Academic journal article Asia-Pacific Business Review

Determinants of Initial and Long-Run Performance of IPOs in Indian Stock Market

Academic journal article Asia-Pacific Business Review

Determinants of Initial and Long-Run Performance of IPOs in Indian Stock Market

Article excerpt

Introduction

Initial public offerings (IPOs) provide an opportunity to the fast growing companies to raise necessary capital to facilitate future growth. The investors also consider IPOs an attractive investment alternative as these are believed to generate relatively higher returns in less time. Regardless of the perceived value of IPOs for the companies and the investors, three empirical anomalies have been documented by the financial economists in the initial public offerings market namely IPO underpricing (1) (i.e. positive excess returns in the short-run); strong concentration of issue activity in certain periods (2) (hot issue phenomenon); and underperformance of IPOs in the long-run (3). Initial public offerings have thus become one of the most puzzling and intriguing area for financial research. Over the past few decades, empirical studies have ubiquitously reported the frequent incidence of high positive average returns of IPOs on the first day of trading. This feature is referred to as underpricing and has been identified as a robust feature of new issues across the world (Loughran and Ritter (1995)). Besides, the prior research has also evidenced the post-issue underperformance of IPOs in the years subsequent to issue. The incidence of underpricing and underperformance of IPOs is inconsistent with stock-market efficiency, which states that two portfolios with same risk shall receive same returns. Moreover, the abnormal performance of stocks after the firm-specific events should be neutral, once the event-related activities are completed (Stehle et al. (2000)).

The best-known pattern associated with the process of going public is the frequent incidence of large initial returns accruing to investors in IPOs of common stock (Ritter, 1997). Underpricing has been documented to be present in varying degrees by the opulent financial literature across different countries. As can be observed from Table 1 in appendix, very high underpricing exists in China, India, Brazil, Thailand, Greece, Japan, etc. and comparatively lesser underpricing has been documented in countries like Austria, Germany, Australia, U.S. and Tunisia. A plethora of theoretical explanations have been offered to elucidate the persistence of such phenomenon. Ibbotson (1975) offered explanations for underpricing of IPOs which have been duly tested in the literature. A strand of literature attributes underpricing to the signalling by the IPO firms (Allen and Faulhaber (1989), Grinblatt and Hwang (1989), Welch (1989) and Chemmanur (1993). High quality firms are believed to signal their quality by underpricing their first issue and by offering smaller proportion of their shares at initial public offering, which enables them to issue more shares at higher returns in the subsequent equity offerings. Hence, the likeliness of subsequent issue is more for the firm that underprices. The signalling hypothesis has been tested and both supporting (Firth and Liau Tan (1997)) and contradicting (Michealy and Shaw (1994), Chi and Padgett (2005)) evidences have been reported. In contrast to signalling hypothesis (which states that IPO firms signal their value through underpricing and higher degree of underpricing is a signal of an expected profitable subsequent issue), market feedback hypothesis suggests that the relationship between underpricing and subsequent issues is dependent on the information revealed to issuers through share prices in the period subsequent to IPO (Jegadeesh et al. (1993)). Investment bankers where book building is used may underprice IPOs to induce informed investors to reveal information during the pre-selling period, which can then be used to assist in pricing the issue (Ritter (1997)). On the contrary, Espenlaub and Tonks (1998) do not find support for this hypothesis.

Underpricing is also suggested to be the result of adverse selection or winner's curse to uninformed investors (Beatty and Ritter (1986), Rock (1986), Ritter (1997)). …

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