Grading Initial Public Offerings (IPOs) in India’s Capital Markets A Globally Unique Concept

Abstract

IPO grading assesses the fundamentals of the Initial Public Offerings (IPOs) and is reflected on a five-point point scale (1-5) with a higher score indicating stronger fundamentals of the IPO issuing firm. SEBI (India capital market regulator) introduced the IPO grading as a mandatory requirement for all IPOs, and the requirement seems to have been borne by the fact that, in India, where institutions are less developed and retail participation in IPOs is significant, quality signal represented by an IPO grade yields discernible benefits to the market. We note that while SEBI and the rating agencies advocate the benefit of the IPO grade, not everyone in the industry and academia is convinced of the grades merits. To analyze the efficacy of IPO grading, we conducted regression analysis study of a total of 63 IPOs that have been graded. Through this study, we find that securities with higher IPO grades tend to exhibit under-pricing to a lesser extent. We also find that, with higher IPO grades, the subscription rate of the IPOs improves across all class of investors, including retail investors. We also find that IPO grades are inversely related to the short-term liquidity of the IPOs, i.e. at least in the short term, higher graded IPOs dont exhibit high turnover ratio. We further find that the IPO grade fails to explain with any significance the subsequent market performance of the issues in terms of capital gains.