Under Pricing and after Market Performance: Indian Initial Public Offering - Research Proposal Example

UNDER PRICING AND AFTER MARKET PERFORMANCE- A STUDY ON INDIAN INITIAL PUBLIC OFFERING Introduction Initial Public Offering (IPO) has been a prominent source of corporate financing for many years. IPO pricing is a much debated and yet unresolved topic in financial literature. Under pricing is one of the much debated anomalies of stock market. Under pricing is the state where the actual price of the stock is less than its intrinsic value. Under priced situation is a short run phenomenon as the market price will come close to intrinsic price when the demand for under priced securities goes up. When an IPO is under priced, the initial market return will be high. Thus, it can be interpreted in another way, i.e., high initial return. The present research study is a detailed examination of the under pricing and long term performance of 20 IPOs in Indian market listed on Bombay Stock Exchange (BSE) or National Stock Exchange (NSE)or both. The paper attempts to investigate both under pricing and under performance of IPOs in the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) for a period of one year. Research Problem Initial Public Offering under pricing and long run poor performance of common stock has been an unresolved puzzle in the financial literature for many years. Researchers and practitioners have attempted many times to explore a theoretical base to explain the behaviour of IPO market in the history of capital market. But, after each study the findings seem to be totally different from that of the previous ones. No single study could explore all the issues connected with IPOs. The present study is an attempt to investigate into the under pricing phenomenon and the long-run performance of IPOs in Indian capital market during the period beginning from August 1st 2007 to August 11th 2008. The study takes only those IPOs which have been priced using book building procedure and listed on Bombay Stock Exchange or National Stock Exchange or both. Literature Review Investment Banking, Reputation and the under pricing of Initial Public Offerings- Randolph P. Beatty & Jay R. Ritter This paper developed by Randolph P. Beatty & Jay R. Ritter involves two propositions. The authors argue that under pricing of an initial public offering and the uncertainty of investors regarding its value are monotonously related and investment bankers enforce the resulting under pricing equilibrium. The empirical evidence support that when the investors lose on account of non receipt of initial return (no under pricing) and issuers will lose when there is too much of under pricing and thus forfeit the value of its reputation capital. Anatomy of Initial Public Offerings of Common Stock- Tinic, Seha M In this paper, Tinic and Seha M demonstrate the anatomy of IPOs. The paper revolves around the hypothesis that under pricing serves as a form of insurance against legal liability and the associated damages to the reputations of investment bankers. The authors, after their empirical study reveal observe that there are implicit support after t he Securities Act of 1933, for the implicit insurance hypothesis. They have located a relationship between gross under pricing and market segmentation among prestigious and fringe investment bankers in the post-1933 period. The Under pricing of Initial Public Offerings and the Partial Adjustment Phenomenon- Kathleen Weiss Hanley In this research paper, the authors demonstrate the relationship between the final offer price disclosed in the preliminary prospectus and the range of anticipated offer prices. They observe that these prices are a good predictor of initial returns. The authors conclude that "issues that have final offer prices which exceed the limits of the offer range have greater under pricing than all other initial public offerings, and are also more likely to increase the number of shares issued" (Hanley, 1993). The Opening Price Performance of Initial Public Offerings of Common Stock, by Christopher B. Barry and Robert H. Jennings In this article, the authors examine samples consisting of 175 operating company IPOs and 54 closed-end fund IPOs over the two-year period between 1988 and 1990. The authors "contrast the returns based on the offering price to the first day's closing price against the returns based on the offering price to the price of the first transaction of the day, and also examine the intraday price on the first day of trades" (Jennings, 1993, 54-63). They observe that the initial return by virtue of under pricing of IPOs happens at the opening transaction. Subscription patterns, offer prices and the under pricing of IPOs: Evidence from India- Arif Khurshed, Alok Pande and Ajai K. Singh This study makes an effort to dissect the under pricing phenomenon in two distinct segments, namely pre-listing period and post-listing period. The results of the study show the presence of sequential learning among IPO investors. It is found that "retail and non-institutional investors follow the Institutional investors' subscription patterns when bidding for shares" (Singh). The transparency of the book building process in the Indian IPOs helps alleviate the winner's curse problem for the non-institutional and retail investors. We also show that market under pricing is primarily driven by the unmet demand of the non-institutional investor groups. This insight is unprecedented in the IPO literature The Long-Run Performance of Initial Public Offerings: The UK Experience 1980-1988- Mario Levis The article entitled 'The Long-Run Performance of Initial Public Offerings: The UK Experience 1980-1988' by Mario Levis is an effort to reiterate the presence of positive first day returns for initial public offerings (IPOs). It further suggests that "small firms tend to go public at the peak of their long-run performance and/or the public listing by itself may be considered by the original shareholders as the ultimate corporate objective" (Levis, 1993, 28-41). Seasoned equity offerings and the short- and long-run performance of initial public offerings in the UK - Mario Levis This article deals with seasoned equity offering and short and long run performance of IPOs. The author observes that "in contrast to the US practice, rights issues is the predominant method of raising additional equity capital in the London market" (Levis, 2006, 125-146). The study further finds that the hypothesis that IPO firms intentionally under price to demonstrate their quality and facilitate subsequent equity offerings is not correct. Underperformance in long-run stock returns following seasoned equity offerings- References and further reading may be available for this article. To view references and further reading you must purchase this article. John Affleck-Graves and D. Katherine Spiess In line with the studies undertaken in the UK (Levis, 2006) and Germany (Przyborowsky, 2002), the authors undertake a study concerning making seasoned equity offerings during the period from 1975 through1989. The study takes "a sample of matched firms from the same industry and of similar size that did not issue equity and finds that the underperformance persists even after controlling for trading system, offer size, and the issuing firm's age and book-to-market ratio" (Graves, 1995, 243-267). Objectives of the Study 1. To identify and describe the factors affecting the IPO under pricing phenomenon in Indian market, 2. To examine the short- and long-run performance of selected IPO firms in the market, 3. To measure the under pricing of selected IPOs in Indian market, and 4. To measure the long term performance of selected IPOs in Indian market Hypotheses The research problem, objectives and hypothesis are interrelated and expressed in different ways so as to extend the scope of the study. The probable outcome is the solution to the research problem, which demanded the very need for a research. The present study is also undertaken with certain hypotheses. They are stated as below: IPOs in Indian market exhibit under pricing behaviour Long-run performance of IPOs in Indian market is negative Methodology The overall design of the present study is quantitative and it solely relies on secondary data. This is fundamentally a survey study where the data are collected using one of the survey methods. The data are collected from the websites of companies which have been selected as samples for the study. No primary data needs to be used as the study is basically historical in nature. Research Design The present research is both descriptive and diagnostic in nature. The study revolves around the IPOs in Indian market over a period of one year to examine the under pricing and long term performance of common stocks. It takes in to account only those IPOs which have been prices as per book building procedure. Therefore, fixed priced IPOs have been kept away from the study. The study is both descriptive and diagnostic in the sense that both research designs share some common characteristics such as setting the objectives and hypothesis and furthermore, the study involves the description of the IPO short and long run performance and the analysis of the association of certain variables in the study. The various components of the research design such as data collection and analysis are described below: Sampling Design The Initial Public Offerings (IPOs) during the last one year commencing from August 1st 2007 to August 11th 2008 constitute the population for the study. The population of the study is finite as the number of IPOs listed on the stock exchange is available and countable. Altogether, during the period of study 87 IPOs have been undertaken in BSE or NSE or both. The sampling frame has been taken from the website 'Chittorgarh.com' that provides latest IPO information. "This is the website to check IPO allotment status online, IPO listing information, IPO News, IPO Reviews, IPO Grey Market Premium and IPO discussion forum" (Chittorgarh). Of the 87 IPOs listed on BSE or NSE or both, 11 IPOs have been issued on fixed price basis. Therefore, the present study takes only 77 IPOs which have been priced using book building process. Out of the population of 77 IPOs, 20 IPOs are taken as samples for the study. Therefore, 20 IPOs which accounts for around 26 percentage of the total population constitute the sample size. Sampling Procedure From the population of the study, a certain number of samples are selected using the probability sampling procedure. In the probability sampling survey, simple random method is the one used to form the sample size. The simple random method ultimately uses lottery method by which the IPOs are selected to form the sample size. Of the total IPOs, the sample should have the following parameters: The firm should have been listed on BSE or NSE or both The IPOs must have been undertaken during the period of study, i.e. August 1st 2007 to August 11th 2008 The IPOs must have been priced using Book building procedure Data and Data Collection As mentioned already, the study solely relies on secondary data. Data on various IPOs carried out during the period commencing from August 1st 2007 to August 11th 2008 are collected constitute the sole data for the study. The data on IPOs are collected from the website 'Chittorgarh.com' and the information on the price and performances of each IPO are then collected from the websites of each IPO firms. Data Analysis "Under pricing of an IPO is measured as the return on the first day of trading (relative to the offering price). It is computed as the difference between the closing price on the first day of trading and the offer price, divided by the offer price"(Singh). The under pricing of IPOs can be measured with the help of the following model: (Source: Singh) Analytical Tool for Measuring Long term performance of IPO "To examine the long-run performance of Indian IPOs, Buy-and-Hold Abnormal Returns (BHAR) and Cumulative Abnormal Returns (CARs) for 120 months of secondary market returns have been calculated" (Singh) The long run performance of IPOs can be measured with the help of the following: Where, BHARiT = the buy-and-hold abnormal return for firm i during holding period T, Rit = the raw return for firm i in month t, and Rmt is the return of the BSE sensex or Nifty used as the benchmark return. (Source: Singh) Limitations of the Study The study is basically a sample survey research. Therefore, sampling errors are the first and foremost problem of the study. However, maximum effort has been made by the researcher to minimise the sampling errors by properly selecting the sample method and sample units. Another limitation of the study is that it relies heavily on secondary data and data are collected from a web site, the authenticity of which is uncertain. However, every effort is put by the researcher to make cross check between various connected data. References Asli Demirguc-Kunt and Vojislav Maksimovic (2002) 'Funding Growth in Bank-Based and Market-Based Financial Systems: Evidence from Firm-Level Data', Journal of Financial Economics, 65, 2002, 337-363 Beatty R and Ritter J, (1986) 'Investment Banking, Reputation, and the Under pricing of Initial Public Offerings', Journal of Financial Economics, Vol. 15, pp. 213-232. Christopher B & Barry, 'Article provided by American Finance Association in its journal', Journal of Finance. Volume (Year): 44 (1989) Issue (Month): 4 (September) Pages: 1099-1103 Download reference Graves John Affleck & D. Katherine (1995) 'Spiess Journal of financial Economics' Volume 38, Issue 3, July 1995, 243-267 Hanley Weiss & Kathleen (1993), 'U.S. Securities and Exchange Commission (SEC)' Journal of Financial Economics (JFE), Vol. 34, No. 2 Jennings H. Robert & Christopher B. Barry, 'The Opening Price Performance of Initial Public Offerings of Common Stock Financial Management', Vol. 22, No. 1 (Spring, 1993), pp. 54-63 Published by: Blackwell Publishing on behalf of the Financial Management Association International Levis Mario (2006) 'European Financial Management' Volume 1 Issue 2,Pages125-146 Published Online: 27Oct2006 Journal compilation 2008 Blackwell Publishing Ltd Levis M, (1993) 'The Long-Run Performance of Initial Public Offerings: The UK Experience' 1980-1988, Financial Management, Vol. 22, pp. 8-41. Przyborowsky Ren Richard Stehle & Olaf Ehrhardt 'European Financial Management' Volume 6 Issue 2,Pages173-196 Published Online: 16Dec2002 Journal compilation 2008 Blackwell Publishing Ltd Rene Stulz and Rohan Williamson (2003) 'Culture, Openness, and Finance' Journal of Financial Economics, Vol. 70, 2003, 313-349 Singh, (2007) 'Initial and After market performance of Indian IPOs', Icfai Journal of Applied Finance, Vole Nov. 2007, Icfai University Press. Thorsten Beck, Asli Demirguc-Kunt, and Vojislav Maksimovic (2008) 'Financing Patterns Around the World: Are Small Firms Different' Journal of Financial Economics, Vol. 89, 2008, 467-487 Tinic S M, (1988) 'Anatomy of Initial Public Offerings of Common Stock', Journal of Finance, Vol. 43 (September), pp. 792-822 Read More