Academic journal article IUP Journal of Corporate Governance

The Effect of Board Size on Underpricing of IPOs: Indian Evidence

Academic journal article IUP Journal of Corporate Governance

The Effect of Board Size on Underpricing of IPOs: Indian Evidence

Article excerpt


Corporate governance as a mechanism shares its evolution with the corporate form of organization. It, however, has garnered eminence and limelight in recent times of heightened competition in the globalized era. The issues of corporate governance have been widely accepted and professed as a means of attaining competitive advantage and sustaining in dynamic environments highlighted by international trade, quality commitments, awakened stakeholders and vigilant regulators. The jolting corporate scandals world over and resulting financial tsunamis have also brought corporate governance to the forefront. The gaffes so spotlit had regulators on their toes, resulting in strict codes of governance in different countries. These regulations were put in force to strengthen the corporate performance and overall economies, thus securing the money of investors and trust of all stakeholders.

Corporate governance, amidst these developments, has emerged as a prolific research area. A growing body of research is being conducted to examine the structures, effectiveness and performance linkages of these corporate governance mechanisms. Empirical investigation into the association of corporate governance to firm performance using different measures has been a dominating area for research in the field of finance. Studies with focus on ownership patterns and structures, board structures, directors' abilities, experience and diversity, disclosure practices have been endeavored in different countries with different samples, the focus largely being on Western and developed countries. The results in different regions and settings have failed to establish any consistency leaving room for further investigations. One of the recent research areas in corporate governance is Initial Public Offering (IPO). IPO underpricing, which remains an unresolved riddle, has found many empirical examinations and explanations.

The mechanisms of corporate governance are being investigated for their potential in explaining the abnormal IPO returns. Yong (2007) suggested that new dimensions in IPO research would emerge from corporate governance, thus corroborating corporate governance in association with IPO as a potent field for empirical examination. In explaining these IPO returns or more precisely underpricing, the inherent means of governance are explored. Corporate boards are the focus of many attempts to improve and analyze corporate governance due to the dominant role they play in monitoring, strategizing and mitigating agency problems.

Board of Directors and IPO

The setup at modern corporations with ownership dispersed in many hands results in lack of alignment between managers and shareholders, leading to accentuated agency problems. The agency costs are borne by the corporate owners and these at the time of IPO can restrict investor participation in the issue unless effective governance is in place. Corporate governance mechanisms aim to combat these challenges and the board of directors are a dominant means to monitor entrenchment on the part of managers and thus keep the value intact. In IPO settings, where the firm springs into public domain from hitherto private domain, being open to public and regulatory scrutiny, the role of board assumes all the more eminence. Management is the source of the highest quality information regarding the firm's future performance potential (Lawless et ai, 1998) in the light of the fact that IPO issuing firms have no track record to woo the investors. The job, on the part of firms, is thus to favorably influence the perceptions of the investors by signaling the potential and capability of the firm. Here, the directors as a board play a significant role. The composition and competence of board of directors is crucial for a successful floatation as investment bankers and regulators weigh them in processing formalities (Filatotchev and Bishop, 2002).

The board's effectiveness in disciplining the management's opportunistic inclinations is critical to the survival of all corporations characterized by separation of ownership and management (Fama and Jensen, 1983). …

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