| dc.description.abstract | Initial public offerings (IPOs) are ordinary equity shares issued by companies that have not previously issued equity shares to the public:
Existing literature in finance suggests that the issue price is generally lower than the price at which the share is traded for the first time in the market (initial market). This implies that money is being left on the table apparently in exchange for nothing.
Long-run (aftermarket) performance of IPOs is also of interest as the existence of price patterns presents opportunities to the investor by way of using active trading strategies to produce superior trading returns. Empirical evidence suggests that gains accruing in the initial market are wiped out in the aftermarket.
There has been a significant growth in IPOs over the last 6 years in India. This can be gauged from the fact that equity issues have grown from Rs 1,230 crores in 1989-90 to about Rs 17,900 crores in 1994-95. Companies can now, also make IPOs at a premium. This provides opportunity for developing and testing hypotheses about the initial and aftermarket performance of IPOs.
The study covers 628 IPOs made between October 1992 and March 1994. Both issues made at par and issues made at a premium are includes in the sample. Different return measures are designed to compute the initial market returns. It is found that the average returns and the variance of returns are similar for issues made at par and issues made at a premium. However, the proportion of issues providing positive excess returns is larger for issues made at par; although both types of issues provide positive excess returns in more than 50% of the cases. Offer-to-open returns account for nearly 89% of the variability in offer-to-close returns. There does not appear to be any impact of market conditions on IPO returns at the time of issue and at the time of listing. Excess returns are directly related to the oversubscription levels. No conclusive evidence has emerged in measurement of an ex-ante measure of riskiness of IPOs.
Issues by small merchant bankers are expected to earn higher excess returns. Aftermarket returns are computed and studied for 290 issues and 180 days. Contrary to popular perception, IPOs trade quite frequently. In the aftermarket, excess returns rise sharply for the first four days of trading and then taper off to again rise at a slower pace.
The thesis has significant implications for managers and policy makers. For the corporate finance manager, the knowledge of price performance of IPOs is important as it would help him in better pricing of his issue. This would help the finance manager reduce the firm’s cost of financing. It would indicate the investor’s willingness to subscribe to subsequent issues by signaling firm’s quality. It would also reflect the extent of transfer of wealth between the old and new shareholders.
For the policy makers it would act as a guide to framing policies concerning IPOs. Rather than over-protect the investor at the expense of the issuer, a policy alternative of allowing all issues to be freely priced is suggested. An indirect means of protection, through greater disclosure/transparency norms along with stiff due diligence requirements is likely to serve the purpose.
The possibility of earning positive excess returns is greater than 50% for both issues at par and issues at a premium which indicates that the investor has more than a fair chance of making an abnormal gain in the market. The high proportion of positive excess returns for issues at par indicates that the investor protection measure of Securities Exchange Board of India in allowing a statutorily fixed issue price seems to have worked quite well. However the investor is being more than protected in relation to freely priced issue as proportion of positive excess returns is greater for issues at par. This is at the expense of the issuer, who under a free pricing mechanism might have been able to raise cheaper resources. Regulatory agencies need to strike a right balance between investor protection and promoting issuer; a policy alternative of allowing all issues to be freely priced but an indirect means of protection through greater disclosure and transparency measures along with stiff due diligence measures is likely to work as well.
For the investor, profit opportunities can be discerned. By buying at the offering and selling on listing price the investor can earn up to 108% an annualized basis. For a holding period for 180 days after listing the investor earns about 20% excess returns.
The study also provides aggregate price trends to the investing public. Thus the investor would be in a position to make a better judgement based upon the risk profile of the IPOs brought out by this study. | |
