Accounting Consevatism

Journal of International Accounting, Auditing and Taxation 21 (2012) 127144
Contents lists available at SciVerse ScienceDirect
Journal of International Accounting,

Auditing and Taxation
Accounting conservatism and IPO underpricing: China evidence

Z. Jun Lin , Zhimin Tian
Department of Accountancy & Law, Hong Kong Baptist University, Renfrew Road, Kowloon Tong, Kowloon, Hong Kong Special Administrative Region
a b s t r a c t
This study examines how accounting conservatism impacts underpricing of initial public offerings (IPOs) in the Chinese stock market. In
addition, we investigate how information asymmetry affects the association of accounting conservatism with IPO underpricing. Based on
regression analysis of 674 A-shares companies that went public through IPOs at both Shanghai and Shenzhen Stock Exchanges in China
during 20012009, we nd that (1) accounting conservatism is negatively associated with the magnitude of IPO underpricing; and (2)
the relationship between accounting conservatism and IPO underpricing is more pronounced when information asymmetry is high. The
ndings should shed a light on what drives IPO underpricing and how it could be affected by accounting conservatism in an emerging
economy.
2012 Elsevier Inc. All rights reserved.
1. Introduction
Going public marks an important watershed in the life of a young company that provides access to public equity capital and
lowers the cost of funding for the companys operation and investment. However, many studies nd that when companies go
public, their share prices jump substantially on the rst day of trading, which is termed as IPO1 underpricing. For instance,
Stoll and Curley (1970), Logue (1973), and Ibbotson (1975) document a systematic increase from the offer price to the rst day
closing price in the U.S. market; Ljungqvist (2007) nds evidence of underpricing in a range of countries including European,
Asia-Pacic and Latin American countries and the U.S. However, rms are worse off due to IPO underpricing although insiders
may maximize their wealth in the IPO process (Kennedy, Sivakumar, & Vetzal, 2006). Chi and Padgett (2002) also report that
IPO underpricing is negatively related to long-run performance of the issuing rms. These phenomena motivate a stream of
research on IPO underpricing and its determinants and consequences.
Among various theories of IPO underpricing, information asymmetry models play a dominant role (Ljungqvist, 2007).
Asymmetric information models assume that one of the parties involved in an IPO knows more about the issuing rm than
the others. So underpricing is necessary to reach equilibrium on the interests of all participants. As information asymmetry
theory plays an extremely important role in the underpricing of IPO rms, the veriability criteria for the recognition of rms
operating performance and nancial reporting should matter. Accounting conservatism requires more stringent standards
of verication for economic gains than losses (Basu, 1997). Thus, the earnings and net assets reported under conservatism
will be more reliable and veriable, and accounting conservatism will constrain the managements opportunistic behaviors
for overstating income and understating potential losses (Bushman & Piotroski, 2006). As a result, information asymmetry
between issuers and other stakeholders of IPO rms under conservative accounting is relatively lower, which should result
in less IPO underpricing.
The important role of accounting conservatism in reducing information asymmetry and IPO underpricing leads to our
rst hypothesis, i.e., accounting conservatism is negatively associated with IPO underpricing. In addition, a higher degree
Corresponding author. Tel.: +852 3411 7537; fax: +852 3411 5581.
E-mail address: linzj@hkbu.edu.hk (Z.J. Lin).
1
An initial public offering (IPO), referred simply as an offering or otation, is when a company (called the issuer) issues its common stocks or shares
to the public for the rst time.
1061-9518/$ see front matter 2012 Elsevier Inc. All rights reserved.
http://dx.doi.org/10.1016/j.intaccaudtax.2012.07.003
128
Z.J. Lin, Z. Tian / Journal of International Accounting, Auditing and Taxation 21 (2012) 127144
of accounting conservatism is needed in a situation with greater information asymmetry in order to reduce the likelihood
of managers manipulation and enhance information quality. Thus, our second hypothesis predicts that the association of
accounting conservatism with IPO underpricing is more pronounced for rms with high information asymmetry. Using a
large sample of A-share companies2 that went public through initial public offerings on both Shanghai and Shenzhen Stock
Exchanges in China during 20012009, we obtain empirical evidence to support the two hypotheses.
Our study contributes to the extant literature in several ways. First, by revealing the impacts of accounting conservatism
on IPO underpricing in the Chinese context, this research supplements a ourishing stream of empirical research on accounting conservatism showing that conditional conservatism is associated with positive outcomes (Ahmed & Duellman, 2007;
Ahmed, Billings, Morton, & Stanford-Harris, 2002; Garca Lara, Garca Osma, & Penalva, 2009; Lafond & Watts, 2008). Our
ndings suggest that accounting conservatism can help reduce IPO underpricing, which should have positive implications
on the effective functioning of capital markets. In addition, our within-country study will corroborate that of Boulton, Smart,
and Zutter (2011) who document a signicant role of earnings quality in IPO underpricing in their cross-country analyses.
Second, this study provides standard setters with additional insight into the role of accounting conservatism in improving
the quality of accounting information in corporate nancial reporting. China introduced a new set of Chinese Accounting
Standards (CAS) in February 2006, which became mandatory for all listed companies on January 1, 2007. The new CAS
substantially changes the nations old accounting system and covers nearly all topics under the current IFRS.3 However,
there is a debate in China on whether the constrictive role of accounting conservatism can be relieved by incorporating the
fair value provisions of IFRS. In addition, the institutional structure in China, especially the involvement of governmental
equity holding and the underdeveloped asset appraisal market, gives managers incentives to overstate earnings in nancial
reporting (Ball, Robin, & Wu, 2003). Both the new CAS and institutional settings in China led to less conservative accounting,
which may have a negative impact on the quality of accounting information (Ahmed, Neel, & Wang, 2010). By exploring
the signicant role of accounting conservatism in the IPO process, the results of this study suggest that the adoption of
conservatism principle in accounting is necessary and important in China where there is a large degree of information
asymmetry.
Third, this study contributes to the literature on the determinants of IPO underpricing by controlling for both deal-specic
and rm-specic characteristics of IPO rms in China. As indicated by our study results, IPO underpricing is negatively
related to offering size, proportion of tradable shares, integer offer price, location of the exchange listed, rm leverage and
protability, while it is positively associated with government (state) ownership, volume of new issues in the market, lapse
period of offering and listing, and underwriter reputation in the Chinese market. The ndings should have both theoretical
and practical implications on the development of the IPO mechanism in the Chinese stock market.
Furthermore, this study helps address a void in the nance literature on IPOs, i.e., how can the quality of accounting
information have a direct impact on IPO underpricing. It is anticipated that this study should stimulate more research on
the interactive effects of accounting conservatism and information asymmetry, which will generate more convincing and
robust empirical evidence to explain IPO underpricing in both developed and less developed markets around the world.
The rest of this paper is organized as follows. Section 2 outlines the study background and relevant literature, and
develops our hypotheses. Section 3 describes the research design and data. Section 4 reports the empirical results, and
Section 5 concludes this study.
2. Study background and hypotheses
2.1. IPO market in China
In pace with the progress of wide-scaled economic reforms since the beginning of the 1980s, the share capital system or
stock companies were restored in China to restructure the inefcient state-owned enterprises (SOEs). The Chinese government reopened capital markets by setting up the Shanghai Stock Exchange (SHSE) and Shenzhen Stock Exchange (SZSE) in
1990 and 1991, respectively, to facilitate listing and trading of stocks in the country (Lin & Chen, 2005). However, IPOs in
China have the following characteristics of new issuances that are distinct from those in most developed countries.
First, before mid-1999, a quota system for IPOs was implemented by the Chinese authorities. Under the quota system,
the State Planning Commission, in conjunction with the Peoples Bank of China (the central bank) and the China Securities
Regulatory Commission (CSRC), sets up an annual quota for new stocks to be issued each year, which is then allocated to
provincial governments or ministerial authorities to select IPO rms under their jurisdiction. The quota system was formally
abolished in mid-1999 and investment banks or securities brokerage rms have assumed greater responsibility in identifying
and developing listing candidates.
2
The Chinese stock market was segregated for domestic and overseas investors when the two stock exchanges, i.e., Shanghai Stock Exchange and
Shenzhen Stock Exchange, were set up in early 1990s. A-shares, denominated in RMB (Chinese currency), are designated only for domestic investors while
B-share, denominated in US$ and HK$ in Shanghai Stock Exchange and Shenzhen Exchange respectively, are issued to overseas investors. A great majority
of Chinese listed rms are A-share rms at present.
3
International Financial Reporting Standards (IFRS) are principles-based standards, interpretations and the conceptual framework adopted by the
International Accounting Standards Board (IASB).
129
Second, the shares of Chinese companies are split into state-owned shares, legal-entity-owned shares, and tradable
shares. The state shares are those directly owned by the central or local governments. Legal-entity shares are those held by
domestic entities or nancial institutions (many of them are SOEs as well). Tradable shares were the only class of shares that
could be traded on stock exchanges before 2006,4 and are further classied as A-, B-, H-, S-, N-, and L-shares.5 Regardless of
the share type, each share is entitled to the same cash ow and voting right.
Third, before 2005, the offer price of an IPO rm was set months before market trading started, and in a great majority of
offerings there was no feedback mechanism through market demand that allowed adjustment to the offer price. However,
since 2005, the book building mechanism has been adopted to replace the original xed price mechanism. Book building
mechanism involves underwriters in eliciting indications of interest from informed investors, which are then used in setting
the offer price (Sherman, 2005). Thus, the information asymmetry among investors will be mitigated, which, in turn, reduces
the level of underpricing. The implementation of book building mechanism indicates Chinas adaptation to international
practices. However, whether the book building mechanism is efcient depends on the institutional features of China. For
example, Li (2009) argues that, because of weak market regulation and surveillance in China, book building offers issuers
greater discretion, gives institutional investors more chances to pursue their own benets, and may result in a higher level
of underpricing in China.
Therefore, Chinese IPOs provide an interesting case study for several reasons. First, as stated earlier, the Chinese government plays a dominant role in IPO processes. The majority of shares of IPO rms are owned by the state or other legal entities
and are not available to the public. Public investors rush to submit applications whenever there is a new issuing, creating
a huge demand for new issues and pushing up stock returns on the initial trading day. Second, in typical Chinese IPOs,
the regulators and many issuers (i.e., SOEs) are controlled by government, and both the managers of issuing rms and IPO
underwriters have close ties with the government. They have an incentive to hide inefciencies and conduct rent-seeking
behaviors, which aggravates information asymmetry between issuers and potential investors and leads to substantial IPO
underpricing. Third, in the Chinese stock market, a dominant portion of investors are individual investors who do not have
access to sufcient information or do not have sufcient knowledge or experience of investment. This situation aggravates
information asymmetry between issuing rms and investors and contributes to large underpricing of IPO stocks. Fourth,
the dominance of government ownership in Chinese rms (even with the privatization of SOEs) has a signicant impact
on Chinas transition from a socialist country to a modern market economy (Cheung, Ouyang, & Tan, 2009). Given that the
state-owned rms frequently suffer severe governance problems (Rajan & Zingales, 2003; Shleifer & Vishny, 1993), corporate
managers and government ofcials have an incentive to cover up governance-related inefciencies and conduct rent-seeking
behaviors. Poor performance resulting from these operating inefciencies and governance conicts will impose a damage to
personal reputation or severe political cost upon the managers and ofcials. This incentive of hiding information or deferring
the disclosure of bad news increases information asymmetry between issuers and investors in China.
Compared with the evidence from other countries, underpricing in China is extremely obvious. Boulton et al. (2011)
examine IPOs from 37 countries and show that IPO rms are underpriced in every country, ranging from underpricing of
120.7% in China to less than 2% in Argentina. Other markets in the U.S., Japan, and Malaysia have average underpricing
of 33.90%, 55.85%, 34.32%, respectively. The rst-day returns of IPOs in the A-share market in China are well above the
average as similar evidence has been documented by prior research that, on average, very large market-adjusted rst-day
returns exist in Chinese IPOs: 298% for the period 19921997 (Chen & Hui-Tzu, 2004); 129% for the period 19962000 (Chi
& Padgett, 2005); and 133.6% for the period 19922006 (Cheung et al., 2009). A few studies have analyzed IPO underpricing
in the Chinese market with respect to the effect of information asymmetry. For example, Mok and Hui (1998) report that the
proxies for ex ante uncertainty explain the pattern of A-share IPO returns during the period 19901993. Chan, Wang, and Wei
(2004) suggest that the institutional setups in China could also magnify information asymmetry and expand underpricing
in the IPO process.
2.2. IPO underpricing and information asymmetry theory
There are three well-known asymmetric information models to explain IPO underpricing in the literature.
First, the best-known asymmetric information model is the winners curse initially presented by Rock (1986). Rock (1986)
assumes that some investors are better informed about the true value of the shares on offer than investors in general, the
issuing rm, or its underwriting banks. Informed investors bid only for attractively priced IPOs, whereas the uninformed
investors bid indiscriminately. This situation imposes a winners curse on uninformed investors. Thus, the returns uninformed investors earned conditional on receiving a share allocation are below the average underpricing returns. However,
Rock (1986) argues that the primary market is dependent on continuous participation of uninformed investors, in the sense
4
Before 2006, state shares and legal-entities shares were not permitted to be traded in the secondary market but could be transferred only to another
institution or person through off-counter deals. They are permitted to be traded on stock exchanges after 2006 when the government introduced the so
called circulation of all shares reform.
5
A-shares are designated only for domestic investors and traded on Shanghai and Shenzhen Stock Exchanges. B-, H-, S-, N-, and L-shares are designated
only for foreign investors to be traded on securities exchanges in China (B-shares), in Hong Kong (H-shares), in Singapore (S-share), on NYSE (N-shares), or
on London Stock Exchange (L-shares).
130
that the informed demand is insufcient to take up all shares on offer even in attractive offerings. This case requires that
conditional expected returns be non-negative so that the uninformed investors can at least break even. In other words, all
IPOs must be underpriced in expectation.
Second, some researchers, Loughran and Ritter (2004) as the most prominent ones, stress the dark side of underwriting
banks. Investors may compete for allocation of underpriced stocks by offering underwriters side-payments. Underwriters
may allocate underpriced stocks to investors in order to induce them to reveal their information truthfully in the book
building process for IPOs. Underwriters may also allocate underpriced stocks to the executives at issuing companies in
the hope of winning their future investment banking business (e.g., seasoned equity offering or SEO), a practice known as
spinning. In each case, underwriters stand to gain from deliberately underpricing the issuers stocks.
The nal group of asymmetric information models emphasizes information asymmetry between issuing rms and potential investors (Su & Fleisher, 1999). An issuing company has better information about the present value or risk of its future cash
ows than outside investors and underwriters do, so underpricing is used to signal the companys true value. High-quality
rms have an incentive to credibly signal their higher quality to the market in order to raise capital on more advantageous
terms (e.g., better seasoned equity offerings). Low-quality rms will not send a signal by underpricing because they do not
expect to recoup their investment in underpricing through after-market SEOs. The best a low-quality issuer can do is to take
the money and run when its stocks are initially offered. Su and Fleisher (1999) also argue that underpricing is a strategy for
rms to signal their value to potential investors.
2.3. Accounting conservatism and IPO underpricing
Since information asymmetry plays an extremely important role in the IPO process, it is natural to ask whether the
quality of information matters. Boulton et al. (2011) investigate the relationship between earnings quality and international
IPO underpricing and nd that IPOs are underpriced less in countries where public rms produce higher quality earnings
information. However, as Boulton et al. (2011) stated in the limitation of their study, for certain countries, it may be problematic when using earnings quality of existing public rms to proxy for earnings quality in the same country rather than
using earnings quality of private rms prior to their IPOs.6 In fact, the earnings quality of IPO rms is very different from
that of the existing public rms due to specic motivations for new issuers such as underpricing incentives and reputation
costs. Besides, there are many studies that investigate the relationship between IPO underpricing and earnings quality from
the perspective of earnings management (Aharony, Wang, & Yuan, 2010; Ball & Shivakumar, 2008; Teoh & Wong, 2002;
Teoh, Welch, & Wong, 1998) and accounting disclosures (Jog & Mcconomy, 2003; Leone, Rock, & Willenborg, 2007; Schrand
& Verrecchia, 2005). Few studies have considered the direct effect of accounting conservatism, which is a very important
attribute of earnings quality (Bushman and Piotroski, 2006).
Prior literature on accounting conservatism highlights the benets of conservatism in contracting (Watts, 2003). Conditional conservatism acts as a governance mechanism that benets both debt and equity holders and increases rm value. For
example, Kim and Pevzner (2010) point out that conditional conservatism has informational benets to shareholders and
they nd that higher current conditional conservatism is associated with lower probability of future bad news. In addition
to these contracting benets, Lafond and Watts (2008) argue that conservatism is expected to lower information asymmetry between managers and outside investors. According to Lafond and Watts (2008), the managers asymmetric loss
function provides them incentives to use their private information to transfer wealth from investors to themselves by overstating nancial performance during their tenure at the rm. Thus, information asymmetry also exists between managers
and investors. Conservative accounting could reduce information asymmetry between managers and investors through
two potential mechanisms. First, conservatism can provide investors of the best possible non-stock-price hard summary
information on current performance (Lafond & Watts, 2008). Hard information here refers to veriable information. As
conservatism requires a higher degree of veriability for gains than losses, the net result of conservative accounting could
be the provision of more veriable information (Chaney, Faccio, & Parsley, 2011). Second, the hard information provides a
benchmark that makes it possible for alternative soft sources (such as management forecasts and voluntary disclosures) to
generate credible information. Investors can compare different-source predictions to the hard numbers that are eventually
realized, which could enable them to evaluate the reliability of competing information sources. In this way, outside investors
will know the true value of issuing rms and the information asymmetry between informed and uninformed investors and
between issuers and underwriters. Thus the information asymmetry between issuers and potential investors can be lessened
and the level of IPO underpricing reduced. We, therefore, set the rst hypothesis as:
H1.
Accounting conservatism is negatively associated with IPO underpricing in the Chinese market.
2.4. Accounting conservatism and information asymmetry

Our second hypothesis addresses the association of the magnitude of information asymmetry with the impact of accounting conservatism on IPO underpricing. Information asymmetry aggravates agency problems between two contractual parties
This problem exists in Boulton et al. (2011) because they could not obtain the data on pre-IPO disclosures of private rms for some countries.
131
(Haw, Lee, & Lee, 2010). Informed parties have more incentives and opportunities to transfer wealth to themselves. This
tendency is greater for pre-IPO rms owned by a small number of large controlling shareholders (Burkart, Gromb, & Panunzi,
1997; Mueller & Inderst, 2001). Therefore, managers in these rms have a greater latitude to indulge their own preferences,
even at the expense of shareholders interests (Francis & Martin, 2010). Lafond and Watts (2008) argue that information
asymmetry between insiders and outside investors lowers the rms stock price by increasing the required rate of return on
the stock and generating agency costs that reduce the rms expected cash ows. The more the relatively private information, the larger the bid-ask spread and the lower the returns to investors without private information (Amihud & Mendelson,
1986). The equilibrium return effect provides managers and other insiders incentives to apply governance mechanisms that
increase public information, so reducing private information and increasing stock price (Lafond & Watts, 2008). However,
managers have a motivation to use their private information to maximize their own utilities, which may generate deadweight
losses to shareholders and reduce the rms cash ows and its stock price. Thus investors prefer rms to use veriable information to restrict managements manipulation. As a result, information asymmetry between insiders and outside investors
generates incentives and demands for accounting conservatism. There are, however, differences in corporate governance
systems and managements control over accounting and reporting processes among rms at varied development stages.
Thus the level of information asymmetry varies at different rms (Kennedy et al., 2006; Rock, 1986). In rms with high
information asymmetry, conservative accounting can play a more signicant role in curbing management manipulation of
accounting information and improving the credibility of nancial statements (Garca Lara et al., 2009), which should contribute more substantially to the reduction of information asymmetry between issuing rms and potential outside investors
(Ahmed et al., 2002). Therefore, for rms with greater information asymmetry, accounting conservatism is likely to play an
even more signicant role in reducing issuing rms incentives to intentionally underprice their stocks. These arguments
lead to the second hypothesis as follows:
H2. The negative association between accounting conservatism and IPO underpricing is more pronounced for rms with
high information asymmetry than for rms with low information asymmetry.
3. Research design and data
3.1. Measurement of accounting conservatism
Based on Givoly and Hayn (2000), we use the total accrual-based measure of conservatism (CONS TA), which is the total
accruals deated by average total assets at the beginning of year, and averaged over a 3-year period centered on the year
before the IPO, multiplied by negative one. According to Givoly and Hayn (2000), total accruals are dened as:
total accruals = (net income + depreciation) cash ow from operations
(1)
3.2. Measurement of IPO underpricing

Consistent with previous studies, we employ the methodology used by Aggarwal, Leal, and Hernandez (1993) to measure IPO underpricing, i.e., we measure the market-adjusted abnormal returns for the rst trading day to proxy for IPO
underpricing. The measurement is described as follows.
The return of stock i at the end of the rst trading day is calculated as:
Ri1 =
P
i1
Pi0
(2)
where Pi1 is the closing price of stock i on the rst trading day, and Pi0 is the offering price and Ri1 is the total rst-day
return on the issuing stock.
The return on market index for the corresponding time period is:
Rm1 =
P
m1
Pm0
(3)
where Pm1 is the closing value of the corresponding Shanghai or Shenzhen A-share market index on the rst trading day
and Pm0 is the closing value of the corresponding Shanghai or Shenzhen A-share market index on the offering day of the
corresponding stock, while Rm1 is the rst-days comparable market return.
Using these two returns, the market-adjusted abnormal return for each IPO on the rst trading day which we use to
measure IPO underpricing is computed as:
MAARi1 = 100
(1 + R )
i1
(1 + Rm1 )
(4)
In addition, we use the difference of market-to-book ratio between that on the listing day and pre-offering (DMB) to
alternatively measure IPO underpricing (Chan et al., 2004). The pre-offering MB ratio is calculated using the offering price
and net assets per share one year before IPO. We assume that MB is higher on the listing day than that in the pre-offering
period if IPO underpricing exists, which will yield a positive DMB as its magnitude denotes the level of underpricing.
132
3.3. Empirical model

We construct the following regression model to test our hypotheses. IPO underpricing is the dependent variable and the proxy of accounting conservatism is the key explanatory variable. In addition, we incorporate several
deal-specic and rm-specic factors contextual to the distinct features in the Chinese IPO market as control
variables:
UPi = 0 + 1 CONSi + 2 BOOKi + 3 CONSi BOOKi + 4 LDAYi + 5 OFF SIZEi + 6 OWN Si + 7 OWN Li + 8 TSi
+ 9 VOLi + 10 INTEGi + 11 EXCHi + 12 UWREPi + 13 LEVi + 14 ROAi + i
(5)
where
UP (MAAR)
UP (DMB)
CONS (TA)
BOOK
CONS*BOOK
LDAY
OFF SIZE
OWN S
OWN L
TS
VOL
INTEG
EXCH
UWREP
LEV
ROA
measure of underpricing with market-adjusted initial returns on the rst trading day of the IPO stock
measure of underpricing with difference of market-to-book ratio between the listing day and pre-offering
proxy for accounting conservatism with total accruals approach, which is measured by income before extra-ordinary items
less cash ows from operations plus depreciation expense deated by average total assets at the beginning of year, and
averaged over a 3-year period centered on the year before IPO, multiplied by negative one
dummy variable, equals to 1 if the rm goes public through book building mechanism and 0 otherwise
the interaction term of CONS and BOOK
number of days between offering and listing of an IPO stock
natural logarithm of the number of offering shares multiplied by offering price, indicating the offering size of individual IPO
stocks
percentage of shares held by government and state-owned legal entities after IPO, representing the proportion of government
ownership in the equity of an issuing rm
percentage of shares held by non-state-owned legal entities after IPO
percentage of publicly tradable shares of each IPO
Number of IPOs in each year
dummy variable, equals to 1 if the offer price is an integer and 0 otherwise
dummy variable, equals to 1 if the new issue is listed on Shenzhen Stock Exchange and 0 if it is listed on Shanghai Stock
Exchange
dummy variable, equals to 1 if the underwriter belongs to Top 5 underwriters nationwide7 and 0 otherwise
a rms total debt divided by its total assets of the year before IPO
after-tax net income divided by total assets of the year before IPO
Regarding the effect of accounting conservatism on IPO underpricing, 1 is predicted to be negative for H1, thus conservative accounting should be able to reduce IPO underpricing. In order to test H2, we partition all issuers into two
subgroups by the extent of information asymmetry in pre-IPO period and analyze whether the association between
accounting conservatism and IPO underpricing is more pronounced when information asymmetry is high. We measure the magnitude of information asymmetry between issuers and potential investors by four proxies that have been
used in prior studies: sales growth, rm age, rm size, and corporate governance. First, as stated by Khan and Watts
(2009), information asymmetry between managers and investors increases with growth options because future cash ows
from growth options are typically unveriable and may produce more agency costs. Second, younger rms tend to have
more growth options and less standardized accounting and reporting systems relative to old rms and have a greater
scale of information asymmetry (Stoll & Curley, 1970). Third, large rms are more mature and have richer information
environments (e.g., more analyst following), which contributes to less overall uncertainty and information asymmetry associated with the realizability of projected gains. Fourth, strong corporate governance rms will better align the
interests of all stakeholders, which will mitigate agency problems and result in relatively less information asymmetry
(Watts, 2003).
Sales growth is measured as the change in sales revenue divided by one-year lagged sales revenue. Firm age is measured as
the number of years passed since a rms establishment date before its IPO. Firm size is measured as the total assets before
IPO. Corporate governance is measured by taking the unweighed average of standardized composing variables including
ownership concentration, ratio of the number of independent directors in the Board, separation of CEO/Chair positions, litigation risk, and leverage risk (Burkart et al., 1997; Jog & Mcconomy, 2003). We use the sample median of each partitioning
proxy to divide the total sample into high information asymmetry sample and low information asymmetry sample. Firms
with high sales growth, young age, small rm size and weak corporate governance are classied as high information asymmetry rms, respectively. We run regressions (Eq. (5)) separately for the high- and low information asymmetry subsamples
to test whether accounting conservatism has a varied impact on IPO underpricing under different information asymmetry
environments.
We rank underwriters according to the number of their IPO deals annually. In general Top-5 underwriters represent high-quality ones nationwide.
133
Table 1
Sample selection.
Sample selection process
Observations dropped
Observations remaining
Initial sample from 2001 to 2009 available from CSMAR

After eliminating rms in nancial industries
After eliminating rms that began their initial public offerings but have not been listed on
stock exchanges
19
2
695
676
674
110
100
78
64
68
68
66
50
Number of IPOs by Year
109
98
15
2001
2002
2003
2004
2005
2006
2007
2008
2009
Fig. 1. Number of IPOs in China by year (the nal sample includes 65 IPOs for 2003 and 77 IPOs for 2008. Two IPOs (each in 2003 and 2008 respectively)
are eliminated from the sample because they have not been listed on stock exchanges in the year although they began their initial public offerings).
3.4. Data
Our sample includes all A-share companies that went public through initial public offerings on both the Shanghai Stock
Exchange and Shenzhen Stock Exchange in China during 20012009.8 IPOs of B-share companies are excluded because their
IPO behaviors and performance are substantially different from those of A-share companies due to varied regulatory requirements (Chan et al., 2004). We exclude companies in the nancial industry because the nancial reporting environment for
nancial institutions signicantly differs from that of other industrial companies. Basic data about IPOs, nancial performance, stock returns, and ownership information are obtained from the database of Chinese Stock Market and Accounting
Research (CSMAR). Following Chan et al. (2004), we also exclude rms that have a lapsed time between offering date and
listing date that exceeds 360 days.
Our initial sample extracted from the CSMAR database includes 695 IPOs. After excluding 19 companies in the nancial
industry and two rms that began their initial public offerings but have not been listed on stock exchanges, we have 674
IPOs for the nal sample.9 Table 1 reports the rm-level sample selection process. The number of new issues in each year is
plotted in Fig. 1, which demonstrates a considerable time-series volatility in the Chinese market. For example, IPO activity
peaked in 2007 with a record of 110 rms going public, but only 15 IPOs took place in 2005.
3.5. Descriptive statistics
Table 2 presents the descriptive statistics for the variables by year. All variables are winsorized at the extreme 1% and 99%
both to mitigate the possible effect of outliers. The average magnitude of IPO underpricing is 110.9% for the entire period,
which is obviously at a substantially high level. A breakdown of the IPOs by year shows that IPO underpricing in the Chinese
market undergoes two stages. There is a decreasing trend in terms of IPO underpricing from 145.0% in 2001 to 86.6% in 2006
and from 192.7% in 2007 to 69.4% in 2009, respectively. In our sample, 54.7% of IPOs (369 of 674) went public through book
building mechanism. The number of days between offering and listing (LDAY) is 26.078 in 2001 and declines to 13.982 in
2009, indicating that the time lag between offering and listing has become shorter and the Chinese IPO market has become
more efcient in recent years. The average offer size (OFF SIZE) is RMB 831.465 million in 2001 (US$1 = RMB 6.5) and
increases to RMB 1652.478 million in 2009, which indicates a negative relationship with the level of underpricing. The
percentage of state shares (OWN S) or government ownership shows a steady decrease from 48.5% in 2001 to 12.0% in 2009.
8
In October 2000, Shenzhen Stock Exchange was temporarily closed to IPOs, leaving Shanghai Stock Exchange as the only IPO market from 2001 to 2003
in China. Our sample starts from 2001 in order to mitigate the effects arising from the suspension of IPO activities on the Shenzhen that Stock Exchange.
9
All rms in the sample period have a lapsed time between offering date and listing date of less than 360 days.
Year
MAAR
CONS
BOOK
134
Table 2
Descriptive statistics for A-share IPOs in China by year.
LDAY
OFF SIZE
OWN S
OWN L
TS
VOL
INTEG
EXCH
UWREP
LEV
ROA
1.450
1.261
0.896
64
0.019
0.015
0.086
64
0.172
0
0.380
64
26.080
23.500
9.030
64
831.500
482.600
1494.000
64
0.485
0.587
0.243
64
0.171
0.033
0.234
64
0.331
0.321
0.064
64
64
64
0
64
0.141
0.000
0.350
64
0.000
0.000
0.000
64
0.438
0.000
0.500
64
0.555
0.580
0.112
64
0.076
0.059
0.045
64
2002
Mean
Median
SD
Obs.
1.277
1.142
0.779
68
0.017
0.018
0.090
68
0.279
0
0.452
68
15.840
15.000
3.371
68
624.200
327.100
1419.000
68
0.443
0.550
0.254
68
0.171
0.026
0.231
68
0.338
0.345
0.072
68
68
68
0
68
0.132
0.000
0.341
68
0.015
0.000
0.121
68
0.206
0.000
0.407
68
0.559
0.576
0.113
68
0.078
0.068
0.045
68
2003
Mean
Median
SD
Obs.
0.723
0.618
0.429
65
0.004
0.005
0.087
65
0.015
0
0.124
65
15.920
15.000
2.600
65
611.600
322.500
1273.000
65
0.385
0.503
0.283
65
0.206
0.069
0.261
65
0.335
0.333
0.069
65
66
66
0
65
0.062
0.000
0.242
65
0.000
0.000
0.000
65
0.169
0.000
0.378
65
0.555
0.578
0.121
65
0.090
0.080
0.050
65
2004
Mean
Median
SD
Obs.
0.744
0.629
0.559
98
0.012
0.008
0.079
98
0
0
0
98
16.460
15.000
2.781
98
360.700
282.100
297.900
98
0.256
0.124
0.273
98
0.267
0.180
0.248
98
0.328
0.321
0.061
98
98
98
0
98
0.122
0.000
0.329
98
0.398
0.000
0.492
98
0.133
0.000
0.341
98
0.527
0.526
0.128
98
0.097
0.093
0.039
98
2005
Mean
Median
SD
Obs.
0.505
0.487
0.329
15
0.018
0.017
0.060
15
0.267
0
0.458
15
16.200
15.000
4.004
15
384.200
285.700
443.000
15
0.251
0.048
0.301
15
0.436
0.580
0.295
15
0.258
0.265
0.039
15
15
15
0
15
0.000
0.000
0.000
15
0.800
1.000
0.414
15
0.200
0.000
0.414
15
0.549
0.516
0.153
15
0.093
0.086
0.056
15
2006
Mean
Median
SD
Obs.
0.866
0.674
0.709
68
0.004
0.004
0.071
68
0.985
1
0.121
68
14.500
14.000
3.239
68
1056.000
309.700
2310.000
68
0.245
0.007
0.288
68
0.364
0.264
0.265
68
0.235
0.205
0.064
68
68
68
0
68
0.132
0.000
0.341
68
0.824
1.000
0.384
68
0.324
0.000
0.471
68
0.567
0.593
0.141
68
0.079
0.071
0.039
68
2007
Mean
Median
SD
Obs.
1.927
1.708
0.997
110
0.014
0.005
0.067
110
0.909
1
0.289
110
13.440
14.000
3.473
110
2285.000
277.300
9329.000
110
0.197
0
0.273
110
0.343
0.265
0.286
110
0.213
0.202
0.061
110
110
110
0
110
0.064
0.000
0.245
110
0.864
1.000
0.345
110
0.409
0.000
0.494
110
0.553
0.573
0.135
110
0.091
0.081
0.040
110
2008
Mean
Median
SD
Obs.
1.220
0.901
0.904
77
0.027
0.027
0.070
77
0.753
1
0.434
77
12.130
12.000
3.254
77
1382.000
321.600
4066.000
77
0.158
0
0.264
77
0.326
0.264
0.280
77
0.201
0.201
0.039
77
78
78
0
77
0.013
0.000
0.114
77
0.922
1.000
0.270
77
0.416
0.000
0.496
77
0.569
0.579
0.158
77
0.100
0.086
0.061
77
2009
Mean
Median
SD
Obs.
0.694
0.629
0.393
109
0.054
0.040
0.098
109
1
1
0
109
13.980
12.000
7.322
109
1652.000
628.300
5364.000
109
0.120
0
0.230
109
0.286
0.197
0.256
109
0.192
0.201
0.033
109
109
109
0
109
0.385
0.000
0.489
109
0.927
1.000
0.262
109
0.193
0.000
0.396
109
0.486
0.477
0.155
109
0.129
0.119
0.069
109
Total
Mean
Median
SD
Obs.
1.109
0.858
0.854
674
0.019
0.011
0.083
674
0.547
1
0.498
674
15.670
15.000
6.075
674
1166.000
349.100
4703.000
674
0.265
0.110
0.289
674
0.278
0.171
0.269
674
0.264
0.235
0.085
674
85.240
78
21.680
674
0.138
0.000
0.345
674
0.556
1.000
0.497
674
0.280
0.000
0.450
674
0.543
0.561
0.138
674
0.095
0.086
0.053
674
Note: Variables are dened as: MAAR, measure of underpricing with market-adjusted initial returns on the rst trading day of IPO stock; CONS, proxy for accounting conservatism, which is measured by income
before extra-ordinary items less cash ows from operations plus depreciation expense deated by average total assets at the beginning of year, and averaged over a 3-year period centered on the year before IPO,
multiplied by negative one; BOOK, a dummy variable, equals to 1 if the rm goes public through book building mechanism and 0 otherwise; LDAY, number of days between offering and listing of an IPO stock;
OFF SIZE, natural logarithm of the number of offering shares multiplied by offering price, indicating the offering size of individual IPO stocks; OWN S, percentage of shares held by government and state-owned
legal entities after IPO, representing the proportion of government ownership in the equity of an issuing rm; OWN L, percentage of shares held by non-state-owned legal entities after IPO; TS, percentage of
publicly tradable shares of each IPO; VOL, number of IPOs in each year; INTEG, a dummy variable, equals to 1 if the offer price is an integer and 0 otherwise; EXCH, a dummy variable, equals to 1 if the new issue
is listed on Shenzhen Stock Exchange and 0 if it is listed on Shanghai Stock Exchange; UWREP, a dummy variable, equals to 1 if the underwriter belongs to Top 5 underwriters nationwide and 0 otherwise; LEV, a
rms total debt divided by its total assets of the year before IPO; ROA, after-tax net income divided by total assets of the year before IPO.
This table presents the description of variables for the entire sample of 674 IPOs by year. All variables are winsorized at the extreme 1% and 99%.
2001
Mean
Median
SD
Obs.
135
It should be noted that the shares owned by the state and legal entities account for more than 50% of the total shares for
the listed companies in the 20012009 period. This situation may contribute to operational inefciencies and information
asymmetry that aggravate IPO underpricing. Analysis of INTEG, EXCH and UWREP shows that 13.8% of IPOs (93 of 674) have
an integer offer price, 55.6% of IPOs (375 of 674) are listed on the Shenzhen Stock Exchange during the sample period, and
28.0% of IPOs (189 of 674) are underwritten by the Top 5 underwriters in China.
The correlations between all variables are presented in Table 3. These estimates do not reveal correlations that are
sufciently high. So the multicollinearity problem is moderate in our model and will not have a signicant impact on the
relationship between the dependent and independent variables used in Eq. (3).
4. Empirical results
4.1. The association of accounting conservatism with IPO underpricing
Table 4 shows the results of cross-sectional analyses for the impact of accounting conservatism on IPO underpricing in
the Chinese market based on Eq. (3). We use total accruals (TA) to proxy for accounting conservatism10 and use both marketadjusted abnormal return (MAAR) and difference of market-to-book ratios (DMB) to measure IPO underpricing. In Model
1, the dependent variable is the market-adjusted abnormal returns (MAAR) on the rst trading day. The main independent
variable is accounting conservatism measured by total accruals (CONS TA). The model is reasonably well specied with
adjusted R2 of 17.9% at the signicance level of 1% (F = 11.45). As we predict, the coefcient on CONS TA is 1.045 at the 10%
signicance level, suggesting that accounting conservatism is negatively and signicantly related to IPO underpricing in the
Chinese market. This nding supports H1.
Results in Model 1 also reveal that the offering mechanism does affect underpricing. The book building mechanism
(BOOK) is found to be positively related to underpricing (MAAR) at the 5% signicance level (2 = 0.196, t = 2.35), which is
consistent with Ljungqvist, Jenkinson, and Wilhelm (2003) and Li (2009). Li (2009) explains the positive relationship between
the book building mechanism and the level of underpricing by stating that book building offers issuers greater discretions
and gives institutional investors more chances to pursue their own benets. Book building mechanism allows shares to be
allocated preferentially and enables investors to call for changes in offer price that will give everyone a fair chance (Sherman,
2005). Besides, we include an interaction term for book building mechanism and accounting conservatism. Model 1 shows
a positive relationship between the interaction (BOOK*CONS) and the level of underpricing (MAAR) at the 10% signicance
level (3 = 1.378, t = 1.85), indicating that the relationship between accounting conservatism and IPO underpricing is less
pronounced after the implementation of book building mechanism. This result further conrms the substitute relationship
between BOOK and CONS as shown in the correlation matrix.
Other results in Model 1 are broadly consistent with the extant IPO underpricing literature. For example, LDAY has a positive relationship to the level of underpricing, although its coefcient is not signicant at the conventional level (4 = 0.002,
t = 0.30). This result can be explained by the specic sample period. Our regression uses IPOs that took place in 20012009,
and as shown in Table 2, the average lapsed time between offering and listing during the test period is 15.67 days. The time
gap is not as unreasonably long as in previous periods. It can be interpreted that the level of underpricing will not be signicantly affected by the time elapsed between offering and listing if issuers can list their offerings within a reasonable duration
period. Regarding the offering size of IPOs (OFF SIZE), we nd a signicantly negative relationship to the level of underpricing
at the 1% signicance level (5 = 0.402, t = 10.41), which is in line with prior studies stating that smaller offer size makes
it easier for institutional investors to control the issuing process and have more money left on the table for themselves. With
respect to the impact of shareholders structure, the results show a positive relationship between the proportion of state
shares (OWN S) and IPO underpricing at the 5% signicance level (6 = 0.360, t = 2.23)11 and a negative relationship between
the proportion of publicly tradable shares (TS) and IPO underpricing at the 5% signicance level (8 = 1.258, t = 2.45),
suggesting that a high proportion of state-owned shares give managers more opportunities to cover up inefciencies, which
aggravates information asymmetry and IPO underpricing. This result is consistent with Chaney et al. (2011) who argue that
politically connected rms have incentives to hide inefciencies and end up with a large degree of information asymmetry.
With a high state ownership, managers are subject to less monitoring and discipline of public investors and they are eager
to cover up inefciencies because they tend to pursue their personal interests such as their bureaucratic careers. However,
a high proportion of tradable shares may reduce the demand for new issues and push down the stock returns on the initial
trading day.
We nd a signicantly positive relationship between IPO volume (VOL) and initial IPO returns (MAAR) at the 1% level
(9 = 0.008, t = 4.72), which is in line with the hot issues market phenomenon. Consistent with Banerjee, Dai, and Shrestha
(2009) and Boulton et al. (2011), integer offer price (INTEG) is negatively related to IPO underpricing (MAAR) at the 5% significance level (10 = 0.210, t = 2.37). Harris (1991) argues that the use of integer offer price intends to reduce uncertainty in
stock pricing and the frequency of integer offer prices should increase in offerings. In this respect, integer offer price nega-
10
We also use discretionary accruals to proxy for accounting conservatism in robustness tests with reduced sample size owing to missing data of some
rms and the result is qualitatively the same (see Section 4.4.).
11
Cheung et al. (2009) also nd similar evidence on the relationship between state ownership and IPO underpricing in the Chinese market.
136
MAAR
TA
BOOK
LDAY
OFF SIZE
OWN S
OWN L
TS
VOL
INTEG
EXCH
UWREP
LEV
ROA
MAAR
CONS
BOOK
LDAY
OFF SIZE
OWN S
OWN L
TS
VOL
INTEG
EXCH
UWREP
LEV
ROA
1
0.0116
0.0542
0.0102
0.316***
0.0128
0.0359
0.0393
0.111***
0.0869**
0.0782**
0.0836**
0.0235
0.0889**
1
0.0622
0.0368
0.0353
0.19***
0.0538
0.101***
0.125***
0.0628
0.158***
0.0235
0.085**
0.248***
1
0.311***
0.156***
0.232***
0.159***
0.578***
0.362***
0.0785**
0.556***
0.0433
0.0349
0.0881**
1
0.0475
0.169***
0.116***
0.27***
0.241***
0.0503
0.303***
0.0234
0.0101
0.0095
1
0.288***
0.124***
0.125***
0.0913**
0.0455
0.243***
0.122***
0.0592
0.0161
1
0.613***
0.304***
0.268***
0.0367
0.559***
0.0593
0.0405
0.283***
1
0.263***
0.0637*
0.0373
0.311***
0.012
0.0656*
0.114***
1
0.354***
0.0858**
0.617***
0.0575
0.03
0.251***
1
0.147***
0.401***
0.0137
0.118***
0.195***
1
0.0888**
0.0486
0.0973**
0.127***
1
0.0322
0.084**
0.25***
1
0.0522
0.0048
1
0.591***
Note: This table reports the correlation of variables used. Variables are dened as in Table 2. All variables are winsorized at the extreme 1% and 99%.
*
Statistical signicance at the 10% level.
**
***
Table 3
Correlation matrix among variables.
137
Table 4
Results for the impact of accounting conservatism on IPO underpricing in 20012009.
Predictions
Intercept
CONS TA
BOOK
TA*BOOK
LDAY
OFF SIZE
OWN S
OWN L
TS
VOL
INTEG
EXCH
UWREP
LEV
ROA
N
R2
Adj. R2
F
MAAR
DMB
3.537***
(8.44)
1.045*
(1.86)
0.196**
(2.35)
1.378*
(1.85)
0.002
(0.30)
0.402***
(10.41)
0.360**
(2.23)
0.068
(0.46)
1.258**
(2.45)
0.008***
(4.72)
0.210**
(2.37)
0.234**
(2.28)
0.232***
(3.44)
0.416
(1.49)
1.936**
(2.45)
0.940
(0.29)
7.676*
(1.77)
2.338***
(3.64)
1.917
(0.33)
0.165***
(4.00)
1.115***
(3.74)
1.766
(1.42)
1.130
(1.00)
2.660
(0.67)
0.070***
(5.68)
0.495
(0.72)
1.498*
(1.89)
1.057**
(2.03)
8.577***
(3.98)
44.985***
(7.39)
674
0.196
0.179
11.45
674
0.247
0.231
15.48
Note: This table reports the cross-sectional analyses for the impact of accounting conservatism on IPO underpricing based on Eq. (3). Denition of variables
is as specied in Table 2. All variables are winsorized at the extreme 1% and 99%. t-Statistics are reported in parentheses.
*
**
***
tively affects the magnitude of underpricing. The coefcient on EXCH reveals that the IPO underpricing in the Shenzhen Stock
Exchange is signicantly lower than that in the Shanghai Stock Exchange at the 5% signicance level (11 = 0.234, t = 2.28),
which is consistent with Yu and Tse (2006). The regulations and investors behaviors in the Shenzhen Stock Exchange are
much closer to those in neighboring Hong Kong where international standards and practices prevail, which may result in
less information asymmetry between issuers and potential investors for the Shenzhen Stock Exchange. Besides, it is noted
that some rms on the Shenzhen Stock Exchange are joint ventures with foreign capitals, while those listed on the Shanghai
Stock Exchange are mostly SOEs (Yu & Tse, 2006). There are more disclosures and less uncertainty in joint venture rms
with foreign partners, so the IPO rms listed on the Shenzhen Stock Exchange are relatively less underpriced.
The magnitude of underpricing is positively related to the reputation of underwriters (UWREP) at the 1% signicance level
(12 = 0.232, t = 3.44), which is consistent with Boulton et al. (2011) and Ritter and Welch (2002). This result further shows that
underwriters in China still play a major role in underpricing in the process of initial public offerings. Large underwriters will
demand high underpricing to pursue their own benets. The coefcient on rm leverage (LEV) is 0.416, which supports the
monitoring role of leverage in reducing managements opportunistic behaviors and information asymmetry between issuers
and potential investors. However, the t-statistic of this variable is not signicant at the conventional level, indicating that
the role of leverage in reducing information asymmetry and IPO underpricing is rather weak in China. Consistent with Rock
(1986) who argues that the degree of information asymmetry is a decreasing function of rm protability, ROA is negatively
related to the level of underpricing at the 5% signicance level (14 = 1.936, t = 2.45), suggesting that protability helps
reduce IPO underpricing in the Chinese market.
Similar results are obtained when IPO underpricing is measured alternatively as the difference of market-to-book ratios
between pre-IPO and listing date (DMB). In Model 2, the coefcient on CONS TA is 7.676 at the 10% signicance level, thus
our empirical results are robust in respect of the association of accounting conservatism with IPO underpricing in the Chinese
market.
138
Table 5
Differences between high- and low information asymmetry groups.
Partition proxy
Growth
Firm age
Firm size
Corp. gove
High information asymmetry
Low information asymmetry
Mean variances
Mean
Std. dev.
Mean
Std. dev.
Variance
t-Statistics
336
337
337
337
0.424
2.412
2.44e+08
1.696
0.274
0.859
8.54e+07
1.399
338
337
337
337
0.023
7.400
6.04e+09
1.696
0.106
2.814
1.92e+09
1.295
0.4003
4.989
5.79e+09
3.393
25.01***
31.13***
5.55***
32.66***
Note: Subgroups are divided based on the median value of the four partition proxies respectively, so rms with high growth, young age, small size and weak
corporate governance are dened as high information asymmetry. Sales growth is measured as the change in sales revenue divided by the one-year lagged
sales revenue. Firm age is measured as the number of years passed since a rms establishment date. Firm size is measured as the total assets before IPO.
Corporate governance is measured by taking the unweighed average of the standardized composing variables including separation of CEO/Chair positions,
the ratio of the number of independent directors to the number of all directors, litigation risk, ownership concentration, and leverage.
***
Signicance of 1%.
4.2. Effect of information asymmetry on the association between accounting conservatism and IPO underpricing
We examine the second hypothesis regarding the impact of pre-IPO information asymmetry on the relationship between
accounting conservatism and IPO underpricing in this section. As explained in Section 3, we divide our sample into high
vs. low information asymmetry sub-groups based on four partition factors, i.e., growth, rm age, rm size, and corporate
governance.12 Table 5 lists the group means and between-group mean variances under the four partitions. All show a
signicant difference between the high and low information asymmetry sub-groups at the signicance level of 1%. For
instance, the average age of the high information asymmetry group is 2.41 years while for the low asymmetry group it
is 7.4 years. The average total assets are RMB 244 million and RMB 6040 million, respectively. Table 6 presents the
analyses for the second hypothesis based on the partitioned sub-samples (e.g., high vs. low information asymmetry). In each
column, the left (right) sub-sample represents high (low) information asymmetry rms. In the regression, the coefcient on
CONS TA is 1.115 for high growth sub-group (t = 1.58), which is more pronounced than the coefcient 0.525 for the low
growth sub-group (t = 0.53). The coefcient on CONS TA for the young rm sub-group is 1.113 at the 10% signicance level
(t = 1.67), which is more pronounced than the coefcient 1.001 for the old rm sub-group (t = 0.85). The coefcient on
CONS TA for the small rm sub-group is 1.568 at the 5% signicance level (t = 1.98), which is more pronounced than the
coefcient 0.206 for the large rm sub-group (t = 0.26). The coefcient on CONS TA for the weak corporate governance
sub-group is 2.419 at the 1% signicance level (t = 2.85), which is more pronounced than the coefcient of 0.278 for the
strong corporate governance sub-group (t = 0.36). The results reveal that the relationship between accounting conservatism
and IPO underpricing is more pronounced for high information asymmetry rms. Furthermore, we evaluate the differences
in the coefcients between high and low information asymmetry sub-samples. We nd that the coefcient on CONS TA is
signicantly more negative in rms with high sales growth, young age, small size, and weak corporate governance than in
their counterparts with low information asymmetry, thus conrming that accounting conservatism has a greater impact on
IPO underpricing under a high information asymmetry environment.
4.3. Reverse causality test
Until now, we have not addressed the potential endogeneity problem of accounting conservatism. An alternative explanation of the negative relationship between accounting conservatism and IPO underpricing is that rms with higher levels
of underpricing are more likely to employ less conservative accounting. This reverse causality explanation is difcult to rule
out since it is hard to specify ex ante which rms are more underpriced and which are not. We deal with this reverse causality
issue in the following ways. First, we use the average of a three-year lagged accounting conservatism measure to address
the causality ow from accounting conservatism to IPO underpricing. Second, we apply the two-step Heckmans procedure
to purge the endogenous component of accounting conservatism. In the rst stage, we estimate a selection model (probit
model) to explain rms overall decisions to choose conservative accounting or not. The dependent variable is an indicator
variable that gets the value of one if a rms accounting conservatism measure at one year before the IPO is above the
sample median and zero otherwise. The explanatory variables include leverage, return on assets, sales growth, total assets,
the ratio of independent directors to all directors, and board size. We use two-year lagged data for explanatory variables as
the determinants for accounting conservatism one year before IPO. Conditional on this rst stage analysis, we analyze in the
second stage the relationship between accounting conservatism and IPO underpricing by including other control variables.
We construct an inverse Mills ratio (IMR) based on the coefcient estimates from the rst step probit model, and include
IMR as an additional explanatory variable in the second-step model. Table 7 shows that IMR has a signicantly negative
coefcient (0.992; t = 1.93) and the coefcient on CONS is still signicantly negative (3.828; t = 3.31), consistent with
12
The partition is based on the group media for each factor individually. Thus the high- and low information asymmetry sub-groups have the same
number of sample rms.
139
Table 6
Results for the impact of information asymmetry on the relationship between accounting conservatism and IPO underpricing.
Sales growth
Intercept
CONS TA
BOOK
TA*BOOK
LDAY
OFF SIZE
OWN S
OWN L
TS
VOL
INTEG
EXCH
UWREP
LEV
ROA
N
R2
Adj. R2
F
Firm age
Firm size
Corporate governance
High
Low
Young
Old
Small
Large
Weak
Strong
3.823***
(6.26)
1.115
(1.58)
0.000
(0.00)
0.612
(0.66)
0.002
(0.22)
0.368***
(5.66)
0.473**
(2.19)
0.085
(0.44)
2.106***
(2.81)
0.004**
(2.03)
0.257**
(2.28)
0.196
(1.40)
0.009
(0.08)
0.492
(1.20)
1.209
(1.17)
3.334***
(5.30)
0.525
(0.53)
0.366***
(2.88)
1.826
(1.33)
0.003
(0.38)
0.460***
(7.89)
0.204
(0.84)
0.247
(1.09)
0.402
(0.55)
0.011***
(4.70)
0.119
(0.82)
0.164
(1.07)
0.255**
(2.00)
0.278
(0.68)
2.921**
(2.23)
4.677***
(7.67)
1.113*
(1.67)
0.180
(1.48)
0.198
(0.18)
0.001
(0.12)
0.494***
(8.40)
0.512**
(2.03)
0.004
(0.02)
2.078***
(2.74)
0.005**
(2.10)
0.224
(1.53)
0.280*
(1.94)
0.166
(1.35)
0.548
(1.31)
2.315*
(1.94)
2.121***
(3.47)
1.001
(0.85)
0.137
(1.12)
2.149
(1.63)
0.006
(0.70)
0.272***
(4.26)
0.199
(0.90)
0.170
(0.85)
0.338
(0.45)
0.011***
(4.84)
0.249**
(2.15)
0.008
(0.05)
0.024
(0.20)
0.276
(0.70)
2.251*
(1.94)
6.101***
(7.96)
1.568**
(1.98)
0.348***
(2.61)
1.919*
(1.74)
0.009
(1.12)
0.880***
(7.36)
0.245
(0.98)
0.145
(0.72)
2.622**
(2.59)
0.008***
(3.21)
0.139
(1.03)
0.642***
(4.01)
0.139
(0.95)
0.504
(1.05)
0.324
(0.25)
2.012***
(3.74)
0.206
(0.26)
0.033
(0.31)
0.089
(0.09)
0.003
(0.46)
0.206***
(4.10)
0.559**
(2.58)
0.113
(0.53)
0.568
(0.98)
0.008***
(3.85)
0.201*
(1.75)
0.220*
(1.73)
0.021
(0.22)
0.702**
(2.11)
2.370**
(2.12)
3.447***
(5.59)
2.419***
(2.85)
0.363***
(3.01)
2.913***
(2.72)
0.000
(0.01)
0.452***
(7.84)
0.409*
(1.74)
0.046
(0.23)
0.208
(0.26)
0.007***
(2.93)
0.125
(1.06)
0.422***
(2.73)
0.236**
(2.53)
0.161
(0.41)
1.505
(1.51)
3.405***
(5.54)
0.278
(0.36)
0.054
(0.45)
0.230
(0.21)
0.002
(0.27)
0.328***
(6.09)
0.337
(1.47)
0.053
(0.24)
1.733**
(2.53)
0.009***
(4.03)
0.257*
(1.91)
0.004
(0.03)
0.150
(1.47)
0.807*
(1.77)
2.148
(1.56)
336
0.164
0.127
4.487
338
0.245
0.212
7.471
337
0.224
0.190
6.636
337
0.184
0.149
5.187
337
0.259
0.227
8.045
337
0.166
0.130
4.573
337
0.232
0.199
6.965
337
0.216
0.182
6.351
Note: This table reports the regression results for test of second hypothesis. Subgroups are divided based on the median value of the four partition proxies
respectively, so rms with high growth, young age, small size and weak corporate governance are dened as high information asymmetry. Sales Growths
is measured as the change in sales revenue divided by the one-year lagged sales revenue. Firm age is measured as the natural logarithm of the number of
years passed since a rms establishment date. Firm size is measured as the natural logarithm of total assets. Corporate governance is measured by taking
the unweighed average of the standardized composing variables including ownership concentration, ratio of the number of independent directors in the
Board, separation of CEO/Chair positions, litigation risk, and leverage. Other variables are dened as in Table 2. t-Statistics are reported in parentheses.
*
**
***
the interpretation that rms with more conservative accounting tend to have lower underpricing. Therefore, we conclude
that our results are robust to the correction of potential self-selection bias that higher underpricing rms are more likely to
employ less conservative accounting.
4.4. Results of robustness tests
We run several robustness tests to check the validity of our study results. First, we use C SCORE developed by Khan and
Watts (2009) as an alternative conservatism measure because the cash-based conditional measure of conservatism may
have a better governance role in reducing information asymmetry. We also partition the full sample into two sub-samples
according to whether or not the rm goes public through book building mechanism. As stock returns are not available for
rms before the IPO, C SCORE in this study is based on the Ball and Shivakumar (2005) accruals model13 rather than the Basu
(1997) model. The accruals model is specied as:
ACCi = 0 + 1 DCFOi + 2 CFOi + 3 DCFOi CFOi + i
(6)
13
This approach presents the advantage of not relying on market measures, thereby reducing the risk of drawing incorrect inferences due to market
inefciencies (Garca Lara et al., 2009).
140
Table 7
Results of reverse causality test using Heckman (1978) two-step procedure.
Panel A: rst-stage probit regression
Panel B: second-stage regression
Intercept
MAAR
Intercept
LEV
ROA
GROWTH
FIRM SIZE
RINDE
BOARD SIZE
N
Pseudo-R2
2.230**
(2.22)
0.772*
(1.71)
4.423***
(3.63)
0.028
(0.20)
0.139***
(2.92)
0.417
(0.90)
0.047*
(1.66)
566
0.057
CONS TA
IMR
BOOK
TA BOOK
LDAY
OFF SIZE
OWN S
OWN L
TS
VOL
INTEG
EXCH
UWREP
LEV
ROA
N
6.006***
(7.51)
3.828***
(3.31)
0.992*
(1.93)
0.048
(0.38)
6.787***
(4.17)
0.01
(1.19)
0.599***
(7.22)
0.178
(0.69)
0.298
(1.22)
2.642***
(3.43)
0.008***
(3.81)
0.200
(1.29)
0.453***
(2.82)
0.349***
(3.25)
0.248
(0.50)
0.355
(0.16)
566
Note: This table reports the results for correcting the self-selection bias using the Heckman (1978) two-step procedure. Panel A presents the rst-stage
probit analysis of rms decision to use conservative accounting or not. The dependent variable equals to one if a rms accounting conservatism at one
year before IPO is above the sample median and zero otherwise. The explanatory variables include leverage (LEV), return on assets (ROA), sales growth
(GROWTH), total assets (TA), the ratio of independent directors to all directors (RINDE), and board size (BOARD SIZE). We use two-year lagged data for
explanatory variables as the determinants for accounting conservatism one year before IPO. Board size is the number of directors. Panel B presents the
results of the second-stage regression. The dependent variable is market-adjusted abnormal returns. IMR is the inverse Mills ratio constructed based on
the coefcients of the probit model in Panel A. Other variables are as dened in Table 2. All variables are winsorized at the extreme 1% and 99%. t-Statistics
are reported in parentheses.
*
**
***
where i indexes the rm; ACC is the income before extra-ordinary items less cash ows from operation plus depreciation
expenses deated by average total assets at the beginning of the year before IPO; CFO is cash ows from operations deated
by average total assets at the beginning of the year before IPO, DCFO is a dummy variable and equals to 1 if CFO < 0 and 0
otherwise; and is the residual. In this model, 2 is expected to be signicantly negative, showing the negative correlation
between accruals and cash ows. 3 is expected to be positive in the presence of accounting conservatism showing a positive
association between contemporaneous cash ows and accruals in the bad news periods, suggesting that accrued losses are
more likely to be reported in the periods of negative cash ows (Ball & Shivakumar, 2005).
We refer to the timeliness of good news 2 as G SCORE and the incremental timeliness of bad news 3 as C SCORE,
which we use to alternatively measure accounting conservatism. G SCORE and C SCORE are linear functions of rm-specic
characteristics (Watts, 2003):
G SCORE = 2 = 0 + 1 SIZEi + 2 MBi + 3 LEVi
(7)
C SCORE = 3 = 0 + 1 SIZEi + 2 MBi + 3 LEVi
(8)
We substitute them into regression Eq. (6) to obtain Eq. (9) below and get C SCORE as a rm-year measure of accounting
conservatism using 0 , 1 , 2 and 3 :
ACCi = 0 + 1 DCFOi + CFOi (0 + 1 SIZEi + 2 MBi + 3 LEVi ) + DCFOi CFOi (0 + 1 SIZEi + 2 MBi + 3 LEVi )
+ (0 SIZEi + 1 MBi + 2 LEVi + 3 DCFOi SIZEi + 4 DCFOi MBi + 5 DCFOi LEVi ) + i
(9)
141
Table 8
Regression results for robustness tests.
Model 1
Intercept
Model 2
OTHERS
BOOK
20012005
20062009
5.802***
(8.45)
2.584***
(4.08)
4.285***
(7.29)
0.753*
(1.73)
3.995***
(6.04)
0.521
(0.97)
CONS TA
Model 4
Model 5
Model 6
Model 7
Model 8
3.902***
(8.93)
3.541***
(8.29)
1.064*
(1.87)
3.456***
(8.20)
1.099*
(1.94)
3.350***
(8.96)
1.046*
(1.86)
3.285***
(7.64)
1.181**
(2.07)
3.475***
(8.56)
1.049*
(1.87)
0.191**
(2.28)
1.386*
(1.85)
0.199**
(2.37)
1.436*
(1.92)
0.192**
(2.31)
1.362*
(1.83)
0.267***
(3.23)
1.543**
(2.07)
0.183**
(2.19)
1.361*
(1.83)
0.002
(0.43)
0.407***
(9.67)
0.391**
(2.41)
0.048
(0.32)
1.256**
(2.43)
0.007***
(4.63)
0.231***
(2.59)
0.198*
(1.92)
0.002
(0.40)
0.392***
(10.08)
0.390**
(2.40)
0.054
(0.37)
1.195**
(2.30)
0.008***
(4.65)
0.224**
(2.51)
0.205**
(1.99)
0.001
(0.27)
0.388***
(9.64)
0.358**
(2.22)
0.071
(0.49)
1.313**
(2.55)
0.008***
(4.67)
0.218**
(2.45)
0.228**
(2.22)
0.236***
(3.49)
0.002
(0.46)
0.426***
(10.83)
0.354**
(2.18)
0.094
(0.64)
1.156**
(2.23)
0.008***
(5.03)
0.192**
(2.11)
0.265**
(2.58)
0.198***
(2.93)
0.363
(1.29)
1.857**
(2.33)
0.105
(1.24)
0.391
(1.39)
1.914**
(2.41)
0.001
(0.27)
0.398***
(10.28)
0.385**
(2.41)
0.059
(0.40)
1.186**
(2.34)
0.008***
(4.71)
0.210**
(2.37)
0.226**
(2.21)
0.227***
(3.36)
0.373
(1.43)
1.986***
(2.66)
1.160*
(1.86)
1.569*
(1.80)
CONS DA
C SCORE
Model 3
0.126**
(2.01)
0.068
(1.61)
0.306***
(2.64)
BOOK
0.927***
(5.91)
0.185**
(2.18)
0.008
(0.88)
0.479***
(7.25)
0.435**
(2.04)
0.044
(0.25)
0.168
(0.20)
0.016***
(6.43)
0.320***
(2.66)
0.601***
(2.60)
0.079
(0.86)
0.169
(0.41)
0.197
(0.17)
1.723
(1.45)
0.002
(0.35)
0.434***
(10.58)
0.398**
(2.42)
0.048
(0.33)
1.737***
(3.22)
0.007***
(4.56)
0.209**
(2.32)
0.315***
(2.91)
0.226***
(3.28)
0.392
(1.36)
1.949**
(2.44)
TA*BOOK
DA*BOOK
LDAY
OFF SIZE
OWN S
OWN L
TS
VOL
INTEG
EXCH
UWREP
LEV
ROA
0.001
(0.07)
0.313***
(3.46)
0.106
(0.40)
0.200
(0.75)
2.486***
(3.60)
0.001
(0.62)
0.012
(0.08)
0.073
(0.57)
0.348***
(3.30)
2.775***
(3.17)
5.374***
(3.47)
0.005
(0.63)
0.566***
(9.72)
0.407*
(1.94)
0.034
(0.20)
0.566
(0.71)
0.019***
(8.36)
0.313***
(2.72)
0.628***
(3.65)
0.068
(0.78)
1.119*
(1.93)
1.019
(0.87)
***
0.017
(2.95)
0.538***
(9.79)
0.427*
(1.76)
0.155
(0.62)
0.180
(0.30)
0.002
(0.90)
0.032
(0.28)
0.434***
(3.98)
0.097
(1.08)
0.668**
(2.01)
1.989**
(2.01)
UWREP1
0.097
(1.24)
UWREP2
0.064*
(1.89)
LEV1
0.012
(0.06)
SD
1.650***
(2.68)
OIA
N
R2
Adj. R2
F
299
0.204
0.171
11.62
358
0.326
0.303
11.96
310
0.337
0.308
11.56
364
0.314
0.289
12.34
653
0.203
0.185
11.58
674
0.183
0.166
10.55
674
0.183
0.166
10.55
673
0.198
0.180
11.57
656
0.207
0.189
11.94
674
0.197
0.180
11.55
Note: This table reports the regression results for robustness tests Model 1 use C SCORE as an alternative conservatism measure and partitions the full
sample into two subsamples according to whether a rm goes public through book building mechanism. Model 2 partitions the sample into two test periods
(20012005 vs. 20062009) to test the effect of circulation of non-tradable shares since 2006 on the association between accounting conservatism and
IPO underpricing. Model 3 use discretionary accruals as an alternative measure of conservatism. Models 4 to 8 use alternative measures of underwriter
reputation, leverage and protability for robustness tests. UWREP1 is a dummy variable and equals to 1 if the underwriter belongs to Top 5 underwriters
in China and 0 otherwise as the underwriters are ranked according to their total underwriting amounts. UWREP2 is a dummy variable and equals to 1 if
underwriter belongs to Top 5 underwriters in China and 0 otherwise, as underwriters are ranked according to their rm size. LEV1 refers to a rms total
debt divided by its net assets of the year before IPO. SD refers to a rms short-term debt divided by its book value of total assets of the year before IPO. OIA
is operating income divided by total assets of the year before IPO. Other variables are as dened in Table 2. All variables are winsorized at the extreme 1%
and 99%. t-Statistics are reported in parentheses.
*
**
***
142
Table 8 (Model 1) reports the regression results using C SCORE as the independent variable to measure accounting conservatism and test H1. The coefcient on C SCORE is 0.126 (t = 2.01) at the 5% signicance level for rms that go public
through other mechanisms than book building mechanism, while the coefcient on C SCORE is insignicant for rms that go
public through book building mechanism. This result is consistent with H1 and conrms the negative relationship between
accounting conservatism and IPO underpricing and the substitutive relationship between accounting conservatism and book
building mechanism.
As described earlier, the original non-tradable shares have been permitted to be traded on stock exchanges in China since
2006. Increased volume of publicly tradable shares offers potential investors more choices and reduces the high demand of
investors for new issues. This fact may mitigate the demand for accounting conservatism and lower the level of underpricing.
We partition the sample into two periods (20012005 vs. 20062009) to test the effect of the circulation of originally nontradable shares since 2006 on the relationship between accounting conservatism and IPO underpricing in the Chinese market.
Results of Model 2 in Table 8 show that the coefcient on CONS TA in the 20012005 period is 0.753 (t = 1.73) at the
10% signicance level but insignicant in the 20062009 period, indicating the negative relationship between accounting
conservatism and IPO underpricing is mitigated after the circulation of non-tradable shares in 2006.
We also consider discretionary accruals (DA) as the measure of accounting conservatism,14 because discretionary accruals
may be more directly affected by managers choice of accounting standards or practices that may result in varied degrees of
accounting conservatism. We employ the modied Jones model (Dechow, Sloan, & Sweeney, 1995) to measure discretionary
accruals. The modied Jones model is specied as follows;
TAit
= 0 + 1
Ait1
REV REC
it
it
Ait1
+ 2
GPPEit
+ it
Ait1
(10)
where TAit is total accruals for rm i in year t, REVit is the change in is total revenue from t 1 to t, and RECit is the
change in accounts receivables for rm i from the previous year. GPPEit is the gross acquisition cost of property, plants and
equipments for rm i in year t, and Ait1 is the value of total assets for rm i in year t 1.
The OLS residuals from Eq. (10) are the estimates of discretionary accruals. The alternative proxy for accounting conservatism (CONS DA) in this study is measured as discretionary accruals multiplied by negative one. The regression results for
H1 are similar when accounting conservatism is proxied by discretionary accruals (CONS DA). In Model 3, the coefcient on
CONS DA is 1.569 at the 10% signicance level while coefcients on other variables are generally the same as that shown
in Table 4 when discretionary accruals are used to measure accounting conservatism.
Finally, besides ranking underwriters according to the number of their IPO deals in the main test, we also rank underwriters in terms of total underwriting amounts and their rm size for robustness tests. In addition, we use a rms total
debt divided by its net assets at the year before IPO and a rms short-term debt divided by its book value of total assets of
the year before IPO to alternatively proxy for leverage risk. We also use operating income divided by total assets at the year
before IPO to proxy for rm protability. Models 48 in Table 8 report the regression results of the robustness tests and our
hypotheses are generally supported after adopting alternative measures of those control variables.
5. Conclusion
The purpose of this study is to investigate whether and how accounting conservatism impacts IPO underpricing in the
Chinese stock market. We utilize the unique data from Chinese IPO rms contextual to their inherent uncertainty and
information asymmetry to test two hypotheses. The results of our regression analyses reveal that IPO underpricing in China
is inversely associated with accounting conservatism, after controlling for deal-specic and rm-specic characteristics. This
evidence is consistent with asymmetric information theory underlying IPO underpricing in the literature. Thus, accounting
conservatism will help to reduce information asymmetry facing IPO rms and mitigate IPO underpricing. In addition, we nd
that the negative impact of accounting conservatism on IPO underpricing is more pronounced for rms with high information
asymmetry than for rms with low information asymmetry, indicating that higher information asymmetry creates more
incentives for conservative accounting by IPO rms. Our ndings should have positive implications for the improvement of
accounting and reporting practices and the effective operation of capital market in the emerging economies like China and
other developing countries.
Generalization of our study ndings must be made with caution as there are some distinct characteristics for the developing Chinese stock market at present. A potential limitation is that this study focuses mainly on the perspective of information
asymmetry to investigate the impact of accounting conservatism on IPO underpricing. However, there are other theories
regarding the causes of IPO underpricing in the literature. Factors other than information asymmetry could be explored to
investigate the association of IPO underpricing with accounting conservatism in future research. In addition, the validity
of the corporate governance variables (e.g., ownership concentration, proportion of outside directors, duality of CEO/Board
chairman positions and litigation risk) being used in our study may be further tested as the Chinese stock market is operating in a context with dominant government ownership and weak rule of law. The environmental differences should be
14
Our main test is based on the total accruals approach because discretionary accruals data are not available for some rms, so the proxy for accounting
conservatism measured by discretionary accruals is based on a smaller sample size.
143
taken into account, if data are available, if similar studies with data from other capital markets are carried out. Finally, more
rigorous empirical models based on multivariate data analysis may be developed to generate more powerful evidence on
the relationship between accounting conservatism and IPO underpricing.
Acknowledgements
The authors are thankful to two anonymous reviewers and Professor Kathleen Sinning (the Journal Editor) for their
insightful comments and editorial support to the previous drafts of this paper.
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Journal of International Accounting, Auditing and Taxation 21 (2012) 127144

Contents lists available at SciVerse ScienceDirect

Journal of International Accounting,

Accounting conservatism and IPO underpricing: China evidence

2.4. Accounting conservatism and information asymmetry

3.2. Measurement of IPO underpricing

3.3. Empirical model

Initial sample from 2001 to 2009 available from CSMAR

Number of IPOs by Year

High information asymmetry

Low information asymmetry

Panel B: second-stage regression

C SCORE = 3 = 0 + 1 SIZEi + 2 MBi + 3 LEVi

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