Selection Bias and the Underwriter Certification of the Largest Shareholders in Seasoned Equity Offerings

Abstract

The largest shareholders of issuing firms in Hong Kong are eligible to underwrite rights issues and open offers. We hypothesize that the largest shareholders as underwriters who possess more information are better than investment banks in certifying firm value. Our analyses show that the largest shareholders self‐select into their preferred issuing firms, and a selection bias in the choice of underwriters arises. After controlling for firm and issue characteristics and addressing the selection bias, our findings support our hypothesis. We also find that investment banks with greater access to information through prior underwriting relationship provide better certification than investment banks without such relationship.

Clustering of percentage gross spreads and the avoidance of underwriter switching

“…How is this key finding related to the competitiveness of HK underwriting services? Based on the descriptive statistics of HK SEOs over the period of 2003–2012 provided by Lee et al. (2018), there were 226 SEOs and 135 SEOs underwritten by investment banks and the largest shareholders of issuing firms, respectively.…”

“…As our data show that there were 110 local and foreign investment banks and securities firms of varying reputations acting as underwriters over that period, this 62.60% of market share of the underwriting services is further shared and divided by them, implying low market concentration for HK SEO underwriting services. Moreover, since the largest shareholders are found to provide better underwriter certification than investment banks in HK SEOs (Lee et al. , 2018; Lee and Poon, 2018) and substantial shareholders are still highly supported by respondents of a recent public consultation to act as underwriters in pre-emptive offers (HKEX, 2018, p. 17), investment banks face stiff competition in protecting their position in the equity underwriting business.…”