Does the Legal System Affect the Cost of External Financing?—Evidence from IPO Underpricing of Foreign Firms Listed in U.S. Stock Markets
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To study the effect of the legal system on the cost of external financing, we examine the initial public offering (IPO) underpricing of foreign companies traded in U.S. stock exchanges. With a dataset of 364 non-U.S. firms' IPOs in the U.S. from 1991 to 2008, we find, first, that firms from highly corrupted countries have higher IPO underpricing. Second, it is revealed that the quality of the home-country public law enforcement reduces the level of IPO underpricing. In particular, the criminal sanction for violations of securities laws is the most significant factor. Moreover, by showing that, even when a non-U.S. firm meets sophisticated U.S. regulations and goes public in a U.S. exchange, its IPO underpricing is still influenced by the home-country's legal and judicial systems, we provide evidence against the functional convergence hypothesis.