IPO Valuation in China

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Valuing IPOs Using Price-Earnings Multiples

Disclosed by IPO Firms in an Emerging Capital
Market
Article in Review of Pacific Basin Financial Markets and Policies September 2008
DOI: 10.1142/S0219091508001428 Source: RePEc
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September 12, 2008 16:30 WSPC/155-RPBFMP 00142.tex
Review of Pacic Basin Financial Markets and Policies

Vol. 11, No. 3 (2008) 429463

c World Scientic Publishing Co.
and Center for Pacic Basin Business, Economics and Finance Research
Valuing IPOs Using Price-Earnings

Multiples Disclosed by IPO Firms in an Emerging
Capital Market
Michael Firth
Department of Finance
Lingnan University, Tuen Mun, NT
Hong Kong, China
mafirth@ln.edu.hk
Yue Li
Joseph L. Rotman School of Management
University of Toronto, 105 St. George Street
Toronto, Ontario, Canada, M5S 3E6
yueli@rotman.utoronto.ca
Steven Shuye Wang

School of Accounting and Finance
The Hong Kong Polytechnic University
Hong Hum, Kowloon, Hong Kong, China
afwang@inet.polyu.edu.hk
Existing studies show that markets use comparable rm multiples to price IPOs.
This study explores IPO valuations in an emerging market where reliable compa-
rable price multiples may not be readily available, or cannot be reliably identied.
In particular, we examine the value relevance of price-earnings multiples disclosed
by managers in IPO prospectuses in China. Using a sample of IPOs from 1992 to
2002, we nd that price-earnings multiples disclosed by IPO rms provide signi-
cant power in explaining price formation in this emerging market. We also nd that
price-earnings multiples disclosed by IPO rms after 1999, when the China Secu-
rities and Regulatory Commission relaxed its internal guideline for approving IPO
applications, are more informative. The results are robust to a variety of empiri-
cal model specications. This study contributes to the existing IPO literature by
showing that the disclosure of price-earnings multiples provides a mechanism for
429
430 Michael Firth, Yue Li & Steven Shuye Wang
IPO rms to convey information about IPO rm quality when reliable comparable
rm multiples may not exist.
Keywords: Valuation; IPOs; price-earnings multiples.
JEL Classication: G24
1. Introduction
This study examines the value relevance of price-earnings multiples disclosed
in IPO prospectuses in China. In particular, we examine whether price-
earnings multiples disclosed by IPO rms explain price formations during
the initial IPO listing process and whether they can predict realized (actual)
price-earnings multiples after the IPO. This paper is motivated by the
fact the securities regulations in China require IPO rms to disclose price-
earnings multiples in IPO prospectuses that management considers appro-
priate for IPO valuation purposes. In addition, the China Securities and
Regulatory Commission (the CSRC) also established some informal guide-
lines with respect to appropriate price-earnings multiples when approving
IPO applications. One reason for the disclosure requirement and the infor-
mal guideline is that the capital market in China is still in its infancy stage
and reliable comparable rm price-earnings multiples do not always exist.
Investors arguably will benet from the disclosure policy through improved
IPO valuation if the disclosed price-earnings multiples reect managers pri-
vate information about IPO quality.
The price-earnings (P/E) valuation method has been used extensively,
both in practice and in academic research, to value a rms stock price
(Alford, 1992). Existing studies show that investors can improve IPO pric-
ing accuracy by using comparable rm price-earnings multiples (Firth, 1998;
Kim and Ritter, 1999). The underlying assumption of this approach is that
comparable rms, when reliably identied, should have similar P/E multi-
ples. Thus, investors can benchmark the stock price as the product of the
rms earnings (or earnings forecasts) and the P/E multiple determined from
a set of comparable rms. The usefulness of this approach depends, to a large
extent, on whether comparable rms exist and whether they can be reliably
identied. Existing research focuses on equity valuation in developed cap-
ital markets and has used a variety of ways to identify comparable rms,
including industry classications, rm-specic risk characteristics, earnings
growth potential, and in-depth analysis from research boutiques. Applica-
tion of the price-earnings valuation method to emerging capital markets
can be dicult because reliable benchmark price-earnings multiples from
Valuing IPOs Using Price-Earnings Multiples 431
comparable rms may not even exist, and this is especially true when a
stock market is relatively new. The CSRC requires IPO rms to disclose in
the IPO prospectus an earnings forecast and a price-earnings multiple that
managers use to determine IPO oer prices. This study assesses whether the
CRSCs disclosure requirement is eective in terms of improving accuracy in
IPO valuation. Specically, we examine the value relevance of price-earnings
multiples disclosed in IPO prospectuses in the price formation process fol-
lowing the IPO listing.
Our research makes a contribution to the literature on the value relevance
of accounting data. It does so in the context of an emerging capital mar-
ket and a fast-growing transitional economy. China has not yet had time to
establish the kind of institutional framework that surrounds securities mar-
kets in the US and other capitalist nations and we argue that this makes
accounting information even more important (Chen et al., 2002; Firth et al.,
2007). Investment bankers, underwriters, and institutional investors all play
vital roles in ensuring the success of the IPO market in the US, and under-
pinning this is the expertise and mutual trust among the parties to the IPO.
The embryonic nature of Chinas securities markets means that investment
bankers, underwriters, and especially institutional investors are either miss-
ing or underdeveloped. As a consequence of this, investors have fewer sources
of information and thus accounting data published in IPO prospectuses is
relatively more important.1
This paper is organized as follows. Section 2 provides the institutional
details underlying this study, reviews relevant literature, and discusses the
motivation of the study. We develop our hypotheses in Section 3 and lay
out our empirical models in Section 4. Section 5 describes data sources and
presents summary statistics of key variables. We discuss the main results
in Section 6 and the results of sensitivity analysis in Section 7. Section 8
concludes with a discussion of policy implications and future research
directions.
2. Institutional Setting and Literature Review

2.1. Institutional setting
The CSRC assesses and approves IPO applications in China. Within the
overall remit of developing a well functioning capital market in China, a
1
In contrast, in more developed markets, it is often dicult to disentangle the value of
accounting data from other sources of information.
major objective of the CSRC has been to control the aggregate supply
of new issues so that investors can absorb them. To protect the interests of
small investors in Chinas stock markets, the CSRC assumes the role of
assessing IPO rm quality by imposing some stringent conditions and dis-
closure requirements. The CSRC monitors the IPO oering price determina-
tion process and requires IPO rms to disclose price earnings multiples that
management deems appropriate for determining the oer price. The CSRC
established some internal (informal) guidelines with respect to acceptable
price earnings multiples by IPO rms which it then uses to assess IPO appli-
cations. For example, before February 1999, it was well known by underwrit-
ers and IPO rms that the CSRC used a ceiling price earnings multiple of
15 to assess IPO applications. IPO rms wishing to set oer prices with
a price earnings multiple higher than 15 needed further approval from the
CSRC, and thus they ran the risk of not receiving approval from the CSRC
(Chan et al., 2004).2 One motivation for this policy was to ensure that
price earnings multiples used by IPO rms to determine IPO oer prices
reect rm quality. The CSRC assesses IPO applications with respect to
the relative price earnings multiples of recent IPO rms and the approval
process eectively acts as a quality control mechanism for IPOs in China.3
This unique institutional setting provides a mechanism for IPO rms to use
price-earnings multiples to signal rm quality. This policy is sensible during
the early stage of Chinas emerging capital markets when reliable compar-
able rm price multiples did not exist or could not be established by average
investors.4
As the stock markets matured, the CSRC issued a new IPO pricing
guideline on February 12, 1999 (CSRC, 1999). The new guideline requires
2
The risk of not being approved by the CSRC may deter IPO rms from inating price-
earnings multiples in order to receive a higher oer price. As shown in Panel B of Table 1,
the price earnings multiples disclosed by IPO rms range from 6.79 to 27.96 with a mean
(median) of 14.63 (14.50) during that period.
3
Two of the authors visited the CSRC in the summer of 2005 for the purpose of this project.
We interviewed senior ocers in the CSRC in charge of IPO disclosure enforcement and
approval. All of them received advanced education in the US or Canada (M.B.A. and
Ph.D.) and some have worked in the Big Five accounting rms in the US and in the
SEC before they returned to China. They all have an excellent knowledge about the IPO
valuation and the related disclosure requirements as practiced in North America.
4
Securities regulators in Malaysia adopted a similar, but more stringent, approach. Before
1996, the Malaysia Securities Commission directly intervened in setting the IPO oer
price by prescribing a price-earnings multiple, ranging from 3.5 to 15.5, depending on the
industrial sector of the IPO rm (Wan-Hussein, 2002).
IPO rms to provide more detailed information about the price earnings
multiple used to determine the IPO oer price. In particular, IPO rms are
now required to provide in their prospectuses recent average price earnings
multiples in Chinas two stock markets, as well as the average price earn-
ings multiples of the relevant industry and comparable rms. IPO rms must
explain in this context how the price earnings multiples used are determined.
Following the issuance of this new guideline, the CSRC no longer approves
IPO applications based on the previously established internal price earnings
multiple guideline of 15 times earnings. The issuance of the new guideline
represents a regulatory regime shift. It reects the CSRCs belief that allow-
ing IPO rms to use price earnings multiples, which are more in line with
market conditions and industry benchmarks, is more informative.
2.2. Literature review

The use of accounting information in combination with comparable rm
multiples, such as P/E multiples, is widely practised in valuing IPOs (Kim
and Ritter, 1999). One issue that arises in using the P/E valuation method
is how to reliably identify comparable rms in the existing capital market.
Ideally, comparable rms should be selected based on variables that explain
cross-sectional variations in P/E multiples. Theory suggests that growth and
risk are the main fundamental factors that may explain dierences between
P/E multiples of comparable rms. Ohlson (1990) expresses a rms P/E
multiple as a function of expected earnings growth rate, expected dividend
pay-out rate, and a risk adjustment arising from the stochastic evolution
of earnings. However, in spite of extensive research, factors that aect P/E
multiples are not completely understood.
Alford (1992) examines the P/E valuation method when comparable
rms are selected on the basis of industry, risk (measured by rm size), and
earnings growth. Using a sample of rms listed in the US in 1978, 1982, and
1986, he nds that selecting comparable rms by industry is relatively more
eective in terms of predicting the P/E multiple of the experimental rm
than other selection criteria. Kim and Ritter (1999) examine IPO valuation
in the US using price-earnings, market-to-book, and price-to-sales multiples
of comparable rms. Comparable rms are identied, either as recent IPOs
in the same industry or comparable rms chosen by a research boutique
that specializes in valuing IPOs. A key nding in their paper is that using
earnings forecasts from a research boutique improves the valuation accuracy
substantially. Liu et al. (2002a) examine the valuation performance of a
comprehensive list of price multiples. They nd that price multiples derived

from earnings, both historical and forecasts from IBES, outperform multiples
derived from other value drivers. Similarly, they show that industry price
multiples derived from earnings perform best in an international setting (Liu
et al., 2002b).
Existing studies suggest that comparable price-earnings multiples, when
reliably identied, contain value relevant information that investors can use
to improve equity valuation. The stock markets in China are still in the
development stage, with few institutional investors and limited nancial ana-
lyst following. We argue that it is dicult for investors in China to employ
comparable rm price-earnings multiples to value IPOs because they do not
exist or cannot be reliably identied. For this reason, the CSRC requires dis-
closures of price-earnings multiples, coupled with the enforcement and the
informal guidelines used to approve IPO listing, in order to provide a P/E
benchmark for investors to value IPOs in Chinas emerging capital markets.
This study examines whether price-earnings multiples disclosed by IPO
rms provide valuation relevant information. Unlike the existing studies that
assess the usefulness of price multiples derived from comparable rms, we
focus on the information content of price-earnings multiples disclosed by
managers in IPO prospectuses. The ndings from this study will shed light
on the eectiveness of this disclosure policy in Chinas emerging capital
markets where comparable rms price-earnings multiples either do not exist
or cannot be reliably identied.
3. Theory and Hypothesis Development

IPO valuation is susceptible to information asymmetry problems because
entrepreneurs typically know their nancial situation, business prospects,
industriousness and integrity better than uninformed outside investors in
the business venture (Leland and Pyle, 1977). Signaling theory suggests
that managers may choose credible mechanisms to convey their private
information about rm quality to investors in order to overcome the infor-
mation asymmetry. Given the lack of other signaling devices in Chinas
emerging markets,5 IPO rms can choose the level of earnings forecasts and
price-earning multiples to signal rm value. These signals are credible in
5
For example, retained ownership, which is central to Leland and Pyles model, may not
be a credible signaling device in China. The retained ownership of IPOs in China reects
the ownership of the state and the aliated ministries and government agencies, rather
than the ownership retained by entrepreneurs.
Chinas regulatory setting because signicant deviations from earnings fore-

casts ex post may trigger sanctions by the securities regulators.
Alternatively, existing studies also show that managers have incentives
to manipulate accounting earnings before IPOs. Management earnings fore-
casts often are optimistic and contain an upward bias.6 One can argue that
price-earnings multiples disclosed by IPO rms in China may be inated
because of rms incentives to obtain higher oer prices. Unlike earnings
forecasts, it is dicult for the CSRC to sanction IPO rms ex post simply
because realized price-earnings multiples after an IPO dier from the price-
earnings multiples disclosed in IPO prospectuses.7 Manipulating earnings
forecasts through accounting accruals is limited for two reasons. First, the
exibility in GAAP cannot be stretched too far and accounting accruals are
a mean reverting process. Exercise of discretion of accounting accruals in
the current period will limit future exibility. Second, current securities reg-
ulations in China require IPO rms to publicly explain why actual earnings
deviates from earnings forecasts when the dierence is signicant.
The above discussion motivates us to examine the extent to which dis-
closures of price-earnings multiples in IPO prospectuses are informative to
investors in China. If price-earnings multiples disclosed in IPO prospec-
tuses convey managements private information about IPO rm quality, as
intended by the CSRCs disclosure policy, the share price after the IPO
will impound such information. Since investors reward high quality rms
with high share prices (high price-earnings multiples after IPO listing), this
suggests that the price-earnings multiples disclosed in IPO prospectuses, if
informative, should predict the realized price-earnings multiples after IPOs.
Our rst hypothesis (in alternate form) is as follows:
H1: Price-earnings multiples disclosed in IPO prospectuses provide relevant

information to predict price-earnings multiples after the IPO.
We test Hypothesis 1 by examining whether managements price-earnings

multiples can explain variations in realized price-earnings multiples after
the IPO.
6
Chen and Firth (1999) nd that earnings forecasts in Chinese IPO prospectuses are
moderately accurate.
7
This is because managers have no, or limited, control over stock prices after IPO listing. It
is interesting to note that, as shown in Section 5, the average price-earnings multiple after
an IPO is two to three times higher than the average price-earnings multiple disclosed by
an IPO rm. Thus, there seems no direct evidence that price-earnings multiples disclosed
in IPO prospectuses are inated.
Our second hypothesis examines whether price-earnings multiples dis-

closed in IPO prospectuses assist investors valuations of IPOs. If man-
agements price-earnings multiples provide a valuation benchmark in the
absence of reliable comparable rm price-earnings multiples in Chinas
emerging capital market, they should improve accuracy in IPO valuation.
Thus, our second hypothesis (in alternate form) is as follows:
H2: Price-earnings multiples disclosed in IPO prospectuses are value rele-
vant and will improve accuracy in IPO valuation.
We test Hypothesis 2 by examining whether price-earnings multiples dis-
closed by IPO rms reduce pricing errors using a number of model
specications.
Finally, we examine the impact of a regulatory regime change on the
informativeness of price earnings multiples in February 1999. As discussed
in Section 2.1, the CSRC issued a new regulation with respect to IPO pric-
ing on February 12, 1999. The new guideline requires IPO rms to provide
detailed information on how the price-earnings multiples disclosed in IPO
prospectuses are determined in the context of the average market price earn-
ings multiple. Specically, IPO rms are required to supply information on
the average price earnings multiples for the whole market, the related indus-
tries, and comparable rms if any. The new rule signals a regulatory regime
shift because the CSRC stopped using the internal guideline on price earn-
ings multiples to assess the qualication for IPO listing. Instead, IPO rms
are allowed to use price earnings multiples to determine oer prices to the
extent they can justify them. Thus, we expect that the price earnings mul-
tiples disclosed after February 1999 will be more in line with existing price
earnings multiples in the markets. We will examine whether price earnings
multiples disclosed after February 1999 are more informative than those used
before by splitting our empirical analyses into two periods: before and after
February 1999.
4. Econometric Models
To test Hypothesis 1, we examine whether price-earnings multiples disclosed
by IPO rms explain actual price-earnings multiples after IPOs. Ohlson
(1990) suggests that P/E multiples are aected by the anticipated dividend
payout, earnings growth, risk in the earnings process, and the risk free inter-
est rate. Following Ohlson, we implement the following econometric model:
PE it = 0 + 1 PE im + 2 GROWTH i + 3 DebtRi
+ 4 RISK i + 5 RM + i , (1)
where PEit is rm is price-earnings ratio at time t after the IPO, where t = 1

day, 7 days, 28 days, 1 year, and 2 years after IPO listing; PEim is rm is
price-earnings multiple disclosed in the IPO prospectus; GROWTHi is a
proxy for earnings growth, measured as the average earnings growth over a
ve-year period (three years before and two years after IPO listing). RISKi is
a proxy for rm specic risk, measured by the standard deviation of earnings
over a ve-year period.8 We also include another proxy, the debt to assets
ratio, DebtRi , before IPO as a further control for rm specic risk. RM is the
market index return, a control variable for prevailing economic expectations
in the equity market. If PEim is informative and conveys managements
private information about the quality of IPO rms, we will expect 1 to be
signicant and positive.
To test Hypothesis 2, i.e., whether PEim improves accuracy in IPO valu-
ation, we must specify a pricing mechanism that investors use to value IPOs.
The signalling literature suggests that IPO rms can use costly signals to
convey private information about rm value. Examples of signals include
levels of earnings forecasts (Hughes, 1986), entrepreneurs retained owner-
ship (Leland and Pyle, 1977), and the quality of auditor and underwriter
(Titman and Truman, 1986). In addition, Ohlson (1995) derives a rm val-
uation model based on some fairly general assumptions on the information
dynamics of accounting variables. In general, IPO rm value is determined
by its ability to generate future earnings. High quality IPO rms either
enjoy greater future growth potential or have more persistent earnings in
the sense that their future earnings can be more reliably predicted by their
present earnings. We do not attempt to validate which valuation model per-
forms best in Chinas emerging capital markets in this study. Rather, we
show that if PEim contains managements private information about IPO
rm quality, it should improve valuation accuracy in the existing valuation
models.
Our rst specication of an IPO valuation model is based on signalling
theory, which suggests that managers of IPO rms use credible signals to
convey their private information about IPO rm value to investors. We adopt
a version of the following signalling valuation model, similar to Downes and
Heinkel (1982), Clarkson et al. (1992), and Li and McConomy (2004):
Vi = 0 + 1 Ki + 2 i + 3 Auditor i + 4 Underwriter i
+ 5 EF i + i , (2)
8
Alternatively, we also measure RISKi by the standard deviation of stock prices after the
IPO and rms values. The empirical results are similar.
where Vi is IPO rm value, measured by the closing price multiplied by

shares outstanding; Ki is the net investment in the rm after the IPO,
measured as the sum of shareholders equity before IPO plus IPO proceeds;
i is the retained ownership by the state, i = i + ln(1 i ), with i
being the number of state shares to the total number of shares outstanding;
Auditori is a dummy variable for auditor quality, which is set equal to one
if a top 10 audit rm as dened in DeFond et al. (1999) is used, and zero
otherwise;9 Underwriteri is a dummy variable for underwriter quality, which
is set equal to one for a top 10 underwriter in terms of total IPO underwriting
volume in 2000 and 2001, and zero otherwise. Finally, EFi is rm is earnings
forecast disclosed in the IPO prospectus.
Model 2 assumes that investors do not dierentiate EFi disclosed by
dierent rms and assigns the same coecient (5 ) to a dollar of earn-
ings forecast. If the price-earnings multiple disclosed by the IPO rm con-
tains information about IPO quality, investors can improve IPO valuation
by allowing 5 to change proportionally according to the price-earnings mul-
tiples disclosed by IPO rms. Thus, we implement the following model:
Vi = 0 + 1 Ki + 2 i + 3 Auditor i + 4 Underwriter i
+ 5 (PE im ) EF i + i (3)
If Model 3 contains, on average, smaller pricing errors than Model 2 does,

it is consistent with our Hypothesis 2. To control for heteroskedasticity and
scale eect (Barth and Kallapur, 1996; Brown et al., 1999), we follow Downes
and Heinkel (1982), Hughes (1986), and Feltham et al. (1991). Specically,
we scale regression Models 2 and 3 by K and estimate Models 4 and 5,
instead:
Vi 1
= 0 + 1 + 2 i + 3 Auditor i
Ki Ki Ki
EFi
+ 4 Underwriter i + 5 + i (4)
Ki
Vi 1
= 0 + 1 + 2 i + 3 Auditor i
Ki Ki Ki
EFi
+ 4 Underwriter i + 5 (P Eim ) + i . (5)
Ki
9
DeFond et al. (1999) obtain proprietary IPO market share data for all public accounting
rms involved in IPO in China. We dene a high quality audit rm as one of the top 10
audit rms listed in Table 8 of DeFond et al. (1999, p. 304).
As a robustness check, we replicate the IPO valuation model used in Kim

et al. (1995), which is slightly dierent from Model 2 and uses per share
data. Kim et al. (1995) examines whether nancial variables such as EPS
prior to the IPO aect closing prices. We use a slightly modied model of
Kim et al. (1995) as follows:
Pi = 0 + 1 RM + 2 Ki + 3 i + 4 INV i
+ 5 Underwriter i + 6 EPS i + ui , (6)
where Pi is the closing price; RM is the market index return on the IPO
listing day; INVi is issue proceeds designated to capital expenditure; EPSi
is earnings forecast per share; all other variables are as dened earlier.
Model 6 constrains 6 to be constant for all IPO rms. Hypothesis 2
suggests that investors can use the price-earnings multiples disclosed by
IPO rms to assess the quality of managements EPS forecast. If the price-
earnings multiples disclosed in IPO prospectuses are informative of IPO
rm quality, we expect that the following valuation model will outperform
Model 6 in terms of pricing error:
Pi = 0 + 1 RM + 2 Ki + 3 i + 4 INV i
+ 5 Underwriter i + 6 (PE im ) EPS i + ui . (7)
Next, we test Hypothesis 2 using an empirical version of the Ohlson
(1995) valuation model where rm value equals a rms book value of share-
holders equity plus abnormal earnings. Specically, Equation (5) in Ohlson
(1995), Equation (8) in our paper, expresses market value of the rm Vt as
follows:
Vt = yt + a1 xat + a2 vt , (8)
where yt is (net) book value of equity; xat is abnormal earnings measured
as earnings minus capital costs of shareholder equity; and vt is other value
relevant information that is not captured by nancial variables. The coef-
cient a1 in Equation (8) is an increasing function of , a parameter that
reects persistence (quality) of abnormal earnings. The Ohlson valuation
model implies that high quality IPO rms should have a high a1 coecient.
We test Hypothesis 2 by implementing the following two valuation mod-
els and examining improvements in pricing error. Model 9 is a simple ver-
sion of Ohlson (1995), Equation (8), without the other information term,
while Model 10 allows a1 to vary proportionally according to the price-
earnings multiples disclosed by IPO rms. Signicance of 2 in Model 10
with a smaller pricing error is consistent with Hypothesis 2. We choose not
to include the other information term in our empirical models for sim-
plicity. Since our tests are based on pricing errors in both models, common
omitted variables, if any, will not bias the results in our favor.
Vt = 0 + 1 yt + 2 xat + t (9)
Vt = 0 + 1 yt + 2 (PE im )xat + t . (10)
To control for heteroskedasticity and scale eect (Barth and Kallapur, 1996;
Brown et al., 1999), we normalize Equations (9) and (10) by shareholder
equity after IPO listing, K, and implement Models 11 and 12 as below:
Vt /Kt = 0 (1/Kt ) + 1 yt /Kt + 2 xat /Kt + et (11)

Vt /Kt = 0 (1/Kt ) + 1 yt /Kt + 2 (PE im )xat /Kt + et . (12)
5. Data Sources and Summary Statistics

The study covers the IPO issues during the period of 1992 to 2002 in the
two stock exchanges (Shanghai and Shenzhen) in China. The total number
of IPOs during the sample period is about 1,224 rms.10 The earnings fore-
casts and price earnings multiples in IPO prospectuses are obtained from
the China Stock Initial Public Oerings Research Database. Price and earn-
ings data after IPO listing are obtained from Taiwan Economic Journal
Database. For any missing data, we searched IPO prospectuses manually
and hand-collected the data we needed. The nal sample consists of about
745 IPO rms.11
Table 1 reports summary statistics for some key variables of the sam-
ple. The average price-earnings multiple disclosed by IPO rms is about
17 over the whole sample period. However, we observe a dierent pattern
after splitting the sample into two sub-periods before and after Febru-
ary 1999. The price-earnings multiples disclosed in the rst sub-period are
lower and less volatile than those in the second sub-sample period, i.e., after
February 1999. The average price-earnings multiple is 14.5 and 23.7 in the
two sub-periods, respectively, while the standard deviation is 2.5 and 9.2,
respectively. The correlations between price earnings multiples disclosed by
IPO rms and realized price multiples after IPO are much higher in the
10
This gure includes all rms that have issued listed securities (A-, B-, and H-shares). Our
study is limited to domestic IPO issues (A-shares). B- and H-shares are sold to foreigners.
11
Since we need the realized earnings one and two years after IPO and some other informa-
tion, the actual sample size reported in dierent tables and in dierent analyses may vary.
The actual number of observations used in the analysis is listed in each table separately.
Table 1. Summary statistics.
No. of
Variable Mean Std. Dev. Min Max Median Obs.
Panel A: Whole sample period

IPO proceeds 356.47 462.11 33.000 7,845.9 246.60 707
Shareholder equity after IPO 615.17 1,047.3 45.00 22,147 410.59 707
Shares outstanding after IPO 256.57 644.39 50.00 12,512 140.00 707
State ownership (%) 70.72 8.98 0.00 98.56 71.79 707
IPO price 6.302 2.271 1.900 20.000 5.950 707
Price on listing day 14.640 7.065 3.420 63.550 13.400 707
Price on day 7 14.546 7.241 3.010 59.200 13.290 707
Price on day 28 14.432 7.261 2.260 60.930 12.960 707
Mgmt. Earnings forecast 80.576 157.80 4.576 2,807.3 44.800 707
Mgmt. EPS forecast 0.3552 0.1805 0.0187 1.7682 0.3220 707
PEim 17.251 6.865 5.560 71.450 15.000 707
PE1 50.226 42.572 6.485 430.98 39.073 707
PE7 49.763 42.159 6.046 383.18 38.638 707
PE28 49.383 42.521 6.294 418.70 38.408 707
PE1Y 50.106 44.001 6.492 919.89 41.558 707
PE2Y 72.196 161.87 6.087 2,492.1 39.776 707
Correlation Matrix PEim PE1 PE7 PE28 PE1Y PE2Y
PEim 1.0000
PE1 0.4173 1.0000
PE7 0.4240 0.9884 1.0000
PE28 0.4292 0.9696 0.9787 1.0000
PE1Y 0.3429 0.2340 0.2458 0.2558 1.0000
PE2Y 0.0802 0.0205 0.0201 0.0313 0.0805 1.0000
No. of
Panel B: Before February 12, 1999

IPO proceeds 267.46 295.40 33.00 2,625.0 181.44 497
Shareholder equity after IPO 463.55 561.20 45.00 4,498.0 323.20 497
Shares outstanding after IPO 224.16 493.72 50.00 6,455.3 120.00 497
State ownership (%) 71.76 8.84 38.46 98.56 73.53 497
IPO price 5.885 1.804 1.900 15.000 5.770 497
Price on day 7 13.393 5.805 3.010 59.020 12.700 497
Price on day 28 13.172 5.918 2.260 60.930 11.950 497
Mgmt. Earnings forecast 76.310 125.18 4.576 1,665.2 44.088 497
PEim 14.515 2.489 5.560 27.960 14.500 497
PE1 42.687 41.418 6.485 430.91 35.286 497
PE7 42.069 40.480 6.046 383.18 35.409 497
PE28 41.175 40.468 6.294 418.70 33.506 497
PE1Y 42.369 46.250 6.492 919.89 36.875 497
PE2Y 60.248 152.19 6.087 2,492.1 35.871 497
Table 1. (Continued )
PEim 1.0000
PE1 0.1435 1.0000
PE7 0.1421 0.9875 1.0000
PE28 0.1238 0.9640 0.9721 1.0000
PE1Y 0.0934 0.0442 0.0519 0.0652 1.0000
PE2Y 0.0597 0.0188 0.0237 0.0220 0.0504 1.0000
No. of
Panel C: After February 12, 1999

IPO proceeds 567.13 671.46 69.255 7,845.9 409.85 210
Shareholder equity after IPO 974.01 1,665.5 149.12 22,147 610.71 210
Shares outstanding after IPO 333.27 903.19 50.566 12,512 178.72 210
State ownership (%) 68.28 8.87 0.00 92.42 68.82 210
IPO price 7.288 2.883 3.050 20.000 6.485 210
Price on day 7 17.275 9.301 4.620 59.200 15.665 210
Price on day 28 17.415 9.070 4.900 59.460 16.045 210
Mgmt. Earnings forecast 90.674 216.27 11.049 2,807.3 210
PEim 23.724 9.198 10.250 71.450 19.860 210
PE1 68.069 39.949 12.186 375.50 63.759 210
PE7 67.972 40.512 14.747 377.00 60.746 210
PE28 68.808 41.009 14.551 403.75 61.487 210
PE1Y 68.417 31.375 11.007 209.03 66.905 210
PE2Y 100.47 180.02 9.162 1,470.6 59.834 210
PEim 1.0000
PE1 0.5763 1.0000
PE7 0.5692 0.9879 1.0000
PE28 0.5670 0.9758 0.9882 1.0000
PE1Y 0.5370 0.6485 0.6557 0.6364 1.0000
PE2Y 0.0085 0.0052 0.0103 0.0358 0.0629 1.0000
IPO proceeds, shareholders equity after IPO, and managements earning forecasts are in
million RMBs; Shares outstanding after IPO is in million shares; prices and EPS are in
RMB; PEit is rm is price-earnings ratio at time t after IPO, where t = 1 day, 7 days,
28 days, 1 year, and 2 years; PEim is rm is price-earnings multiple disclosed in its IPO
prospectus.
second sub-sample period than those in the rst sub-sample period. This
observation is consistent with our expectation that the price earnings multi-
ples disclosed after February 1999 are more informative. Interestingly, over
the whole sample period, as well as in both sub-sample periods, the average
of actual price earnings multiples after IPO is about three times as large
as the average of price earnings multiples disclosed by IPO rms, which
suggests the existence of systematic IPO under-pricing. Finally, the state
ownership is slightly lower in the second sub-sample period (68.28%) than
that in the rst one (71.76%).
6. Empirical Results and Analysis

Table 2 reports the estimates and related test results of Equation (1). If
PEim is informative and conveys managements private information about
the quality of IPO rms, then we will expect 1 to be signicant and pos-
itive. Table 2 shows that 1 is signicantly positive at the 5% level for all
the cases, i.e., for t = 1 day, 7 days, 28 days, 1 year, and 2 years. This result
is consistent with Hypothesis 1 that price-earnings multiples disclosed by
IPO rms have predictive power for realized P/E ratios after listing. In an
ideal world where there is no information asymmetry between management
and investors, 1 should be close to 1. In our case, however, all 1 estimates
are signicantly bigger than 1 (around 2 to 2.6). This is partly due to the
large under-pricing of IPOs in China (see, for example, Chen et al., 2004),
and partly due to the control by the CSRC to ensure the price earnings
multiples used by IPO rms were consistent with the informal guideline,
which was considerably lower than the market average. There is some evi-
dence that rm risk proxies RISKi and DebtR1 are negatively associated
with realized price-earnings multiples, consistent with the Ohlson (1990)
model. It is interesting to see that there is a dramatic improvement in the
adjusted R2 values in every model in Panel C of Table 2 in comparison to
Panel B. This nding is consistent with our prior expectation that earnings
multiples after February 1999 are more informative in terms of explaining
actual price formation after IPO listing.
Table 3 reports the estimates for the scaled signalling Models 4 and 5.
Model 4 assumes that investors do not dierentiate EF disclosed by dierent
rms and assign the same coecient (5 ) to a dollar of earnings forecast,
while Model 5 allows 5 to change proportionally to price-earnings multiples
disclosed by IPO rms. Results in Table 3 show that for all sample periods,
Model 5 produces smaller mean forecast errors (MFE) and higher adjusted
R2 than Model 4. The t-tests for the MFE dierence between Models 4 and 5
are signicantly positive at the 5% level for the whole sample and for the
later period 1999 to 2002. In addition, we observe a dramatic improvement
in adjusted R2 in the second period between Models 5 and 4. Overall, the
Table 2. Estimation of the Ohlson (1990) model.

PE it = 0 + 1 PE im + 2 GROWTH i + 3 DebtR i + 4 RISK i + 5 RM + (1)
1 day 7 day 28 day 1 year 2 year
Panel A: Whole sample

Intercept (0 ) 6.5698 5.5687 3.6948 12.196 43.495
PEim (1 ) 2.5880 2.6151 2.6859 2.2162 1.9244
Growth (2 ) 0.2779 0.3148 0.6893 0.1244 0.7221
DebtR (3 ) 0.0061 0.0061 0.0081 0.0042 0.0046
Risk (4 ) 0.0623 0.0625 0.0674 0.0834 0.1799
RM (5 ) 5.8953 4.7366 4.4674 3.5499 0.5406
No. of 693 693 693 681 662
observations
Adj. R2 0.1709 0.1775 0.1936 0.1277 0.0026
Log likelihood 3,523.08 3,514.34 3,501.64 3,488.08 4,317.39
Intercept (0 ) 2.0797 3.2555 5.5535 8.9245 6.6463
PEim (1 ) 2.8817 2.7495 2.5149 2.3964 4.6442
Growth (2 ) 0.1454 0.1804 0.6371 0.1188 0.2800
DebtR (3 ) 0.0060 0.0059 0.0075 0.0033 0.0162
Risk (4 ) 0.0662 0.0624 0.0847 0.1078 0.1553
RM (5 ) 4.1397 1.7877 2.0243 2.3496 0.7461
No. of 485 485 485 473 459
observations
Adj. R2 0.0226 0.0213 0.0219 0.0132 0.0049
Log likelihood 2,497.20 2,486.60 2,472.53 2,476.10 2,965.62
Intercept (0 ) 9.3756 8.5770 9.4884 30.433 142.20
PEim (1 ) 2.4568 2.4829 2.4948 1.6994 1.0400
Growth (2 ) 1.8848 1.9584 1.8651 1.5198 48.874
DebtR (3 ) 0.0170 0.0162 0.0101 0.0203 0.0330
Risk (4 ) 0.0720 0.0739 0.0768 0.0925 0.1602
RM (5 ) 18.803 21.590 12.939 1.7783 19.825
No. of 208 208 208 208 203
observations
Adj. R2 0.3305 0.3257 0.3203 0.2998 0.0122
Log likelihood 1,015.61 1,020.16 1,023.88 970.14 1,341.07
PEit is rm is price-earnings ratio at time t after the IPO, where t = 1 day, 7 days,
28 days, 1 year, and 2 years. PEim is rm is price-earnings multiple disclosed in its
IPO prospectus. GROWTHi is a proxy for earnings growth, measured as the average
earnings growth over a l year period, l = 1, 2, 3. DebtRi is a proxy for rm specic
risk, measured by the Debt/Assets ratio. Riski is another proxy for rm specic risk,
measured by the standard deviation of earnings over a l year period, l = 3, 4, 5. RMt
is the market index return at time t. For all estimates, and indicate signicance of
the t-test based on robust standard errors at the 5% and 10% levels, respectively.
Table 3. Estimation of scaled signalling models.

Vi 1 EFi
= 0 + 1 + 2 i + 3 Auditor i + 4 Underwriter i + 5 + i (4)
Ki Ki Ki Ki
Vi 1 EFi
= 0 + 1 + 2 i + 3 Auditor i + 4 Underwriter i + 5 (PE im ) + i (5)
Ki Ki Ki Ki
1 day 7 day 28 day

Models 4 5 4 5 4 5

Intercept: 1/K (0 ) 225.03 341.28 192.06 311.00 417.50 537.53
Investment (1 ) 2.109 1.266 1.931 1.011 1.393 0.552
Ownership /K (2 ) 3.539 2.304 4.222 2.868 2.758 1.528
Auditor (3 ) 0.035 0.2022 0.160 0.056 0.510 0.252
Underwriter (4 ) 0.085 0.185 0.073 0.027 0.201 0.096
EF /K or 14.702 1.290 15.044 1.354 15.179 1.314
PE EF /K (5 )
No. of observations 746 746 746 746 746 746
Adj. R2 0.5431 0.5444 0.5182 0.5281 0.4927 0.4901
Log likelihood 2,001.8 2,000.8 2,058.5 2,050.8 2,148.7 2,150.6
Mean Forecast Error 0.1474 0.1355 0.1485 0.1343 0.1397 0.1274
(MFE)
t-test for MFE dierence 2.259 [0.031] 2.499 [0.017] 2.243 [0.032]
Intercept: 1/K (0 ) 256.19 363.65 225.01 335.23 473.34 585.34
Investment (1 ) 1.468 0.921 1.232 0.607 0.448 0.079
Ownership /K (2 ) 3.464 2.318 4.166 2.898 2.641 1.508
Auditor (3 ) 0.175 0.383 0.059 0.244 0.258 0.022
Underwriter (4 ) 0.288 0.406 0.102 0.219 0.070 0.055
EF /K or 15.538 1.295 15.921 1.363 16.204 1.326
PE EF /K (5 )
Adj. R2 0.5697 0.5531 0.5425 0.5365 0.5173 0.4989
Log likelihood 1,479.3 1,489.3 1,523.9 1,527.4 1,593.5 1,603.4
(MFE)
Intercept: 1/K (0 ) 559.71 919.37 717.19 1043.90 586.58 938.36
Investment (1 ) 2.073 1.154 1.991 1.087 2.538 0.536
Ownership /K (2 ) 13.241 6.726 9.324 3.467 8.153 1.746
Auditor (3 ) 1.516 1.207 1.465 1.187 1.172 0.869
Underwriter (4 ) 0.151 0.132 0.218 0.200 0.203 0.186
EF /K or 7.525 2.151 8.477 2.111 6.431 2.015
PE EF /K (5 )
1 day 7 day 28 day

Models 4 5 4 5 4 5

Adj. R2 0.2623 0.4589 0.2435 0.4302 0.1923 0.3938
Log likelihood 434.9 401.6 437.6 407.1 428.7 397.9
(MFE)
Vi is rm market value, EF and PE are managements earnings forecast and price-

earnings multiple forecast before IPO respectively, and K is shareholders equity after
the IPO. i is the retained ownership by the state, i = i + ln(1 i ), where i is the
number of state shares to the total number of shares outstanding. Auditori is a dummy
variable for auditor quality, which is set equal to one if a top 10 audit rm as dened
in DeFond et al. (1999) is used, and zero otherwise; Underwriteri is a dummy variable
for underwriter quality, which is set equal to one for a top 10 underwriter in terms of
total IPO underwriting proceeds raised in 2000 and 2001, and zero otherwise. For all
estimates, and indicate signicance of the t-test based on robust standard errors
at the 5% and 10% levels, respectively. The mean forecast error (MFE) of Model 5 is
deducted from the MFE of Model 4. A t-test is used to examine if the dierences are
signicant (p-values in squared brackets).

Since we are interested in the improvement in pricing IPO more accurately, MFE is
a measure of the P forecast error in Vi , not in V /K. Specically, MFE for each model is
calculated as 1/n (Vi vi )/Vi , where Vi is the actual value and vi is a forecast from
the estimated model.
results in Table 3 are consistent with Hypothesis 2 and with our prior expec-
tation that price-earnings multiples disclosed in the second period are more
informative.
As a robustness check, Table 4 reports the estimates for Models 6 and 7,
and the test results are consistent with those reported in Table 3. In par-
ticular, Model 7 produces smaller mean forecast errors (MFE) and higher
adjusted R2 than Model 6. The t-tests for the MFE dierence between Mod-
els 6 and 7 are all signicant at the 5% level. Once again, we observe a
dramatic improvement in adjusted R2 in the second period in comparison
to the rst period using three dierent closing prices. For instance, the R2
jumps from 0.1257 in Model 6 to 0.4187 in Model 7 during the second period
while for the rst period, we observe a modest increase of R2 from 0.2336
to 0.2958 using the rst day closing price. Thus, the results in Table 4 cor-
roborate the ndings in Table 3 and are consistent with Hypothesis 2 and
our prior expectation on the informativeness of price-earnings multiples dis-
closed after 1999.
Table 4. Estimation of Kim et al. (1995) model.

Pi = 0 + 1 RM + 2 Ki + 3 i + 4 INV i + 5 Underwriter i + 6 EPS i + ui (6)
Pi = 0 + 1 RM + 2 Ki + 3 i + 4 INV i + 5 Underwriter i
+ 6 (P Eim ) EPS i + ui (7)
1 day 7 day 28 day

Models 6 7 6 7 6 7

Intercept: (0 ) 12.563 7.415 12.111 6.976 11.702 6.479
RM (1 ) 6.813 7.354 6.606 7.260 6.526 7.228
K (2 ) 0.0001 0.0001 0.0001 0.0002 0.0001 0.0002
Ownership (3 ) 0.0325 0.0174 0.0368 0.0207 0.0352 0.0185
Investment (4 ) 0.0007 0.0010 0.0005 0.0009 0.0006 0.0010
Underwriter (5 ) 0.7871 0.5764 0.9888 0.7494 1.1749 0.9221
EPS or 10.218 1.448 11.547 1.522 12.178 1.574
PE im EPS ( 6 )
Adj. R2 0.1092 0.3442 0.1249 0.3584 0.1348 0.3800
Log likelihood 2,266.5 2,161.6 2,280.8 2,174.5 2,277.8 2,163.7
(MFE)
t-test for MFE 6.364 [0.000] 6.467 [0.000] 6.568 [0.000]
dierence
Intercept: (0 ) 9.415 8.074 8.806 7.413 7.977 6.631
RM (1 ) 5.245 6.435 4.726 6.062 4.897 6.359
K (2 ) 0.0005 0.0002 0.0005 0.0001 0.0001 0.0005
Ownership (3 ) 0.0139 0.0113 0.0170 0.0141 0.1202 0.0088
Investment (4 ) 0.0013 0.0009 0.0011 0.0006 0.0009 0.0004
Underwriter (5 ) 0.4495 0.3070 0.6078 0.4488 0.9036 0.7315
EPS or 12.484 1.108 13.970 1.223 15.193 1.300
PE im EPS (6 )
Adj. R2 0.2336 0.2958 0.2538 0.3171 0.2886 0.3459
Log likelihood 1,413.6 1,393.5 1,429.6 1,408.6 1,428.6 1,408.7
(MFE)
t-test for MFE 2.392 [0.023] 2.310 [0.028] 2.128 [0.042]
dierence
Intercept: (0 ) 14.756 6.679 14.613 6.833 15.167 7.150
RM (1 ) 7.458 10.397 8.638 11.726 6.508 9.437
K (2 ) 0.0001 0.0002 0.0001 0.0002 0.0001 0.0001
Ownership (3 ) 0.0566 0.0006 0.0661 0.0105 0.0668 0.0111
1 day 7 day 28 day

Models 6 7 6 7 6 7
Investment (4 ) 0.0035 0.0045 0.0034 0.0043 0.0033 0.0043

Underwriter (5 ) 0.6512 0.4634 0.9248 0.7109 0.8957 0.7077
EPS or 23.549 1.961 24.858 1.967 23.474 1.950
PE im EPS (6 )
Adj. R2 0.1257 0.4187 0.1417 0.4174 0.1328 0.4278
Log likelihood 751.69 708.4 753.2 712.1 748.8 704.7
(MFE)
t-test for MFE 4.415 [0.000] 4.437 [0.000] 4.428 [0.000]
dierence
Pi is the closing price. EPSi is earnings forecast per share, RM is the market index
return, INV is issue proceeds designated to capital expenditure, EPS and PE are
managements earnings per share forecast and price-earnings multiple, respectively,
K is shareholders equity after the IPO, i is the retained ownership by the state,
i = i + ln(1 i ), where i is the number of state shares to the total number of
shares outstanding. Underwriteri is a dummy variable for underwriter quality, which
is set equal to one for a top 10 underwriter in terms of total IPO underwriting pro-
ceeds raised in 2000 and 2001, and zero otherwise. For all estimates, and indicate
signicance of the t-test based on robust standard errors at the 5% and 10% levels,
respectively. The mean forecast error (MFE) of Model 7 is deducted from the MFE
of Model 6. A t-test is used to examine if the dierences are signicant (p-values in
squared brackets).
Finally, Table 5 reports the estimates for the Ohlson (1995) valuation
model. The estimates of the Ohlson model indicate that Model 12 has smaller
forecast errors than Model 11 in Panels A and C in all three cases. However,
the improvements in pricing error in Panel B (i.e., before 1999) are signicant
only when Day 7 closing prices are used. This result is not surprising as
we expect that the price-earnings multiples disclosed in the second period
are more informative. Overall, the results in Table 5 are consistent with
Hypothesis 2 and the results reported in Tables 24.
7. Sensitivity Analysis
A maintained assumption in this study is that comparable rm price earn-
ings multiples are not readily available or cannot be reliably identied in
Chinas emerging capital markets. To assess the validity of this argument
and to ensure that our main results in Section 6 are not aected by this
Table 5. Estimation of scaled Ohlson (1995) model.

Vt /Kt = 0 (1/Kt ) + 1 yt /Kt + 2 (PE im ) xat /Kt + et (12)
1 day 7 day 28 day

Models 11 12 11 12 11 12

Intercept: (0 ) 450.89 476.37 459.42 478.39 589.05 619.50
yt (1 ) 2.546 2.153 2.423 1.991 1.954 1.583
xt (2 ) 15.900 16.315 15.867
PE xt (2 ) 1.345 1.415 1.319
No. of 722 722 722 722 722 722
observations
Adj. R2 0.5353 0.5337 0.5074 0.5165 0.4935 0.4865
Log likelihood 1,954.8 1,956.0 2,011.8 2,005.2 2,090.8 2,095.8
Mean Forecast 0.1515 0.1439 0.1513 0.1412 0.1396 0.1332
Error (MFE)
t-test for MFE 2.017 [0.052] 2.446 [0.020] 1.729 [0.090]
dierence
Intercept: (0 ) 482.67 510.41 494.16 515.78 641.96 674.40
yt (1 ) 1.902 1.489 1.736 1.269 1.048 0.657
xt (2 ) 16.742 17.203 16.939
PE xt (2 ) 1.413 1.489 1.406
No. of 528 528 528 528 528 528
observations
Adj. R2 0.5592 0.5538 0.5291 0.5360 0.5181 0.5080
Log likelihood 1,479.8 1,483.0 1,525.4 1,521.5 1,586.5 1,592.0
Mean Forecast 0.1480 0.1402 0.1468 0.1355 0.1289 0.1225
Error (MFE)
t-test for MFE 1.501 [0.129] 1.955 [0.059] 1.216 [0.190]
dierence
Intercept: (0 ) 1,034.5 1,100.3 1,033.3 1,097.0 857.48 919.14
yt (1 ) 2.451 1.743 2.406 1.719 2.864 2.205
xt (2 ) 19.268 19.771 16.154
PE xt (2 ) 1.894 1.895 1.669
No. of 194 194 194 194 194 194
observations
Adj. R2 0.2137 0.3050 0.2149 0.3030 0.1683 0.2552
Log likelihood 404.5 392.5 404.6 393.1 395.9 385.2
1 day 7 day 28 day

Models 11 12 11 12 11 12
Mean Forecast 0.1347 0.1233 0.1371 0.1252 0.1355 0.1253

Error (MFE)
t-test for MFE 1.882 [0.068] 2.038 [0.051] 1.835 [0.074]
dierence
Vt is the market value of the rm i. yt is (net) book value of equity, xat is abnormal
earnings measured as earnings minus capital costs of shareholder equity, K is sharehold-
ers equity after the IPO. PEim is rm is price-earnings multiple disclosed in the IPO
prospectus. For all estimates, and indicate signicance of the t-test based on robust
standard errors at the 5% and 10% levels, respectively. The mean forecast error (MFE)
of Model 12 is deducted from the MFE of Model 11. A t-test is used to examine if the
dierences are signicant (p-values in squared brackets).

assumption, we replicate all the empirical analyses by including a control

for price earnings multiples of comparable rms identied by industry clas-
sication. The idea is that if investors can reliably identify comparable rms
and the associated benchmark price earnings multiples, they would not need
to rely on the price earnings multiples disclosed by IPO rms to value IPOs.
Following Alford (1992), we attempt to match all our IPO sample rms
with listed companies by industry group.12 For each IPO sample rm, we
identity comparable rms as the companies with the same industry code (up
to three digits), and listed on the same stock exchange, i.e., the Shanghai
or the Shenzhen Stock Exchange before the listing date. For instance, for
IPO rm i, we dene PEic as its comparable rm price earnings multiple,
calculated as the average P/E ratio of all rms with the same industry
code and listed in the same stock exchange before rm is listing date. We
eliminate outlier comparable rms (i.e., P/E > 100 and P/E < 0) when
calculating the average to preserve comparability.13 Since not all our IPO
12
The CSRC classies listed companies using a system similar to the SIC code. It rst
classies all businesses into 13 industry groups (coded by letters from A to M). For exam-
ple, A is for agriculture and C is for manufacturing. It then uses up to four digits to group
similar operations within each industry into sub-groups. See CSRC (2001) for details.
13
We eliminate comparable rms with very high P/E ratios because they are unrealistic.
Firms with extremely high price earnings ratios are the ones that experienced a signicant
decrease in earnings in the previous period.
sample rms have comparable rms on their listing dates, our sensitivity
analyses reported below have smaller sample sizes in general. Table 1(a)
provides summary statistics for the sample rms used in the sensitivity
analysis in this section.
Table 1(a). Summary statistics.
Variable Mean Std. Dev. Min Max Median # of Obs.
Panel A: Whole sample period

IPO proceeds 371.68 357.04 33.000 2,964.0 270.40 435
Shareholder equity 629.86 663.86 62.00 4,957.2 449.61 435
after IPO
Shares outstanding 233.62 309.17 50.00 3,600.0 153.40 435
after IPO
State ownership (%) 69.93 8.76 0.00 98.18 71.14 435
IPO price 6.479 2.298 2.500 20.000 6.010 435
Price on day 7 14.755 7.531 3.010 59.200 13.320 435
Price on day 28 14.698 7.527 2.290 60.930 13.080 435
Mgmt. Earnings 75.307 96.977 4.576 850.42 47.540 435
forecast
Mgmt. EPS 0.3482 0.1854 0.0187 1.7682 0.3137 435
forecast
PEim 17.546 6.860 6.790 71.450 15.000 435
PEic 32.829 20.530 1.760 98.350 28.700 435
PE1 52.054 45.951 6.485 430.91 40.890 435
PE7 51.520 44.773 6.046 383.18 39.265 435
PE28 51.523 46.267 6.441 418.70 39.248 435
PE1Y 51.017 48.775 9.103 919.89 42.004 435
PE2Y 82.912 196.97 11.019 2,492.1 41.162 435
Correlation Matrix PEim PEic PE1 PE7 PE28 PE1Y PE2Y
PEim 1.0000
PEic 0.2667 1.0000
PE1 0.3954 0.1878 1.0000
PE7 0.4100 0.1938 0.9903 1.0000
PE28 0.4109 0.1809 0.9770 0.9829 1.0000
PE1Y 0.2948 0.0782 0.1578 0.1718 0.1748 1.0000
PE2Y 0.0787 0.0840 0.0084 0.0194 0.0206 0.0613 1.0000

IPO proceeds 298.24 301.13 33.00 2,625.0 221.60 297
after IPO
after IPO
Table 1(a). (Continued )
State ownership (%) 70.51 7.05 38.46 98.18 72.02 297

IPO price 6.090 1.797 2.500 15.000 5.900 297
Price on day 7 13.528 5.988 3.010 59.020 12.520 297
Price on day 28 13.349 6.088 2.290 60.930 12.060 297
Mgmt. Earnings 74.503 96.796 4.576 850.42 47.820 297
forecast
Mgmt. EPS 0.3821 0.1952 0.0187 1.7682 0.3444 297
forecast
PEim 14.626 2.030 6.790 27.960 14.500 297
PEic 27.564 18.402 1.760 460.96 23.780 297
PE1 43.784 45.219 6.485 430.91 36.974 297
PE7 42.903 42.838 6.046 383.18 36.207 297
PE28 42.332 44.243 6.441 418.70 34.459 297
PE1Y 42.896 53.643 9.103 919.89 37.672 297
PE2Y 68.546 190.97 11.019 2,492.1 35.494 297
PEim 1.0000
PEic 0.0493 1.0000
PE1 0.1394 0.0348 1.0000
PE7 0.1373 0.0293 0.9917 1.0000
PE28 0.1458 0.0044 0.9755 0.9777 1.0000
PE1Y 0.0603 0.0531 0.0084 0.0058 0.0007 1.0000
PE2Y 0.0507 0.0971 0.0296 0.0351 0.0354 0.0410 1.0000

IPO proceeds 529.73 413.58 108.80 2,694.0 400.00 138
after IPO
after IPO
State ownership (%) 68.68 9.40 0.00 92.42 69.17 138
IPO price 7.251 3.024 3.490 20.000 6.320 138
Price on day 7 17.509 9.705 5.130 59.200 15.620 138
Price on day 28 17.742 9.660 4.960 59.460 16.105 138
Mgmt. Earnings 77.038 97.697 11.200 721.34 44.874 138
forecast
Mgmt. EPS 0.2751 0.1366 0.0400 1.4295 0.2536 138
forecast
PEim 23.828 9.051 11.330 71.450 20.225 138
PEic 44.180 20.349 2.040 94.820 40.100 138
PE1 69.853 42.468 12.186 375.50 64.011 138

PE7 70.066 43.337 14.747 377.00 62.065 138
PE28 71.303 44.439 14.551 403.75 61.918 138
PE1Y 68.496 29.466 11.007 175.93 62.627 138
PE2Y 113.83 206.65 15.563 1,470.6 62.012 138
PEim 1.0000
PEic 0.09731 1.0000
PE1 0.5261 0.2327 1.0000
PE7 0.5131 0.2317 0.9873 1.0000
PE28 0.5010 0.2277 0.9770 0.9893 1.0000
PE1Y 0.5108 0.1149 0.5637 0.5790 0.5618 1.0000
PE2Y 0.0042 0.2043 0.0020 0.0053 0.0369 0.0254 1.0000
IPO proceeds, shareholders equity after IPO, and managements earning forecasts are in
million RMBs; Shares outstanding after IPO is in million shares; prices and EPS are in
RMB; PEit is rm is price-earnings ratio at time t after IPO, where t = 1 day, 7 days,
28 days, 1 year, and 2 years; PEim is rm is price-earnings multiple disclosed in its IPO
prospectus. PEic is the average P/E ratio of comparable rms for rm i.
Specically, we replicate Models 1, 5, 7 and 12 by introducing PEic as a

control variable with the following specications.
PE it = 0 + 1 PE im + 2 GROWTH i + 3 DebtRi + 4 RISK i
+ 5 RM + 6 PE ic + i (1a)
Vi 1
= 0 + 1 + 2 i + 3 Auditori + 4 U nderwriteri
Ki Ki Ki
EFi EFi
+ 5 (P Eim ) + 6 (P Eic ) + i (5a)
Ki Ki
Pi = 0 + 1 RM + 2 Ki + 3 i + 4 INV i + 5 Underwriter i
+ 6 (PE im ) EPS i + 7 (PE ic ) EPS i + ui (7a)
Vt /Kt = 0 (1/Kt ) + 1 yt /Kt + 2 (PE im )xat /Kt

+ 2 (PE ic )xat /Kt + et . (12a)
Table 2(a) reports the estimates and related test results of Equation (1a).
After controlling for the comparative rm P/E ratios, PEim remains sig-
nicant throughout the whole sample period, consistent with Table 2.
Table 2(a). Estimates of the Ohlson (1990) model with a control for PEic .
PE it = 0 +1 PE im +2 GROWTH i +3 DebtR i +4 RISK i +5 RM +6 PE ic + (1A)
1 day 7 day 28 day 1 year 2 year

Intercept (0 ) 4.9384 3.2645 1.9666 17.139 62.520
PEim (1 ) 2.4075 2.4549 2.5579 2.0571 2.5154
Growth (2 ) 0.3023 0.2618 0.3820 2.7686 22.960
DebtR (3 ) 0.0111 0.0093 0.0098 0.0077 0.0318
Risk (4 ) 0.0665 0.0658 0.0719 0.0375 0.1190
RM (5 ) 7.4210 4.8237 3.0527 3.5311 13.437
PEic (6 ) 0.1846 0.1904 0.1751 0.0264 0.5762
No. of observations 430 430 430 428 412
Adj. R2 0.1491 0.1625 0.1615 0.0776 0.0281
Log likelihood 2,216.27 2,202.11 2,217.10 2,255.37 2,620.74
Intercept (0 ) 0.7446 3.3270 2.8634 14.380 12.086
PEim (1 ) 3.0224 2.7028 2.7802 2.3049 3.0005
Growth (2 ) 0.0301 0.0423 0.2936 3.4814 5.1616
DebtR (3 ) 0.0115 0.0096 0.0094 0.0085 0.0480
Risk (4 ) 0.0727 0.0734 0.1007 0.0249 0.1002
RM (5 ) 6.1587 0.8082 0.1405 3.5503 3.2612
PEic (6 ) 0.0761 0.0587 0.0163 0.01431 0.0860
Adj. R2 0.0076 0.0043 0.0048 0.0028 0.0020
Log likelihood 1,520.39 1,504.68 1,514.04 1,565.01 1,642.30
Intercept (0 ) 22.978 20.863 21.521 51.562 217.89
PEim (1 ) 2.2870 2.3048 2.2902 1.2660 2.1176
Growth (2 ) 1.6649 1.7603 1.5137 1.9963 68.666
DebtR (3 ) 44.246 42.028 39.643 9.8099 109.99
Risk (4 ) 0.0985 0.0999 0.1025 0.1122 0.0499
RM (5 ) 3.3768 4.5419 4.9220 14.046 68.596
PEic (6 ) 0.3903 0.4059 0.4093 0.0346 2.4908
Adj. R2 0.3058 0.2929 0.2744 0.2681 0.0583
Log likelihood 686.03 691.13 696.85 638.73 898.73
PEit is rm is price-earnings ratio at time t after the IPO, where t = 1 day, 7 days, 28
days, 1 year, and 2 years. PEim is rm is price-earnings multiple disclosed in its IPO
prospectus. PEic is the average P/E ratio of comparable rms for rm i. GROWTHi
is a proxy for earnings growth, measured as the average earnings growth over a l year
period, l = 1, 2, 3. DebtRi is a proxy for rm specic risk, measured by the Debt/Assets
ratio. Riski is another proxy for rm specic risk, measured by the standard deviation of
earnings over a l year period, l = 3, 4, 5. RMt is the market index return at time t. For
all estimates, and indicate signicance of the t-test based on robust standard errors
at the 5% and 10% levels, respectively.
Interestingly, the coecient on the comparable P/E ratios (PE ic ) is sta-

tistically signicant only in some cases and sometimes with a wrong sign. In
addition, it should also be noted that the coecient on PEic is rather small,
indicating that the marginal explanatory power of comparable rm price
earnings multiples is limited. This evidence is consistent with the assumption
that comparable rm price earnings multiples are not reliable and it pro-
vides support for Hypothesis 2. Once again, we observe signicantly higher
R2 in Panel C than in Panel B, consistent with our prior belief that PEim
is more informative during the second period.
Table 3(a) reports the estimates for the scaled specication of the sig-
nalling Models 4 and 5A. Model 4 assumes that investors do not dierentiate
earnings forecasts disclosed by dierent rms and assigns the same coe-
cient (5 ) to a dollar of earnings forecast, while Model 5A allows 5 to
change proportionally according to the managements price-earnings mul-
tiple PEim and the comparable rms price-earning multiple PEic . Results
in Table 3(a) show that for all sample periods, Model 5A produces smaller
mean forecast errors (MFE) than Model 4. Most of the t-tests for the MFE
dierence between Models 4 and 5 are signicantly positive at the 5% level.
More important, consistent with the results reported in Table 3, price earn-
ings multiples disclosed by IPO rms remain signicant in determining IPO
price after introducing a control for comparable rm price earnings multiples.
Similarly, results reported in Table 4(a) (Models 6 and 7A) are also consis-
tent with the results reported in Table 4, and are in support of Hypothesis 2
and our prior expectation.
Finally, Table 5(a) reports the sensitivity analysis results from
Model 12A. Once again, we nd that Model 12A outperforms Model 11
with a smaller MFE, and PEim remains signicant after we control for
comparable rm PEic . Interestingly, the coecients on PEic have a smaller
absolute value relative to those on PEim and have a negative sign in most
of the cases, which is theoretically impossible. This evidence is consistent
with PEim being more informative and our assumption that PEic cannot be
reliably identied by investors in Chinas emerging capital markets.
Overall, the sensitivity analyses indicate that the key results reported in
Section 6 remain robust. The valuation relevance of price earnings multiples
disclosed by management in IPO prospectuses is not mitigated by investors
use of comparable rm price earnings multiples in Chinas emerging capital
markets. The ndings in this section further support our hypotheses that the
required disclosure of price earnings multiples is informative of IPO quality
in China.
Table 3(a). Estimation of scaled signalling models with a control for PEic .
Vi 1 EFi
= 0 + 1 + 2 i + 3 Auditor i + 4 Underwriter i + 5 + i (4)
Ki Ki Ki Ki
Vi 1
= 0 + 1 + 2 i + 3 Auditor i + 4 Underwriter i
Ki Ki Ki
EFi EFi
+ 5 (PE im ) + 6 (PE ic ) + i (5A)
Ki Ki
1 day 7 day 28 day

Model 4 5A 4 5A 4 5A

Intercept: 1/K (0 ) 450.93 244.62 612.82 353.86 576.48 335.65
Investment (1 ) 3.343 2.591 3.290 2.361 2.974 2.000
Ownership /K (2 ) 10.306

7.094 12.806

8.704 14.274 10.160
Auditor (3 ) 0.731 0.716 0.565 0.475 0.277 0.168
Underwriter (4 ) 0.152 0.120 0.316 0.307 0.417 0.404
EF /K or 10.611 1.158 10.741 1.324 10.291 1.226
PEim EF /K (5 )
PEic EF /K (6 ) 0.086 0.129 0.066
Adj. R2 0.3864 0.4717 0.3825 0.5097 0.4360 0.5465
Log likelihood 1,106.41 1,072.0 1,130.00 1,077.23 1,120.14 1,070.24
(MFE)
t-test for MFE 2.315 [0.028] 2.337 [0.026] 2.828 [0.008]
dierence
Intercept: 1/K (0 ) 497.75 317.61 674.36 433.78 593.49 378.30
Investment (1 ) 3.044 2.555 2.960 2.276 2.407 1.696
Ownership /K (2 ) 10.986

8.169 13.723

9.946 14.725 11.047
Auditor (3 ) 0.934 0.874 0.778 0.633 0.528 0.378
Underwriter (4 ) 0.095 0.045 0.291 0.236 0.435 0.403
EF /K or 11.303 1.146 11.441 1.323 11.278 1.228
PE im EF /K (5 )
PEic EF /K (6 ) 0.085 0.1353 0.067
Adj. R2 0.4277 0.4975 0.4273 0.5442 0.4881 0.5847
Log likelihood 789.91 769.24 806.32 770.40 797.76 764.82
(MFE)
t-test for MFE 1.526 [0.125] 1.613 [0.109] 2.045 [0.049]
dierence
1 day 7 day 28 day

Models 4 5A 4 5A 4 5A

Intercept: 1/K (0 ) 600.72 1,066.5 812.11 1,248.8 591.63 1,028.5
Investment (1 ) 3.552 0.2981 3.423 0.273 3.815 0.774
Ownership /K (2 ) 6.372 3.311 1.370 7.746 4.529 4.565
Auditor (3 ) 1.092 1.016 0.974 0.918 0.728 0.656
Underwriter (4 ) 0.011 0.024 0.038 0.074 0.016 0.015
EF /K or 3.668 1.733 1.578 1.718 3.485 1.608
PEim EF /K (5 )
PEic EF /K (6 ) 0.023 0.004 0.016
Adj. R2 0.1581 0.2965 0.1442 0.2774 0.1185 0.2361
Log likelihood 270.31 257.01 275.08 262.46 273.94 263.17
(MFE)
t-test for MFE 1.088 [0.220] 1.278 [0.176] 1.114 [0.214]
dierence
Vi is rm market value, EFi and PEim are managements earnings forecast and price-
earnings multiple forecast before IPO respectively, and K is shareholders equity after the
IPO. i is the retained ownership by the state, i = i + ln(1 i ), where i is the
number of state shares to the total number of shares outstanding. Auditori is a dummy
variable for auditor quality, which is set equal to one if a top 10 audit rm as dened in
DeFond et al. (1999) is used, and zero otherwise; Underwriteri is a dummy variable for
underwriter quality, which is set equal to one for a top 10 underwriter in terms of total IPO
underwriting proceeds raised in 2000 and 2001, and zero otherwise. PEic is the average
P/E ratio of comparable rms for rm i. For all estimates, and indicate signicance
of the t-test based on robust standard errors at the 5% and 10% levels, respectively. The
mean forecast error (MFE) of Model 5 is deducted from the MFE of Model 4. A t-test is
used to examine if the dierences are signicant (p-values in squared brackets).

calculated as 1/n (Vi vi )/Vi , where Vi is the actual value and vi is a forecast from the
estimated model.
8. Conclusion
This study examines the usefulness of price earnings multiples disclosed in
IPO prospectuses by companies in China. Using a sample of IPO issues from
the period 1992 to 2002, we nd that price earnings multiples disclosed by
IPO rms provide value relevant information to investors. In addition, we
nd that the price earnings multiples disclosed by IPO rms following the
regulatory change in early 1999 are more informative and improve the pric-
ing accuracy more than the price earnings multiples disclosed before 1999.
Table 4(a). Estimation of Kim et al. (1995) model with a control for PEic .
Pi = 0 + 1 RM + 2 Ki + 3 i + 4 INV i + 5 Underwriter i + 6 EPS i + ui (6)
Pi = 0 + 1 RM + 2 Ki + 3 i + 4 INV i + 5 Underwriter i + 6 (PE im )
EPS i + 7 (PE ic ) EPS i + ui (7A)
1 day 7 day 28 day


Intercept: (0 ) 12.637 7.579 12.198 7.126 11.615 6.424
RM (1 ) 8.895 8.496 8.374 7.989 8.446 8.078
K (2 ) 0.0010 0.0000 0.0012 0.0000 0.0007 0.0005

Ownership (3 ) 0.0402 0.0216 0.0469 0.0274 0.0409 0.0205
Investment (4 ) 0.0024 0.0023 0.0023 0.0022 0.0019 0.0018
Underwriter (5 ) 1.0324 1.2000 1.2197 1.3636 1.3389 1.4807
EPS or 11.348 1.4266 12.803 1.4913 13.570 1.5571
PE im EPS (6 )
PE ic EPS (7 ) 0.0331 0.0457 0.0446
Adj. R2 0.1263 0.3660 0.1418 0.3791 0.1448 0.3931
Log likelihood 1,460.81 1,390.21 1,473.79 1,402.57 1,477.23 1,401.77
(MFE)
t-test for MFE 5.206 [0.000] 5.317 [0.000] 5.365 [0.000]
dierence
Intercept: (0 ) 9.049 7.900 8.310 7.103 7.334 6.225
RM (1 ) 5.498 6.279 4.371 5.251 4.712 5.717
K (2 ) 0.0004 0.0002 0.0005 0.0002 0.0005 0.0009
Ownership (3 ) 0.0167 0.0146 0.0208 0.0185 0.0129 0.0105
Investment (4 ) 0.0017 0.0014 0.0015 0.0011 0.0010 0.0006
Underwriter (5 ) 0.9791 0.9567 1.1073 1.0787 1.3408 1.3036
EPS or 13.929 1.0871 15.572 1.2021 17.097 1.2955
PE im EPS (6 )
PE ic EPS (7 ) 0.0402 0.0449 0.0419
Adj. R2 0.2398 0.2949 0.2638 0.3208 0.3117 0.3590
Log likelihood 901.54 889.90 910.07 897.63 904.60 893.56
(MFE)
t-test for MFE 1.984 [0.056] 1.444 [0.141] 1.5144 [0.127]
dierence
1 day 7 day 28 day


Intercept: (0 ) 16.419 7.050 16.345 7.451 16.654 7.590
RM (1 ) 9.044 13.133 9.438 13.622 7.596 11.611
K (2 ) 0.0002 0.0011 0.0004 0.0009 0.0001 0.0013
Ownership (3 ) 0.0660 0.0060 0.0784 0.0094 0.0726 0.0029
Investment (4 ) 0.0056 0.0055 0.0058 0.0055 0.0051 0.0049
Underwriter (5 ) 0.1442 0.6260 0.3831 0.8381 0.2022 0.6710
EPS or 23.773 1.9887 26.217 1.9536 25.049 1.9360
PE im EPS (6 )
PE ic EPS (7 ) 0.0357 0.0708 0.0700
Adj. R2 0.1424 0.4763 0.1674 0.4694 0.1437 0.4510
Log likelihood 500.86 465.57 502.91 470.61 504.08 472.21
(MFE)
t-test for MFE 3.794 [0.000] 3.800 [0.000] 3.725 [0.000]
dierence
Pi is the closing price. EPSi is earnings forecast per share, RM is the market index
return, INV is issue proceeds designated to capital expenditure, EPSi and PEim are
managements earnings per share forecast and price-earnings multiple, respectively,
K is shareholders equity after the IPO, i is the retained ownership by the state,
i = i + ln(1 i ), where i is the number of state shares to the total number of
shares outstanding; Underwriteri is a dummy variable for underwriter quality, which is
set equal to one for a top 10 underwriter in terms of total IPO underwriting proceeds
raised in 2000 and 2001, and zero otherwise. PEic is the average P/E ratio of the
comparable rms for rm i. For all estimates, and indicate signicance of the
t-test based on robust standard errors at the 5% and 10% levels, respectively. The
mean forecast error (MFE) of Model 7 is deducted from the MFE of Model 6. A t-test
is used to examine if the dierences are signicant (p-values in squared brackets).
Moreover, we nd that the price earnings multiples disclosed by IPO rms

remain valuation relevant after we control for price earnings multiples of
listed comparable rms. The results in this study suggest that price earn-
ings multiples disclosed by IPO rms are informative of IPO quality in
Chinas emerging capital markets. Our results are robust to dierent model
specications.
The ndings in this study have some policy implications for securities
regulators in China and other emerging capital markets. First, requiring
IPO rms to disclose price earnings multiples in IPO prospectuses may be
an eective mechanism for IPO rms to convey value relevant information
to investors in an emerging market where reliable comparable rm price
earnings multiples are not readily available (or cannot be reliably identied)
and other signaling devices are not available. With proper enforcement and
monitoring by securities regulators, disclosures of price earnings multiples
by IPO rms can be a credible signal of IPO quality and thus assist IPO
Table 5(a). Estimation of Ohlson (1995) model with a control for PEic .
Vt /Kt = 0 (1/Kt ) + 1 yt /Kt + 2 (PE im ) xat /Kt + 3 (PE ic xat )/Kt + et (12A)
1 day 7 day 28 day

Models 11 12A 11 12A 11 12A

yt (1 ) 173.40 191.24 165.60 186.68 293.68 288.63
xt (2 ) 13.406 13.866 13.506
PE im xt (2 ) 1.375 1.586 1.444
PE ic xt (3 ) 0.156 0.226 0.128
Intercept: (0 ) 3.601 3.328 3.533 3.185 3.149 2.789
Adj. R2 0.3446 0.4385 0.3264 0.4759 0.3729 0.4981
Log likelihood 1,089.8 1,055.5 1,117.4 1,062.0 1,112.2 1,063.1
(MFE)
t-test for MFE 2.168 [0.038] 2.226 [0.034] 2.942 [0.005]
dierence
yt (1 ) 178.85 196.08 173.46 197.45 318.81 315.18
xt (2 ) 14.239 14.754 14.638
PE im xt (2 ) 1.415 1.638 1.512
PE ic xt (3 ) 0.142 0.217 0.116
Intercept: (0 ) 3.273 2.982 3.163 2.764 2.580 2.171
No. of 306 306 306 306 306 306
observations
Adj. R2 0.3737 0.4718 0.3546 0.5151 0.4135 0.5486
Log likelihood 796.54 769.96 817.37 773.12 811.43 770.87
Mean Forecast 0.1730 0.1577 0.1744 0.1529 0.1558 0.1338
Error (MFE)
t-test for MFE 2.001 [0.054] 2.066 [0.048] 2.852 [0.007]
dierence
yt (1 ) 738.59 779.20 771.06 811.07 695.15 734.20
xt (2 ) 1.204 3.506 2.065
PE im xt (2 ) 1.388 1.390 1.363
PE ic xt (3 ) 0.305 0.244 0.278
Intercept: (0 ) 3.551 3.045 3.413 2.901 3.654 3.161
1 day 7 day 28 day

Models 11 12A 11 12A 11 12A
No. of 131 131 131 131 131 131

observations
Adj. R2 0.1204 0.1532 0.1250 0.1572 0.1033 0.1343
Log likelihood 255.29 252.29 257.68 254.71 256.98 254.16
Mean Forecast 0.1262 0.1221 0.1269 0.1218 0.1235 0.1185
Error (MFE)
t-test for MFE 0.494 [0.352] 0.704 [0.310] 0.674 [0.317]
dierence
Vt is the market value of the rm i. yt is (net) book value of equity, xat is abnormal earnings
measured as earnings minus capital costs of shareholder equity, K is shareholders equity
after the IPO. PEim is rm is price-earnings multiple disclosed in the IPO prospectus.
PEic is the average P/E ratio of comparable rms for rm i. For all estimates, and
indicate signicance of the t-test based on robust standard errors at the 5% and 10%
levels, respectively. The mean forecast error (MFE) of Model 12A is deducted from the
MFE of Model 11. A t-test is used to examine if the dierences are signicant (p-values
in squared brackets).

valuation and investors assessments of long term stock performance. Second,

our study shows that price earnings multiples disclosed after 1999 are more
informative following the regulatory regime change. This nding suggests
that as the capital market matures in China, there is no longer a need for
the CSRC to screen price earnings multiples as a criterion to assess IPO
applications. Instead, requiring IPO rms to provide detailed information
and analysis about other benchmark price-earnings multiples allows them to
choose price-earnings multiples that are more in line with the rm quality
in comparison to other investment opportunities. Our study shows that this
policy change in screening IPO applications by the CSRC is eective and
benets both investors and IPO rms.
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IPO Valuation in China

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Valuing IPOs Using Price-Earnings Multiples

Michael Firth Yue Li

SEE PROFILE SEE PROFILE

Steven Shuye Wang

Review of Pacic Basin Financial Markets and Policies

Valuing IPOs Using Price-Earnings

Steven Shuye Wang

430 Michael Firth, Yue Li & Steven Shuye Wang

Valuing IPOs Using Price-Earnings Multiples 431

2. Institutional Setting and Literature Review

432 Michael Firth, Yue Li & Steven Shuye Wang

Valuing IPOs Using Price-Earnings Multiples 433

2.2. Literature review

434 Michael Firth, Yue Li & Steven Shuye Wang

comprehensive list of price multiples. They nd that price multiples derived

3. Theory and Hypothesis Development

Valuing IPOs Using Price-Earnings Multiples 435

Chinas regulatory setting because signicant deviations from earnings fore-

H1: Price-earnings multiples disclosed in IPO prospectuses provide relevant

We test Hypothesis 1 by examining whether managements price-earnings

436 Michael Firth, Yue Li & Steven Shuye Wang

Our second hypothesis examines whether price-earnings multiples dis-

Valuing IPOs Using Price-Earnings Multiples 437

where PEit is rm is price-earnings ratio at time t after the IPO, where t = 1

438 Michael Firth, Yue Li & Steven Shuye Wang

where Vi is IPO rm value, measured by the closing price multiplied by

If Model 3 contains, on average, smaller pricing errors than Model 2 does,

Valuing IPOs Using Price-Earnings Multiples 439

As a robustness check, we replicate the IPO valuation model used in Kim

440 Michael Firth, Yue Li & Steven Shuye Wang

Vt /Kt = 0 (1/Kt ) + 1 yt /Kt + 2 xat /Kt + et (11)

5. Data Sources and Summary Statistics

Valuing IPOs Using Price-Earnings Multiples 441

Table 1. Summary statistics.

Panel A: Whole sample period

Panel B: Before February 12, 1999

442 Michael Firth, Yue Li & Steven Shuye Wang

Correlation Matrix PEim PE1 PE7 PE28 PE1Y PE2Y

Panel C: After February 12, 1999

Valuing IPOs Using Price-Earnings Multiples 443

6. Empirical Results and Analysis

444 Michael Firth, Yue Li & Steven Shuye Wang

Table 2. Estimation of the Ohlson (1990) model.

1 day 7 day 28 day 1 year 2 year

Panel A: Whole sample

Valuing IPOs Using Price-Earnings Multiples 445

Table 3. Estimation of scaled signalling models.

1 day 7 day 28 day

Panel A: Whole sample

446 Michael Firth, Yue Li & Steven Shuye Wang

1 day 7 day 28 day

No. of observations 215 215 215 215 215 215

Vi is rm market value, EF and PE are managements earnings forecast and price-

Valuing IPOs Using Price-Earnings Multiples 447

Table 4. Estimation of Kim et al. (1995) model.

1 day 7 day 28 day

Panel A: Whole sample

448 Michael Firth, Yue Li & Steven Shuye Wang

1 day 7 day 28 day

Investment (4 ) 0.0035 0.0045 0.0034 0.0043 0.0033 0.0043

Valuing IPOs Using Price-Earnings Multiples 449

Table 5. Estimation of scaled Ohlson (1995) model.

1 day 7 day 28 day