۱- Introduction

۲- Literature review and hypothesis development

۳- Data and variables

۴- Empirical analysis

۵- Conclusion

References

Abstract

This paper documents an anomaly in privately-placed stock returns in China and provides an explanation based on deliberate interest transfers. Using a sample of private investments in public equity (PIPEs) with lock-up periods ending between 2007 and 2015, we find that stocks with price inversion (unlock-date price lower than the issuing price) generate higher short-term returns post lock-up period than other stocks, and the greater the degree of price inversion, the better the short-term returns. This anomaly cannot be explained by the effects of price reversal, investors’ under-reaction to companies’ prospects, or improved governance after PIPEs. Rather, it reflects the interests transferred by issuing firms to participating investors via means including aggressive earnings management and dividend increase, given the unique regulations on PIPEs in China. Interest transfer is particularly pronounced if local investors participate in a PIPE, but sound corporate governance can restrain it.

Introduction

Private investments in public equity (PIPEs) have become increasingly important compared with public offering of equity in both the US (Floros and Sapp, 2012) and China. In both countries, PIPEs are now the major method of equity refinancing for public companies. Prior research on PIPEs examines primarily market reactions to PIPEs, and finds that while the announcement effect is generally positive, the long-term returns following PIPEs are negative. The positive abnormal returns upon PIPE announcements are attributed to improved monitoring and governance brought about by PIPE-participating institutional investors (Wruck, 1989) or signaling of favorable information about PIPE-issuing firms (Hertzel and Smith, 1993). The negative long-term returns after PIPEs are attributed to investors’ over-optimism (Hertzel et al., 2002), issuing firms’ managerial entrenchment (Krishnamurthy et al., 2005; Barclay et al., 2007), or prior earnings management (Chen et al., 2010). Unlike the long-term negative returns on PIPE-issued stocks documented in the US market, using a sample of Chinese PIPE-issued stocks with lock-up periods ending between 2007 and 2015, we find that these stocks earn an average return of 16.7% in one year and 29.2% in two years after PIPEs.