Initial Public Offering: underpricing and underperformance

Abstract

Initial public offering (IPO) is a type of public offering in which shares of a company are sold to institutional and retail (individual) investors. An IPO is underwritten by one or more investment banks, who also arrange for the shares to be listed on one or more stock exchanges. Through this process, a private company is transformed into a public company. Initial public offerings can be used to raise new equity capital for the company concerned and to enable easy trading of existing holdings or future capital raising by becoming publicly traded enterprises. An IPO allows a company to tap into a wide pool of potential investors thus allowing them to raise large amount of funds without any repayment obligations or incurring any form of debt. Along with these benefits, significant costs are also associated with the IPO process involving banking and legal fees. Disclosure of sensitive information also acts as a cost for the company along with compliance with regulatory requirements. But the most significant of these would be the loss of control and agency problem as a result of a public issue. After the IPO, shares which are traded in the free market are known as free float. Generally, stock exchanges determine a minimum level of free float both in terms of total value and as a proportion of total share capital of the respective company. This report covers the predominant types of IPOs along with the role of underwriters and the IPO process followed in India. Then we move on to the existing literature on underpricing and underperformance of IPOs. This is followed by the description of our data and methodology covering the summary statistics and the statistical models. Finally, we discuss the results and give the conclusion to this paper.