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“The Analysis of the Initial and Post Issue
Performance of Initial Public Offerings (IPOs) in Indian Stock Market”
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THESIS
Submitted to
Kumaun University, Nainital For the award of the Degree of
DOCTOR OF PHILOSOPHY
(Ph.D.)
In
Commerce
Under the supervision of:
Dr. B.D. Kavidayal Professor
Department of Commerce DSB Campus, Kumaun University
Nainital, Uttrakhand
Research Scholar:
Ajay Kumar Chauhan
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PREFACE
Indian capital market has witnessed a drastic development as a result of economic
liberalisation in the country since 1991. This includes abolishing the regulated regime
under the Controller of Capital Issues (CCI) and establishing the Securities and
Exchange Board of India (SEBI) as the market monitor in 1992. The technological
advancements 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,
whether local or global, as a new investment opportunity to earn high returns. The
research statistics have proven that in the Indian financial markets, equity instruments
provide higher returns in long period as compared to other traditional forms of
investments such as fixed deposits and gold etc. Thus there has been a continuous
increase in the tendency of investors to make investments in equity by taking more
risk in order to earn superior returns from the stock market. Capital market is
considered as the best opportunity to fulfill the dreams of retail investors. As the
Indian economy is considered as one of the highest developing economy in the world,
the investors expect the good returns in view of that. The funds from different class of
investors including Foreign Institutional Investors, qualified institutional investors
and retail investors is expected to increase in the future in the Indian stock market.
Along with the developments in the secondary market, the primary market has also
shown the tremendous improvement in recent years. Initial public offering (IPO), also
referred to simply as a "public offering", “going public” or "flotation" is when a
company issues equity shares to the public for the first time. They are often issued by
smaller, younger companies seeking capital to expand, but can also be done by large
privately owned companies looking to become publicly traded. For the individual
investor, although it is tough to predict what the stock or shares will do on its initial
day of trading and in the near future since there is often little historical data with
which to analyze the company, yet they are very popular among the investors. In last
few years a large number of IPOs have come in the market and have been successful
in attracting the investor’s attention and funds. The history of IPO under pricing in
Indian stock market made IPO investment at the time of issue relatively safer for the
investors also the companies perceive it as a reasonably reliable source of raising of
Estelar
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funds in a scenario of highly volatile interest rates in the economy. At the end, the
both entities are seems to be in the win-win position.
This study is an effort to analyze the initial returns provided by Initial Public
Offerings (IPO’s) over and above the benchmark index S & P CNX Nifty after the
issue on the listing day as well as the performance of IPO’s in terms of the long term
returns up to the period of one to five years after the listing of the issue using event
study methodology and to identify the different factors that explains the return
behavior of IPOs in different time periods of the emerging Indian economy. The study
includes the IPO of the companies, which offer public issue as the Initial Public
Offerings (IPOs) during the period Jan 2000 to Dec 2010 through National stock
exchange (NSE). The data used for the study is secondary in nature and collected
from the CMIE database PROWESS and the official website of National stock
exchange. The analysis is done using the software SPSS and MS Excel. It is found
that the frequency of IPOs is high in bullish period i.e. most of the companies prefer
to come with IPOs when the market sentiments are good. The average age of the firm
issuing IPOs is found to be 15 years. The most of the IPOs are from the private
companies which belong to the manufacturing and services industries. The average
return provided by the IPOs on the listing day is 21.54 percent and the cumulative
average abnormal return (CAAR) of the IPOs is found to be 28.01 percent. It is also
found tha t the returns on the listing day as well as abnormal returns on the application
funds are positive and are 2.07 percent and 4.20 percent respectively. The weighted
average return on the invested capital (application money) on the listing day is found
to be the 4.46 percent. The results in the study support the anomalies of underpricing
of IPOs in short run in Indian stock market.
Applying the multiple regressions model it is found that the returns of the IPO on the
listing are highly influenced by the subscription and the behavior of the Index during
the same period and are not influenced by the factors such as promoter’s holding, age,
issue size and the time delay. The results of the long term performance (without
adjusting the market returns) indicate that the IPOs gives negative returns in the next
four years after the listing. If an investor buys the stocks on the listing day he/she has
to hold for many years (at least five) to make good returns. Abnormal returns are
calculated after adjusting the market returns in the returns provided by the IPOs after
the listing. The results indicates that the abnormal returns provided by 259 IPOs after
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one year from listing are -32.71 percent, abnormal returns 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 -54.64 percent, 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. This poor performance of Indian IPOs in long
term indicates the fundamental anomaly of underperformance of IPOs in long term.
This anomaly is not only exists in India but also found to be present in almost all
stock markets.
For the first time in the world, the Indian stock market regulator, Securities and
Exchange Board of India (SEBI), introduced the system of IPO grading and made it
mandatory for the companies going public since May 2007. This is done in order to
decrease the information asymmetry between the retail investors and qualified
institutional buyers (QIBs) and to protect the wealth of retail investors from the
investments in low quality Initial Public Offerings (IPOs). IPO grades, which are
based on the fundamentals of the companies and are supposed to indicate quality
signals about the future prospects of the company’s performance and hence ensure
better returns from the investments in quality IPOs. This is done to help the majority
of investors so that they can make wise investments. The effort is also made in the
study to investigate the relevance of IPO grading on the under pricing, long term
returns, liquidity and the P/E ratio of the companies. For the purpose of the study, 83
IPOs are selected, which came after May 2007 through National Stock Exchange
(NSE) and possess IPO grades at the time of issue. The IPO’s of different IPO grades
have been analyzed in terms of underpricing, liquidity, P/E ratio and long term returns
using t-test and regression analysis. The results indicate that the QIBs consider IPO
grading significantly and hence also affects the overall subscription of the IPO. The
listing day liquidity of higher graded IPOs is low but commands better liquidity in the
long term. Long term performance of the higher graded IPO is better than lower
graded IPO’s. However, the IPO Grading in not relevant in explaining the Listing Day
returns. Also the IPO grading has no impact on the subscription behavior of retail
investors.
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ACKNOWLEDGEMENTS
This work of mine would not seen the light of the day had the blessings,
cooperation, encouragement, guidance, precious time and views of good many not
have been there with me all along in bringing out it and therefore my heart knows no
bounds in acknowledging so indispensable.
At first I would thank providential powers who bestowed on me the incessant
inspiration and sustained strength in the form of life blood to carry out this project. I
am heartily thankful from the heart’s bottom to my supervisor, Dr. B D Kavidayal,
Professor, Department of Commerce, DSB Campus, Kumaun University, Nainital
whose able guidance, high standard commitments, rigorous approach, stimulating
support and encouragement, beyond repayment, from the initial to the final level
enabled and motivated me to complete the thesis and develop an understanding of the
subject. I am also thankful to Prof. B. D Awasthi, Head, Department of Commerce
and other members of Commerce department for having given me the opportunity to
pursue Doctoral Programme at the Department and for the support during the period
of research.
My heartfelt thanks, gratitude and regards are due to Dr. Keval Badhani,
Associate Professor, Department of Commerce who has obliged me by readily
extending scholastic hand, unflinching co-operation and motivation whenever
required. I am also indebted to the officials of National Stock exchange, SEBI, and
other institutions for providing the valuable information in their official website that
helps in conducting the research work.
I am indebted to my mother and father, who have been the lifelong source of
inspiration in my endeavors and other family members. I would be remiss if I failed to
thank my gracious wife Vartika Chauhan who extended exceptional support and
encouragement.
I would like to thank all the librarians, respondents and individuals whose
contribution directly or indirectly resulted in this thesis being materialized as the
thesis sought assistance from analysis of experts, academic works and reports etc.
Place: (Ajay Kumar Chauhan)
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CONTENTS
Chapteriszation Topic Name Page No.
v Certificate
v Preface
v Acknowledgements
CHAPTER-1: Initial Public Offerings (IPOs) In Indian Stock Market 1
1.1 Capital Market 2
1.2 Primary market in India 2
1.3 Initial Public Offerings (IPOs) 5
1.4 Different kinds of issues 9
1.5. Offer Documents (ODs) 11
1.6. Issue Requirements 12
1.7. Pricing of an Issue (IPO) 17
1.8. Book Building Process 18
1.9. Categories of Investors 19
1.10. Intermediaries involved in the Issue Process 24
1.11. The Offer Document 26
1.12. SEBI’s Role in an Issue 28
1.13. IPO Grading in India 32
1.14. New Provisions in Initial Public Offerings (IPO) 34
1.15. Basis of Allocation/Basis of Allotment 35
1.16. The Market Index (S&P CNX NIFTY) 36
1.17. Statement of the problem 39
Chapter-2: Review of the Literature , Objective and Research Methodology 42
2.1 Review of the literature 43
2.2 Research Methodology 60
2.2.1Rationale of the study 61
2.2.2 Statement of the problem 62
2.3 Objective of the study 62
2.4 Research design 62
2.4.1 Sampling 62
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2.4.2 Description of the variables 63
2.4.3. Data Collection 64
2.5 Statistical tools to be used 65
2.6 Hypothesis to be tested 68
2.7 Software used 69
Chapter- 3: Performance of Initial Public Offerings (IPOs) in Short Run and in
Long Term in Indian Stock Market 73
3.1 Frequency distribution of Initial Public Offerings (IPOs) 74
3.2 Age profile of the companies came with IPOs 78
3.3 Ownership group 82
3.4 Industry Profile of the companies came with IPOs 82
3.5 Returns of IPOs on the listing day 83
3.6 Categories wise returns 86
3.7 Abnormal Returns of IPOs on the listing day using
Event study methodology 88
3.8 Returns on the application money 92
3.9 Long term performance of IPOs over the market 93
Chapter- 4: Factors Contributing IPO Performance 101
4.1 Correlation between the subscription, the return on the 102
listing day and the abnormal return.
4.2 Subscription and the returns 103
4.3 Factors influencing the short term return of IPOs on 104
the listing day
4.4 Significance of IPO Grading in Indian Stock Market 109
4.4.1 Frequency Distributions of the IPO 111 Grading of the Companies
4.5 IPO grading and category wise subscription 113
4.6 IPO grading and the underpricing (short term returns of IPOs) 115
4.7 IPO grading and the long term performance of IPOs 116
4.8 IPO Grading and liquidity on the listing day 118
4.9 Impact of IPO grading on IPO performance 119
4.10 Criticism of IPO Grading 120
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CHAPTER-5: Conclusions and Suggestions 123
Bibliography 135
Appendix 142
List of companies
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LIST OF TABLES
Table No. Title of the Table Page No.
Table 1.1 Industry wise classification of capital raised 8
Table 1.2 Listing criteria for companies on the cash market segment of NSE
15
Table 1.3 Difference between Book building issue and fixed price issue
19
Table 3.1(a) Number of IPOs in different years 75
Table 3.1(b) Frequency of IPOs indifferent scenarios 77
Table 3.2 Frequencies of the companies issuing IPOs with respect to different age group
80
Table 3.3 Frequency of companies that belongs to the different ownership groups
82
Table 3.4 Frequency of companies that belongs to different industries
83
Table 3.5.1 Descriptive statistics of the return on the listing day 84
Table 3.5.2 Independent Sample T test 86
Table 3.6(a) Age group and returns 87
Table 3.6(b) Issue size and returns 87
Table 3.6(c) Ownership groups and returns 87
Table 3.6(d) Promoter’s holding after the issue and returns 88
Table 3.7.1 Abnormal returns 89
Table 3.7.2 Independent sample t test between fixed issue and book building issue
92
Table 3.8 Descriptive statistics of returns on the application money on the listing day
93
Table 3.9(a) Long term performance of IPOs 95
Table 3.9(b) Long term market adjusted performance of IPOs. 96
Table 3.9(c) Independent sample T test 100
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Table 4.1(a) Correlation between the subscription, the returns on the listing day and the abnormal return
103
Table 4.2 Subscription wise returns 103
Table 4.3.1 Simple regression models 106
Table 4.3.2 Multiple regression model with abnormal return as a dependent variable
107
Table 4.3.3 Independent sample t test between IPOs and other similar company after one year of listing.
108
Table 4.4.1 Frequency distribution of the IPO grading of the companies
111
Table 4.4.2 IPO grades and the age of the companies 112
Table 4.5.1 IPO grading and subscription in different categories 113
Table 4.6 IPO grading and listing day returns 115
Table 4.7 IPO grading and long term returns 117
Table 4.8 IPO grades, liquidity and price to book value ratio on the listing day
118
Table 4.9 Impact of IPO grading on different output variables 120
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LIST OF FIGURES
Figure No. Title of the Figure Page No.
Figure 1.1 Resources mobilized from the primary market (Rs. in Crores)
7
Figure 1.2 Types of issues 10
Figure 1.3 Life cycle of an IPO 30
Figure 3.1(a) Number of IPOs in different years 75
Figure 3.1(b) The behavior of the market index (S & P CNX NIFTY) during the period Jan 2000 – Dec 2010
76
Figure 3.1(c) Number of IPOs in different scenarios 78
Figure 3.2(a) Frequency distribution of the age of the companies came with IPOs
80
Figure 3.2(b) Frequencies of the companies issuing IPOs according to the age group
81
Figure 3.5 Frequency distribution of the returns on the listing day. 85
Figure 3.7 Frequency distribution of the abnormal returns on the listing day.
90
Figure 3.9(a) Long term performance of the IPOs 97
Figure 3.9(b) Market adjusted returns of IPOs in long run 98
Figure 4.4.1 Frequency distribution of the IPO grading of the companies
112
Figure 4.4.2 IPO grading and subscription in different categories of investors
114
Figure 4.6 IPO grading and listing day returns 116
Figure 4.7 IPO grading and long term returns 117
Figure 4.8 IPO grading, list price to book value ratio and liquidity on the listing day
119
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List of Abbreviations
ASBA Applications supported by blocked amount
BHAR Buy and Hold Abnormal Rate of Return
BRLM Book Running Lead Manager
BSE The Stock Exchange, Mumbai
CAAR Cumulative Average Abnormal Return
CAR Cumulative Abnormal Return
CC Clearing Corporation
CCI Controller of Capital Issues
CCIL Clearing Corporation of India Limited
CDSL Central Depository Services (India) Limited
CM Clearing Member
CM Segment Capital Market Segment of NSE
CMIE Centre for Monitoring Indian Economy
CRAs Credit Rating Agencies
CRISIL Credit Rating Information Services of India Limited
DIP Disclosure and Investor Protection
DPs Depository Participants
ECS Electronic Clearing Service
NEFT National Electronic Funds Transfer
EFT Electronic Fund Transfer
ELSS Equity Linked Saving Schemes
EPS Earning Per Share
ETFs Exchange Traded Funds
FDI Foreign Direct Investment
FDRs Foreign Deposit Receipts
FDs Fixed Deposits
FIBV International World Federation of Stock Exchanges
FIIs Foreign Institutional Investors
FIs Financial Institutions
FPO Further Public Offer
GDP Gross Domestic Product
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IPO Initial Public Offer
IRDA Insurance Regulatory and Development Authority
IISL India Index Services & Products Limited
IRDA Insurance Regulatory and Development Authority
MFs Mutual Funds
NIIs Non-Institutional Investors
NSE National Stock Exchange
OCBs Overseas Corporate Bodies
OD Offer Document
PAN Permanent Account Number
PSU Public Sector Unit
PUEC Paid Up Equity Capital
QIB Qualified Institutional Buyers
QIP Qualified Institutional Placement
RBI Reserve Bank of India
RI Right Issue
RIIs Retail Individual Investor
ROC Registrar of Companies
RTGS Real Time Gross Settlement
S&P Standard and Poor’s
SAD Seasonal Affective Disorder
SEBI Security and Exchange Board of India
SEO Seasoned Equity Offerings
VC Venture Capitalist
WR Wealth Relative
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