Academic journal article South Asian Journal of Management

Determinants of Pricing IPOs: An Empirical Investigation

Academic journal article South Asian Journal of Management

Determinants of Pricing IPOs: An Empirical Investigation

Article excerpt

This paper aims to investigate the pricing of IPOs by using market average P/E and issue mechanism, delay in listing along with a set of financial and signaling information. A database of 172 IPOs issued during the period 2002-2007 in India is considered for the study. The result indicates that market P/E as measured by BSE-Sensex (i.e., P/E at the time of issue) is significant and positive in affecting both offer price and list price. We lend support to the view that book building mechanism command higher prices for the IPOs than fixed priced offer. Other variables, i.e., book value per share, earnings per share, IPO activity period, investment bank prestige, and post issue promoter group retention are also significant and positive in evaluating IPO price. We find that listing delay is adversely affecting the list price. Subscription rate is also found positively associated with list price.

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

This research examines the pricing of Initial Public Offerings (IPOs) . As addressed in this research an IPO is the process by which a company goes public, i.e., offers its shares to the public for sale for the first time. Despite considerable research on IPO valuation, factors affecting IPO pricing is still debated and discussed. Prior studies focused on signaling (Leland and PyIe, 1977; Keasey and McGuinnness, 1992; Brown, 2002; and Li et al, 2004) and financial information (Klein, 1996; Ghicas et al, 2000; Bartov et al, 2002; Bhagat and Rangan, 2004; and Aggarwal et al, 2009), and comparable multiple (Kim and Ritter, 1999; and Schreiner, 2007) to estimate the value for an IPO. Though comparable firms price -earning (P/E) is widely used for evaluating IPOs, little evidence is encountered for the application of secondary market P/E as an explanatory variable for IPO pricing. This paper focuses on the research gap by estimating the price for Indian IPOs by using market P/E along with a set of value drivers, i.e., signaling, financial information, and IPO activity period. Further, to make it more informative the pricing across issue mechanism (i.e., book build and fixed price offer) including delay in listing is also explored.

Prior theoretical and empirical evidence indicate that comparable peer group firms average P/E plays an important role in affecting the offer price1. Overall this strand of literature concludes that an IPO firm affiliated with high valued peer group (P/E) command higher prices. Although, listed peer group firms P/E is a key factor for IPO value, emerging markets (Indian IPO market) doesn't have enough listed firms in each industry category. Even in some sectors the comparable firms having secondary market trading history is not available. Thus, under the emerging new issue market environment, market (sensex) P/E can be used as an effective surrogate for the comparable P/E for the IPO firm. Empirical studies, i.e., Gupta et al. (1998) suggests that market P/E is among the best indicators of the market's mood and state which has significant bearing on the individual company P/E. Further, Pal and Mittal (201 1) find that sensex (market index) is significantly reflecting the macroeconomic factors. Taking cue from this we use market P/E as possible predictor for the IPO price.

Issuing firms in India have the freedom of using either fixed price or book building route to market the IPOs. However in recent times book building overtakes fixed price mechanism both in volume and value terms. There is hardly any empirical study to explore the impact of issue mechanism on IPO price (both offer price and list price). Existing studies (Ghosh, 2005; and Khurshed et al, 2009) find that IPOs frequently exhibit incorrect pricing, i.e., either lower or higher than the sustainable market price of the equity shares. Valuation is therefore is considered as an important issue for analysis of IPOs. More precisely, whether or not the IPO pricing reflects the financial information, signaling, issue mechanism, and market factors is a challenge for the issuing firm. …

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