A STUDY ON INITIAL (LISTING) RETURNS PROVIDED BY INITIAL ... · PDF fileInitial Public Offer...

Indian Journal of Economics & Business, Vol. 15, No. 2, (2016) : 229-241

* Research Scholar, Mahatma Gandhi University, Meghalaya** Asst. Professor, Department of Commerce, Shri Guru Tegh Bahadur Khalsa College, University of

Delhi

A STUDY ON INITIAL (LISTING) RETURNSPROVIDED BY INITIAL PUBLIC OFFERINGS

GYANESH KUMAR MAHESHWARI* ANDBIBHU PRASAD SAHOO**

Abstract

Indian capital market has witnessed a drastic development as a result of economicliberalisation in the country since 1991. This includes abolishing the regulated regimeunder the Controller of Capital Issues (CCI) and establishing the Securities andExchange Board of India (SEBI) as the market monitor in 1992. The technologicaladvancements in the stock market, improved trading process, strict regulatory controls,enlarged investor base has brought a new environment of stock investment in India,likely to develop in the future also. Investors perceive Indian capital market, whetherlocal or global, as a new investment opportunity to earn high returns. The researchstatistics have proven that in the Indian financial markets, equity instruments providehigher returns in long period as compared to other traditional forms of investmentssuch as fixed deposits and gold etc. Thus there has been a continuous increase in thetendency of investors to make investments in equity by taking more risk in order toearn superior returns from the stock market. Capital market is considered as the bestopportunity to fulfil the dreams of retail investors.

INTRODUCTIONThe capital market is an important constituent of the financial system. Capitalmarket is one of the significant aspects of every financial market. It is a market forthe long term funds- both debt and equity – and funds raised within and outsidethe country. It provides long term debt and equity finance for the government andthe corporate sector. The capital market aids economic growth by mobilizing thesavings of the economic sectors and directing the same towards channels ofproductive use. Capital market can be classified into primary and secondarymarkets. The primary market is a market for new shares, where as in the secondarymarket the existing securities are traded. Capital market institutions provide rupeeloans, foreign exchange loans, consultancy services and underwriting. CapitalMarket plays an important role in the economy of a country as it serves two functions

230 Gyanesh Kumar Maheshwari and Bibhu Prasad Sahoo

all at once. First, Capital Market serves as an alternative for a company’s capitalresources. The capital gained from the public offering can be used for the company’sbusiness development, expansion, and so on. Second, Capital Market serves as analternative for public investment. People could invest their money according totheir preferred returns and risk characteristics of each instrument. Hence thedevelopment of an efficient capital market is necessary for creating a climateconducive to investment and economic growth.

INITIAL PUBLIC OFFERINGS (IPOs)A corporate may raise capital in the primary market by way of an initial publicoffer, rights issue or private placement. An Initial Public Offer (IPO) is the sellingof securities to the public in the primary market. It is the largest source of fundswith long or indefinite maturity for the company. Requirement of funds in order tofinance the business activities motivates small entrepreneurs to approach the newissue market. Initial Public Offer (IPO) is a route for a company to raise capitalfrom investors to meet the expenses for its projects and to get a global exposure bylisted in the Stock Exchange. An Initial Public Offer (IPO) is the selling of securitiesto the public in the primary stock market. Company raising money through IPO isalso called as company ‘going public’. From an investor’s point of view, IPO gives achance to buy shares of a company, directly from the company at the price of theirchoice (In book build IPO’s). Many a times there is a big difference between theprice at which companies decides for their shares and the price on which investorare willing to buy shares and that gives good listing gain for shares allocated to theinvestor in IPO. From a company’s perspective, IPO’s help them to identify theirreal value which is decided by millions of investors once their shares are listed onstock exchanges. IPO’s also provide funds for their future growth or for payingtheir previous borrowings.

“An initial public offering (IPO), referred to simply as an “offering” or “flotation”, is whena company (called the issuer) issues common stock or shares to the public for the firsttime.”

Therefore, when an unlisted company makes either a fresh issue of securities oroffers its existing securities for sale or both for the first time to the public, it iscalled an IPO. This paves way for listing and trading of the issuer’s securities inthe Stock Exchanges.

Life cycle of an IPO

1. Issuer Company - IPO Process Initialization

Appoint lead manager as book runner

Appoint registrar of the issue

Appoint syndicate members

A Study on Initial (Listing) Returns Provided by Initial Public Offerings 231

2. Lead Manager’s - Pre Issue Role - Part 1

Prepare draft offer prospectus document for IPO

File draft offer prospectus with SEBI

Road shows for the IPO

3. SEBI – Prospectus Review

SEBI review draft offer prospectus

Revert it back to Lead Manager if need clarification or changes (Step 2)

EBI approve the draft offer prospectus, the draft offer prospectus isnow become Offer Prospectus

1. Lead Manager - Pre Issue Role - Part 2

Submit the Offer Prospectus to Stock Exchanges, registrar of the issue andget it approved

Decide the issue date & issue price band with the help of Issuer Company

Modify Offer Prospectus with date and price band. Document is nowcalled Red Herring Prospectus

Red Herring Prospectus & IPO Application Forms are printed and posted tosyndicate members; through which they are distributed to investors

2. Investor – Bidding for the public issue

Public Issue Open for investors bidding

Investors fill the application forms and place orders to the syndicate members(syndicate member list is published on the application form)

Syndicate members provide the bidding information to BSE/NSE electronicallyand bidding status gets updated on BSE/NSE websites

Syndicate members send all the physically filled forms and cheques to theregistrar of the issue

Investor can revise the bidding by filling a form and submitting it toSyndicate member

Syndicate members keep updating stock exchange with thelatest data

Public Issue Closes for investors bidding


3. Lead Manager – Price Fixing

Based on the bids received, lead managers evaluate the finalissue price

Lead managers update the ‘Red Herring Prospectus’ with the final issue priceand send it to SEBI and Stock Exchanges

4. Registrar - Processing IPO Applications

Registrar receives all application forms & cheques from Syndicate members

They feed applicant data & additional bidding information oncomputer systems

Send the cheques for clearance

Find all bogus application

Finalize the pattern for share allotment based on all valid bid received

Prepare ‘Basis of Allotment’

Transfer shares in the demat account of investors

Refund the remaining money though ECS or Cheques

Lead manager – Stock Listing

Once all allocated shares are transferred in investors dp accounts, LeadManager with the help of Stock Exchange decides Issue Listing Date

Finally share of the issuer company gets listed in Stock Market

Source: www.nseindiaonline.com

REVIEW OF THE LITERATUREThe literature reviews of the previous researches done on the returns behaviour ofIPOs all over the world including Indian stock market are mentioned below:

Ritter (1984)analyzed the “hot issue” market of 1980, the 15-month periodstarting from January 1980 and extending through March 1981 during which theaverage initial return on unseasoned new issues of common stock was 48.4 percent.This average initial return compares with an average of 16.3 percent during the“cold issue” market comprising the rest of the 1977-82 periods. This research paperdocumented tremendous disparities between the initial returns from naturalresource issues vis-à-vis non natural resource issues in the United States during1977–82, underlining the role of industry classification in IPO under-pricing. Rock(1986) proposed the “Winner Curse hypothesis” to reasonably explain an IPO’spositive initial return. The hypothesis implies that more uncertain issues should


have higher initial returns. Allen and Faulhaber’s (1989) empirical evidencesuggested the existence of ‘hot-issue’ markets for initial public offerings: in certainperiods and in certain industries, new issues are under-priced and rationingoccurred. This research paper develops a model consistent with this observation,which assumes the firm itself best knows its prospects. In certain circumstances,firms with the most favourable prospects find it optimal to signal their type byunder-pricing their initial issue of shares, and investors know that only the bestcan recoup the cost of this signal from subsequent issues. P. Ishwara (2010)analyzed 107 companies which entered capital market through IPOs in the financialyear 2008-09 and found that the private companies are dominated in the new issues.Out of 107 issues, 86 companies gained in listing their shares in BSE and NSE andrest of the companies reported negative return to the investors. The study showedthat, Market forces and Individual companies’ performance reflect stockperformance. SoumyaGuha Deb (2011) examined the underpricing in Indian IPOsduring the period from 2001 to 2010. Using a sample of 187 IPOs, the resultsindicated evidence of underpricing on the average in Indian IPOs during this period.Alok Pande and R Vaidyanathan (2012) looked at the pricing of IPOs in theNSE, in particular, it sought to empirically explain the first day underpricing interms of the demand generated during the book building of an issue, the listingdelay 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. G Sabarínathan(2013) found some interesting changes in the characteristics of the companies thatmade IPOs during the period 1993-94 to 2011-12. The changes in characteristicsare in terms of the size of the issue, size of the issuer as measured by the post issuepaid capital, the stage of evolution of the issuer, the pricing of the issue, fraction ofshareholding of the issuer that has been offered for public ownership, the industry/business that the issuer is engaged in and the exchanges on which the shares werelisted. Seshadev Sahoo and Prabina Rajib (2013) evaluated the priceperformance of IPOs with respect to short-run underpricing and long-rununderperformance for 92 Indian IPOs issued during the period 2002-2012 up to aperiod of 36 months including the listing day. The result indicated that on an averagethe Indian IPOs are underpriced to the tune of 46.55 per cent on the listing day(listing day return vis-à-vis issue price) compared to the market index.

OBJECTIVES OF THE STUDYThe primary objective of the study is to analyze the initial returns provided byInitial Public Offerings (IPO’s) over and above the benchmark index S & P CNXNifty after the issue on the listing day as well as the performance of IPO’s in termsof the long term returns up to the period of six months after the listing of theissue using event study methodology and to identify the different factors(ownership structure, age of the company, market demand (subscription), industrytype, promoter’s group, issue size, bullish/bearish period) that explains the returnbehavior of Initial Public Offerings in different time periods of the emerging Indianeconomy.


Hypothesys to be testedThere is no significant difference between the long term post listing IPO returns (upto the period of six months and one year) and the market (S & P CNX Nifty) returns.

Number of IPOs in different years

Year Frequency Percentage

2004 19 5.052005 41 10.902006 61 16.222007 95 25.272008 28 7.452009 20 5.322010 61 16.222011 34 9.042012 10 2.662013 2 0.532014 5 1.33Total 376 100

Number of IPOs in different years


The behavior of the stock market as represented by the market index S & P CNXNIFTY was different during the period considered in the research study. The fig3.1(b) represents the behavior of NIFTY from the year 2004 to 2014. In order tofind out the impact of market sentiments on the decision of the companies to goingpublic, the period of Jan 2004 to Dec 2014is divided into two categories: Bearishperiod and Bullish Period as shown below:

� Bearish period (Jan 2008 up to Feb 2009), and

� Bullish period (Jan 2005 up to Dec 2007).

The behavior of the market index (S & P CNX Nifty) during the period Jan2004 - Dec 2014

The frequency of IPOs during these two different periods is shown in table3.1(b). Analyzing the frequency distribution of IPOs in these different scenarios, itis found that the frequency of IPOs is higher in bullish scenario as compared to the


bearish scenario. It can be concluded from the results that most of the companiesprefer to come out with the IPOs in bullish scenario. The reason for the selection ofgoing public by most of the companies in the bullish scenario may be the ease ofpricing and the confidence of success of the issue, whereas in bearish scenario thecompanies avoids or postpone the decision to come with IPOs due to the risk ofunder subscription or the failure of the issue. The difficulty in pricing of the issuemay be another possible reason of less frequency of IPOs in the bearish scenario.As a result the large number of IPOs in Indian stock market comes in bullish market.When the economy is performing well, stock prices are moving up, investors are inbuying mode and the companies are assured about the rising demands of theirproducts and services, the promoter plans for the capacity expansion or to start thenew projects and hence decided for raising funds through IPOs. The response fromthe investors to the issue in bullish scenario is supposed to be good and results inoversubscription in case of most of the cases. The largest number of IPOs came inthe year 2007, when Indian stock market performed very well and the stock indiceswere at their historical heights. In bearish period, very few companies decided toissue IPOs as shown below in table.

Frequency of IPOs in different scenarios

Trend

Bearish Trend Bullish Trend

Total 54 322 376

Age profiles of the companies came with initial public offerings (IPOs)The life cycle of any company can be divided into four stages. These are introduction,expansion, maturity and decline. The company spends first five years in theintroduction stage followed by the expansion stage in the next 5 to ten years. Afterthis the company reaches at the maturity level. The stage of the life cycle at whichthe company exists seems to play an important role in selection of the IPOs as achoice of raising funds from the general public. The companies in the expansionstage come with an IPO to raise funds in order to finance the expansion planswhereas the companies in maturity stage comes with an IPOs to finance the newdiversified projects. In addition to this the government also offers their shares tothe general public as per their disinvestment plans.

For the purpose ofanalyzing the age profiles of the companies who decided tocome with IPOs in Indian stock market, the age of the company is calculated bysubtracting the year in which the company came with IPO from the year ofincorporation.

Age =Year of Incorporation – Year in which the issue comes

The frequency distribution of the age profiles of the companies is shown in theabove table a. From the analysis it is found that the average age of the firm issuingIPOs is 15.98 years and more than 82 percent of the firms are under 20 years of


age. There are very few firms which are older than 25. The results indicates thatthe well-established firms which are in their growth stage and in the mode ofexpansion, modernization or diversification decided to come with issue in theprimary market to raise funds through IPOs. The selection of the primary marketby these firms in order to raise funds indicates the strength and health of the Indianprimary market. Normally a company starts as a small business unit by thepromoters, where the promoter invests his hard earned money along with the fundsraised from financial institutions as loans. When the business grows with time thepromoters need more capital and start searching for alternative source of funds tofinance the expansion and modernization in the business. The decision of ‘Goingpublic’ not only provides capital for the expansion of their business, but also providesglobal recognition and wide investor base. The selection of the primary market bythese firms in order to raise funds provides an opportunity for the investors toshare wealth earned by the organization. Hence sound practices in primary marketare good for the overall health of the Indian economy.

Frequency distribution of the age of the companies came with IPOs.Frequencies of thecompanies issuing IPOs with respect to different age group


Age Group Frequency Percent

0 to 5 years 42 12.3 %

6 to 10 years 77 22.5 %11 to 15 years 101 29.5 %

16 to 20 years 54 15.8 %21 to 25 years 27 7.9 %

26 to 30 years 11 3.2 %Above 30 years 30 8.8 %

Total 342 100.0

Frequencies of the companies issuing IPOs according to the age group


The above hypothesis is tested by applying the Independent sample T testbetween the mean returns provided by the IPOs and the market index between theclosing of the issue and the listing day. The result of independent sample t test isshown in table 3.5.2. The results indicate that the t statistic is higher than two andsignificance value (P value) is less than five percent, hence the null hypothesis ofno difference between the IPO returns and market returns between the closing ofthe issue and the listing day cannot be accepted. Hence with ninety five confidencelevel, it can be concluded that returns provided by the IPOs and market (S & PCNX NIFTY) are significantly different between the closing of the issue and thelisting day. In fact the returns provided by the IPOs are significantly better thanmarket return in short run. However no significant correlation is found betweenthe mean returns provided by the IPOs and the market index between the closingof the issue and the listing day

Independent Sample T test

Returns Mean S.D. Correlations T-Statistic

Return provided by IPOs from issue 25.09 35.36 0.069 4.767date up to the listing dayReturn provided by the Market from -17.61 136.66 0.288 0.000issue date up to the listing day

Long term performance of IPOs

Statistic Returns after Returns after Returns after Returns after Returns afterone year of Two year three year four year five year

listing of listing of listing of listing of listing

Frequency 259 226 210 129 65

Average Return -14.49% -17.28% -14.64% -0.92% 26.75%S.D. 101.76% 136.85% 181.33% 123.06% 154.28%

Minimum -99.44% -99.43% -98% -98.60% -91.80%Maximum 920% 1345.16% 2146% 772% 677.00%

Skewness 0.05 0.06 0.09 0.03 0.02Kurtosis 0.40 0.55 0.97 0.12 0.06

After adjusting the market returns in the long term returns provided by theIPOs after the listing, the abnormal returns provided by these IPOs after the listingday in long term are shown in table 3.9(b). The results indicates that the abnormalreturns provided by 259 IPOs after one year from listing are -32.71 percent, abnormalreturns provided by 226 IPOs after two year from listing are -46.43 percent,abnormal returns provided by 210 IPOs after three year from listing are -54.64percent, abnormal returns provided by 129 IPOs after four year from listing are -78.91 percent and after five years the abnormal returns increases to -96.22 percent.


poor performance of Indian IPOs in long term indicates the fundamental anomalyof underperformance of IPOs in long term. This anomaly not only exists in Indiabut is found to be present in almost all stock markets.

CONCLUSIONThe long term performance of the IPO is also compared with the index returns forthe same period. These abnormal returns are calculated by subtracting the indexreturns from the IPO returns. It is found that the abnormal returns after one yearfrom listing are -32.71 percent, after two year from listing are -46.43 percent, afterthree year from listing are -54.64 percent, after four year from listing are -78.91percent and after five years the abnormal returns increases to -96.22 percent. Henceit can be concluded that the abnormal returns provided by the IPOs in long termare very poor. This poor performance of Indian IPOs in long term proves thefundamental anomaly of underperformance of IPOs in the long term. This anomalynot only exists in India but was found to be present in almost all stock markets.Looking at these depressing performances of the IPO in the long run, the retailinvestors are suggested not to invest after the listing of the IPOs in Indian stockmarket.

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A STUDY ON INITIAL (LISTING) RETURNS PROVIDED BY INITIAL ... · PDF fileInitial Public Offer...

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