis- plundered by the state. Satta et al. (2017) found that IPO develop-
persed. Autore et al. (2014) established that several dimensions of ment of the host nation with a high degree of political stability was
institutional quality are significantly connected with the underpricing of more satisfactory, while the discourse power and accountability of
IPO in developed markets, while the relationship is not clear in emerging the host country insignificant influence the development of IPO. A
markets. However, some researchers have different viewpoints that study of industrialised countries, Cherif and Gazdar (2010), claimed
there may be an unrelated or inversely related relationship between insti- that political factors are critical for financial markets development. A
tutional quality and underpricing. If strong institutions may reduce the comparative analysis of the impact of political instability on the equity
fear of investors by reducing ex-ante uncertainty, the correlation may earnings of developing and developed markets shows that developed
exist between strong institutional efficiency and underpricing of IPOs markets are more likely to be affected by this risk than emerging mar-
(Engelen & Van Essen, 2010). The companies controlled by a family trust kets with higher returns on stocks. Privatisation is an important stimu-
in countries with more developed systems get more benefits over the lator of political risk that in turn brings volatility in stock market
costs, while centralised family ownership enterprises hardly need to development, in particular, more explicit effect on local markets, while
under-price of IPO to maintain control (Peng & Jiang, 2010). Country- accelerated return in emerging markets, performing a price function
level institutional quality has six dimensions; voice and accountability, (Perotti & Van Oijen, 2001). Shaghaghi et al. (2019) argue that political
political stability, government effectiveness, regulatory quality, rule of stability positively affects total stock price index, meaning that better
law and control of corruption. political stability can improve equity market performance. Countries
with greater political risk are more prone to IPO underpricing for their
financial markets. In this case, the issuers are more risk-averse than the
2.1 | Voice and accountability investors and hence underpricing can be a part of the compensation for
the country risks. The hypothesis is proposed:
Voice and accountability imply the level of involvement of people in
governmental elections, as well as freedom of speech and free media Hypothesis H2. Political stability and the absence of violence have a
(Kaufmann et al., 2009). This indicator examines whether the govern- positive influence on IPO underpricing.
ment can be held accountable for its political actions (Daude &
Stein, 2007). Asongu (2012) shows that the performance of the stock
market can be significantly associated with the quality of government. 2.3 | Government effectiveness
These outcomes of empirical evidence indicate that markets with
high-quality institutions would have equity markets with greater firm The efficiency of the government relates to the legitimacy of the
size, higher turnover ratio, larger trading and a higher number of listed government's policy commitment. A study of developing countries
4 of 12 WEI ET AL.

from the African continent signifies the positive role of government confidence in and abide by the rules of society, and in particular the
effectiveness in superior stock market performance, particularly quality of contract enforcement, and property rights.” Thus, the rule
(Hearn, 2014). Government effectiveness parameters illustrate of law shows investors' self-assurance on country regulation and rules.
impressive market capitalisation, high turnover ratio, trading volume Porta et al. (1998) advocated that in countries where weak legal system
and a large number of listed companies (Asongu, 2012). Those coun- existed can be turned into strong legal enforcement. When a country
tries where effective government policies truly implemented and effi- has strong legal enforcement can protect the investors' interest besides
cient institutional environment are available to investors guarantee an managers and potential shareholders. Further, Hope (2003) explained
improvement in stock market performance and the optimistic and that the quality of the disclosure of firm is influenced by strong enforce-
effective policies reduce transaction and agency costs, which enhance ment of a legal system that improves the investors' confidence intensity
shareholding. Autore et al. (2014) also found that government effec- in return respectively. Thus, due to the effective legal system, it is
tiveness positively associates with IPO underpricing in developed possible to protect the vulnerability of external investors.
markets. While Chong et al. (2010) argued that other markets' evi- On the other hand, countries where the rules and regulations are
dence of IPO underpricing is inadequate to assess the underpricing in stringent limits the chances for an insider to make more profits or to
H-shares. Consequently, the connection should be tested. The transfer profits from the firm to external investors. Therefore, when rules
hypothesis is proposed; and regulations are stringent reduces the uncertainty when IPOs are
going to the public. According to Engelen and Van Essen (2010), who
Hypothesis H3. There is a positive relationship between government explained that expropriation risk was higher, ex-ante uncertainty
effectiveness and IPO underpricing. increased; therefore, issuers had to offer an underprice to attract inves-
tors. When regulations and rules are implemented in a better way,
reduces the ex-ante uncertainty and respectively underpricing. The find-
2.4 | Regulatory quality ing suggested a negative association among the rule of law and under-
pricing. In contrast, Autore et al. (2014) shows a positive relationship
Regulatory effectiveness tests whether the government is capable of between the rule of law and underpricing. The hypothesis is proposed;
implementing and enforcing legislation and regulations (Kaufmann
et al., 2009). For non-U.S. companies listed in the U.S. exchange, they Hypothesis H5. Rule of law has a positive influence on IPO
have less IPO underpricing if the home country of those companies has underpricing.
more effective public law enforcement (Wang & Jiang, 2019).
Hearn (2013) found evidence that information disclosure at the comp-
any's positive association with the quality of supervision, from the per- 2.6 | Control of corruption
spectives of IPO prospectuses length. Especially after the country fixed
effect is used to consider the potential heterogeneity among sample The control of corruption reflects the public's perception of the degree
countries, the institutional quality index always has a strong correlation. of private use of public power and the level of government corruption
Supporting demonstrations of Smith Jr and Watts (1992), Hearn (2013) governance, both on a small scale and a large scale (Kaufmann
also found evidence that the company's ability of earnings positively con- et al., 2009). Bolgorian (2011) examined the corruption perception index
nects with the level of corporate information disclosure, which indicated and equity market development of 46 countries throughout 2007–2009,
that it was necessary to infer economic growth opportunities and taking firm scale and the trading value as measures of equity market
increase disclosure to alleviate litigation problems (Bloomfield, 2008). development. The research proves a strong and inverse association of
Pistor et al. (2000) studied the laws protecting shareholders and creditors corruption and equity market development. Lalountas et al. (2011) argue
and find an increasing paradigm of remarkable changes governing such that global development is a powerful tool to deal with corruption, par-
laws in transition economies, suggest strong trends towards convergence ticularly in middle and high-income countries, and seem least effective in
of statutory laws through transition economies. The degree of corporate the case of low-income countries. Love (2011) has shown that political
information asymmetry has an inverse correlation with law implement, stability and a low tendency to corruption will assist in improving the
and corporate information asymmetry in developed countries is also rela- capital market. Wang and Jiang (2019) provided evidence that those
tively low. The following hypothesis is proposed; companies from the countries with high level of corruption have
greater underpricing of IPO among the non-U.S. companies listed in
Hypothesis H4. Regulatory quality has a negative influence on IPO U.S. exchange. They explained that high corruption increased the ex-ante
underpricing. uncertainty of IPO valuation.
The research results of Chiou et al. (2010) also show that
effective legal and political environment and low level of corruption
2.5 | Rule of law can improve stock investment performance and reduce its risk. Li and
Filer (2007) agreed that increasing stock investors prefer markets with
According to the Kaufmann et al. (2009) who explained the “rule of better protection of property rights, fair and transparent legal sys-
law capturing perceptions of the extent to which agents have tems, helping increase investors' confidence. The empirical results of
WEI ET AL. 5 of 12

Low et al. (2011) suggested that the absence of corruption control Hong Kong market. The data utilised were extracted from Bloomberg,
can increase equity returns after risk adjustment. Corruption can DataStream and worldwide governance indicators. The only dependent
lower investors' confidence in the stock market and regulators of trad- variable in the study is underpricing (initial return). Underpricing is the
ing rules. It also increases investors' risk level. Song and Tang (2015) percentage difference between the closing price on the first day of
established that market sentiment is inversely associated with IPO public listing and the offer price (Mehmood et al., 2020a; Mehmood
underpricing. The hypothesis is proposed et al., 2020b). When the offer price is below to closing price on the
first listing day, the stock is considered underpriced. To analyse IPOs
Hypothesis H6. Control of corruption has a negative influence on underpricing, this study used formula in the following:
IPO underpricing.
Pit −Pit− 1
Initial return ðRit Þ = ð1Þ
Pit− 1

2.6.1 | IPO setting in the Hong Kong market Further, the independent variables are six aspects of institutional quality,
including voice and accountability, political stability and violence, govern-
A number of regulatory changes have occurred in the Hong Kong IPO ment effectiveness, regulatory quality, and control of corruption. While,
market over the last several decades. At the beginning of the 1990s, the institutional quality (political stability and violence, regulatory quality, and
majority of IPOs were carried out through fixed-price offerings. After the control of corruption) is measured by the percentile rank that indicates the
first H-share listing in July 1993, hybrid equity offerings involving Hong country's rank among all countries covered by the aggregate indicator,
Kong subscriptions for retail investors and international investment for with 0 corresponds to lowest rank, and 100 to highest rank (Kaufmann
both domestic and foreign institutional investors became widespread. et al., 2009). While government effectiveness is measure by the estimate
Previously, the issuers and the underwriters decided on subscription and that gives the country's score on the aggregate indicator, in units of stan-
allocations. However, in view of the substantial decline in shares allo- dard normal distribution, that is, ranging from approximately −2.5 to 2.5
cated to the subscription tranche in 1994 and 1995 (SEHK, 1997), (Kaufmann et al., 2009).
amendments were made to the SEHK listing requirements on 26 June Lastly, firm size is used as control variable in this study. The firm size
1998 to ensure that at least 10% of the IPO shares are allocated to retail which is a market capitalization computed as the total number of shares
investors and that a compulsory claw-back provision is made for over- issued multiply be offer price (Ong et al., 2020a). The higher the issue
1
subscribed issues. As far as the claw-back provision is concerned, under- size is, the lower the underpricing, and vice versa (Alanazi & Al-
writers must allocate 30 per cent of the issue to retail investors if the Zoubi, 2015; Chi & Padgett, 2005; Samarakoon, 2010). Mohd-Rashid
subscription demand is about 15 to 50 times the initial allocation, 40% if et al. (2018) and Yung and Zender (2010) asserted that firm size is the
it is about 50 to 100 times, and 50% if it is N100 times. Hong Kong most suitable proxy to describe information asymmetry, as such, the
underwriters still hold the main responsibility in determining the alloca- large firms shows lower uncertainty as compared to smaller, which there
tion method for oversubscribed issues. Oversubscribed subscription by influence final IPO offer price. Due to the informed investor's partici-
shares are normally allocated by ballot, down-scaling or a mixture of pation, the existence of information asymmetry is confirmed, which gives
both.2 Under the balloting method, there is a high likelihood that the strong signals of the firm's prospects and growth. Usually, informed
reception of an allocation is lower than unity as the IPO shares are allot- investors are institutional investors have detailed firms information that
ted to fewer applicants via random selection. Under the down-scaling tends to provide quality signals to uninformed investors (Chowdhry &
method, all the investors will be allotted shares albeit each will only Sherman, 1996). In line, information asymmetry is higher in developing
receive a portion of the overall shares applied. countries as compared to developed. The preceding literature shows a
negative relationship among firm size and underpricing of IPO
 ska, 2012; Marisetty & Subrahmanyam, 2010).
(Jewartowski & Lizin
3 | D A T A A N D M E T H O D O LO G Y The cross-sectional regression model for analysing the connection
of six dimensions on governance indicators and IPO underpricing is as
In this section, data source, sample and variables used are explained. This shown in the following.
study incorporated 986 listed IPOs in the Hong Kong market from
January 2000 to December 2017 to explain underpricing phenomena. UND = a + β1 VAi + β2 PAi + β3 GEi + β4 RQi + β5 RLi + β6 CCi + β7 FSi + εi
The present study chosen data from January 2000 as the beginning spe- ð2Þ
cifically to avoid the effect of the Asian Financial crisis period in the

1
More details are available in the SEHK consultation paper (1997). In 1994, the average
subscription size was 31% of the total issue size, in comparison to 12.5% when the claw-back
3.1 | Robust equation
effect is disregarded and 18.75% when the maximum claw-back effect is taken into account
in 1995.
2 The present work proposed to investigate the model efficiency using
Further descriptions of these methods can be derived from McGuinness (1993) and Vong
and Trigueiros (2009). the quantile regression analysis. As such, the quantile regression
6 of 12 WEI ET AL.

analysis is used to determine the more comprehensive picture of pre- computed by percentile rank, while government effectiveness is com-
dictor variable effects. Therefore, present work used specific quantile puted by estimates. The highest value of voice and accountability is
such as 50th, 75th, 90th to explain the predictor variable relationship 69.9531 and the lowest value is 51.7413 that show relatively lower
because specific percentiles parameter estimates the changes by a percentile rank level; while the mean value is 60.364. The mean
unit change in the predictor variable. (median) of political stability is 82.4607 (79.8942) and a maximum of
95.6311 and minimum of 72.3810, meaning the relatively high fluctu-
yi = xi β0 + εθi with Quantðyi , xi Þ = xi β0 ð3Þ ation. Government effectiveness is the only independent variable
using an estimate. The average mean value is 1.6777 and the median
Q0:50 UNDi = β0:50,1 VAi + β0:50,2 PSi + β0:50,3 GEi + β0:50,4 RQi + β0:50,5 RLi is 1.7459. The maximum level of government effectiveness is 1.9146
+ β0:50,6 CCi + β7 FSi + εi while the minimum is 1.3263. The mean of regulatory quality is
ð4Þ 98.6815 and the median is 99.5192. The highest and lowest degree
of control of corruption is 94.7619 and 86.2944, respectively. The
Q0:75 UNDi = β0:75,1 VAi + β0:75,2 PSi + β0:75,3 GEi + β0:75,4 RQi + β0:75,5 RLi rule of law mean value is 88.89 with the maximum and minimum
+ β0:75,6 CCi + β7 FSi + εi range of 95.19, 74.75 respectively. The control of corruption's mean
ð5Þ of 91.8737 and median of 92.3077 is relatively close. Compared with
the percentile rank of the other four institutional quality index, regula-
Q0:90 UNDi = β0:90,1 VAi + β0:90,2 PSi + β0:90,3 GEi + β0:90,4 RQi tory quality keeps comparatively stable and has a small gap of the
ð6Þ
+ β0:90,5 RLi + β0:90,6 CCi + β7 FSi + εi largest value of 100 and the lowest value of 95.9184. Further, Table 1
also offers a statistical description of the control variable, namely the
firm size. The mean value of market capitalization in Hong Kong stock
exchange is HK$700.7583 million and its median value is HK$100
million. During 2000 until 2017, the firm size of offerings fluctuated
4 | DATA ANALYSIS AND FINDINGS at the range from the highest value of HK$24126.6 million to the low-
est value of HK$0.0019 million.
4.1 | Descriptive statistic

Table 1 demonstrates the descriptive statistic that concludes the 4.2 | Pearson correlation
entire data of samples. As shown in Table 1, the average underpricing
level is 64.82% and the median is 0.0566. The maximum and minimum The coefficients of correlation on the variables are shown in Table 2.
underpricing are from −0.95 to 21 with a standard deviation of Correlation coefficients are used in statistics to test the connection of
2.3011 during 2000 and 2017. This indicates the existing of the huge two variables and their range is from +1 to −1. The result stated that
gap of underpricing of newly listed firms of Hong Kong stock voice and accountability, government effectiveness, regulatory qual-
exchange. ity, rule of law and control of corruption are positively correlated
The statistical description of voice and accountability, political whereas, political stability and firm size is negatively correlated with
stability, regulatory quality, rule of law and control of corruption underpricing of IPO. Maddala and Lahiri (1992) explained that

TABLE 1 Descriptive statistics

Mean Median Max Min SD
UND (percentage) 0.6482 0.0566 21.0000 −0.9500 2.3011
VA (percentile) 60.3640 60.5911 69.9531 51.7413 5.4430
PS (percentile) 82.4607 79.8942 95.6311 72.3810 6.6546
GE (estimate) 1.6777 1.7459 1.9146 1.3263 0.2163
RQ (percentile) 98.6815 99.5192 100.0000 95.9184 1.6584
RL (percentile) 88.8940 90.9953 95.1923 74.7525 6.6519
CC (percentile) 91.8737 92.3077 94.7619 86.2944 2.6447
FS 700 100 24,126 0.0019 2175

Note: Underpricing refers to the percentage change between the closing price on the first day of public
listing and the offer price. Voice and accountability, (VA) percentile rank that shows 0 lowest to 100
highest. Political stability, (PS) percentile rank that shows 0 lowest to 100 highest. Government
effectiveness, (GE) shows estimate value between −2.5 and 2.5. Regulatory quality, (RQ) percentile rank
that shows 0 lowest to 100 highest. Rule of law, (RL) percentile rank that shows 0 lowest to 100 highest.
Control of corruption, (CC) percentile rank that shows 0 lowest to 100 highest. Firm size, (FS) refers to
the total value of a company's stock within the stock market.
WEI ET AL. 7 of 12

TABLE 2 Correlation matrix

1 2 3 4 5 6 7
VA 0.0512 1
PS −0.0614 0.3798 1
GE 0.1798 0.6827 0.2306 1
RQ 0.1039 0.7028 0.3657 0.7107 1
RL 0.1489 0.5848 0.2149 0.6825 0.6544 1
CC 0.0138 0.6488 0.3170 0.6214 0.6367 0.6993 1
FS −0.0743 0.1118 0.1173 0.0777 0.0461 0.0780 0.1338

Note: Underpricing refers to the percentage change between the closing price on the first day of public
listing and the offer price. Voice and accountability, (VA) percentile rank that shows 0 lowest to 100
highest. Political stability, (PS) percentile rank that shows 0 lowest to 100 highest. Government
effectiveness, (GE) shows estimate value between −2.5 and 2.5. Regulatory quality, (RQ) percentile rank
that shows 0 lowest to 100 highest. Rule of law, (RL) percentile rank that shows 0 lowest to 100 highest.
Control of corruption, (CC) percentile rank that shows 0 lowest to 100 highest. Firm size, (FS) refers to
the total value of a company's stock within the stock market.

T A B L E 3 Results of regression of
Variable Expected sign Coefficient SE t-statistic Prob.
IPO underpricing on selected variables,
2000–2017 C 52.799 10.1889 5.182 0.0000
VA Negative −0.0265 0.0159 −1.6623 0.0968*
PS positive 0.0108 0.0152 0.7119 0.4767
GE Positive 2.7723 0.5442 5.094 0.0000***
RQ Negative −0.2909 0.0881 −3.301 0.0010***
RL Positive 0.2323 0.0348 6.6713 0.0000***
CC Negative −0.5225 0.0755 −6.9192 0.0000***
FS Negative −0.0001 0.0002 −3.894 0.0001***
R-squared 0.1157
Adjusted R-squared 0.1093
Durbin-Watson stat 1.3373

Note: Asterisks ***, **, * indicate significance at 1%, 5%, and 10%. Underpricing refers to the percentage
change between the closing price on the first day of public listing and the offer price. Voice and
accountability, (VA) percentile rank that shows 0 lowest to 100 highest. Political stability, (PS) percentile
rank that shows 0 lowest to 100 highest. Government effectiveness, (GE) shows estimate value between
−2.5 and 2.5. Regulatory quality, (RQ) percentile rank that shows 0 lowest to 100 highest. Rule of law,
(RL) percentile rank that shows 0 lowest to 100 highest. Control of corruption, (CC) percentile rank that
shows 0 lowest to 100 highest. Firm size, (FS) refers to the total value of a company's stock within the
stock market.

independent and dependent variable effects can change where a (Hearn, 2012). The result indicates that lower development in voice
strong correlation exists. and accountability are tied to raise higher information asymmetric
level, which thereby increases IPO underpricing. This result is also tied
with information asymmetry theory that asserted that lower develop-
4.3 | Regression analysis ment in voice and accountability presents lower information transpar-
ency, results in higher underpricing. The results also show the
To verify the hypotheses towards the connection of institutional qual- significant positive relationship between government effectiveness
ity with an underpricing level of IPO, the cross-sectional ordinary least and IPO underpricing at 1% of significant degree. The stock market
square (OLS) is discussed in this section. As regression outcomes are would have better performance and lower transaction and agency
shown in Table 3, the model produces R2 of 11.57% and adjusted R2 cost in those markets with stronger government effectiveness
of 10.93%. The adjusted R2 of 10.93% indicates that all independent (Asongu, 2012; Hooper et al., 2009). Result indicates that economic
variables tested in this study can interpret the 10.93% of the varia- growth of Hong Kong depends on the solidity and stability of govern-
tions in IPO underpricing, which is consistent with (Ong et al., 2020b). ment effectiveness. This argument is confirmed by Alam et al. (2017)
Voice and accountability have a negative significant relationship who asserted significant positive relationship among government
with IPO underpricing. This result is consistent with the findings of effectiveness and economic growth. Autore et al. (2014) also have the
8 of 12 WEI ET AL.

same findings with this study on the association of government effec- that weak control corruption will increase equity returns after risk
tiveness and IPO underpricing. adjustment. The absence of corruption control can reduce investors'
Regulatory quality tests whether the government have the ability confidence in the transaction regulation of the stock market and raise
to implement and execute laws and regulations. Regulatory quality their doubts towards reality and effectiveness of market information
has a negative connection with IPO underpricing at 1% of significant or news. Song and Tang (2015) prove that investors sentiment can
degree, implying that a stronger degree of regulatory quality, lower negatively affect IPO underpricing. Also, the market information fail-
underpricing. It is argued that a stronger level of law enforcement can ure arising from corruption issues seemed to make the information
lead to higher information asymmetry and Beatty and Ritter (1986) not transparent and unreliable. Due to the positive correlation of
prove that greater ex-ante uncertainty can promote higher under- information asymmetry level and IPO underpricing, absence of corrup-
pricing of IPO. The efficiency of the government relates to the legiti- tion control would lead to higher underpricing of IPO. With respect to
macy of the Government's policy commitment. The rule of law is the control variable, the finding is that market capitalisation has a neg-
positively significant with IPO underpricing. Porta et al. (1998) advo- ative association with the underpricing of IPO significant at 1%. This
cated that in countries where the existing weak legal system can be implied that firm size has a meaningful relationship with IPO under-
converted into strong legal enforcement. When a country has strict pricing, and market capitalisation of firms have a visible impact on
legal enforcement, it can protect the investors' interest besides man- underpricing of offerings while political stability is insignificant to
agers and potential shareholders. In line, Autore et al. (2014) have explain underpricing in Hong Kong.
shown a positive relationship between the rule of law and
underpricing.
The control of corruption measures the ability of the government 4.4 | Robustness regression
to manage corruption. The regression results indicate that it has a sig-
nificantly negative association at 1% between corruption control with The result of quantile regression analysis is presented in Table 4 to
underpricing. Countries with stronger corruption control have lower explain the association of underpricing. Angrist and Pischke (2008),
underpricing. The empirical results of Low et al. (2011) have shown advocated that due to quantile regression, dependent variable

T A B L E 4 Results of quantile
50th Quantile 75th Quantile 90th Quantile
regression analysis
Variable Coefficient Prob. Coefficient Prob. Coefficient Prob.
C 3.2426 0.0002 15.9117 0.0000 67.1747 0.0000
3.7429 5.9658 9.5408
VA 0.0002 0.9205 −0.0011 0.8886 −0.0579 0.0001***
0.0999 −0.1401 −3.8643
PS −0.0010 0.4517 −0.0126 0.0315** −0.1435 0.0000***
−0.7529 −2.1539 −5.7746
GE 0.1331 0.0418** 1.0350 0.0000*** 4.6786 0.0000***
2.0386 5.2082 6.6714
RG −0.0195 0.0180*** −0.0550 0.0170*** 0.0637 0.2054
−2.3699 −2.3910 1.2671
RL 0.0106 0.0033*** 0.0658 0.0005*** 0.5090 0.0000***
2.9450 3.4823 7.8774
CC −0.0256 0.0003*** −0.1798 0.0000*** −1.1860 0.0000***
−3.6213 −4.5568 −7.7949
FS 0.0000 0.0059*** 0.0000 0.0345** 0.0000 0.4017
−2.7621 −2.1173 −0.8390
Pseudo R-square 0.0063 0.0293 0.1940

Note: Asterisks ***, **, * indicate significance at 1%, 5%, and 10%. Underpricing refers to the percentage
change between the closing price on the first day of public listing and the offer price. Voice and
accountability, (VA) percentile rank that shows 0 lowest to 100 highest. Political stability, (PS) percentile
rank that shows 0 lowest to 100 highest. Government effectiveness, (GE) shows estimate value between
−2.5 and 2.5. Regulatory quality, (RQ) percentile rank that shows 0 lowest to 100 highest. Rule of law,
(RL) percentile rank that shows 0 lowest to 100 highest. Control of corruption, (CC) percentile rank that
shows 0 lowest to 100 highest. Firm size, (FS) refers to the total value of a company's stock within the
stock market.
WEI ET AL. 9 of 12

distributional characteristics become easier and this is the reason it is manage improvement at the country-level institutional quality. Stron-
considered as a powerful tool to examine on cross-section IPO under- ger information asymmetry on account of reducing regulator quality
pricing (Andriansyah & Messinis, 2016; Mehmood et al., 2020a). level would bring more uncertainties and higher risk, further affecting
Besides, a quantile regression analysis has exclusive benefits to dem- underpricing level. Therefore, issuers should implement appropriate
onstrate the association of the independent and dependent variable strategies to follow the change of regulator quality. Likewise, lack of
with outside mean. Therefore, due to the quantile regression, it is pos- high level of government effectiveness and corruption control may
sible to generate useful details understanding of dependent and inde- reduce information transparency and affect the underpricing level at
pendent variables which have normally non-linear relationship among different degree. Higher underpricing of IPO can help issuers increase
variables. Thus, it is useful to explain; how median values influence the demand of investors because investors have the preference for
dependent variable percentile on independent variable besides using new offerings with the lower issued price and high return. The regula-
minimum, maximum and mean value. Wherein, voice and accountabil- tors should focus on building or improving an effective and efficient
ity, political stability, government effectiveness, regulatory quality, legal system in ensuring the regulation is efficient in lowering informa-
rule of law and control of corruption are the main variables and firm tion asymmetry and promoting a higher level of decision-making for
size is the only control variable in this study. Accordingly, at 90th qua- all markets participants. Regulators and other relevant government
ntile voice and accountability, political stability, control of corruption departments must realise that all disclosed information or change of
are negatively significant. Government effectiveness, regulatory qual- regulation may affect the degree of IPO underpricing and decision of
ity, and the rule of law are positively significant and firm size is not investors and issuers.
significant to explain underpricing. At 75th quantile, political stability This study did not consider the characteristics of firm age and
regulatory quality and control of corruption is negatively significant. industry, because the difference in the characteristics of the com-
While, government effectiveness, rule of law and firm size are posi- pany age and size will have a specific effect on the financial condi-
tively significant to explain IPO underpricing. Further, at 50th quantile tion of the firm, and thus affect the assessment and decision-
government effectiveness, rule of law and firm size is positively signif- investment of investors on target IPO companies. On the other
icant. Regulatory quality and control of corruption are negatively sig- hand, this study did not make a comparison for underpricing of
nificant to influence underpricing. These results are similar to the those companies simultaneously listed in A-share and H-shares and
findings of ordinary least square. Thus, based on prior model quantile hence find the difference and offer further suggestions for inves-
regression is used to determine key influencing factors of under- tors. This study's suggestion will provide important contributions to
pricing. The Pseudo R-squared of 50th, 75th, and 90th is 0.06%, 2.9%, future researchers in understanding the relation of institutional
and 19.40%. quality and the degree of underpricing of IPOs due to distinct
uniqueness in different markets, including across companies' infor-
mation asymmetry as per issuance year. In addition, the future
5 | C O N CL U S I O N study should include the Hang Seng Index because the perfor-
mance of the Hang Sang Index may affect investors sentiment on
This paper mainly investigated the relationship between governance the underpricing of IPO. As such, the study sample size is from
indicators and underpricing of IPOs through using ordinary least January 2000 to December 2017, the future studies may extend
square for the H-shares. A sample of 986 listed companies of Hong the time frame onward to 2017 to investigate the relationship
Kong from 2000 until 2017 is used for this study. The preliminary between country level institutional quality and IPO underpricing in
findings suggested 64.82% underpricing. While, results from OLS Hong Kong market. This study did not take into account firm-
advocated that voice and accountability, regulatory quality, control of specific attributes, such as business age or the nature of its indus-
corruption and firm size is negatively significant. Wherein, govern- try. This kind of firm age and industry characteristic may be impor-
ment effectiveness, rule of law, are positively significant and political tant to determine the level of underpricing. Future researches
stability is not significant to explain IPO underpricing in Hong Kong. can examine in more detail the effects and interactions of issues,
The result suggested that institutional quality increases information companies and industry characteristics on underpricing.
asymmetry among issuers and investors due to poor country-level
efficiency, thereby reducing transparency and increasing the IPOs' ACKNOWLEDG MENTS
underpricing vice versa. The authors are grateful to the anonymous referees of the journal
The outcomes of this paper are beneficial to the main participants for their extremely useful suggestions to improve the quality of
of the market, such as investors, issuers and regulators. For instance, the paper. The authors also would like to acknowledge their
the absence of effective institutional quality would cause market gratitude for funding from the Fundamental Research Grant Scheme
information failures and hence further lower the transparency of FRGS/1/2018/SS01/UUM/02/7) (S/O Code: 14203) provided by the
information. For example, investors were worried about the reality Ministry of Higher Education, Malaysia.
and accuracy of market information, thus a lower level of institutional
quality can increase IPO underpricing. Therefore, the investors should DATA AVAILABILITY STAT EMEN T
observe the ability of the Hong Kong government or regulators to The data set is available on request.
10 of 12 WEI ET AL.

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Rasidah Mohd-Rashid https://orcid.org/0000-0001-7231-2319
Downes, D. H., & Heinkel, R. (1982). Signaling and the valuation of
Waqas Mehmood https://orcid.org/0000-0002-7975-220X unseasoned new issues. The Journal of Finance, 37(1), 1–10.
Ahmad Hakimi Tajuddin https://orcid.org/0000-0002-7697-3234 Engelen, P. J., & Van Essen, M. (2010). Underpricing of IPOs: Firm-, issue-
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IPO pricing: Evidence from Malaysia. International Journal of Banking AUTHOR BIOGRAPHIES
and Finance, 15(1), 1–19.
Ong, C. Z., Mohd-Rashid, R., & Taufil-Mohd, K. N. (2020b). Underwriter
reputation and IPO valuation in an emerging market: Evidence from Haitian Wei is a Master's degree student at the School of Eco-
Malaysia. Managerial Finance, 46, 1283–1304. https://doi.org/10. nomics, Finance and Banking, Universiti Utara Malaysia (UUM).
1108/MF-11-2019-0579 His research interests are in the areas of corporate finance and
Papaioannou, E. (2009). What drives international financial flows? Politics,
investment.
institutions and other determinants. Journal of Development Economics,
88(2), 269–281.
Rasidah Mohd-Rashid is an associate professor of finance at the
Peng, M. W., & Jiang, Y. (2010). Institutions behind family ownership and
School of Economics, Finance and Banking, Universiti Utara
control in large firms. Journal of Management Studies, 47(2), 253–273.
Perotti, E. C., & Van Oijen, P. (2001). Privatization, political risk and stock Malaysia (UUM). She joined the Universiti Utara Malaysia (UUM)
market development in emerging economies. Journal of International in 2008. Her research areas are investment and corporate finance.
Money and Finance, 20(1), 43–69. She is currently the Managing Editor of the International Journal
Pistor, K., Raiser, M., & Gelfer, S. (2000). Law and finance in transition
of Banking and Finance, published by UUM publisher. She is a
economies. The Economics of Transition, 8(2), 325–368.
Porta, R. L., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. W. (1998). Law Research Fellow at the Economic and Financial Policy Institute
and finance. Journal of Political Economy, 106(6), 1113–1155. (ECoFI), Senior Associate Fellow at the Asian Research Institute
Riley, J. G. (1979). Noncooperative equilibrium and market signalling. The for Corporate Governance (ARICG) and Associate Fellow at the
American Economic Review, 69(2), 303–307.
Institute for Strategic & Sustainable Accounting Development
Ritter, J. R. (2003). Differences between European and American IPO mar-
kets. European Financial Management, 9(4), 421–434. (ISSAD). She is also a reviewer of few international refereed
Samarakoon, L. P. (2010). The short-run underpricing of initial public offer- journals including Emerging Market Finance and Trade, Interna-
ings in the Sri Lankan stock market. Journal of Multinational Financial tional Journal of Emerging Market, Journal of Financial Reporting
Management, 20(4–5), 197–213.
and Accounting and others. She has published in a number of
Satta, G., Notteboom, T., Parola, F., & Persico, L. (2017). Determinants of the
long-term performance of initial public offerings (IPOs) in the port indus- scholarly journals such as Economic Systems, Emerging Market
try. Transportation Research Part A: Policy and Practice, 103, 135–153. Review, Borsa Istanbul Review, Pacific Accounting Review, Manage-
Shaghaghi, F., PakMaram, A., & Badavarnahandi, Y. (2019). The role of rial Finance, Review of Behavioral Finance, Asian Academy of Man-
institutional quality in forecasting the total stock Price index: Case
agement of Accounting and Finance, International Journal of
study of developing and developed countries. International Journal of
Finance & Managerial Accounting, 4(14), 73–89. Economics and Management, Asian Journal of Business and Account-
Smith, C. W., Jr., & Watts, R. L. (1992). The investment opportunity set ing, Global Business Review, Journal of Islamic Accounting and Busi-
and corporate financing, dividend, and compensation policies. Journal ness Research, and others.
of Financial Economics, 32(3), 263–292.
Song, K., & Lee, Y. (2012). Long-term effects of a financial crisis: Evidence Waqas Mehmood is a PhD candidate at School of Economics,
from cash holdings of east Asian firms. Journal of Financial and Quanti- Finance and Banking, Universiti Utara Malaysia. His area of inter-
tative Analysis, 47, 617–641.
est is Corporate Finance, Investment Finance, specifically in Initial
Song, S., & Tang, S. (2015). Investor sentiment, underwriters' behaviour
and IPO pricing: Empirical analysis from off-line institutional investors' public offerings. He is also a reviewer of few international refer-
bids. China Journal of Accounting Studies, 3(4), 348–373. eed journals including Pacific Accounting Review, Global Business
Spence, M. (1976). Informational aspects of market structure: An introduc- Review, South Asian Journal of Business Studies, Journal of
tion. The Quarterly Journal of Economics, 90(4), 591–597.
Financial Economic Policy. Nankai Business Review International
Stock Exchange of Hong Kong (SEHK) (1997). Consultation paper relating
and others. He has published in a number of scholarly journals
to offer mechanism in initial public offerings. Retrieved from http://
www.sfc.hk/sfc/EN/html/speeches/public/consult/consultation/007. such as Pacific Accounting Review, Review of Behavioral Finance,
html. Global Business Review, International Journal of Business and Society
Stulz, R. M. (2005). The limits of financial globalization. the Journal of and others.
Finance, 60(4), 1595–1638.
Vong, A. P. I., & Trigueiros, D. (2009). An empirical extension of Rock's IPO Ahmad Hakimi Tajuddin is a finance and banking lecturer at the
underpricing model to three distinct groups of investors. Applied Finan-
School of Accounting and Finance, Taylor's University since
cial Economics, 19(15), 1257–1268.
March 2018. Prior to that, he served for seven years as a credit
Wang, S., & Jiang, J. (2019). Does the legal system affect the cost of exter-
nal financing? Evidence from IPO underpricing of foreign firms listed officer and treasury dealer in two financial institutions in Malaysia.
in US stock markets. International Journal of Economics and Business His research areas focus on initial public offering, Sukuk and the
Research, 18(2), 186–214. stock market. His written works have appeared in refereed
Yartey, C. A. (2010). The institutional and macroeconomic determinants of
journals such as International Journal of Islamic and Middle East-
stock market development in emerging economies. Applied Financial
Economics, 20(21), 1615–1625. ern Finance, International Journal of Economic & Management,
12 of 12 WEI ET AL.

Journal of Economic Cooperation and Development, Afro-Asian

How to cite this article: Wei H, Mohd-Rashid R, Mehmood W,
Journal of Finance and Accounting, Journal of Islamic Accounting
Tajuddin AH. Institutional quality and initial public offering
and Business Research and International Journal of Social
underpricing: Evidence from Hong Kong. J Public Affairs. 2021;
Economics.
e2676. https://doi.org/10.1002/pa.2676