SHORT RUN PERFORMANCE OF INITIAL PUBLIC OFFERINGS IN INDIA

CHAPTER 5 SHORT RUN PERFORMANCE OF INITIAL PUBLIC OFFERINGS IN INDIA It is a pervasive feature of markets, the world over, those investors who subscribed to initial public offerings, on the offer day, experienced high initial returns on the first day of trading, the phenomenon is known as Underpricing. The scenario for Indian IPO market is no different as evidenced by findings in this chapter. This chapter studies the listing performance in Indian stock market on shares purchased in IPOs. 5.1 SAMPLE DESCRIPTION The sample consists of 251 companies, which came to the market during Nov.1994 to April 2006 and got enlisted on the National Stock Exchange. Table 5.1 reports the distribution of IPOs by year of issuance and by issue size. Table 5.1 Characteristics of the Year of Issuance Number of IPOs Percentage Out of Total Issue Percentage Out of Total 1994 16 6.37 18781.07 0.47 1995 51 20.32 250505 6.29 1996 14 5.58 119721.3 3.01 1997 6 2.39 562263.4 14.13 1998 5 1.99 23869.8 0.60 1999 13 5.18 135148.7 3.40 2000 25 9.96 151601.00 3.81 2001 3 1.20 24571.22.62 2002 7 2.79 198987.70 5.00 2003 9 3.59 164660.1 4.14 2004 21 8.37 743837.00 18.69 2005 47 18.73 922068.90 23.16 2006 34 13.55 664502.40 16.69 Total 251 100 3980518.00 100 Par 47 18.73 134086.80 3.37 Premium 204 81.25 3846431.00 96.63 117

The maximum number of IPOs is observed in year 1995 with 51 IPOs, followed by 47 in 2005, 34 in 2006. The worst year has been 2001, which reports only 3 firms, for the sample, that went public. Looking at the distribution based on issue size, the picture is somewhat different. Furthermore, the highest percentage (20.32) of total proceeds was seen in 1995 followed by 18.73 per cent in 2005, 13.55 per cent in 2006, and 9.96 per cent in 2000 and so on. Out of 251 IPOs, 47 firms issued shares at premium and raised 96.63 per cent of total issue size. The figures for 2003-2006, indicate that Indian Capital market witnessed big IPOs during these years. These IPOs took minimum 15 days and maximum 742 days to list on the National Stock Exchange. The average listing time was 85 days, much higher than SEBI s requirement (30 days). Other characteristics of the sample have been given and discussed along with the analysis of performance of IPOs. 5.2 THE INITIAL LISTING PERFORMANCE OF INDIAN IPOS It is universally found that the purchase on the very first day of trading earns the investors a high return. Table 5.2 examines the significant underpricing for the IPOs listed on the National Stock Exchange during Nov.1994 April 2006. As summarised in the Table 5.2, the IPOs show the average raw return of 40.08 per cent and the Mean Market Adjusted Excess Return (MAER) of 39.36 per cent with Nifty. The maximum and minimum values of raw returns are 1400 per cent and 95.86 per cent respectively. The underpricing is found to be present in 64.54 per cent companies of the sample. While 34.26 per cent of the companies show negative returns (overpriced), 1.20 per cent companies are fairly priced (zero returns). The after market trading lead-time i.e. the time taken for listing in Indian context varies from 15 days to 742 days, so after adjusting for this variation, the annualized average raw and Market Adjusted Excess Return are 319.38 per cent and 299.89 per cent respectively. This indicates the yearly returns that investor would have earned. 118

In the sample selected for the study, there are 46 par (Rs. 10) issues and 205 premium (>Rs. 10) issues. It clearly reveals the positive and statistically significant initial returns across all price groups. The returns given by par and premium issues are 113.11 per cent and 23.69 per cent respectively. When the offer price rises above Rs 10, the initial returns decline. The mean MAER is 111 per cent for par issues, while it is 23.29 per cent for premium issues. So, on an average par issues are more underpriced as compared to premium issues. The scenario is same, even for annualized returns. Moreover, par issues coming from first generation entrepreneurs or from promoters, not having track record should give higher returns as there are more chances of these issues being underpriced. It would be desirable to find out whether the premium amount has any bearing on the underpricing of these IPOs. The above discussion corroborates the existence of significant underpricing in Indian stock market and confirms the findings of other Indian studies like Kumar (1995), Ramana(1995), Shah(1995), Madhusudan and Thiripalraju (1997), Krishnamurti and Kumar (2002), Singh and Mittal (2003), Shelly and Singh (2008)) etc. Table 5.2 Initial Listing of Par Issues Vs Premium Issues Offer Price Characteristics. Raw Annualised Annualised Raw (N) (Rs.) (%) (%) (%) (%) 251 All Mean 40.08* 39.36* 319.38* 299.89* Maximum 1400 1404.98 11355.56 11395.98 Minimum -95.86-146.37-854.33-917.05 Positive (%) 64.54 65.34 64.54 65.34 Negative (%) 34.26 34.66 34.26 34.66 Zero (%) 1.20 0.00 1.20 0.00 46 Par Issues Mean 113.11** 111** 599.83 581.22 Maximum 1400 1404.98 11355.56 11395.98 119

Minimum -89.60-85.86-389.33-373.07 Positive (%) 69.57 65.22 69.57 65.22 Negative (%) 26.09 34.78 26.09 34.78 Zero (%) 4.35 0.00 4.35 0.00 205 Premium Issues Mean 23.69* 23.29* 256.45* 236.77* Maximum 807.64 787.12 4754.68 4633.85 Minimum -95.86-146.37-854.33-917.05 Positive (%) 63.41 65.37 63.41 65.37 Negative (%) 36.10 34.63 36.10 34.63 Zero (%) 0.49 0.00 0.49 0.00. 5.3 LISTING PERFORMANCE BY OFFER PRICE The effect of offer-price on the underpricing is numerically reflected in the Table 5.3. Offer price is a price at which one new share is offered to general public. According to Daily et al(2003), Shelly and Singh(2010) information contained in prospectus send signals, intentionally or otherwise, to potential investors. The investors use this information in determining price at which they will be willing to purchase IPO shares on listing day. One of the signals, included amongst others, is the offer price. They found that initial price of an IPO offering may carry value as an indicator of underpricing. It is the investment banker who is entrusted with responsibility for assessing the pre-market demand for prospective IPO in an effort to set the offer price. Presumably, a very low offer price may signal little demand, little value or both. Based on the above discussion, it is expected that higher offer prices are associated with offerings of firm having good track records, and thus a negative relationship is hypothesized between offer price and initial listing returns or underpricing. As displayed in Table 5.3, it clearly reveals, the positive and statistically significant initial returns across all offer price ranges, except price range of 50-100 and above 100. The first day average 120

raw and with respect to offer price indicates that larger returns are associated with small offer price IPOs i.e.113.11 per cent. As the offer price increases, the returns decline. The return slightly rise for the next quintile of offer price and then again decline. So, see-saw pattern emerges for raw and market-adjusted excess, annualised raw and annualised MAER returns across different segments of offer price. Offer Price (P) Table 5.3 Initial Listing of IPOs by Offer Price Raw Annualised Raw (N) (Rs.) (%) (%) (%) (%) Annualised 251 All 40.08* 39.36* 319.38* 299.89* 46 P=10 113.11** 111** 599.83 581.22 70 10<P=<50 24.07*** 24.19** 214.40** 198.78*** 53 50<P=<100 25.20 26.03 272.03** 263.89** 82 P>100 22.39 20.74 282.29* 251.66* ***Significantly different from zero at 10 percent level Thus, the findings of the above table substantially support the hypothesis of inverse relation between offer price and initial returns. 5.4 LISTING PERFORMANCE BY AGE OF THE FIRM The age of the IPO firm is one of the significant determinants of underpricing of IPOs. Ritter (1984) hypothesized that smaller firms, which have a little or no operating history, are associated with high ex ante uncertainty. The age of the firm, which is measured in years, in terms of difference between the year of incorporation of a firm and the year of going public, is expected to be related with the level of underpricing inversely. Table 5.4 classifies firms in term of ages. The analysis of table depicts that there is no linear relationship between age and underpricing of the IPOs. The highest returns of 69.23 per cent are given by the firms falling in the age group of (5-9) years. The 121

same pattern is displayed by market adjusted excess returns. The next highest returns are given by firms in the age group of 9-13 years with 54.74 per cent followed by the firms in the age group >13 years with 28.75 per cent at third spot. And, this again is true for all categories of returns. There emerges no apparent pattern in all categories of average returns across the age groups. But one thing, which is clear, is that middle aged firms are more underpriced than younger firms. The analysis of presents the same pattern as that of raw returns. Table 5.4 Initial Listing of IPOs by Age Age Raw Annualised Raw Annualised N (years) (%) (%) (%) (%) 251 All 40.08* 39.36* 319.38* 299.89* 13 <=5 22.73 17.28 318.84 240.31 31 >5 and <=9 69.23*** 65.31*** 629.19** 596.34** 65 >9 and <=13 54.74** 52.61** 273.67 248.85 142 >13 28.75 29.82 275.36** 266.64** ***Significantly different from zero at 10 percent level 5.5 LISTING PERFORMANCE BY OFFER SIZE Table 5.5 correlates underpricing across different segments of offer size. Offer size is measured, in terms of gross proceeds, earned from the issue. It is expected that smaller offerings are more speculative, on average, than larger offerings (Beatty and Ritter (1986)). Normally, larger offerings are associated with established firms and the investors are likely to be more informed about prospects of such firms, therefore, less underpricing is expected for them. Table 5.5 reveals that the highest return is 78.07 per cent which was obtained by the companies with the issue size of Rs. <1000 Lakhs, followed by 36.11 per cent against the companies with 122

the offer size of Rs. 4000-8000 Lakhs while, the remaining issues show lower returns for investors. The hypothesis of ex-ante uncertainty with offer size proxying for information asymmetry, is evident for smaller offer size issues. As the issue size increases, the IPOs returns start declining and then rises, again declines till the end, thus shows an irregular pattern. For the issue size of above Rs. 12000 lakhs, the returns continue showing declining trend. This may, again be attributed to more confidence shown by investors in smaller issues, which resulted in pushing up the market price. It is concluded that the issue size plays a conclusive role in deciding the listing performance of IPOs in Indian market. Table 5.5 Initial Listing of IPOs by Offer Offer (S) Raw Annualised Raw Annualised N (Rs. in Lakhs) (%) (%) (%) (%) 251 All 40.08* 39.36* 319.38* 299.89* 60 S<=1000 78.07*** 80.07** 372.23 371.63 69 1000<S<=4000 30.69 28.66 295.54 274.28 43 4000<S<=8000 36.11 36.48 320.24 308.78 27 8000<S<=12000 21.72 19.35 310.05** 271.53*** 52 S>12000 21.52* 19.36* 294.19* 258.49* 5.6 LISTING PERFORMANCE BY AFTER MARKET TRADING LEAD TIME Lead-time is the time lag between the closing date of the issue and the instant when it gets enlisted with the stock exchange. This lead time varies for different issues. Earlier, it used to take a long period for new issues to get listed, but this has been reduced in the recent past. Different issues take different time spans for listing. The SEBI acceptable listing delay is only 30 days at present, which has been reduced from, earlier level of 70 days and 45 days. The listing 123

delay in the sample used in the present study ranges between 15 days to as many as 742 days and this lead-time averages at 85 days. So, to scrutinise the effect of delay in IPO listing performance, a cross-sectional analysis was attempted dividing the lead-time into four categories. Table 5.6 presents the initial listing returns of Indian IPOs after market trading lead time. Table 5.6 Initial Listing of IPOs by After Market Trading Lead Time After Market Trading Lead Annualised Raw Time (T) Raw N (Days) (%) (%) (%) (%) Annualised 251 All 40.08* 39.36* 319.38* 299.89* 81 T<=30 26.34* 22.73* 367.40* 315.32* 59 30<T<=60 78.43*** 75.84*** 680.91** 654.59*** 67 60<T<=90 17.93 19.97 104.18 113.02 44 T>120 47.67 50.59 73.91 80.42 As analysed from Table 5.6, the average raw returns are the highest for issues having listing delay in the second quintile of 30-60 days, followed by the issues with lead time of more than 120 days. Both these ranges show average returns higher than average for overall sample. As far as market adjusted excess return is concerned, same pattern follows. For annualised raw returns and annualized market- adjusted returns no apparent pattern is evident across segments of listing delay. The only observable pattern, which emerges, is that raw returns,, annualised raw return and annualised market adjusted raw returns are significant, for first and second quintile. Thus, the above analyses do not support the hypothesis that lower listing delays imply efficiency and hence better performance. It is concluded that the evidence of affect of listing delay on initial returns is quite inconclusive. 124

5.7 LISTING PERFORMANCE ACROSS LEAD MANAGERS It is generally believed that there is a relationship between the underpricing of new issues and merchant banker s reputation. Table 5.7 throws light on this relationship. Top 6 merchant bankers were selected in terms of number of issues handled in the sample. The results indicate that average returns estimated for the issues handled by these 6 lead managers are significantly different from zero in some of the cases. SBI Capital Market handled maximum number of issues. But their returns, though positive, were lower than the overall returns. Even the DSP Merill Lynch, Enam Financial Consultant Private Limited, JM Morgan Stanley Private Limited, Kotak Mahindra earned lesser returns than the overall samples. Table: 5.7 Initial Listing of IPOs Across Lead Managers Lead Managers Raw Annualised Raw N (%) (%) (%) (%) Annualised 251 All 40.08* 39.36* 319.38* 299.89* 15 DSP Merrill lynch Ltd 18.41 20.48 84.20 84.54 19 Enam Financial 16.76 17.21 265.02 244.65 22 ICICI Securities Ltd 60.47 59.93 434.88 411.49 19 JM Morgan Stanley Pvt. 25.11 27.36 109.21 113.34 12 Kotak Mahindra 21.28 13.48 338.17 294.78 38 SBI Capital Markets Ltd 19.57 18.77 260.64** 241.40** 126 Others 52.85* 51.84* 383.04* 360.64** ***Significantly different from zero at 10 percent level Another interesting observation is that issues (22) managed by ICICI seem to give abnormally high returns to the extent of 60.47 per cent. Generally these are bigger issues and take lesser time to list. Further, it is found that merchant bankers like DSP, Enam, Kotak, JM Morgan underprice less as compared to others. 125

The above discussion indicates that in general, no lead manager has shown any significant capability in pricing the IPOs. Further, the present analysis is based on the assumption that the lead manager plays an active role in deciding the price of issue. But the market practices in some cases do not seem to confirm it. 5.8 LISTING PERFORMANCE BY YEAR OF LISTING Results of year-wise analysis given in Table 5.8 indicate that the returns are significantly different from zero in the period of 2000-2006. The period from 1994-1996, 2000-2006 is a boom period and 1997-1999 is depression period and according to that analysis has been made. Table 5.8 Initial Listing of IPOs by Year of Listing Year of Listing Raw Annualised Raw Annualised N Years (%) (%) (%) (%) 251 All 40.08* 39.36* 319.38* 299.89* 76 1994-1996 46.29 51.18 208.48 220.45 22 1997-1999 5.63 1.96 18.07 15.46 153 2000-2006 41.95* 38.87* 417.80* 380.26* ***Significantly different from zero at 10 percent level The raw and market adjusted excess returns from issues listed during 1997-1999 show lesser returns. For the issues, which opened in 2000-06 the performance is better than the overall. The issues that opened in the year 2000-06, earned lesser than the year 1994-96. The above analysis shows that IPOs have given excellent returns during the boom period. This table further reveals that the issues that opened in 1994-96 were of smaller size and took maximum time to be listed on the stock exchange. 126

5.9 LISTING PERFORMANCE BY INDUSTRY Table 5.9(a) classifies the firms into four industry groups based on the nature of industry to which they belong. Table 5.9(a) Initial Listing of IPOs by Broad Industry Groups Industry Groups Raw Annualised Raw Annualised (N) (%) (%) (%) (%) 251 All 40.08* 39.36* 319.38* 299.89* 170 Manufacturing 44.69* 44.36* 373.88* 356.64* 60 Services 28.81*** 28.17*** 184.85* 167.93* 2 Mining and Drilling 27.82 26 304.87 250.58 19 Miscellaneous 35.75 31.40 258.19 214.11 ***Significantly different from zero at 10 percent level The industry classification used here has been obtained from the website of Capital Market Journal (www.capitalmarket.com). Needless to say, there is some arbitrariness in allocating firms into these categories. An inspection of Table 5.9(a) demonstrates that companies going public during 1994-96 are not evenly distributed over all industry groups. Manufacturing firms are heavily represented in the sample followed by service, miscellaneous groups and mining and drilling firms. As can be seen from the Table 5.9(a), the raw as well as market-adjusted returns are significantly different from zero in all industry groups except miscellaneous, mining and drilling. When the performance of these industry groups is compared vis-à-vis overall performance, it is clear that manufacturing firms performed better than the overall. The firms in the service, mining and drilling and miscellaneous categories earned lesser returns than the overall. Another observable trend from this table is that the manufacturing firms are of larger size as compared to the service 127

firms. That is why the manufacturing firms are more underpriced than the service firms. Table 5.9 (b) classifies the firms in fifteen industry groups based on the activities in which they are engaged. A perusal of the Table 5.9(b) reveals that the companies going public during 1994-96 are not evenly distributed among all industry classifications. Firms in the industry groups such as Textile, Non Metallic, and Software dominate other industry groups in the sample. The raw and market adjusted returns were significantly different from zero in software and engineering industry group. Textile industry got the highest returns followed by Non metallic and Software. Communication, transport and diversified industries earned the lowest returns. Maximum number of companies in the sample belongs to the software industry, which earned better rate of return than the overall sample. For Annualised Raw Return and Annualised MAER, the highest returns are again given by industry belonging to textile, software, engineering etc. Another sustainable observation is that the issues offered to the Indian public in the chemical, financial services etc are of bigger size as compared to all other industries. Table 5.9(b) Initial Listing of IPOs by Industries Industry Raw Annualised Raw N (%) (%) (%) (%) Annualised 251 All 40.08* 39.36* 319.38* 299.89* 39 Chemicals 3.44 3.25 139.82 123.25 9 Food Processing 9.73 14.93 144.68 152.64 23 Machinery 5.17 7.52 178.07 187.14 14 7 Metals and Metal Products Non Metallic Mineral 29.12 23.75 316.01 245.77 89.72 90.41 404.71 370.82 128

51 Software 82.82* 80.94* 581.04* 565.60** 18 Textiles 110.42 109.69 816.15 787.35 5 Transport Equipment 7.32 7.34 206.56 193.92 4 Diversified -7.04 0.56 23.65 29.97 2 Mining and Drilling 27.82 26 304.87 250.58 7 Construction 35.68 31.69 369.04 315.47 7 Engineering 47.98 47.02 474.38*** 440.14*** 38 Financial Services 29.47 29.21 132.24 125.43 8 Communication 2.89 3.66 20.25 2.48 19 Miscellaneous 35.75 31.40 258.19 214.11 ***Significantly different from zero at 10 percent level 5.10 LISTING PERFORMANCE BY SUBSCRIPTION RATIO The significance of oversubscription, which reveals investors demand for an issue, was found by Rock (1986). He contented positive relation between oversubscription and underpricing, that is, oversubscription is a result of large orders placed by informed investors, when they have favourable information about prospects of issue. Indian Capital market, which has high degree of retail participation and the procedure of proportionate allotment within specified categories, is expected to make way for Rock (1986) phenomenon. Table 5.10 classifies firms in terms of their subscription Ratio. Table 5.10 Initial Listing of IPOs by Subscription Ratio Subscription Ratio Raw Annualised Raw (SR) N (Times) (%) (%) (%) (%) Annualised 225 All 40.08* 39.36* 319.38* 299.89* 129

9 <=1 26.75 29.04 199.86 207.97 110 >1 and <=10 2.22 0.73 30.08 13.21 40 >10 and <=20 17.93 18.11*** 228.77* 203.61* 40 >20 and <=40 67.26* 64.02* 544.58* 506.58* 26 >40 171.7* 170.85* 1204.23* 1189.88* ***Significantly different from zero at 10 percent level From Table 5.10, the significant positive average returns are evident for two categories of returns. In fact, a monotonic relation is being observed between average returns and the level of subscription. As the level of subscription ratio goes up, the average returns move in the same direction. It implies that the higher the informed demand about a particular issue, the higher the returns on listing day. The same pattern is displayed by MAER, Annualised raw returns and Annualised market adjusted excess returns. Thus it is concluded that significant cross sectional differences are exhibited in listing performance when IPOs are analyzed, in terms of segmentation (par vs premium), on basis of their issue size, offer price and firm specific factors. It is found that par issues are more underpriced than the premium issues. Offer price is inversely related with the initial returns. Analysis in terms of age reveals that middle aged firms are more underpriced than the younger firms. It is found that small size issues are more underpriced because of information asymmetry. However, no concrete relationship is found between listing delays and underpricing. Analysis in terms of lead managers shows that no lead manager has any significant capability to price the IPOs. Year- wise analysis shows that IPOs have given better results during boom period. Industry-wise analysis show that IPOs of manufacturing firms performed better than other categories. It is found that oversubscribed issues performed better on listing day which implies that oversubscription is the result of order placed by informed investors. 130