Presence of Underpricing with Context to Indian Companies Finance Essay

The objective of the study is to investigate which factors are causing under-pricing of Indian IPOs. As well as it gives a deep knowledge of the Indian Stock market to the Author, as Author intents to have its own Investment firm. Introduction Firms often require raising capital in order to expand their operations. One of the most popular ways for doing it is by Initial Public Offering. IPOs have history of initial first day gains which is also called money left on the table. If we 3 Hot issues with regards to IPO 1. Under pricing 2. The Hot Issue market 3. The long run underperformance Literature Review deals with the writings of the research topic which have been undertaken across the world. It includes books, articles, and research papers. Reasons for under pricing 1. Industry and Activity based classification 2. Reputation of Lead Managers 3. Informed institutional and uninformed individual investors. 4. Literature Review 1. What is the previous work already conducted on the same? 2. What are its weaknesses and Strengths? 3. Objective or issue of your research? 4. The Term Under pricing refers to lower offered price of an IPO then its listed price. Now once we know what is under pricing then the concern comes is that why is under pricing done and what makes us believe that under pricing exists? What are the forces behind it and who is benefitted from it? Our entire research revolves around these questions. Now our research country is India but does it exists in other part of the World as well. Well different academic researchers have conducted a research around this Topic from time to time and have come up with different findings and theories. Most of the Academics have found positive results with regards to IPO Underpricing. We will discuss the works of these academics in detail in next section however I would like to address the major findings of these writers with regards to the reason behind Underpricing. Theories of underpricing can be grouped under four broad headings: asymmetric information, institutional, control, and behavioural. Asymmetric information models assume that one of these parties knows more than the others, and that the resulting informational frictions give rise to underpricing in equilibrium. Institutional theories focus on three features of the marketplace: litigation, banksA¿A½ price stabilizing activities once trading starts, and taxes. Control theories argue that underpricing helps shape the shareholder base so as to reduce intervention by outside shareholders once the company is public. Finally, behavioural theories assume the presence of A¿A½irrationalA¿A½ investors who bid up the price of IPO shares beyond true value. (https://mba.tuck.dartmouth.edu/Pages/Faculty/Espen.Eckbo/PDFs/Handbookpdf/CH7-IPO%2005-24-06.pdf) Lines taken from Page 1 Abstract Lot of literature already exists with regards to presence of Underpricing. LetA¿A½s have a view on them one by one and discuss the questions unanswered by these theories or existing literature. BaronA¿A½s Model (1982) Leland and PyleA¿A½s Model (1977)/ Asymmetric Information Model: Leland and PyleA¿A½s gave the concept of asymmetry information with regards to IPOA¿A½s. They suggested that quality and valuation of a project can be valued by value of shares retained by its on entrepreneurs. If a project is of really high value then entrepreneurs who have inside information about the project will personally like to invest more in their own projects and would keep more shares with them. On the other hand entrepreneurs who know that their projects are of low quality would be less interested in retaining more shares with them. Thus valuation of an IPO can be measured by the percentage of shares retained by its owners. If owners are retaining more percentage of shares with them then the project tends to be of high quality and if project is of low quality then owners will keep a lesser percentage of shares with them. Adverse Selection and RockA¿A½s Model of WinnerA¿A½s Curse Problem: RockA¿A½s model (1986) Information Acquisition: Benveniste and SpindtA¿A½s (1989) Prospect Theory: Loughran and Ritter (2003) Corruption Hypothesis: Loughran and Ritter (2003), Signaling Hypothesis: Welch (1989) supported signalling theory of IPO underpricing. According to it firms signal quality of IPO to less informed investors. This fact was supported by Allen and Faulhaber (1989) and Grinblatt and Hwang (1989). They said that when information asymmetries exist then investors are not able to distinguish between high quality firms and low quality firms. High quality firms then signal their quality at a cost too high which becomes difficult for a low quality firm to be replicated by discounting the offering price from market price. A Protection from Legal Liability Models of Book Building: ShermanA¿A½s (2000)

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Research Methodology The Aim of this study is to understand extent of Underpricing which exist in Indian IPOA¿A½s. We will discuss the methodology which will be used to understand data of given IPOA¿A½s. Objectives of Study Following are the objectives which are kept in mind before conducting this study. 1. Existence of Regulatory framework regarding IPOA¿A½s data in India. 2. Presence of Underpricing from date of offer to date of listing. 3. Analyzing the IPO performance in Short Run and in Long Run for period of 3 years. 4. Examining Factors effecting price of IPOA¿A½s. Data and Methodology Data for the following research has been collected from NSE of India. Data is selected on below given criteria:- 1. IPOA¿A½s are listed in NSE at least before 3 years for short run and long run analysis of performance. 2. Data includes the following information:- Name of Organization, Offer Price, listing price, Current Price and date of offering and listing. 3. Short Run Analysis: IPOA¿A½s from 1990 are included for study and research. Total number of companies are ............... 4. Long Run analysis: IPOA¿A½s from 1990- 2007 are used to measure performance and underpricing in long run. 5. Factor influencing prices of IPOA¿A½s will be discussed to examine performance of IPOA¿A½s. Results are computed to check the real value of the stock or its deviation from real value. Underpricing will be reflected if results computed are positive on the other hand if results are negative then it reflects that share are overvalued. Results will be analyzed for different time periods from One week to 6 Months. IPO return is computed as the difference between the closing price and opening price divided by the offer price. Where R_Return = SubscriberA¿A½s initial return (hereafter raw return) P1= Closing price on the first day of trading P0= Offer Price Next thing which needs to be observed is time gap between application date and listing date. Generally Time Gap in India is quite large so it involves an opportunity cost. So we need to compute it as per changes in market. So the next equation would be Where MAER is Market Adjusted Excess Return M1= Closing Value of Market Index on First day of closing M0= Closing Value of Market Index on the Offer Closing Date Next thing comes is equation for checking price for different time periods from 1 week to 6 months so equation formed would be like this:- Now R_Ret.t =Raw return of stock at time t after listing day Pt= Closing price at the time t P0= Closing price on Listing day Similarly, the market adjusted excess returns are calculated for given time period by the following formula Hypothesis 1. Age does not contribute to price performance in IPO. 2. Size of Issue does not affect pricing performance of IPO. 3. There is no relation between subscription level and pricing information of IPO. 4. There is no relation between listing lead time and pricing performance of IPO. 5. Long Run underpricing is more than short run underpricing. Refrences 1. Allen, Franklin, and Gerald R. Faulhaber, "Signaling By Underpricing in the IPO Market," Journal of Financial Economics, 23 (1989), pp. 303-323 2. Grinblatt, Mark, and Chuan Yang Hwang, "Signaling and the Pricing of New Issues," Journal of Finance, 44 (June 1989), pp. 393-420. 3. Welch, Ivo, "Seasoned Offerings, Imitation Costs, and the Underpricing of Initial Public Offerings," Journal of Finance, 44 (June 1989), pp. 421-449

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