Going Public with Good Governance: evidence from China

• Author: Larry Li,Tony Naughton
• Published date: 01 November 2007
• Date: 01 November 2007
• DOI: http://doi.org/10.1111/j.1467-8683.2007.00640.x

Going Public with Good Governance:

evidence from China

Larry Li* and Tony Naughton

Board characteristics have not been a signif‌icant area of study in the IPO literature. We focus

on the emerging corporate governance reform in China to investigate the relationship between

a range of board characteristics and IPO initial returns and long-term performance. We f‌ind

evidence that board size is positively related to short-term returns, while in the long-term, a

positive relationship exists between performance and the voluntary post-listing separation of

the roles of CEO and Chair of the Board. Our long-term results suggest that at least some

Chinese listed f‌irms are actively and voluntarily moving toward better governance structures.

Keywords: Board characteristics, China, IPO performance

Introduction

In a company’s life cycle, an initial public

offering (IPO) typically happens atthe stage

when a single investor or a group of pro-

prietary investors can no longer satisfy its

equity demands. An IPO, therefore, represents

an important milestone in the life-cycle of

the entrepreneurial f‌irm (Certo et al., 2001).

During the stage of going public, how to deter-

mine the appropriate price for an IPO is a

diff‌icult task because of uncertainty about

the appropriate offering price and the risk

involved in underwriting issues. Structuring

the f‌irm for the IPO is an important con-

sideration in this process. In this paper, we

focus on one particular feature of the process

of preparing f‌irms for listing – the structure

and composition of the Board of Directors.

Generally speaking, IPOs are underpriced,

which means the offering price is normally

lower than the f‌irst trading day market price.

So IPO underpricing is def‌ined as the

premium subscribing investors receive at the

initial stage of market trading, being the dif-

ference between subscription price and the

f‌irst day closing price. Such an underpricing

phenomenon has been well documented, and

several theories have emerged attempting to

explain this premium (Baron, 1982; Beatty and

Ritter, 1986; Welch, 1989), however, no conclu-

sive explanation has been found so far. The

long-term performance of the IPO return is

very different from the short-term perfor-

mance. The empirical evidence from the US

and other countries indicates that IPOs under-

perform in the long-term relative to the overall

market (Ritter, 1991; Levis, 1993; Aggarwal

et al., 1993). Although many papers identify

variables that explain the extent of under-

pricing, very few studies deal with the func-

tion of corporate governance.

One of the most signif‌icant governance

issues is the structure of the Board of Direc-

tors. Board size, director independence and

board leadership structure have dominated the

discussion of board design and are treated as

important determinatesof the ability of boards

to protect investors’ interests (Fama and

Jensen, 1983). Typically, empirical researchers

argue that f‌irms with certain board features,

such as more outside directors, and dual lead-

ership structure, will perform better than their

counterparts. However, the empirical results

of previous studies testing the relationship

between f‌irm performance and the functions

of board characteristics are mixed.

The present study examines board structure

at the time of an IPO and the changes in board

structure that occur in Chinese listed com-

panies as they progress from IPO status to

become more well-established f‌irms. China is

*Address for correspondence:

School of Economics, Finance

and Marketing, RMIT Univer-

sity, Victoria 3000, Australia.

E-mail: larry.li@rmit.edu.au

1190 CORPORATE GOVERNANCE

Volume 15 Number 6 November 2007

© 2007 TheAuthors

Journal compilation © 2007 BlackwellPublishing Ltd, 9600 Garsington Road,

Oxford, OX4 2DQ, UK and 350 Main St,Malden, MA, 02148, USA