Polluted IPOs 

By | October 13, 2022

Regulatory oversight is important for safeguarding investors’ interests and ensuring the efficient functioning of financial markets. However, oversight can sometimes fail due to extraordinary factors such as resource constraints and political connections. Our recent study shows that oversight failure can also occur because of reduced productivity of regulators due to severe fine particulate matter air pollution. Prior medical research and economic research has shown that fine particular matter (PM2.5) affects human productivity by  impairing respiratory function and cognitive capacity. The unique institutional setting for this study is the approval of initial public offerings (IPOs) by the Securities Regulatory Commission of China (CSRC).(CSRC). 

Firms in China going public for the first time must obtain regulatory approval from the CSRC. These firms must submit required documents to the CSRC for a preliminary review to obtain approval. During the process, the regulators often require additional information and materials to be submitted and will decide whether the applicant meets the listing requirements. The last and perhaps most critical step before the IPO approval is a formal Q&A and review session. During this session, the firm and its underwriters answer questions posed by a seven-member committee appointed by the CSRC. The objective of the review session is for the committee to process additional information gathered from the session to make a final decision on IPO approval that is announced shortly after the meeting. Beijing, where the CSRC is located and the IPO review takes place, has suffered from severe fine particulate air pollution for years due to coal-powered industrial production and heating. Unlike large pollutants, PM2.5, travel indoors and can directly affect committee members during the review session. We examine whether the IPO review outcome varies by the density of PM2.5 observed at the closest air quality monitoring station to the CSRC on the review day. 

A few unique institutional features help us empirically identify the causal effects of PM2.5 on review outcomes. First, the CSRC uses a lottery system to randomly select review committee members for each IPO application to ensure the homogeneous quality of the review team. Therefore, there is no endogenous matching between committee member quality and firm quality, and thus the review outcome. Second, because the timing of the review is predetermined one week before the review date, committee members cannot predict the air quality on the review day, given that there is almost zero correlation between PM2.5 levels on the review day and a week earlier. Such a condition ensures that review committee members would not prepare questions differently ahead of time because of severe pollution on the review day. It is important to note that reviewers must be physically present on the day of the review under normal circumstances. Moreover, because of the Government Office Space Standards issued by the National Development and Reform Commission, Chinese government offices are not allowed to install indoor air purifiers, which can help mitigate the effects of PM2.5 on humans.  

We assembled a comprehensive sample of 1,488 IPO applications in China, filed between 2014 and 2020, from the China Stock Market and Accounting Research (CSMAR) database. We obtained the names of the review committee members for each IPO firm and the review decisions from the CSRC website. We manually collected each review member’s full resume from Chinese Wikipedia (i.e., Baidu Baike) to determine the member’s characteristics and professional background. We also obtained transcripts of the review sessions, which included questions raised by the committee members that were made public for IPOs after 2015 from CSMAR. 

Our baseline regressions include PM2.5 levels on the review day, firm-level control variables, committee member characteristics, weather conditions, industry, province, calendar quarter, committee chairman, and day of week fixed effects. We find that the IPO passing rate is 4.5 percentage points higher for every 100-point increase in PM2.5 concentration, measured by micrograms per cube meter (μg/m3). The passing rate is twelve percentage points higher on extremely hazy days (i.e., days with PM2.5 particles above 150 μg/m3). The results are robust to using subsamples and controlling for air pollution observed at IPO firms’ headquarters on the review day. The falsification tests show that the IPO passing rate is not affected by PM2.5 levels measured in the evening before the review, on the review assignment day, and in the adjacent city on the review day. We also use wind speed as an instrumental variable for air pollution and find similar results. 

To shed light on whether the higher IPO passing rate reflects potential errors in regulators’ decision-making, we first conduct heterogeneity tests by including the interaction between air pollution level and an indicator of whether the firm is in a polluting (or green) industry. We find that firms operating in green industries have higher passing rates on polluted days than on clear days. Because firms are assigned randomly to different review dates, the higher passing rate of green IPOs on polluted days should not reflect the better quality of those firms. Second, we examine stock performance and operating performance after IPOs and find that IPO firms approved on polluted days have worse market-adjusted stock returns within one year of listing and lower profitability and return on equity. Our back-of-the-envelope calculation suggests the total investor loss due to lax oversight by the review committee amounted to roughly 28 billion RMB (USD $4 billion) between 2014 and 2020. The evidence shows that the review committee’s decision-making quality is worse on polluted days, resulting in large losses to investors.   

High densities of PM2.5 can affect the quality of IPO approval decisions in two important ways, both leading to biases and errors in decision-making but in different directions. On the one hand, short-term exposure to PM2.5 temporarily reduces the cognitive capacity of reviewers (see Ebenstein et al., 2016; Zhang et al., 2018). Due to reviewers’ reduced ability to craft challenging questions and uncover errors for the IPO applicants on polluted days, they allow more (low-quality) firms to list their stocks. However, air pollution can also impose psychological pressure and depress an individual’s mood. This effect can be manifested in pessimism and depression-like symptoms (see Fonken et al., 2011). As a result, review members’ negative moods on polluted days may prompt them to reject IPO applications, leading to lower passing rates. Our baseline results suggest that the effect of air pollution on IPO approval is likely through the cognitive capacity channel. 

We next perform three tests using the review transcripts, review committee member heterogeneity, and heterogeneity in firm complexity to further pin down the cognition channel. We first find that, on hazy days, the reviewers ask fewer, shorter, and less complex questions and are less likely to ask follow-up questions. Second, the effect is more pronounced when the review committee comprises older members and non-residents of Beijing, likely because the effect of PM2.5 on the cognitive performance of those individuals is more severe as suggested by prior research. Last, because firms with complex operations are harder to evaluate and require more in-depth analysis by the committee members than less complex firms, the cognitive capacity of committee members is particularly important when evaluating those firms. We find that the probability of IPO approval is higher for complex firms than non-complex firms on polluted days. The evidence together supports that the declined productivity of review members on polluted days results from their declined cognitive capacity. 

This study is one of the first to show that transitory air pollution affects the productivity of high-stakes decision-makers in the financial system. We show that air pollution can directly affect the productivity of regulators, resulting in lax oversight that can be costly to investors. Our findings help shed light on an important channel through which air pollution has a far-reaching effect on financial markets and investors. Our study also suggests that policies that allow for some work flexibility may mitigate the impact of environmental shocks on the productivity of high-stakes decision-makers. 


Meng Miao is an Associate Professor of Finance at the School of Finance, Renmin University of China. 

Wei Wang is a Distinguished Professor of Finance at Smith School of Business, Queen’s University. 

Zhengyu Zuo is a doctoral student at the School of Economics, Renmin University of China. 


This post is adapted from their paper “Polluted IPOs,” available on SSRN.

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