“What do Connections Offer? Causal Evidence from IPO Approval in China” by Ms. Juan MA
Ms. Juan MA
PhD Candidate in Business Administration
Department of Strategy
Harvard Business School
While there is a growing recognition that connections with the government add value to firms, it remains unclear whether connections are abused to help under-qualified firms gain undue advantage. Using a unique dataset obtained from China’s central government, I analyze the likelihood of getting the China Securities Regulatory Commission (CSRC)’s approval for a sample of 1,076 firms that applied for initial public offerings (IPOs) from 2009 to 2012. I first show that IPO applicants connected to the Public Offerings Review Committee (PORC) via auditing/law services are associated with a higher likelihood of obtaining IPO approval. Using a specific regulatory change and a natural experiment, I further document the following findings. First, among firms that obtained approval, improved government transparency (i.e. having the government disclose why a specific IPO decision is made) reduces IPO fraud and mitigates IPO underpricing for connected firms more than otherwise similar firms. This suggests that connections do not simply help firms acquire private information when policy discretion is exercised; rather, they are abused to help weak and fraudulent firms obtain government approval. Second, though connections matter, their effect decreases significantly with improved transparency. The odds for connected firms of obtaining approval are reduced by two-thirds after the government justifies its decisions publicly. Third, assignment of PORCs into single IPO reviews, which is determined by a pre-specified random process, also affects the likelihood of obtaining approval. In particular, auditors sitting on the PORCs favor firms connected via auditing/law services, but securities examiners act to suppress the connected. This suggests that the government’s internal checks and balances may also play a role in curbing connected firms from extracting rents from the public.