Private placement of public equity in China as a channel of tunneling and its wealth effects

Abstract

Private placement of public equity is dominating SEO and rights offering in

China’s equity refinancing practice, but has been scarcely studied. By retrieving

entries from financial data vendor Wind and collecting relevant data from reading

statements of private placements, I build a proprietary database and study five

aspects of private placement in China. Firstly I study which listed firms are more

likely to choose private placement over SEO in refinancing. Firms whose

controlling shareholder is state-owned and who want to establish business

connections with potential investors are the most likely to conduct private

placement. Secondly I look into the controlling shareholder’s decision whether to

purchase privately placed shares or not. The controlling shareholder does not care

about holdings dilution caused by not participating in a private placement. No

matter how severe information asymmetry is on the issuer’s true value, there are

always institutional investors contributing capital to it, so its largest shareholder

does not have to participate in the offering for the sake of solving underinvestment

problem. Thirdly I investigate how the offer discount is determined.

China’s private placements are sold to investors at an average discount of 24.83%.

Such discount does not reflect the largest shareholder or institutional investors

increased monitoring efforts after the placement. There is also no consistent

evidence that information costs explain the discount. In private placements where

the largest shareholder buys shares, however, the discount is as high as 43.16%.

Fourthly I calculate announcement period abnormal return of private placements.

The abnormal return is significantly positive. Again, increased monitoring from

the largest shareholder or big institutional investors does not explain the

positivity. There is mixed evidence whether reduction of information asymmetry

causes positive announcement-period abnormal return and inadequate evidence

whether more credible information leads to higher market reaction. Fifthly but not

finally, I document positive long-run abnormal return of private offerings,

evidence supportive of the under-reaction hypothesis. All these adventure

indicates that the largest shareholder does not deserve the excess discount in the

placement. The largest shareholder can ask for a lower price than institutional

investors’ for longer locking period of private shares, but it does not, showing that

liquidity is not a concern of it. It does not have to contribute capital to the issuer

for under-subscription of shares, because no matter how uncertain firm value is,

institutional investors are willing to dedicate enough proceeds. Thus information

asymmetry is no problem for the largest shareholder either. Positive long-run

abnormal return also does not justify the excess discount. I argue that the largest

shareholder tunnels by excess discount, rational of itself but harmful to other

shareholders.