Board composition and IPO Operating Performance

Finally, the relation between board composition and IPO long-term operating performance will be further investigated. A well-balanced board of directors is the key corporate governance mechanism monitoring corporate financial reporting practices and operating activities (Fama and Jensen. 1983). Corporate governance plays an important role in mitigating the agency conflicts between firm managers and diffuse shareholders (Jensen and Meckling, 1976). When the ownership is highly concentrated, the primary objective of corporate governance has broadened to protect minority shareholders from expropriation by a controlling blockholder and his management team (Shleifer and Vishny. 1997).

So, the board composition might have an effect on IPO long-term performance changes relative to the pre-IPO level. In Table 6-13, firms are further segregated into three portfolios by the level of board independence. As discussed earlier, board composition is calculated as the proportion of board members (at the end of

the IPO year) who represent the controlling shareholder and hold a senior position in the controlling shareholder’s entity simultaneously. The first portfolio represents the firms with the lowest proportion (no more than 30%) of board members representing controlling shareholders at the end of the IPO year, and the second portfolio with controlling shareholders retaining the board seats at a range between 30% and 50%. In the third portfolio, controlling shareholders occupy more than 50% of the board seats.

Panel A presents industry-adjusted ROA and CFO figures of IPO firms before and after the IPO by the three board composition portfolios. In terms of ROA figures, IPO firms with the board more dependent on controlling shareholders seem to report higher operating performance (15.81%) than the firms with an independent board do (11.23% and 11.30% respectively) in the pre-IPO year; in the post-IPO years, firms with a more dependent board report slightly higher ROA figures than those with a less dependent board do. Similarly, in terms of CFO figures, the results show that firms with a more dependent board report slightly higher CFO performance than the remaining firms do before and after the IPO.

Panel B examines the changes of industry-adjusted ROA and CFO figures from before to after the IPO by the three board composition portfolios. It shows that, in terms of ROA figures, IPO firms with a more dependent board report a quicker decline (-15.38%) than the remaining firms do (-11.63% and -11.72 respectively) from Y (-1) year to the post-IPO period, but the AN OVA test is not strongly significant (p-value = 0.33). in terms of CFO figures, IPO firms with a more dependent board seem to decline from the pre-IPO year to the post-IPO period more quickly (-8.54%) than the remaining firms do (-4.79% and -4.33% respectively), but statistically insignificant.

operating performance. The table shows that, in terms of industry-adjusted ROA and CFO figures, IPO firms with a more dependent board seem to outperform the firms with a less dependent board in the Y (-1) year; moreover, IPO firms with a more dependent board are likely to report a larger performance decline from before to after the IPO than the remaining firms.

6.6 Summary

In this research, 239 Chinese A- (and B-) share IPOs going public between f January 1999 and 31®* December 2000 are examined. The investigation period covers 6 years in total, including the one financial year prior to the IPO year and the four financial years subsequent to the IPO year.

Based on either ROA or CFO performance, Chinese IPOs report a significant decline from the pre-IPO period to the post-IPO period, and ROA figures show an extraordinarily large decline, compared with CFO figures. Sales figures, sales growth ratios of IPO firms before and after the IPO have also been examined. The findings show a significant decline in sales growth from before to after the IPO. Actual sales of IPO firms are likely to decrease in the post-IPO period relative to the pre-IPO level, particularly when the figures are scaled by lagged total assets In addition, Megginson and Netter (2001) conjecture that state ownership is widely believed inefficient, and privatisation results in improved performance; however, China’s privatisation reform does not seem to lead to an ‘improved performance’ for those state-controlled enterprises. One of the possible explanations is that the state retains a very large percentage of ownership in public firms before and even after the IPO, so operating efficiency is barely improved due to the concern of agency conflicts between the state-owned controlling shareholders and corporate executives is not alleviated subsequent to the IPO.

Secondly, the finding above shows that IPOs significantly outperform their industry peers in the pre-IPO period in terms of operating performance measures (ROA, CFO): they are likely to underperform their industry peers in the post-IPO period, but the evidence is not strongly significant. It seems that that pre-IPO operating performance may be artificially exaggerated. So, in this research, the main research question is to explore the reasons why Chinese IPOs abnormally outperform their industry peers prior to the IPO. and why there is a significant decline in post-IPO operating performance relative to the pre-IPO level.

Finally, the effects of firms’ ownership and governance characteristics on IPO long-term operating performance have also been examined. There is no significant evidence that firms controlled by the State report a larger (or smaller) decline in operating performance from before to after the IPO than non state-controlled firms Flowever, the test results show that IPO firms, which are more controlled by controlling shareholders, for example a more concentrated ownership structure and a less independent board of directors from controlling shareholders, are likely to report higher operating performance in the pre-IPO year, and report larger performance changes in the post-IPO period relative to the pre-IPO level. It seems that ownership concentration and board composition may have an effect on the long-run operating performance of Chinese IPOs.