Financial market development and the benefit of regulatory reforms that improve market transparency and consequent IPO performance reveal important issues related to corporate finance, governance, operations, and risk management. The authors’ findings are of interest to individuals involved in market liberalization and regulatory differences across markets, as well as investors in IPOs and business entities that need access to capital.

The existing body of knowledge on the relationship between financial market development and IPO underpricing fails to control for such factors as heterogeneous institutional and legal environments across markets. Identifying whether these factors are a cause or effect of observed patterns complicates any statistical analysis.

The authors address these problems by studying Chinese IPOs. The Chinese experience of varied economic growth and financial market development across its 31 provinces in the mainland provides a very good background for the authors to examine the impact of financial market development on IPOs and their subsequent returns without contending with other institutional heterogeneity. The 31 provinces have large financial market development disparities but are subject to the same set of institutional and regulatory constraints. Such highly developed cities as Beijing and Shanghai differ dramatically in growth and financial market development from underdeveloped areas such as Yunnan, but their seasoned stock and IPO markets are under one regulatory umbrella, so they resemble a pseudo-multinational market.

The authors use data from the China Stock Market & Accounting Research database for 1,246 IPOs from 1997 through 2009. They also use the Financial Market Development Index (FMDI), which was created during a 2011 study to measure the development of non-state-owned enterprises. According to the authors, the state-owned enterprises (SOEs) in mainland China have easier access to capital than non-SOEs. The FMDI for each province evaluates the amount of deposits and short-term loans held by non-state-owned financial institutions.

The authors show that financial market development is a statistically significant driver of economic growth and not vice versa.

The authors also demonstrate the positive effect that occurred on FMDI and IPO underpricing after the 2005 Chinese stock market reform that significantly reduced the number of non-traded securities.

The authors observe a strong and negative relationship between financial market development and stock idiosyncratic volatility and stock illiquidity. They also observe a strong positive relationship between financial market development and the stock turnover ratio, analyst attention, and the number of underwriters within each province. Their examination of one- and three-year buy-and-hold periods indicates that financial market development might improve IPO long-term performance.

Firms with headquarters in better-developed financial markets experience less IPO underpricing because higher market transparency and lower information asymmetry reduce the need for firms to underprice. The benefits of financial market development on IPO underpricing are greater for financially constrained firms, particularly non-SOEs. Non-SOEs still experience more difficulty accessing capital than SOEs.

Ostensibly, research along these lines is of interest only to international investors. However, I find the authors’ strong efforts to address the bias that can result from observable or unobservable between-country heterogeneity to be intriguing and ingenious. The article is an excellent example of how research design can contribute to econometrics’ credibility revolution by—to paraphrase Edward Leamer (American Economic Review 1983)—taking the con out of econometrics.