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Research note: An investigation of the relation between pre-IPO dividends and vendor sales

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Abstract

In contrast to post-listing dividend initiations, the corporate finance literature offers limited coverage of pre-IPO dividends. The present inquiry assesses IPOs in Hong Kong where both pre-listing dividend distributions and IPO vendor sales occur with regularity. As a means of distributing cash to controllers, pre-IPO dividends potentially offer an exit route for insiders without the need for a conspicuous vendor sale at IPO. This study extends the limited evidence on the “Pre-IPO Dividend puzzle” (Martin and Zeckhauser 2010) and the information signaling role of prelisting cash distributions (Wang et al. 2023) in two important ways. First, unlike the mainland PRC, where regulatory proscriptions discourage secondary offers, vendor sales occur often in Hong Kong. Second, in contrast to the US, mainland PRC, and most other jurisdictions, Hong Kong’s tax environment neither encourages nor discourages dividends relative to capital gains. For individual investors, the Hong Kong SAR Government imposes a zero rate of tax on both stock income and capital gains. Most issuers in the Hong Kong market during the study period demonstrated a significant record of pre-IPO profits. Accordingly, the incidence of cash payouts is at a high rate relative to rates evident in other major IPO locales. Hong Kong therefore provides a novel setting for investigation of pre-IPO dividend behavior. Present study findings suggest that pre-IPO cash distributions do not substitute for IPO vendor sales. Post-listing cash distributions also exhibit little to no association with vendor sales. However, ex-ante uncertainty, as proxied by offer price range, bears positive correlation with the frequency of post-listing dividend omissions. Finally, issuers distributing cash pre-IPO demonstrate greater frequency of pay-outs post-IPO.

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Notes

  1. A substantial, three-year pre-profit requirement for listing on the Main Board of Hong Kong Exchanges and Clearing Limited (HKEX) contributes to the high rate of pre-IPO cash distributions. See Note 6 in this paper for guidance on the specific Main Board Listing Rule (HKEX MBLR) provisions relevant for market entry.

  2. IPOs typically have three possible configurations: (1) A simple primary issue form; (2) a combination offer of both primary and secondary shares; or (3) an offer of secondary shares without an adjoining primary offer. In a primary offer, the sale of new shares generates proceeds for the issuer (i.e., the listing entity). In a secondary offer, one or more pre-listing shareowners sell existing shares, generating receipts for the vendors. Given the adverse signal that originates from vendor sales (Leland and Pyle 1977), IPOs typically consist of either (1) an exclusive primary offer or (2) a combination of primary and secondary offer in which new shares substantially outnumber existing “sale” shares. In most jurisdictions, a type (3) offering, where none of the IPO shares are new, and all are sold by vendors, is possible but very unusual.

  3. Privately controlled issuers with onshore (i.e., mainland PRC) legal incorporation are however commonplace on the Shanghai and Shenzhen exchange markets. Until the advent of the Shanghai STAR market, only companies of mainland PRC incorporation were able to list in Shanghai or Shenzhen. The first non-mainland PRC incorporated entity listed onshore was China Resources Microelectronics, a Red-Chip company incorporated in the Cayman Islands (see Woo et al., 2020 for details). Since this date, several Red-Chip counters (which, by definition, always have offshore incorporation) have sought listing on the Shanghai STAR and Shenzhen ChiNext markets.

  4. The HKSAR Government impose zero tax on both dividends and realized capital gains on personal stock trading positions. However, for trading companies, dividend income and realized capital gains contribute to profit, and thus attract corporate profit tax. For dividends paid by H-share and Red-Chip companies, mainland PRC authorities require such companies to pay dividends after the deduction of a 10 percent withholding tax.

  5. Secondary offers are far from unusual in US IPOs. Martin & Zeckhauser (2010, page 42) report that secondary and primary offer shares account for around 10 and 90 percent of IPO shares, respectively. Within the present study context, there is a similar balance of old and new shares, with secondary (primary) offers accounting for around 9.5 (90.5%) percent of all shares sold in IPOs on HKEX. Most IPOs containing vendor shares entail a bundling of primary and secondary offer shares (i.e., a type (2) IPO; see Note 2 above). In such offerings, new shares typically outnumber pre-existing vendor shares.

  6. Where a listing applicant is unable to meet the Exchange’s “Profit Test”, two alternative hurdles apply, notably the “Market Cap/Revenue” or “Market Cap/Revenue/Cashflow Test”. Both alternative routes require a high market capitalization for listing entry. Consequently, most Main Board firms list via the longstanding “Profit Test”. For details of the three tests, see HKEX: https://www.hkex.com.hk/-/media/HKEX-Market/Listing/Getting-Started/201802/201802-new-Listing_en.pdf.

  7. See Page 353 of the HKEX Fact Book 2021

  8. For these, and other reasons, Red-Chip and H-share issuers are of great importance to central and/or provincial government policy makers. H-share companies, given their mainland PRC incorporation, and in many cases leading industry position, typically wield greater economy-wide impact than Red-Chips. While exceptions exist, H-share companies on average rank higher in the perceived taxonomy of political-strategic importance (McGuinness 2016).

  9. See https://www1.hkexnews.hk/search/titlesearch.xhtml.

  10. Non-monotonic effects between family equity stakes and cash pay-outs are also possible (see Huang et al. 2012 for Taiwan). Results on the association between family ownership and firm performance vary across markets (Jiang & Peng 2011). Additionally, He et al. (2012) report greater dividend stability in state-controlled firms relative to family-dominated entities.

  11. The application of this arrangement reflects provisions in the relevant Basic Law (as available at:

    https://www.basiclaw.gov.hk/filemanager/content/en/files/basiclawtext/basiclaw_full_text.pdf).

  12. The relevant 2SLS analysis results are not shown in this paper’s tables but are available on request.

  13. Results in this area are also strongly significant when considering either DumD2bef or DumD3bef in place of DumD1bef. Detailed findings are available on request.

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Acknowledgements

The author wishes to acknowledge the helpful comments and guidance of the Editor-in-Chief and an anonymous reviewer.

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  1. Sheffield University Management School, The University of Sheffield, Sheffield, UK

    Paul B. McGuinness

  2. Department of Finance, The Chinese University of Hong Kong, Hong Kong, China

    Paul B. McGuinness

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McGuinness, P.B. Research note: An investigation of the relation between pre-IPO dividends and vendor sales. Rev Quant Finan Acc 62, 889–910 (2024). https://doi.org/10.1007/s11156-023-01225-5

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