Chapter 1 Introduction

Chapter 1 Introduction
The decision to go public, or make an initial public offering (IPO) of equity, represents an important landmark in a firm s life cycle! " #ell functioning IPO market pro$ides e%it options for stakeholders in young firms, access to lo# cost capital for gro#ing firms, and greater access to capital for future e%pansion of large firms! &lo# of capital to firms can stimulate gro#th in an economy! Thus, the performance of an IPO of a firm is under scrutiny and under#riters often use a mechanism of 'underpricing( to pro$ide a risk premium to the in$estors for the uncertainty of returns!

a! Ob)ecti$e
The phenomenon of underpricing go$erns the returns an IPO #ill generate in the secondary market, and the purpose #as to study the factors that cause this underpricing and ho# they affect it! *ainly the ob)ecti$es are+ i! To study the relationship of different factors of secondary market #ith underpricing of IPOs! To study industry,#ise trend of IPO underpricing!

ii!

b! -cope
The study is confined to Indian IPOs and focuses on the factors of secondary market that affect the IPO pricing across $arious industries!

c! .imitations
The sample si/e #as limited to the period 0anuary 1223 4 "pril 1211 in #hich there #ere 123 IPOs! "ll the IPOs are book,built (no fi%ed price IPOs)! Classification of IPOs on the basis of industry has been done purely by kno#ledge and understanding of primary operation of the firms!
2

Chapter 1 Initial Public Offerings

Chapter 1 Initial Public Offering , IPO

Initial public offering or IPO is a #ay for a company to raise capital through in$estors and get listed in the stock e%change to become a publicly traded company for the first time! &or a company, the cost of borro#ing money through IPO is less in comparison to other popular options a$ailable in the market! Through IPO, company di$ersifies its equity base to large number of in$estors! 5hen securities of a company is listed in stock e%changes, it also gets benefited in term of brand building as its being discussed on almost day to day basis among millions of in$estors and e%perts! " company raising money through IPO is also called as the company 6going public ! &rom an in$estor s point of $ie#, IPO gi$es a chance to buy shares of a company, directly from the company at the price of their choice (in book built IPO7s)! *any a times there is a big difference bet#een the price at #hich companies decides for its shares and the price on #hich in$estor are #illing to buy share and that gi$es a good listing gain for shares allocated to the in$estor in IPO! &rom a company s perspecti$e, IPO help them to identify their real $alue #hich is decided by millions of in$estors once their shares are listed in stock e%changes! IPO7s also pro$ide funds for their future gro#th or for paying their pre$ious borro#ings! In an IPO, the issuer obtains the assistance of an under#riting firm, #hich helps it determine #hat type of security to issue, the best offering price and the time to bring it to market! " company #ith the help of lead managers (merchant bankers or syndicate members) decides the price or price band of an IPO! Companies and lead managers do a lot of market research and road sho#s before they decide the appropriate price for the IPO! Companies carry a high risk of IPO failure if they ask for higher premium! *any a time in$estors do not like the company or the issue price and don7t apply for it, resulting in an undersubscribed issue! In this case, companies either re$ise the issue price or suspend the IPO!

a! .ife cycle of an IPO

The life cycle of an IPO is as follo#s+ 1. Issuer Company - IPO Process Initialization
4

2.

3.

%.

&.

*.

-.

1! "ppoint lead manager as book runner! 1! "ppoint registrar of the issue! 8! "ppoint syndicate members! Lead Manager's - Pre Issue Role - Part 1 1! Prepare draft offer prospectus document for IPO! 1! &ile draft offer prospectus #ith -9:I! 8! ;oad sho#s for the IPO! !"I - Prospectus Re#ie$ 1! -9:I re$ie# draft offer prospectus! 1! ;e$ert it back to .ead *anager if need clarification or changes (-tep 1)! 8! -9:I appro$e the draft offer prospectus, the draft offer prospectus no# becomes the Offer Prospectus! Lead Manager - Pre Issue Role - Part 2 1! -ubmit the Offer Prospectus to -tock 9%changes, registrar of the issue and get it appro$ed! 1! <ecide the issue date = issue price band #ith the help of Issuer Company! 8! *odify Offer Prospectus #ith date and price band! <ocument is no# called ;ed >erring Prospectus! ?! ;ed >erring Prospectus = IPO "pplication &orms are printed and posted to syndicate members@ through #hich they are distributed to in$estors! In#estor - "idding 'or t(e pu)lic issue 1! Public Issue Open for in$estors bidding! 1! In$estors fill the application forms and place orders to the syndicate members (syndicate member list is published on the application form)! 8! -yndicate members pro$ide the bidding information to :-9AB-9 electronically and bidding status gets updated on :-9AB-9 #ebsites! ?! -yndicate members send all the physically filled forms and cheques to the registrar of the issue! C! In$estor can re$ise the bidding by filling a form and submitting it to -yndicate member! D! -yndicate members keep updating stock e%change #ith the latest data! 3! Public Issue Closes for in$estors bidding! Lead Manager - Price +i,ing 1! :ased on the bids recei$ed, lead managers e$aluate the final issue price! 1! .ead managers update the 7;ed >erring Prospectus7 #ith the final issue price and send it to -9:I and -tock 9%changes! Registrar - Processing IPO .pplications 1! ;egistrar recei$es all application forms = cheques from -yndicate members! 1! They feed applicant data = additional bidding information on computer systems! 8! -end the cheques for clearance! ?! &ind all bogus applications! C! &inali/e the pattern for share allotment based on all $alid bids recei$ed!
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D! Prepare 7:asis of "llotment7! 3! Transfer shares in the <emat account of in$estors! E! ;efund the remaining money though 9C- or Cheques! /. Lead manager 0 toc1 Listing 1! Once all allocated shares are transferred in in$estors <P accounts, .ead *anager #ith the help of -tock 9%change decides Issue .isting <ate! 1! &inally shares of the issuer company get listed in -tock *arket! Initial Public Offering can be made through the fi%ed price method, book building method or a combination of both!

b! :ookbuilding F- &i%ed Price Process

<ifference bet#een shares offered through book building and fi%ed price process (-ource+ :-9)+ +eatures +i,ed Price process "oo1 "uilding process

Pricing

Price at #hich securities #ill be Price at #hich the securities are offeredAallotted is not kno#n in ad$ance offeredAallotted is kno#n in ad$ance to to the in$estor! Only an indicati$e price the in$estor! range is kno#n! <emand for the securities offered is kno#n only after the closure of the issue! Payment if made at the time of subscription #herein refund is gi$en after allocation! <emand for the securities offered can be kno#n e$eryday as the book is built!

2emand

Payment

Payment only after allocation

Once a company is listed, it is able to issue additional common shares in a number of different #ays, one of #hich is the follo#,on public offering (&PO)! This method pro$ides capital for $arious corporate purposes through the issuance of equity #ithout incurring any debt! This ability to quickly raise potentially large amounts of capital from the marketplace is a key reason many companies seek to go public!

c! "d$antages and <isad$antages of Going Public

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"n IPO accords se$eral benefits to the pre$iously pri$ate company+

9nlarging and di$ersifying equity base 9nabling cheaper access to capital Increasing e%posure, prestige, and public image &acilitating acquisitions (potentially in return for shares of stock) Creating multiple financing opportunities+ equity, con$ertible debt, cheaper bank loans, etc!

There are se$eral disad$antages to completing an initial public offering+

-ignificant legal, accounting and marketing costs, many of #hich are ongoing ;equirement to disclose financial and business information *eaningful time, effort and attention required of senior management ;isk that required funding #ill not be raised Public dissemination of information #hich may be useful to competitors, suppliers and customers!

IPOs can be a risky in$estment! &or the indi$idual in$estor, it is tough to predict #hat the stock #ill do on its initial day of trading and in the near future because there is often little historical data #ith #hich to analy/e the company! "lso, most IPOs are of companies going through a transitory gro#th period, #hich are sub)ect to additional uncertainty regarding their future $alues!

Chapter 8 Company Profile

Chapter 8 Company Profile

-tandard Chartered -ecurities (India) .imited is a leading broking company that helps retail and institutional in$estors #ith their capital market in$estment requirements!

a! :irth of the Company

-tandard Chartered -ecurities (India) .imited is a #holly,o#ned subsidiary of -tandard Chartered :ank (*auritius) .imited (-C:*), #hich acquired the company from -ecurities Trading Corporation of India (-TCI) o$er 122E,1212! Prior to the acquisition, -tandard Chartered -ecurities #as kno#n as HTI -ecurities .imited (HTI-9.)! On "ugust 18, 1223, -C:* agreed to acquire HTI-9. from -TCI in three tranches! "s a part of first tranch, -C:* acquired ?IJ stake in HTI-9. on 0anuary 11, 122E, after #hich, the name of the Company #as changed from HTI-9. to -tandard Chartered,-TCI Capital *arkets .imited #!e!f! 0anuary 13, 122E! -C:* acquired further 1C!IJ stake in the Company on <ecember 11, 122E, as a part of second leg of the transaction and increase its total stake from ?IJ to 3?!IJ in the Company! "s a last part of the acquisition, -C:* increased its stake to 122J in the Company by acquiring the residual stake of 1C!1J from -TCI on October 2E, 1212! Consequently the Company became the #holly o#ned subsidiary of -C:* and #as re,named -tandard Chartered -ecurities (India) .imited!

b! >olding Company
-tandard Chartered -ecurities is part of the -tandard Chartered Group, an international financial ser$ices group that offers a $ariety of financial ser$ices including Consumer :anking, 5holesale :anking, Corporate "d$isory, Capital *arket -er$ices, -*9 :anking, and Pri$ate :anking! -tandard Chartered P.C, listed on the .ondon, >ong Kong and *umbai stock e%changes, ranks among the top 12 companies in the &T-9,122 by market capitalisation! The .ondon,headquartered Group has operated for o$er 1C2 years in some of the #orld7s most dynamic markets, leading the #ay in "sia, "frica and the *iddle 9ast! The -tandard Chartered Group in India is also represented by -tandard Chartered :ank, India7s largest international :ank #ith I? branches across 83 cities and India is one of the
9

Group s key markets #orld#ide! 9mploying about 1I,222 people, -tandard Chartered :ank has played a significant role in the history of the banking industry in India since opening its first branch in Kolkata, 1C2 years ago, on 11 "pril 1ECE!

c! People
Chairman 4 *anaging <irector 4 <irector 4 <irector 4 <irector 4 "dditional <irector 4 "dditional <irector 4 "dditional <irector 4 -unil Kaushal ;atnesh Kumar Pradeep ;ana Tim "ndre# -an)eeb Chaudhuri "nanth Barayan "nurag "dlakha Fishal Kapoor

d! :ranch Offices
"hmedabad :hopal Chandigarh >yderabad 0aipur Kochi Fadodara :engaluru :hubanes#ar Chennai Indore Kanpur -iliguri Kolkata *umbai Be# <elhi Pana)i Pune -urat

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e! Offerings
"t -tandard Chartered -ecurities, the aim is to offer simplified in$estment solutions that pro$ide long,term $alue to its customers! &or its institutional clients, it offers products such as equity capital markets, equity and deri$ati$e broking! The retail di$ision caters to online as #ell as offline customers, offering products such as equity and deri$ati$e broking, depository ser$ices, mutual funds and fi%ed income instruments! -tandard Chartered -ecurities has a dedicated team of research analysts #ho #ork independently to pro$ide in$estment and trading recommendation to its institutional and retail customers! " net#ork of relationship managers and customer care e%ecuti$es offer efficient e%ecution backed by indepth research and e%pertise to customers across the country! It has a large net#ork #ith pan India presence in C8 locations through 82 branches and CD authorised centers! -tandard Chartered -ecurities is registered as a trading and clearing member #ith :ombay -tock 9%change .imited (:-9), Bational -tock 9%change of India .imited (B-9) and *CL -tock 9%change .imited (*CL)! The Company is also registered as <epository Participant #ith Central <epository -er$ices (India) .imited (C<-.) as #ell as Bational -ecurities <epository .imited (B-<.)!

11

Chapter ? .iterature ;e$ie#

12

Chapter ? .iterature ;e$ie#

The underpricing of IPOs has been documented e%tensi$ely in $arious researches! ;itter and 5elch (1221), .oughran, ;itter and ;ydq$ist (1II?), .)ungq$ist and 5ilhelm (1221) among others, establish the global nature of this phenomenon across many countries and capital markets! The regulatory set,up and design of Indian IPOs pro$ides an opportunity to make a distinct contribution to this literature! Hnlike in the H- #here bookbuilding has been the preferred method of IPO price disco$ery for more than t#o decades, the Indian IPO market did not use this method until 1III! >o#e$er, by 122D,23, the bookbuilding mechanism came to dominate the fi%ed,price method and by then, more than E2J of the IPOs priced their shares using the bookbuilding mechanism! The Indian IPO s bookbuilding process is transparent and it is required by regulation that the subscribers application information, by in$estor type, be a$ailable online during the IPO bookbuilding period! 9mpirical e$idence on the pricing of initial public offerings indicates that IPOs are, on a$erage, offered at prices that are belo# their subsequent secondary market trading prices! &or e%ample, o$er the period from 1ID2 to 1IE3, Ibbotson, -indelar, and ;itter report that a$erage IPO 'underpricing( is 1D!83 percent! &urthermore, Ibbotson and 0affe (1I3C) and ;itter (1IE?) document that the ne# issues market e%hibit cycles of high initial returns follo#ed by lo# or e$en negati$e initial returns! This e$idence is indicati$e of an equilibrium phenomenon! Bumerous theories ha$e offered se$eral e%planations for underpricing of initial public offerings+ 1! The in$estment bankers are better informed about the demand for the ne# issue than the issuer! To compensate the in$estment banker for his superior kno#ledge, the optimal contract bet#een the issuer and the in$estment banker results in underpricing! 1! " group of 'informed( in$estors kno# more about the issuing firm s prospects than do 'uninformed( in$estors! Gi$en their information, informed in$estors participate only in IPOs that are underpriced! "s a consequence, uninformed in$estors recei$e a disproportionate allocation of o$er,priced issues! Therefore, to keep uninformed in$estors participating in the ne# issues market, issuers persistently underprice to ensure them a normal rate of return! 8! "ccording to Ibbotson (1I3C) and Tinic (1IEE) underpricing may ser$e as 'implicit insurance( against legal liabilities of issuers and in$estment bankers resulting from IPOs that, after the fact, turn out to be unprofitable in$estments!
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?! Papers by Chemmanur (1IEI) and Guenther (1II1) say that underpricing is necessary to compensate in$estors for re$ealing pri$ate information! :y contrast, papers by "llen and &aulhaber (1IEI), Grinblatt and >#ang (1IEI), and 5elch (1IEI) argue that underpricing ser$es as a costly signal that separates high quality from lo# quality firms!

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Chapter C *a)or ;easons for Hnderpricing

15

Chapter C *a)or ;easons for Hnderpricing

"pparently, the prime focus of the e%planations offered for underpricing of initial public offerings has been the role that is played by three ma)or factors+ "symmetric information Incomplete spanning -easoning effect Gi$en the paucity of operating histories of most issuing firms, it is a reasonable and logical perspecti$e that at least a portion of the obser$ed underpricing can be traced to the influence of asymmetric information factors! "nother phenomenon is of incomplete spanning of primary issues in the secondary market! :y imperfect spanning it is meant that there does not e%ist a secondary market firm (or portfolio of firms) #hose technology perfectly replicates the stochastic returns to the issuing firm s technology! 9qui$alently it can be said that there does not e%ist a perfect substitute for the IPO in the secondary market! In fact, the absence of a perfect substitute for a ne# issue in the secondary market should, in most instances, gi$e rise to a positi$e initial return e$en if there is no asymmetry of information bet#een the parties in$ol$ed in ne# issues! "s IPOs enter the secondary market place, the degree of incomplete spanning diminishes for subsequent IPOs #ith related technologies! This industry or 'seasoning effect( results in lo#er underpricing for subsequent IPOs! Thus, these principals of the secondary market collecti$ely establish a price differential consistent #ith obser$ed underpricing! "lso, paper by -chipper and -mith (1IED) report that stocks of a subsidiary of a corporation, that ha$e a #ell,established operating history, #ould predict lo# or no underpricing! &or e%ample, most IPOs in the genetic engineering industry are by young startup companies #ith entirely ne# technology! :y contrast, almost all financial firms (e!g! banks and sa$ings and loans) going public for the first time ha$e both a #ell,established operating history and a large number of comparable firms in the secondary market! -ome papers present little or no underpricing for these latter firms!

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a! *arket -tructure
The trading of IPOs takes place in t#o distinct markets 4 the primary market and the secondary market! The primary market constitutes the offering stage of IPOs, and it is here that IPO o''ering prices are established! The larger, more centrally accessible secondary market constitutes the )idding stage of IPOs, #here IPOs and all 'seasoned( assets publicly trade! -ince the secondary market price cannot be obser$ed in actuality at the same time as the primary market price, empiricists measure IPO underpricing by initial returns reflecting prices at t#o different points in time 4 the offering stage and the subsequent after,market bid stage! *arkets are partially segmented in that the primary market is accessible only to primary in$estors #ho are a subset of the uni$erse of in$estors! :y contrast, the secondary market is accessible to all market participants! This characteri/ation is a reasonable appro%imation of the actual #orkings of the IPO market!

b! <istribution Bet#orks
The di$ersity of in$estor participation at the offering stage of most IPOs is limited by $irtue of limitations in distribution net#orks and selling efforts of participating in$estment bankers! Be# issues are a$ailable only through the firms that are members of the retail distribution group! "s a consequence, the degree to #hich an IPO recei$es #idespread distribution depends upon the si/e of the issue, the number of retail distributors, and the degree of regional or national attention! This type of access restriction is especially rele$ant for smaller and percei$ed lo#er quality IPOs, because most ma)or bracket in$estment bankers 4 #ith e%cellent national distribution net#orks 4 #ill not handle such issues!

c! Commission Generation
Indi$idual in$estor access to a gi$en IPO is also limited by #hether an in$estor regularly conducts business #ith, and thereby generates large commissions for, a brokerage house that is participating in the distribution of the IPO!

d! Optimi/ation of Trade,off
<istribution restrictions, ho#e$er, raise the question as to #hy competition among in$estment bankers does not open up the issues to a #ider population of in$estors to increase issue proceeds! The ans#er presumable lies in an optimi/ation of the trade,off bet#een the desire for greater in$estor participation 4 and, hence, lo#er underpricing 4 $ersus the
17

benefits of limited in$estor participation! -uch benefits may arise from a strategy on the part of in$estment bankers to target sales to kno#ledgeable in$estors! &or e%ample, :en$eniste and -pindt (1IEI) argue that in$estment bankers sell ne# issues repeatedly to the same in$estors, thereby learning information about ne# issue demand from 'regular in$estors( in IPOs!

e! .egal and ;egulatory Constraints

In addition to limitations in distribution net#orks, legal restrictions and regulatory constraints also limit in$estor access to the IPO market! " large proportion of all publicly traded equity is held by institutional in$estors@ ho#e$er, many of these in$estors are sub)ect to institutional restrictions, such as prudent,in$esting rules, that se$erely limit their opportunities to participate in IPOs! Casual empiricism suggests that there may be certain in$estors, such as $enture capitalists, #ith no such legal and regulatory restrictions! To the e%tent that they face no restrictions, they are potentially classified as primary in$estors #ho ha$e unrestricted access to both the primary and secondary markets!

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Chapter D <eterminants of IPO Hnderpricing

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Chapter D <eterminants of IPO Hnderpricing

The $arious determinants of IPO underpricing help in analy/ing and assessing the reasons behind such underpricing! :ased on research papers, such as *auer and -enbet (1II1), the follo#ing determinants ha$e been identified+ Offering price in the primary market i!e! the price at #hich unit share of the IPO is offered! IPO bid price (first closing bid price) at the initial public trading in the secondary market #hereby the primary asset is completely accessed! The difference bet#een the t#o prices deli$ers a gap that is consistent #ith #hat is typically kno#n as IPO 'underpricing(! This gap, in turn, is the initial return of the IPO! ize o' t(e issue determines #hether the issue #ill recei$e #idespread distribution and hence, $isibility among the in$estors or not! .ge o' t(e issuing 'irm determines the operating history of the firm, as it has been obser$ed by some researchers that longer the operating history of a firm, lo#er is the underpricing of its issue! 3ime o' O''er determines the 'seasoning effect( also kno#n as the 'industry effect( that arises due to spannability and substitution that changes #ith the time period in #hich an issue is offered in an industry! The 2imson )eta is the beta coefficient of the secondary market return in the <imson time,series regression! It is the systematic risk in an in$estment! Residual ris1 is the left o$er risk generated due to $arious factors! To obtain a pro%y for residual risk, square root of mean square error from the <imson time,series regression is taken into account!

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Chapter 3 ;esearch *ethodology

21

Chapter 3 ;esearch *ethodology

To in$estigate the effect of secondary market on the underpricing of IPOs, the entire population of book,built IPOs from 0anuary 1, 1223 to *arch 81, 1211 (fi$e years and t#o months) has been taken for study! These are the IPOs #hich #ere offered during the aforesaid period! <uring this period, there #ere 1?D IPOs! Out of these, 18 issues failed and #ere recalled by the issuers before the completion of the bookbuilding e%ercise! The remaining 188 issues form a part of our data! Out of these, 1D IPOs sho#ed irrational and insignificant results in the <imson time,series regression so these did not form part of the study! Thus, 123 IPOs is sample si/e for the study! 9%ploratory ;esearch using secondary data has been used to conduct this pro)ect!

a! "ssumptions
&or analytical tractability, in this study it has been assumed that+ 1! There e%ists one primary market #here an IPO offering price is determined, #hereas the secondary market constitutes a central market space! In reality, there may be many primary markets differentiated by IPO type and in$estor access! 1! Capital markets are other#ise perfect and frictionless in the usual sense (including no short sale restrictions)! 8! "ll in$estors are risk,a$erse, utility ma%imi/ers! ?! "ll in$estors ha$e identical preferences and #ealth!

b! ;egression "nalysis Hsing <ummy Fariables

Predominantly the methodology used for the study of underpricing of IPOs is ';egression analysis using dummy $ariables!( Fariables that assume 2 and 1 $alues are called dummy $ariables! -uch $ariables are thus essentially a de$ice to classify data into mutually e%clusi$e categories! Ten dummy $ariables ha$e been used in order to conduct the study industry,#ise and deri$e e%hausti$e results! The 'hot period( has also been incorporated, using a dummy $ariable for it, to study its effect on the initial returns of the IPO!

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"lso, 'Correlation .nalysis( has been used to establish relationship among the si% determinants of underpricing!

c! <ata Collection (-econdary data)

B-9 #ebsite :-9 archi$es (:-9 :ha$ Copy) ;ed >erring Prospectus

Tools used for data analysis+ -P-9$ie#s C *- 9%cel 1223

6<ate of issue offering , 6date of listing , 6offer pri/e and 6issue si/e of the IPOs #as obtained from B-9 s historical data! 6Closing price of the stock on the first day of trading #as procured from :-9 archi$es! 6Mear of incorporation of companies #as obtained from either the company s #ebsite or its ;ed >erring Prospectus (;>P)! The 6age of the firm is calculated as the difference in year of the firm going public and the year of its incorporation! The earliest year of incorporation has been taken e$en if the firm #as incorporated in a different name than the one in #hich it #ent public! The 6time of offering is measured in months, #here 0anuary 1223 is month 1 and *arch 1211 is month D8! To calculate 6beta coefficient , <imson time,series regression methodology has been used! C2 days returns of each stock from its first day of trading and their corresponding returns of C2 days of -9B-9L #ere taken for the regression analysis! Hsing 9$ie#s C soft#are, the coefficient of the market return i!e! beta coefficient has been obtained! To calculate 6residual risk , the sum squared residual $alue in the abo$e mentioned regression series #as used! The square root of the mean of this $alue #as calculated to obtain the residual risk (square root of the mean square error)!

Mears 1223 and 122E are taken as '(ot period( because this period #itnessed unusual highs and lo#s in the capital markets due to the occurrence of the great depression! Mear 1223 #as associated #ith unusually high returns in certain industries and the market sentiments
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predicted rising returns for the coming year! :ut in year 122E, the capital markets in India recei$ed a blo# from the recession that hit the H- but ad$ersely affected the capital markets all o$er the #orld!

d! Industry,#ise Classification
"ll the 123 IPOs ha$e been classified into 12 industries 4 1! :anks and other financial ser$ices 1! >ealthcare and Pharmacy 8! IT ?! Telecomm and *edia C! ;ealty and Infrastructure D! Po#er and 9nergy 3! Te%tiles E! "uto and its ancillaries I! ;etail 12! Others &urther, in order to classify all IPOs and to gi$e them a numeric representation in order for it to be used in calculations, IPOs ha$e been numbered from 1 to 12 based on the industry to #hich it belongs (in the same order of numbering as mentioned abo$e)! -P-- tool has been used to conduct correlation analysis among the si% determinants! It has also been used to run regression analysis using dummy $ariables!

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Chapter E "nalysis

25

Chapter E <escripti$e -tatistics

The sample consists of 123 IPOs during the period 0anuary 1, 1223 4 *arch 81, 1211! To be included in the sample, an offering must+ a) :e under#ritten b) Bot recalled by the issuers before the completion of the bookbuilding e%ercise c) :e traded on the :-9

3a)le 1 presents the distribution of offerings by year of offer! <ata are from B-9 #ebsite! TABLE 1 Distribution of Initial Public ff!rin"s b# $!ar% &an 2007 ' (arc) 2012 *u+b !r of IP s 79 30 13 55 28 2 207

$!ar 2007 2008 2009 2010 2011 2012, Total

,Till (arc) 31% 2012 To b! inclu-!- in t)! sa+.l!% an off!rin" +ust/ 011 b! un-!r2ritt!n3 021 b! succ!ssful an- not r!call!- b# issu!r3 031 b! tra-!- on t)! B4E

Mear 1223 #itnessed the IT sector boom in India #ith a lot of soft#are companies going public! -ubsequently, recession )olted the #orld economy and the primary market also sa# the implications! In year 1212, markets started to re$i$e and #ent into a self,heal mode!
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The graph belo# sho#s the money raised through IPOs in the financial years from 1223, 1211 (Partial <ata for year 1211) (source+ chittorgarh!com)

The graph belo# sho#s the succeeded $ersus failed IPOs in the financial years from 1223, 1211 (Partial <ata for year 1211) (source+ chittorgarh!com)

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a! IPO Initial ;eturns

IPO initial returns are calculated as 4

ln (P1AP1)
#here, P1 is the offer price and P1 is the closing price of the IPO on first day of trading in the secondary market (:-9 price)!

b! -ystematic and ;esidual ;isks

<imson market model regression is used to estimate the beta coefficient and residual risk! -tock ;eturn 4 C2 post,offering returns starting from the first return (initial return) on each IPO #ere recorded! These are closing prices of the IPO on :-9! *arket ;eturn 4 ln (P1AP1) #here, P1 is the closing price of -9B-9L on the last date of IPO offering and P1 is the closing price of -9B-9L corresponding #ith the time period of returns on each IPO!

The post,offering return on IPOs is the dependent $ariable and the market return is the independent $ariable!

&or each IPO, the follo#ing post,offering time,series regression is estimated+

r),t N O) P (Q) rm,t P R),t)

#here, r),t rm,t R),t Q) O) N the post,offering return on IPO j at time t@ N the return on the -9B-9L market inde% at time t@ and N the residual error term N the <imson beta of IPO j N the $alue of constant of IPO j

Hsing 9$ie#s C, the <imson equation #as estimated for each IPO j and the coefficient of market return #as noted as beta $alue! &inally to obtain a pro%y for the residual risk of IPO j, the square root of the mean square error #as calculated! The $alue of sum squared residual
28

#as obtained from the <imson time,series regression run in 9$ie#s C! The mean of this $alue and then the square root #as calculated to obtain the $alue of residual risk!

c! "ge of Issuing &irm

The age of an IPO at the time of offering #as determined by consulting the ;ed >erring Prospectus of the company or the company s official #ebsite! "ge is measured as the number of years that the principal component of the company s business has been operating at the time of the offering (in years)!

d! -i/e of Offer
The si/e of an IPO is computed as the offer price times the number of shares in the offering! This si/e is in the unit of currency (;s!)!

e! Industry
&inally, IPOs are grouped into industry categories according to the company s main area of operation and the type of offerings it pro$ides! To do this, company s #ebsite andAor their ;ed >erring Prospectus #as used! Thus, 12 industry categories #ere identified 4 :anks = financial ser$ices, healthcare = pharmacy, IT, telecomm = media, realty = infrastructure, po#er = energy, te%tiles, auto = ancillaries, retail, and others!

3a)le 2 presents descripti$e statistics on sample IPOs grouped by industry category! The table sho#s mean and median initial return, after,market beta and residual risk, offering si/e, company age, and the minimum and ma%imum time of offering! Time is measured in months, #here 0anuary 1223 is month 1 and *arch 1211 is month D8! Inferences from Table 1+ 1) There is some $ariability of a$erage underpricing across industry groups, #ith the lo#est amount, 8!I percent, associated #ith healthcare and pharmacy industry, and the highest amount, 1?!1 percent, associated #ith IT industry! 1) There is some o$erpricing as #ell that can be seen particularly in the te%tiles industry, #ith the a$erage o$erpricing being 11!3 percent!
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8) The a$erage initial return for the entire sample of 123 IPOs is 11!2 percent and the median is E!C percent! It sho#s that the distribution of initial returns has a positi$e ske#! ?) The ma%imum o$erpricing for the entire sample of 123 IPOs is 11D!I percent and ma%imum underpricing is 111!I percent! The $ariability pan IPOs is thus, quite high! C) 9$ery industry has at least 1 IPO #ith a negati$e initial return! "ccordingly, there is some 'o$erpricing,( and it is e$ident across industries!

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Chapter I ;esults

31

Chapter I ;esults
" multiple regression frame#ork is used to test the predictions of $arious theories presented in the re$ie#ed research papers! &irstly, a preliminary analysis is done by e%amining the simple correlations bet#een sample underpricing and access and risk pro%ies! Panel " of 3a)le 3 presents Pearson correlation coefficients calculated bet#een initial returns (I;), <imson beta (:9T"), residual risk (;9-;I-K), offering si/e (-IS9), age ("G9), and time (TI*9) of offering!

TABLE 3 P!arson 5orr!lation 5o!ffici!nts an- 6!"r!ssions on In-ustr# Du++# 7ariabl!s of IP Initial 6!turns% 4#st!+atic an- 6!si-ual 6is8% ff!rin" 4i9!% A"! of :ir+% anTi+! of ff!rin" for 207 IP s -urin" t)! .!rio- &anuar# 1% 2007 ' (arc) 31% 2012 6E46I4 = '0>173, 00>0131 '0>122 00>0811 0>091 00>1911 0>085 00>2251 1>000

I6
Panel A. Correlation and (pValues)

4I;E

A<E

TI(E 0>002 00>9811 0>052 00>4571 1>000 0>302, 00>0001 0>091 00>1911

BETA '0>007 00>9151 '0>058 00>4041 0>302, 00>0001 1>000 0>085 00>2251

4I;E

0>019 1>000 0>170, 00>7831 00>0141 A<E 0>023 0>170, 1>000 00>7411 00>0141 TI(E '0>190, 0>002 0>052 00>0061 00>9811 00>4571 BETA '0>132 '0>007 '0>058 00>0581 00>9151 00>4041 6E46I4= 0>107 '0>173, '0>122 00>1241 00>0131 00>0811 Panel B. Regressions on Industry Dummy Variables 62 0>048 0>202 0>028 :'statistic 1>111 5>551 0>639 .'?alu! 0>357 0>000, 0>763
An , in-icat!s si"nificanc! at t)! 5'.!rc!nt l!?!l>

0>037 0>851 0>570

0>024 0>544 0>841

0>055 1>269 0>256

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Inferences from Table 8, Panel "+ 1) 9$ery pair,#ise correlation coefficient bet#een I; and the $arious e%planatory $ariables is not statistically significant at the C,percent le$el, e%cept the one bet#een I; and TI*9! That correlation coefficient (,2!1I2) is significant at reasonable confidence le$els (2!22D)! 1) Thus, as predicted by theoretical analysis, IPO underpricing is negati$ely related to the TI*9 in #hich the offering occurred during the sample period! This result is consistent #ith the 6seasoning prediction! 8) There is significant correlation bet#een independent $ariables ;9-;I-K and -IS9! :igger the si/e of IPO offering smaller is the residual risk! ?) There is significant correlation bet#een independent $ariables "G9 and -IS9! "n older company is more likely to go public #ith a bigger si/e of IPO offering! C) There is significant correlation bet#een independent $ariables :9T" and TI*9! "s the time of offering increases, the systematic risk associated #ith the IPO also increases as substitutes are already a$ailable in the market for the IPO! This phenomenon has been described as the 6industry effect! Panel : of Table 8 reports ;1 s and F,statistics from regressions of I;, :9T", ;9-;I-K, -IS9, "G9, and TI*9 on industry dummy $ariables! ;1 indicates the 6goodness of fit of a model! F test is used to test the o$erall significance of a multiple regression! P $alue tests the significance of the results, in this study at a confidence le$el of C percent! Only the regression of -IS9 on industry dummy $ariables is significant at C,percent le$el, indicating that there are significant differences in the $alues of -IS9 across industry groups! >ere, industry classification e%plains 12 percent of the $ariation in the si/e of IPO offerings! Goodness of fit is also highest in the case of regression of -IS9 on industry dummy $ariables (12 percent)!

In order to estimate the influence of the other $ariables on initial returns, the follo#ing regression model is estimated+ I;) N O2 P O1 -IS9) P O1 "G9) P O8 TI*9) P O? :9T") P OC ;9-;I-K) P T Ui IB<H*i) P >OT<H*) P V) #here, V) is the error term and $alue of i is from 1 to 12 (industry classification)

33

The dependent $ariable I;), and the first C e%planatory $ariables are as defined abo$e! The ne%t set of $ariables, IB<H*i), are industry dummies that are set equal to 1 if offering j is in the ith industry! >OT<H*) is also a dummy $ariable that is set equal to 1 if offering j occurred during the hot issue period (0anuary 1, 1223 to <ecember 81, 122E)! 3a)le % reports the estimation of the abo$e regression equation #ith and #ithout industry dummies! In the regression run #ithout industry dummy $ariables+ 1) Coefficients of TI*9 and ;9-;I-K are statistically significant at C,percent le$el and ha$e the predicted signs! 1) The coefficient of TI*9 is negati$e (due to the seasoning effect), but it is not significantly different from /ero at reasonable confidence le$els! 8) The coefficient of ;9-;I-K is positi$e as increasing underpricing is associated #ith increasing residual risk! ?) The goodness of fit of the model is D percent and the model is statistically significant! In the regression run #ith industry dummy $ariables+ 1) The coefficient estimates of the e%planatory $ariables are essentially unaltered! 1) "lmost similar results #ere obtained as #ithout the industry dummy $ariables regression! 8) The goodness of fit of the model is higher as IPO industry classification pro$ides additional e%planatory po#er!

3a)le & sho#s the industry group regressions of IPO Initial ;eturns on the e%planatory $ariables! The estimated regression model, I;) N O2 P O1 -IS9) P O1 "G9) P O8 TI*9) P O? :9T") P OC ;9-;I-K) P V)

1) Fariable -IS9 is statistically significant in the 6IT industry, though the coefficient is /ero!
34

1) Fariable "G9 is statistically significant in the 6>ealthcare and Pharmacy industry, and its coefficient is negati$e! "s predicted by studies, increasing industry underpricing is associated #ith decreasing age! Thus, firms in >ealthcare and Pharmacy industry #hich ha$e shorter operating history are more likely to ha$e underpricing! 8) "lthough the coefficient of TI*9 is negati$e in almost e$ery industry, it is positi$e and significant in the 6Te%tiles industry but the $alue of coefficient is nearly /ero! It means the impact of seasonality is found only in the Te%tile Industry! ?) The $alue of ;9-;I-K is statistically significant in industries 6>ealthcare and Pharmacy , 6IT and 6;ealty and Infrastructure ! 9%cept in IT, the coefficient of ;9-;I-K is positi$e in the other t#o industries indicating that #ith increasing underpricing in these t#o industries is associated #ith increasing residual risk! C) "s it can be seen the number of IPOs in each industry is fe# as #ell as the time period of the study is short, leading to a fe# erratic results inconsistent #ith prior researches!

35

Chapter 12 Conclusion

36

Chapter 12 Conclusion
This pro)ect pro$ides an empirical in$estigation of the role of secondary market in the pricing of initial public offerings! Htili/ing a segmented market approach, #herein IPO offering $alues are determined in the primary market and after,market bid prices are determined in the centrally accessed secondary market, #e deri$e a price differential in the primary and secondary markets that is consistent #ith IPO underpricing! The price differential reflects a primary risk premium that captures both limited in$estor accessibility of the IPO in the primary market and the risk associated #ith imperfect substitutability of the IPO in the secondary market! "s seen in the results, follo#ing can be concluded+ The difference bet#een an IPO s secondary market $alue and initial offer $alue is attributable to a primary market risk premium that is a function of incomplete spanning of the initial issue by secondary market assets and the degree of in$estor access to the primary market! "s IPOs enter the secondary market place, the degree of incomplete spanning diminishes for subsequent IPOs #ith related technologies 4 seasoning effect! Thus, three principal determinants #ere identified 4 access, substitution, seasoning! This phenomenon could also be #itnessed in the industry,#ise study!

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