Entrepreneurial finance meets government investment at initial public offering: The role of minority state ownership

• Published date: 01 March 2018
• Date: 01 March 2018
• Author: Tang Wang,Zhijian Xu,Hao Jiao,Xiaoming Yang
• DOI: http://doi.org/10.1111/corg.12227

EMPIRICAL

Entrepreneurial finance meets government investment at initial

public offering: The role of minority state ownership

Tang Wang

1

|Hao Jiao

2

|Zhijian Xu

3

|Xiaoming Yang

4

1

Department of Management, College of

Business Administration, University of Central

Florida, BA1‐341, 12744 Pegasus Drive,

Orlando, FL 32826, USA

2

School of Business and Economics, Beijing

Normal University, 19 Xinjiekou Road, Beijing,

China

3

School of Business, Nanjing University, 22

Hankou Road, Nanjing, China

4

Center for Innovation, Entrepreneurship &

Franchising, College of Business

Administration, University of Nebraska

Omaha, 6708 Pine Street Omaha, Nebraska

68182, USA

Correspondence

Hao Jiao, School of Business, Beijing Normal

University, 19 Xinjiekou Road, Beiing, China

Email: haojiao@bnu.edu.cn

Funding information

National Natural Science Foundation of China,

Grant/Award Number: 71773115 and

71572017

Abstract

Manuscript Type: Empirical

Research Question/Issue: Prior studies on the role of state investment tend to focus on

either majority state ownership or aggregating majority and minority state ownership. Drawing

upon signaling theory, we theorize that the negative intent signaled by minority state ownership

reduces initial public offering (IPO) market performance. In addition, we hypothesize that foun-

ders as chief executive officers and outside directors not from state‐owned enterprises,

representing the positive signal of intent, can attenuate the negative effect of minority state

ownership.

Research Findings/Insights: The empirical results, based on 274 small and private firms in

China's newly launched stock market, provide support for the hypotheses based on price pre-

mium, first‐day turnover rate, first‐day price increase, underpricing, and Tobin's Q.

Theoretical/Academic Implications: To the best of our knowledge, this is the first study to

examine how minority state ownership affects small and private firm IPO performance. It sug-

gests new avenues of research on ownership structure and the principal‐principal problem in

the corporate governance of emerging economies. This study reveals the distinctive nature and

effect between controlling state ownership and minority state ownership. The current research

also opens new avenues of research on applying signaling theory, signal of intent in particular,

in an IPO study.

Practitioner/Policy Implications: This study reveals the negative intent signaled by minor-

ity state ownership in privately controlled firms at IPO due to the weak monitoring capacity, lim-

ited resource provision, and enhanced political interdependency between private controllers and

minority state owners. As minority state ownership becomes a more salient phenomenon in

emerging markets, it guides policy makers in governance choices for government‐funded firms.

KEYWORDS

Corporate Governance, board of director, CEO, Initial public offering, New venture, state

ownership

1|INTRODUCTION

In recent years, the government or state around emerging markets

started to invest in private firms through a variety of vehicles such as

venture capital (Colombo, Cumming, & Vismara, 2016), development

banks (Inoue, Lazzarini, & Musacchio, 2013), pension funds (Coronado,

Engen, & Knight, 2003), or sovereign wealth funds (Bremmer, 2010).

Such investments tend to pursue not only financial return but also

significant social payoffs or localized public benefits (e.g., job creation

or economic growth in a specific region or sector). Such state‐backed

investments into private firms also aim to create industrial policies to

foster entrepreneurial development. For instance, China launched

Small and Medium Enterprise (SME) and Growth Enterprise Market

(GEM) boards on the stock exchange to not only encourage small

and private firms to raise money from the public equity market but also

to fuel state investment funds into those ventures from the earliest

Received: 3 October 2016 Revised: 14 September 2017 Accepted: 15 September 2017

DOI: 10.1111/corg.12227

Corp Govern Int Rev. 2018;26:97–117. © 2018 John Wiley & Sons Ltdwileyonlinelibrary.com/journal/corg 97

stage all the way to initial public offering (IPO) (Ding, Nowak, & Zhang,

2010). Brazil, on the other hand, authorized the Brazilian National

Development Bank (BNDES) to provide loans and equity to private

and public firms and, therefore, gained control by serving as a minority

shareholder (Inoue et al., 2013). A major consequence of such invest-

ment is the phenomenon we term as “minority state ownership”.

To what extent does minority state ownership impact firm perfor-

mance? Our study explores this question in a context of private, entre-

preneurial firm IPOs. IPOs represent a major milestone and

transformation event for entrepreneurial firms. IPOs offer a unique set-

ting to test the effect of minority state ownershipin which investor con-

fidence is determined by the signals that characterize the intention of

minority state owners at and after IPO (Certo, Holcomb, & Holmes,

2009). The focus on minority state ownership in the IPO context

addresses the following two literature gaps. First, the extant literature

on state ownership and IPO performance either treats state ownership

as the majority owner like state‐owned enterprises (SOEs) (Chen,

Cumming, Hou, & Lee, 2016; Fan, Wong, & Zhang, 2007b, 2014) or

makes no distinction between majority and minority state ownership

(Wang, 2005). While scholars have started to pay attention to various

forms of minority state ownership, these studies have not systemati-

cally considered its impact on IPO outcome. For example, Colombo

et al. (2016) studied government as venture capitalists(VCs) (i.e., minor-

ity owner) to foster the development of the venture capital industry and

to narrow the equity capital gap of innovative startups. The only study

that explicitly addresses minority state ownership is by Inoue et al.

(2013) using a Brazilian sample and not in the IPO context. We believe

that distinguishing minority state ownership from majority state owner-

ship is both necessary and important in corporate governance research

because different roles of state ownership (majority vs. minority) could

have a differential effect on firms' IPO performance. Unlike SOEs with

majority state control and selection rights of firm's CEO and chairman

(Fan et al., 2007b, 2014; Liang, Ren, & Sun, 2015; Shen & Lin, 2009;

You & Du, 2012), the minority state owners only possess limited and

weak governance capability while the private owners maintain primary

control of the firm. As a result, the minority state owner can only pro-

vide limited resources such as funding, information, advice, and so on.

Moreover, the political background of minority state ownership and

the real control of the private owner can create political interdepen-

dence. In such a relationship, private owners may rely on state owners

for political networks and favorable regulations. At the same time,

minority state owners may also count on private owners to realize the

social payoffs or localized public benefits such as charitable donations

and job creation. Therefore, the governance structure of firms with

minority state ownership could have a very different effect on firms'

IPO performances compared to firms with majority state ownership.

The second literature gap resides in IPO research itself. Prior

research has looked into how signals, in particular signals of quality,

released by IPO firms might impact IPO firm performance (Chahine &

Tohmé, 2009; Chancharat, Krishnamurti, & Tian, 2012; Li & Naughton,

2007). That is, investor confidence toward a company at IPO can be

affected by signals reflecting the quality of the focal company and man-

agement team, such as the characteristics of founders (Nelson, 2003),

board of directors (Certo, 2003), and external partners (Ragozzino &

Reuer, 2011). The signal of intent, on the other hand, has not been

applied in the context of IPO on CEOs (Fischer & Pollock, 2004),

despite its application in other contexts such as CEO succession and

alliance literature (Balboa & Marti, 2007; Connelly, Certo, Ireland, &

Reutzel, 2011; Gomulya & Boeker, 2014; Park & Mezias, 2005). There-

fore, we believe that investor confidence can also be shaped by a signal

of intent released by the IPO firm's ownership structure. In particular,

the intention of minority state owners may not align with private

shareholders' objectives on profitability and efficiency, which result in

weak resource provision and managerial control documented as princi-

pal‐principal conflicts. In addition, the discrepancy of intention and sub-

sequent principal‐principal conflicts between state and private owners

also gives investors the impression that the private owners have to

spend more time and energy on maintaining political ties with the gov-

ernment (Li, Meng, Wang, & Zhou, 2008; Sun, Mellahi, & Wright, 2012)

and eventually lose their business mindsets and acumen. We therefore

theorize that the negative intent signaled by minority state ownership

reduces investor confidence and IPO market performance. In addition,

we hypothesize that founders as CEOs (founder‐CEOs hereafter) and

outside directors not from state‐owned enterprises (non‐SOE outside

directors hereafter), representing the positive signal of intent aligning

with other shareholders, can attenuate the negative effect of minority

state ownership on investor confidence and IPO market performance.

Drawing on the theoryof signaling of intent, this research examines

the effect of minority state ownershipon investor confidence and mar-

ket performance among 274 small and private firms in China's newly

launched stock market. First, we find that minority state ownership

reduces the IPO market performance, ranging from price premium,

first‐day turnover rate, first‐day price increase, to Tobin's Q. Interest-

ingly, minority stateownership does not affect underpricing due to the

opposing effect between excessive demand and negative signaling

intent associated with stateownership. In addition, we find that foun-

der‐CEOs can attenuate the negative impact of minority state owner-

ship only on price premium, underpricing, and Tobin's Q. The analyses

also show that non‐SOE outside directors can mitigate the negative

effect of minority state ownershipon price premium, first‐day turnover

rate, first‐dayprice increase, underpricing,and Tobin's Q. The study con-

tributesto the corporation governance literaturein two important ways.

First, to the best of our knowledge,it is the first study to examine how

minoritystate ownership affects small and privatefirm IPO performance

from the principal‐principalconflict viewpoint. Second, complementing

other IPO studies focusing on signal of quality,we look alternatively at

the signal of intent by minority state ownership, founder‐CEOs, and

non‐SOE outside directors. Overall, this research sheds more light on

the role and influenceby minority state ownership in emerging markets.

2|THEORY AND HYPOTHESES

2.1 |Signaling theory in IPO

Entrepreneurship scholars have long considered IPO as an attractive

context for studying investors' reactions to various signals (Certo

et al., 2009). High levels of information asymmetry between insiders

and external investors characterize the IPO process, which increases

uncertainty, complicates the valuation of firms entering the public mar-

ket for the first time, and leads to a discount on the offer price. Firms

98 EMPIRICAL