Institutional Ownership and Private Equity Placements: Evidence from Chinese Listed Firms

• Date: 01 June 2019
• Author: Liping Lu,Qing He,Terence Tai Leung Chong,Dongxu Li
• DOI: http://doi.org/10.1111/irfi.12182
• Published date: 01 June 2019

Institutional Ownership and

Private Equity Placements:

Evidence from Chinese Listed

Firms*

QING HE

†

,DONGXU LI

‡

,LIPING LU

§,¶

AND TERENCE TAI LEUNG CHONG

k

†

China Financial Policy Research Center and School of Finance, Renmin University of

China, Beijing, China

‡

Department of Finance, Ohio State University, Columbus, OH

§

Department of Finance, VU University Amsterdam, Amsterdam, The Netherlands

¶

School of Business, Xiangtan University, Hunan, China and

k

Department of Economics and Lau Chor Tak Institute of Global Economics and

Finance, The Chinese University of Hong Kong, Hong Kong

ABSTRACT

This paper examines the impact of institutional ownership on the perfor-

mance of private equity placements (PEPs) for listed firms in China. We find

that the presence of institutional investors can alleviate the information

asymmetries between listed firms and the market. The market reaction to

PEP announcements is significantly smaller if there is a higher portion of

institutional shareholdings. Long-term firm operational performance after

PEPs is positively correlated with institutional shareholdings. Moreover, we

find that the relationship between institutional shareholdings and PEP per-

formance is mainly driven by nonlisted corporate investors and mutual

funds. Finally, the relationship between PEP performance and institutional

shareholdings is stronger in smaller PEP issuers.

JEL Codes: G23; G30; G32; G38; K22

Accepted: 27 December 2017

I. INTRODUCTION

Institutional shareholders are pivotal players in the capital market. According

to Hanouna et al. (2015), the value of assets managed by US mutual funds man-

agement companies increased from 4.4 to 12.7 trillion USD during 2000–2014.

* We would like to thank Julan Du for his helpful comments. This paper is supported by the MOE

Project of Key Research Institute of Humanities and Social Sciences at Universities

(No. 16JJD790056), National Natural Science Foundation of China (Nos. 71402181 and 71603225),

National Social Science Foundation of China (No. 15ZDA027), the Fundamental Research Funds for

the Central Universities, and the Research Funds of Renmin University of China (No. 13XNJ003).

© 2018 International Review of Finance Ltd. 2018

International Review of Finance, 19:2, 2019: pp. 315–346

DOI: 10.1111/irfi.12182

Institutional investors in emerging markets also expanded rapidly. During

2008–2012, the value of total assets under the management of private equity

firms and hedge funds doubled, and that of mutual funds, insurance compa-

nies, pension funds and commercial banks increased by 50% in 25 emerging

economies.

1

What is the role of institutional investors in the capital market? Do they sim-

ply exploit the information of their portfolio companies, or do they actively

participate in external corporate governance? Existing literature has shown

that institutional investors conduct progressively stronger external supervision

as their shareholdings increase (Black and Coffee 1994). Marciukaityte

et al. (2005) show that an increase in institutional ownership helps alleviate the

information asymmetries between corporate boards and outside investors. How-

ever, the role of institutional investors still remains unclear in emerging mar-

kets. As corporate ownership is highly concentrated in emerging economies,

controlling shareholders may extract private benefits at the expense of minority

shareholders (Allen et al. 2005; He et al. 2017). Institutional investors may col-

lude with controlling shareholders to expropriate corporate resources (Pound

1988), especially in emerging economies where financial and legal systems are

still underdeveloped.

In this paper, we provide new evidence on the role of institutional investors

in China for private equity placements (PEPs). PEPs are a channel through

which listed firms can raise external funds (Carey et al. 1993). Unlike public

offerings, PEPs typically involve a small group of investors with a strong capital

base. In this way, the cost of raising external capital may be reduced, for exam-

ple, a low communication cost between the firm and investors. In the mean-

while, issuing new equity to large shareholders may also help align the interests

of corporate insiders with minority shareholders. Studying PEPs provides us a

setting in which we can observe the market attitudes toward various institu-

tional investors in China. PEPs have gradually become a dominant financing

tool for listed firms since the issuance of “Measures for the Administration of the

Issuance of Securities by Listed Companies”in May 2006 by China Securities Regu-

latory Commission (CSRC). About 225 billion RMB was raised through PEPs in

2013, accounting for 80.16% of total funds raised in that year. This percentage

was much higher than the fund raised through other external financing chan-

nels such as public offerings [e.g., seasoned equity offerings (SEOs)]. Thus, an

analysis of the participation of institutional investors in the PEPs will shed light

on their roles in China’s capital markets.

China’unique setting is well-suited to examine the role of institutional

investors. First, the number of institutional investors has grown rapidly in

recent years in tandem with fast economic growth in the country. The number

of mutual funds increased from 50 in 2001 to 2048 in September 2014, and the

1 These data are from the report “Development and Regulation of Institutional Investors in

Emerging Markets”in June 2012, published by International Organization of Securities

Commissions.

© 2018 International Review of Finance Ltd. 2018316

International Review of Finance

value of net assets under the management of mutual funds increased by nearly

30 times in the same period. Second, He and Rui (2016) find that the supervi-

sion over managers and largest shareholders has become more efficient in

China recently. Investigating the role of institutional investors in China may

help us understand the incentives of capital market participants in emerging

countries. Finally, since the market-oriented reform in the financial sector in

1994,

2

more and more private and foreign institutional investors have obtained

licenses to undertake investments in the capital market. A large number of

nonstate-owned institutional investors has emerged and played an increasingly

important role in China’s capital markets. The increasing heterogeneity of insti-

tutional investors provides us with a valuable setting to investigate how share-

holder identities affect firm performance.

Using the PEP data from Shanghai and Shenzhen Stock Exchanges during

2005–2013, we find that the market reacts positively to PEP announcements on

average, but the reaction is smaller if there are higher institutional sharehold-

ings ex ante the PEP announcements. Also, institutional shareholdings ex ante

have predictive power over the issuing firm’s long-term operational perfor-

mance ex post the PEPs. Thus, we argue that institutional shareholdings could

alleviate the information asymmetries between listed firms and market inves-

tors so that the market would exhibit less over-optimism about PEP announce-

ments. In other words, without the presence of institutional investors ex ante,

the market reaction to PEP announcements would be higher. With increased

participation of the original institutional investors in the PEP, the market reac-

tion would increase significantly.

We show that institutional ownership has an impact on the market return of

PEP announcements through the signaling effect. Apart from the fact that insti-

tutional ownership has been widely used as a proxy for information asymmetry

(O’Brien and Bhushan 1990), further findings also support our argument that

signaling effect leads to the positive market reaction. First, we classify institu-

tional investors into strategic and liquidity investors following Noe (2002) and

Ferreira and Matos (2008). We find that the impact of the participation of origi-

nal institutional investors on the market reactions is greater for liquidity inves-

tors than that for strategic investors. Unlike strategic investors, liquidity

investors are normally outside parties who do not share potential business ties

with the issuer. Thus, liquidity investors are less likely to collude with the firm

and more likely to reveal the true type of the firm. As a result, the signaling

effect of liquidity investors is expected to be stronger than that of strategic

investors. Second, when the largest shareholder participates in the PEP, higher

2 In March 2015, Xiaochuan Zhou, the Governor of the People’s Bank of China, stated that

“The continued expansion of Qualified Foreign Institutional Investors (QFIIs) is an important

part of China’s current financial reform. China will expand investment quotas for the Quali-

fied Domestic Institutional Investors (QDIIs) and QFIIs.”Relevant information can be found

on the website of Xinhua News Agency, titled “China to expand quotas of QDII, QFII, Xiao-

chuan Zhou”posted on November 27, 2013 (http://en.xinhua08.com/a/20131127/1278431.

shtml).

© 2018 International Review of Finance Ltd. 2018 317

Institutional Ownership and Private Equity Placement