The dual-tranche offer mechanism in Hong Kong and the characteristics of IPO subscription demand and initial return levels

Prior Hong Kong-based studies have dealt predominantly with Initial Public Offerings (IPOs) configured in a single-tranche offer form (see McGuinness (1992); Cheng et al. (2004); Fung et al. (2004); Vong (2006) for the main board; and Vong and Zhao (2008) for the Growth Enterprise Market (GEM)). This study revisits the issue by examining a recent set of IPOs utlizing a dual-tranche offer form, in which a local retail offer is accompanied by a book-built placing. This mechanism utilizes a number of features ('claw-backs', adjustable offer prices and over-allotment options) which allow for important supply and demand adjustments during the offer period. The absence of such features within the single-tranche offer form, which prevailed right up to the end of the 1990s, suggests radically different pricing characteristics across single- and dual-tranche regimes. Assessment is first made of ex-ante type variables, constructed using publicly available data prior to the close in retail applications. Average retail subscription rates on issues immediately prior to a given offering, the clustering of IPOs and the performance of the overall Hong Kong secondary market in the period surrounding the retail application window all serve as significant factors in explaining both IPO returns and excess subscription demand. Mainland PRC-incorporation (H-share issuers), advising sponsorship quality, an issuer's propensity to disclose a forecast of earnings and price-to-earnings levels also appear significant. In terms of ex-post variables, both IPO underpricing and subscription demand were positively related to over-allotment option exercise and the SD of post-listing returns. Significantly, there is no evidence to support the notion that the incidence and/or size of subsequent seasoned equity issues helps to promote IPO underpricing. This is investigated by examining equity capital-raising activities over a 36-month post-listing period. Given the mixed evidence to date (across markets and studies) on this issue, the results documented in this study provide an additional important data point to suggest that seasoned equity issuance is of second-order importance in relation to IPO underpricing. Finally, a measurement form for excess demand was also developed to reflect the idiosyncratic nature of the dual-tranche allotment mechanism. Subscription numbers were evaluated in relation to retail tranche supply adjustments, arising from 'claw-backs' and employee share allotments. Consistent with Vong's (2006) earlier work on simple IPO subscription rates, after-market volatility appeared much more strongly tied to excess demand than to initial return levels. A number of analogues of excess demand, notably over-allotment option exercise and the proportion of shares allotted to retail applicants subscribing at the minimum order level, were significant in explaining initial returns. Finally, and consistent with Hanley (1993), higher initial return levels were apparent in issues priced towards the upper end of the offer price range.