Product diversification strategy, business group affiliation, and IPO underpricing: A study of Chinese firms

Abstract

Research Summary: Extant research has largely ignored if and how product diversification strategy influences IPO performance. We intend to fill this gap in the literature, especially in relation to transition economies where the role of diversification is institutionally bound. Specifically, drawing on the strategic actions and political connections arguments, we contend that the level of a firm's product diversification has a positive relationship with IPO underpricing. Given the prominent role of business groups in shaping firms’ diversification strategies in transition economy, we further examine whether business groups’ nonmarket capital—political, relational, and reputational capital—moderates the relationship between product diversification strategy and IPO underpricing. Managerial Summary: Due to the lack of transparency, investors in transition economies face higher ex ante uncertainties and have to bear more investment risks. As such, IPO firms have to “leave more money on the table” to compensate investors. This study aims to answer the question of whether and how an IPO firm's corporate strategy and business group affiliation affect investors' perceived uncertainties and, thus, the need to leave a large amount of money on the table to compensate investors. Using a sample of IPO firms in China, this study finds that the nonmarket capital that stems from business group affiliation helps mitigate the uncertainties investors perceive with higher levels of diversification, thus reducing the need for IPO firms to discount their offerings too much so that they can retain more wealth for business development.

Too much of a good thing? The nonlinear influence of noncontrolling large shareholders on corporate innovation

“…Therefore, in a firm with diversified products, controlling shareholders and executives will simultaneously make a variety of innovative decisions in response to the diverse business environments. Furthermore, as product diversification continues to increase, the degree of information asymmetry between noncontrolling large shareholders and controlling shareholders and executives will increase (Wang et al, 2019). Therefore, in firms with a high degree of product diversification, it will be very difficult for noncontrolling large shareholders to fully monitor the opportunistic behavior of controlling shareholders and executives in innovative decision-making.…”

“…In this environment, in order to better protect their own long-term interests, noncontrolling large shareholders will have stronger incentives to supervise the innovative decision-making of controlling shareholders and executives, which will make noncontrolling large shareholders' impact on corporate innovation stronger. On the other hand, as the diversification of a firm's products increases, the business activities of the firm will become extremely complex and specialized (Zhong et al, 2021b), and the degree of information asymmetry between decision makers and supervisors will increase (Wang et al, 2019). Under this circumstance, it will be much more difficult for noncontrolling large shareholders to supervise the decision-making behaviors of controlling shareholders and executives, especially innovative decision-making behaviors (Bushman et al, 2004;Zhong et al, 2021b).…”

Entrepreneurial strategies during institutional changes: Evidence from China's economic transition

“…Cocoon institutions provide temporal protection from broader institutional uncertainties, which are especially high at an intermediate phase of marketization because the new rules and the old rules are equally likely to be dominant. High institutional uncertainty tends to impede firms' growth, as resource providers are hesitant to make investments (Wang, Wan, & Yiu, 2019) and firms also wait and see what happens next. Therefore, cocoon institutions facilitate firm growth by providing a local institutional environment that facilitates organizational ambidexterity, which is a core competency during the transition period.…”

Family Involvement, Governmental Connections, and IPO Underpricing of SMEs in China

“…For example, the average underpricing for all firms listed in Chinese stock markets (including both the major board and the small and medium enterprises [SMEs] board) was more than 100% during 1990 to 2010. However, firms listed in the U.S. stock markets have averaged, over the past five decades, only a 17% IPO underpricing rate (X. A. Wang et al, 2019).…”