Within days of its $4.4 billion IPO on the New York Stock Exchange last June, the Chinese ride-hailing giant Didi Global got sideswiped. Regulators in Beijing forced the firm to remove its apps from domestic stores and suspend new user registrations. Earlier this year, Didi's investors voted to delist in New York, hoping to revive its fortunes by listing in Hong Kong. But those plans were upended by a data privacy investigation that led to a $1.2 billion fine
In response to Didi and other big tech firms listing abroad, the Chinese government recently proposed tough rules for companies looking to go public outside the country
Image: Shutterstock
The clampdown on the company once seen as China’s answer to Uber was widely viewed as retribution for its overseas initial public offering. In response to Didi and other big tech firms listing abroad, the Chinese government recently proposed tough rules for companies looking to go public outside the country, including several layers of official review before new share listings are approved.
These new restrictions come on top of China’s long-standing limits on domestic IPOs. The overall effect of these policies, says Charles Lee, has been a “brain drain” of capital, talent, and intellectual property out of the country.
That’s one of the striking findings in a recent paper coauthored by Lee, professor emeritus of accounting at Stanford Graduate School of Business. With Yuanyu Quopen in new window of the University of International Business and Economics and Tao Shenopen in new window of Tsinghua University, Lee found that China’s steep barriers to market entry stifle innovation and competition, distort the value of private companies, and amplify the influence of incumbent companies and their owners.
Chinese firms seeking to go public need to hit stringent revenue and profitability thresholds and must be individually approved by the state. The rules have substantially ratcheted up the economic value of a public listing in the country — so much so that some firms bypass IPOs altogether by executing a reverse merger. By combining with a public firm and taking control of the combined entity, a private firm can gain access to equity markets — a prized commodity in China.
Carefully analyzing each reverse merger, Lee and his collaborators find that between 2007 and 2020, unlisted Chinese firms paid more than $500 million on average for the value of a public company’s stock market listing. To put that figure into context, roughly one-third of the listed firms during this period were trading below the shell value they might fetch in a reverse merger.
This piece originally appeared in Stanford Business Insights from Stanford Graduate School of Business. To receive business ideas and insights from Stanford GSB click here: (To sign up: https://www.gsb.stanford.edu/insights/about/emails)