STUDY THE UNDERPRICING AND PRICING MECHANISMS USED IN IPOS IN BSE Prashant Kumar 1, Mukesh Kumar 2 1,2 Research Scholar Department of Business Administration, University of Lucknow, (India) ABSTRACT Initial Public offerings are the fresh issue of share in primary market by company for the first time to generate fund for investment in company s growth and expansion. Underpricing is one of the phenomenons that common in IPOs Market in most of the country. Underpricing in IPOs is the difference between the first day open price and closing price of IPOs. When the Offer price is lower than the first day trade price the IPOs is said to be underpriced. When the first day trade price is lower than the offer price the IPOs are said to be overpriced. So the Underpricing and Overpricing is related with the first day open price and close price of same day of IPOs. In this paper we have study pricing mechanisms used in issuing IPOs and we have found that Book Building is preferred method of pricing in India. The data have been taken data from official website of BSE. For data analysis we have taken the help of Excel and SPSS. The work of different scholars and researchers are reviewed to support the stud and included as a part of literature review. Based on our analysis concluded is made and references are given acknowledging the work of other researchers. Keywords: Book Building, Fixed pricing, IPO, Overpricing, Underpricing. I. INTRODUCTION 1.1 Initial Public Offerings Initial public offerings are the fresh issue of securities first time in primary market. It is a process by which unlisted company get listed in capital market. In India the regulatory authority of capital market is SEBI, so before going to public company has to satisfy certain criteria and guidelines as specified by SEBI for company to get listed in BSE and NSE. The company goes public to generate fund for the growth and expansion of company. Once the IPO is listed in primary market and trading start it converted into secondary market. 1.2 Pricing Mechanisms In India there are two types of pricing mechanisms used mainly Fixed Price Method and Book Building Method. In fixed price, the price is set from the date the prospectus is registered. Price at which the securities are allotted is known in advance to the investor. Demand for the securities offered is known only after the closure of the issue. While payment is made at the time of subscription where in refund is given after allocation. Book building is a process undertaken by which demand for the securities proposed to be issued by a body corporate is elicited and built up and the price for such securities is assessed for the determination of the quantum of securities to be issued by means of a notice, circular, advertisement, document or information memoranda or offer document.------ SEBI. In 1998 SEBI formulated the rules for issuing shares through Book Building, It was recommended by Malegam Committee in 1995. 150 P a g e
1.3 Concept of Underpricing and Overpricing of IPOs Underpricing in IPOs is the difference between the first day open price and closing price of IPOs. When the Offer price is lower than the first day trade price the IPOs is said to be underpriced. When the first day trade price is lower than the offer price the IPOs are said to be overpriced. So the Underpricing and Overpricing is related with the first day open price and close price of same day of IPOs. Mathematically it can be represented as Underpricing = (P1-P0)/ P0, Where P1= Listing day closing price of IPOs and P0= Opening Price of IPOs II. LITERATURE REVIEW Mishra, A. in his paper Underpricing of Initial public offerings in India: A comparison of the fixed price and book building methods explains that for IPOs using a book-build a significant positive relationship is documented between revisions in the offer price and the ensuing level of underpricing. Bansal, R., and A. Khanna in their study Pricing Mechanism and explaining underpricing of IPOs: evidence from Bombay stock exchange, India. found that there were no significant difference in the level of proportion of under pricing and overpricing of IPOs that priced through book build with those that are priced through fixed price option. These results are not in agreement with earlier researches. ahoo, S. and Prabina Rajib, 2010 in his work After market pricing performance of Initial Public offerings (IPOs): Indian IPO Market. Found that IPOs are underpriced on the initial listing days and thereafter underperforms compared to the market benchmark. Work also evaluated the long-run price performance of IPOs in Indian capital market. Jain, N. and C. Padmavathi, in paper tilled Underpricing of IPOs in Indian capital Market found that those IPOs also underpriced that are issued by book building method and is the result of investor s high willingness to pay, high demand of issue, high firm values and high fluctuations in the market returns. They also found that high value firm is more underpriced in India. Pande, A. and R. Vaidyanathan, in their study Determinants of IPO Underpricing in the National Stock Exchange of India. found that degree of under pricing over the year has reduced in India and gain from the IPOs getting diffused within one month of the listing of the firms and on an average the gains in one month after listing are lesser than those of the market. Degeorge, F., F. Derrien, and K.L. Womack, 2007, in their study states the book building has captured most of the market share globally but is the most costly procedure available in terms of direct and indirect initial under pricing. Bora, Bedanta; Anindita Adhikari and Andajeya Jha (2012), in their paper An empirical Perspective on Book building as Effective tool for price discovery proved that Book building mechanisms is preferred over other price mechanisms followed in India but the issue raised through fixed price are relatively more promising in long terms as compared to the issue raised through book building method. Ritter, Jay R. (2003) in his study Difference between European and American IPO Markets. Examines that fixed price offerings have become uncommon in recent years in France as well as other European nation. 151 P a g e
Kumar, P. (2015) in his study on Pricing Mechanisms for IPOs Issued in India: A Comparison of Book Building and Fixed Price Methods states that book building is adopted by most of the companies in India and is popular than fixed Price option. Kumar, P. and Dr. Mohammad Anees (2014) in their study on A study on popularity of Book building over fixed price option states that due to flexibility in Book Building method it is popular and used by most of the companies going for IPOs. III. OBJECTIVE The objectives of study are as follows: i) To examine the popular pricing mechanisms in issuing IPOs. ii) To study the underpricing and overpricing of IPOs and examine the magnitude of underpricing and overpricing with the pricing mechanisms used. IV. RESEARCH METHODOLOGY To meet the objective data collected from official website of BSE is taken. The time period is April 2010 march 2015. Sample is IPOs issued in BSE, and the sample size is 139. The SPSS and Excel are used to analyze the data using appropriate statistical tool. Steps in analysis are as follows: i. To examine which pricing mechanisms is popularly used we used T- test. ii. Underpricing is measured by the formula : Underpricing = (P1-P0)/ P0, Where P1= Listing day closing price of IPOs and P0= Opening Price iii. We have determine the no of issues underpriced and overpriced and also in which mechanisms they are underpriced or overpriced as tabulated in table in analysis part. V. DATA ANALYSIS AND FINDINGS One-Sample Statistics N Mean Std. Deviation Std.Error Mean Fixed Price 122 0.39 0.489 0.044 Book Building 122 0.61 0.489 0.044 Table-1 One-Sample Test Test Value = 0 t- value Df Sig.(2-tailed) Mean Difference 95% Confidence Interval of the Difference Lower Upper Fixed Price 8.708 121 0.000 0.385 0.30 0.47 Book Building 13.896 121 0.000 0.615 0.53 0.70 Table-2 152 P a g e
Table 1 show that the mean value of fixed price is 0.39 and that for Book Building is 0.61 and which is clear that the Book Building is preferable pricing mechanisms. Table 2 shows value of t for fixed price is 8.708 and for Book Building is 13.896 which is greater than 1.972. Thus by following the decision rule, the null hypothesis is rejected and the alternate hypothesis is accepted, this is confirmed by the significance level which is 0.000 that is below 0.05. It can be concluded that Book building is preferred over Fixed Price method for issuing IPOs in India. Pricing Mechanisms and Underpricing & Overpricing of IPOs Table-3 IPOs Book Fixed Under Over BB BB FP FP Year Issued Build Price priced priced Underpriced Overpriced Underpriced Overpriced 2010-11 47 45 02 16 26 16 25 00 01 2011-12 21 20 01 10 11 10 10 00 01 2012-13 06 02 04 02 02 01 01 01 01 2013-14 21 01 20 10 07 01 00 09 07 2014-15 27 06 21 10 12 01 05 09 07 122 74 48 48 58 29 41 19 17 From Table 3 we have found that during the study period we have taken (April 2014- March 2015) the total no of IPOs issued were 122 out of which 74 were issued through Book Building method and 48 were issued using Fixed Price option which clearly shows that Book Building is more popular method of using IPOs in India which is statistically proven using t-test (table2). During the period 48 IPOs were underpriced in which 29 were issued using Book Building and 19 by Fixed price method and 58 overpriced in which 41 were issued by Book Building and 17 by fixed price method. VI. CONCLUSION From the study of IPOs issued in BSE from April, 2010 - March 2015 we examine that most of the IPOs are issued through Book Building which is supported statistically using t-test as shown in table 1 which is also supported by the descriptive analysis from table 3. Our study is also supported from the work of different researcher about IPOs pricing mechanisms that we reviewed in our study. The study also focuses on to find out the underpricing and overpricing of IPOs which is shown in table 3. Where we have seen that most of the IPOs underpriced as well as overpriced were issued using Book Building. REFERENCES [1] Mishra, A.K. Underpricing of Initial Public Offerings in India: A comparison of the Fixed Price and Book Building Methods. Indian journal of Capital Market (October- December 2008), 27-35. [2] Sahoo, S. and Prabina Rajib, After market pricing performance of Initial Public offerings (IPOs): Indian IPO Market. Vikalpa Vol 35 No-4 (Oct- Dec 2010), 27-43 [3] Bora, Bedanta; Anindita Adhikari and Andajeya Jha (2012), An empirical Perspective on Book building as Effective tool for price discovery, IPEDR vol- 29 168-172. 153 P a g e
[4] Bansal, R. and Dr. Ashu Khanna, Pricing Mechanism and explaining underpricing of IPOs: evidence from Bombay stock exchange, India. International Journal of Research in Finance & Marketing Vol-2 Issue -2, 205-216. [5] Jain, N. and C.Padmavathi, Underpricing of IPOs in Indian capital Market Vikalpa (Jan march 2012) vol-37 [6] Degeorge, F., Fracois Derrien and Kent L. Womack,(2007) Analyst hype in IPOs: Explaining the popularity of Bok building. The Review of Financial studies vol-20 no4. [7] Pande, A. and R. Vaidyanathan, Determinants of IPO Underpricing in the National Stock Exchange of India. Electronic copy available at: http://ssrn.com/abstract=1081272. 1-24. [8] Ritter, Jay R. Difference between European and American IPO Markets. (2003) European financial Management vol-9. No-4, 421-434. [9] Kumar, P. and Dr. Anees, M., A study on popularity of Book building over fixed price option, International Journal in Multidisciplinary and Academic Research, Vol. 3, May-June (ISSN 2278-5973) online, 77-83 [10] Kumar, P. Pricing Mechanisms for IPOs Issued in India: A Comparison of Book Building and Fixed Price Methods, Emerging Issues in Accounting and Finance, ISBN No- 978-81-930017-0-7, 145-148 [11] http://www.bseindia.com/bookbuilding/about.asp [12] http://www.nseindia.com [13] http://www.sebi.gov.in [14] http://ssrn.com/abstract Bibliography: [1] Lee, N. and Ian Lings, Doing Business Research- A Guide to theory and Practice, Sage Publication 2010 [2] Khan & Jain, Financial Management, TMH, 2002 [3] Subramanyam, Investment Banking, TMH, 2005. [4] Pathak, B.V. The Indian Financial System, Pearson Education II Edition. [5] Kunjukunju, B. and S. Mohanan., Financial Markets and Financial Services in India, New Century publication 2012. Annexure: Figure 1 154 P a g e
Figure 2 Figure 3 155 P a g e