Title - Pricing and performance of IPOs: Evidence from Indian stock market

Summary

The paper talks about the IPO underpricing and long-term under-performance of the newly issued
companies relative to the comparable stocks in the market. The study has been done for the Indian
Stock Market. The study consists a 15-year period (from 2001 to 2015). The study treats the Book-Built
and Fixed Price Offers IPOs separately. The sample of 464 IPOs (365 book-built IPOs and 99 fixed-price
IPOs) that went public from the financial year 2001 to 2011 are selected for the study.

The literature review of the paper is broken down into two sections –
1. Listing Day Underpricing – The paper initially talks about two different Information Asymmetry
Theories – Baron’s and Rocks’. Then it discusses the Signaling Model for the underpricing. There is also a
brief about the Herding Theory by Welch. A study has also found that underpricing is negatively related
to the rate of allocation to the uninformed investors, conforming the adverse selection. The paper also
mention the Lawsuit Avoidance Theory of IPO Underpricing. Studies have found that firms with greater
underpricing are associated with weaker future earnings performance, fewer and smaller dividend
initiations, and less frequent trips to the capital market. It has also been found that found that initial
returns (underpricing) are directly related to information production and inversely related to
institutional allocations. A study done for Indian market suggest that the extent of oversubscription
determines the first day gain; signals that lead to oversubscription are market index during the period of
IPO, type and nature of business, foreign collaboration, or the track record of promoters/company.

2. Long Run Performance – The literature review talks about the long-term under-performance of the
firms with newly issue IPOs as compared to the matching firms. Various studies in different countries
have found the results as mentioned above. A study has found that firms which initially had superior
projected growth substantially underperformed indicating that investors appear to believe the inflated
long-term growth projections. A study reported that market-adjusted underperformance of IPOs over
the three-year holding period is less severe for IPOs which are handled by more prestigious
underwriters. It is also found that underperformance primarily is concentrated among small firms with
low book-to-market ratios.

Objectives of the study:

1. To ascertain the listing day performance (underpricing) of IPOs in India.
2. To analyze listing day performance of book-built and fixed-price IPOs, separately.
3. To ascertain post-listing aftermarket performance of IPOs in India.
4. To analyze post-listing aftermarket performance of book-built and fixed-price IPOs, separately.

Hypotheses:
1. The IPOs are not underpriced based on the listing day performance.
2. Investors cannot earn abnormal returns from IPOs in the post-listing period performance.

Methodology
1. Listing Day Underpricing:

Adjusted Initial Day Return – Average AIR –

t-statistic – Standard Error –

2. Long Run Performance:

a) Raw return on security on day t – b) Market returns on day t –

c) Benchmark Adjusted Return for stock i on day t –

d) Average benchmark-adjusted return on a portfolio of n stocks for day t –

e) Cumulative benchmark-adjusted aftermarket performance from day u to day v –

Findings:
The study finds that Indian IPOs are underpriced based on their performance on first trading day. Using
the closing price on the listing day, book-built issues are underpriced by about 21-22% while the fixed-
price issues are underpriced by about 53-54%.

Analysis of three months’ post listing performance of IPOs reveals that soon after listing Indian IPOs
underperform the market. Even beyond three-month post listing, IPOs have consistently
underperformed their benchmark.

Consequently, this leads us to reject the hypothesis—that investors cannot earn abnormal returns in the
long run. Such positive performance of fixed-price issues is, in fact, the reason why the
underperformance for the whole sample is less severe when compared to that of book-built issues in
the long run.
**t-critical = 1.65