Who do you take to tango? Examining pairing mechanisms between underwriters and initial public offering firms in a nascent stock market

Research Summary: Previous studies on initial public offerings (IPOs) in mature stock markets have documented that high-reputation underwriters primarily work with high-quality firms and vice versa—that is, they are paired through a quality-matching mechanism. We propose that in a nascent stock market, a pricing mechanism may also play a role, through which pricing (the underwriting fee) sets the pairing. We examine these two mechanisms in the context of China's ChiNext stock exchange, which was launched in 2009 and experienced dramatic regulatory improvements in 2012–2013. With data on IPOs in 2009–2017, we find evidence to support the pricing mechanism's effect before the regulatory improvements and the quality-matching mechanism's effect after the improvements. We contribute to the literature by developing an evolutionary view on the pairing mechanisms between important capital market participants. Managerial Summary: In a mature stock market, underwriter reputation signals the underlying quality of initial public offering (IPO) firms to external investors because high-reputation underwriters primarily work with high-quality IPO firms and vice versa. We find that in a nascent stock market before the market experiences regulatory improvements, underwriters and IPO firms are paired through a pricing mechanism. That is, underwriters with higher reputation charge higher underwriting fees, and IPO firms with lower quality pay higher fees. Since the pricing mechanism rather than the quality-matching mechanism sets the pairing, underwriter reputation does not have a signaling effect. Instead, we find that higher underwriting fees signal lower quality of IPO firms. Our findings shed important insights on how market participants are paired in other nascent markets, nascent technology fields and industries.