Determinants of IPO Underpricing in the National Stock Exchange of India Alok Pande* and R Vaidyanathan**
The National Stock Exchange (NSE) is India’s first fully demutualized stock exchange. It is also the largest exchange in India in terms of volumes in both equity and derivatives segments. Previous studies on Initial Public Offerings (IPOs) in India have been largely confined to the Bombay Stock Exchange (BSE). This study looks at the pricing of IPOs in the NSE, in particular, it seeks to empirically explain the first day underpricing in terms of the demand generated during the book building of an issue, the listing delay between the closure of the book building and the first day listing of the issue, and the money spent on the marketing of the IPOs by the firms. It also seeks to understand any emerging pattern in Indian IPO market with reference to the previous studies. Moreover, it seeks to find the Post-IPO returns for one month in the NSE. The results suggest that the demand generated for an issue during book building and the listing delay positively impact the first day underpricing, whereas the effect of money spent on the marketing of the IPO is insignificant. It is also found that in consonance with the extant literature, the Post-IPO performance in one month after the listing for the firms under study, is negative.
The Initial Public Offering (IPO) market in India has recently attracted the attention of the media for scams in the allotment of shares. The charges are that a few individuals got a large number of shares allocated in IPOs of various companies under fictitious names. The role of the banks as well as Depository Participants (DPs) has therefore, come under scanner. The market regulator—Securities and Exchange Board of India (SEBI) has already passed an order asking the DPs for payment of a disgorgement amount of Rs. 1160 mn (approximately US$28.3 mn).1 The recent scam in the allotment of shares in IPOs raises an interesting question—What makes the investors rush towards IPOs? It seems that there is a significant difference in the prices at which the IPOs are offered to the investors and the price at which they trade on the day of the listing. So, if the investors get shares allotted in an IPO at a lower offer price and then sell them on the first day of listing at higher prices, then they can make substantial gains. This phenomenon is known as ‘Underpricing’ in the IPO market. In other words, the market (on the day of the listing) seems to believe that the offer price of the stock was lower and deserves a higher price. The higher the underpricing, the greater is the amount of money that can be made by investors who got allocations in the IPO and sell these on the day of listing. This phenomenon is also referred to as ‘money left on the table’ by the firms. * Doctoral Student, IIM Bangalore, India. He is the corresponding author. E-mail: email@example.com * Professor of Finance and Control, IIM Bangalore, India. E-mail: firstname.lastname@example.org †
An earlier version of this paper was presented at the APRIA Conference in Taipei in July 2007. The authors have greatly benefitted from the feedback received at the Conference and by the comments of an anonymous referee. Hindu Business Line, November 22, 2006.
© 2009 The Icfai University Press. All Rights Reserved. The Icfai Journal of Applied Finance, Vol. 15, No. 1, 2009 14
Studying the IPOs in the Indian markets is important for another reason. India has become the first country in the world to introduce a rating mechanism for the IPOs prior to their listing. While rating of debt instruments is fairly common, equity ratings is a unique concept. Ostensibly, the aim of this exercise, started at the behest of the market regulator in India, SEBI, is to make the investors more informed about the fundamentals of the firms in which they are investing their money. It is also likely to have an impact on the huge oversubscriptions...
References: 1. Allen F and Faulhaber G (1989), “Signaling by Underpricing in the IPO Market”, Journal of Financial Economics, Vol. 23, No. 2, pp. 303-323. 2. Baron D P (1982), “A Model of the Demand for Investment Banking Advising and Distribution Services for New Issues”, Journal of Finance, Vol. 37, No. 4, pp. 955-976.
28 The Icfai Journal of Applied Finance, Vol. 15, No. 1, 2009
3. Benveniste L M and Spindt P A (1989), “How Investment Bankers Determine the Offer Price and Allocation of New Issues”, Journal of Financial Economics, Vol. 24, No. 2, pp. 343-361. 4. Brealey R A and Myers S C (2003), Principles of Corporate Finance, 7th Edition, Tata McGraw-Hill, New Delhi. 5. Cook D O, Kieschnick R and Van Ness R A (2006), “On the Marketing of IPOs”, Journal of Financial Economics, Vol. 82, No. 1, pp. 35-61. 6. Cornelli F and Goldreich D (2001), “Book Building and Strategic Allocation”, Journal of Finance, Vol. 56, No. 6, pp. 2337-2369. 7. Frieder L and Subrahmanyam A (2005), “Brand Perceptions and the Market for Common Stock”, Journal of Financial and Quantitative Analysis, Vol. 40, No. 1, pp. 57-85. 8. Grinblat M and Hwang C Y (1989), “Signaling and the Pricing of New Issues”, Journal of Finance, Vol. 44, No. 2, pp. 393-420. 9. Habib M and Ljungqvist A (2001), “Underpricing and Entrepreneurial Wealth Losses in IPOs: Theory and Evidence”, Review of Financial Studies, Vol. 14, No. 2, pp. 433-458. 10. Hughes P J and Thakor A V (1992), “Litigation Risk, Intermediation and the Underpricing of Initial Public Offerings”, Review of Financial Studies, Vol. 5, No. 4, pp. 709-742. 11. Ibbotson R G (1975), “Price Performance of Common Stock New Issues”, Journal of Financial Economics, Vol. 2, No. 3, pp. 235-272. 12. Kim M and Ritter J R (1999), “Valuing IPOs”, Journal of Financial Economics, Vol. 53, No. 3, pp. 409-437. 13. Leland H E and Pyle D H (1977), “Informational Asymmetries, Financial Structure and Financial Intermediation”, Journal of Finance, Vol. 32, No. 2, pp. 371-387. 14. Lerner J (1994), “Venture Capitalists and the Decision to Go Public”, Journal of Financial Economics, Vol. 35, No. 2, pp. 293-316. 15. Loughran T and Ritter J R (2003), “Why has IPO Under Pricing Changed Over Time?”, Working paper, University of Notre Dame and University of Florida. 16. Loughran T, Ritter J R and Rydqvist (1994), “Initial Public Offerings: International Insights”, Pacific-Basin Finance Journal, Vol. 2, No. 2, pp. 165-199. 17. Majumdar U (2003), “Price Performance of Initial Public Offerings in India”, Finance India, Vol. 17, No. 3, pp. 899-929. 18. Miller R E and Reilly F K (1987), “An Examination of Mispricing, Returns and Uncertainty for Initial Public Offerings”, Financial Management, Vol. 16, No. 2, pp. 33-38.
Determinants of IPO Underpricing in the National Stock Exchange of India 29
19. Muscarella C J and Vetsuypens M R (1989), “A Simple Test of Baron’s Model of IPO Underpricing”, Journal of Financial Economics, Vol. 24, No. 1, pp. 25-135. 20. Pagano M, Panetta and Zingales L (1998), “Why Do Firms Go Public? An Empirical Analysis”, Journal of Finance, Vol. 53, No. 1, pp. 27-64. 21. Purnanandam A K and Swaminathan B (2002), “Are IPOs Underpriced?”, Working Paper, Cornell University, New York. 22. Rock K (1986), “Why New Issues are Under Priced?”, Journal of Financial Economics, Vol. 15, Nos. 1-2, pp. 187-212. 23. Ruud J S (1993), “Underwriter Price Support and the IPO Underpricing Puzzle”, Journal of Financial Economics, Vol. 34, No. 2, pp. 135-151. 24. Security Exchange Board of India, SEBI, Annual Reports, various issues, Mumbai. 25. Shah A (1995), “The Indian IPO Market: Empirical Facts”, Centre for Monitoring Indian Economy, available at http//220.127.116.11/search?q=cache 26. Sherman A E (2000), “IPOs and Long-term Relationships: An Advantage of Book Building”, Review of Financial Studies, Vol. 13, No. 3, pp. 697-714. 27. Sherman A E (2005), “Global Trends in IPO Methods—Book Building versus Auctions with Endogenous Entry”, Journal of Financial Economics, Vol. 78, No. 3, pp. 615-649. 28. Sherman A E and Titman S (2002), “Building the IPO Order Book—Underpricing and Participation Limits with Costly Information”, Journal of Financial Economics, Vol. 65, No. 1, pp. 3-29. 29. Welch I (1989), “Seasoned Offerings, Imitation Costs and the Underpricing of Initial Public Offerings”, Journal of Finance, Vol. 44, No. 2, pp. 421-449. 30. White H (1980), “A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity”, Econometrica,Vol. 48, No. 4, pp. 817-838.
Reference # 01J-2009-01-02-01
The Icfai Journal of Applied Finance, Vol. 15, No. 1, 2009
Please join StudyMode to read the full document