Legal protection and underpricing of IPOs: Evidence from China

• Chinese IPOs from a province with better legal framework have less underpricing.
• This result is evident after controlling for time-invariant, province-fixed effects.
• The underpricing is negatively associated with the protection of property rights.
• These tendencies are evident only after the introduction of a book-building system.

Chinese data enable investigation of the relationship between underpricing of initial public offerings (IPOs) and legal protection with controlling for time-invariant characteristics of regions. Our investigation of Chinese IPOs between 1997 and 2009 shows that firms from a province with more developed legal framework experience less underpricing after controlling for time-invariant, province-fixed effects. We also find that the extent of underpricing is decreased by the strength of legal protection of property rights. Importantly, these tendencies are evident only after the introduction of a book-building system, which provides issuers and underwriters with discretion on offering price determination. These results offer robust evidence that legal protection mitigates ex ante uncertainty regarding property rights protection, and thereby, reduces underpricing.