“The Analysis of the Initial and Post Issue

Performance of Initial Public Offerings (IPOs) in Indian Stock Market”

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THESIS

Submitted to

Kumaun University, Nainital For the award of the Degree of

DOCTOR OF PHILOSOPHY

(Ph.D.)

In

Commerce

Under the supervision of:

Dr. B.D. Kavidayal Professor

Department of Commerce DSB Campus, Kumaun University

Nainital, Uttrakhand

Research Scholar:

Ajay Kumar Chauhan

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PREFACE

Indian capital market has witnessed a drastic development as a result of economic

liberalisation in the country since 1991. This includes abolishing the regulated regime

under the Controller of Capital Issues (CCI) and establishing the Securities and

Exchange Board of India (SEBI) as the market monitor in 1992. The technological

advancements in the stock market, improved trading process, strict regulatory

controls, enlarged investor base has brought a new environment of stock investment

in India, likely to develop in the future also. Investors perceive Indian capital market,

whether local or global, as a new investment opportunity to earn high returns. The

research statistics have proven that in the Indian financial markets, equity instruments

provide higher returns in long period as compared to other traditional forms of

investments such as fixed deposits and gold etc. Thus there has been a continuous

increase in the tendency of investors to make investments in equity by taking more

risk in order to earn superior returns from the stock market. Capital market is

considered as the best opportunity to fulfill the dreams of retail investors. As the

Indian economy is considered as one of the highest developing economy in the world,

the investors expect the good returns in view of that. The funds from different class of

investors including Foreign Institutional Investors, qualified institutional investors

and retail investors is expected to increase in the future in the Indian stock market.

Along with the developments in the secondary market, the primary market has also

shown the tremendous improvement in recent years. Initial public offering (IPO), also

referred to simply as a "public offering", “going public” or "flotation" is when a

company issues equity shares to the public for the first time. They are often issued by

smaller, younger companies seeking capital to expand, but can also be done by large

privately owned companies looking to become publicly traded. For the individual

investor, although it is tough to predict what the stock or shares will do on its initial

day of trading and in the near future since there is often little historical data with

which to analyze the company, yet they are very popular among the investors. In last

few years a large number of IPOs have come in the market and have been successful

in attracting the investor’s attention and funds. The history of IPO under pricing in

Indian stock market made IPO investment at the time of issue relatively safer for the

investors also the companies perceive it as a reasonably reliable source of raising of

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funds in a scenario of highly volatile interest rates in the economy. At the end, the

both entities are seems to be in the win-win position.

This study is an effort to analyze the initial returns provided by Initial Public

Offerings (IPO’s) over and above the benchmark index S & P CNX Nifty after the

issue on the listing day as well as the performance of IPO’s in terms of the long term

returns up to the period of one to five years after the listing of the issue using event

study methodology and to identify the different factors that explains the return

behavior of IPOs in different time periods of the emerging Indian economy. The study

includes the IPO of the companies, which offer public issue as the Initial Public

Offerings (IPOs) during the period Jan 2000 to Dec 2010 through National stock

exchange (NSE). The data used for the study is secondary in nature and collected

from the CMIE database PROWESS and the official website of National stock

exchange. The analysis is done using the software SPSS and MS Excel. It is found

that the frequency of IPOs is high in bullish period i.e. most of the companies prefer

to come with IPOs when the market sentiments are good. The average age of the firm

issuing IPOs is found to be 15 years. The most of the IPOs are from the private

companies which belong to the manufacturing and services industries. The average

return provided by the IPOs on the listing day is 21.54 percent and the cumulative

average abnormal return (CAAR) of the IPOs is found to be 28.01 percent. It is also

found tha t the returns on the listing day as well as abnormal returns on the application

funds are positive and are 2.07 percent and 4.20 percent respectively. The weighted

average return on the invested capital (application money) on the listing day is found

to be the 4.46 percent. The results in the study support the anomalies of underpricing

of IPOs in short run in Indian stock market.

Applying the multiple regressions model it is found that the returns of the IPO on the

listing are highly influenced by the subscription and the behavior of the Index during

the same period and are not influenced by the factors such as promoter’s holding, age,

issue size and the time delay. The results of the long term performance (without

adjusting the market returns) indicate that the IPOs gives negative returns in the next

four years after the listing. If an investor buys the stocks on the listing day he/she has

to hold for many years (at least five) to make good returns. Abnormal returns are

calculated after adjusting the market returns in the returns provided by the IPOs after

the listing. The results indicates that the abnormal returns provided by 259 IPOs after

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one year from listing are -32.71 percent, abnormal returns provided by 226 IPOs after

two year from listing are -46.43 percent, abnormal returns provided by 210 IPOs after

three year from listing are -54.64 percent, abnormal returns provided by 129 IPOs

after four year from listing are -78.91 percent and after five years the abnormal

returns increases to -96.22 percent. This poor performance of Indian IPOs in long

term indicates the fundamental anomaly of underperformance of IPOs in long term.

This anomaly is not only exists in India but also found to be present in almost all

stock markets.

For the first time in the world, the Indian stock market regulator, Securities and

Exchange Board of India (SEBI), introduced the system of IPO grading and made it

mandatory for the companies going public since May 2007. This is done in order to

decrease the information asymmetry between the retail investors and qualified

institutional buyers (QIBs) and to protect the wealth of retail investors from the

investments in low quality Initial Public Offerings (IPOs). IPO grades, which are

based on the fundamentals of the companies and are supposed to indicate quality

signals about the future prospects of the company’s performance and hence ensure

better returns from the investments in quality IPOs. This is done to help the majority

of investors so that they can make wise investments. The effort is also made in the

study to investigate the relevance of IPO grading on the under pricing, long term

returns, liquidity and the P/E ratio of the companies. For the purpose of the study, 83

IPOs are selected, which came after May 2007 through National Stock Exchange

(NSE) and possess IPO grades at the time of issue. The IPO’s of different IPO grades

have been analyzed in terms of underpricing, liquidity, P/E ratio and long term returns

using t-test and regression analysis. The results indicate that the QIBs consider IPO

grading significantly and hence also affects the overall subscription of the IPO. The

listing day liquidity of higher graded IPOs is low but commands better liquidity in the

long term. Long term performance of the higher graded IPO is better than lower

graded IPO’s. However, the IPO Grading in not relevant in explaining the Listing Day

returns. Also the IPO grading has no impact on the subscription behavior of retail

investors.

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ACKNOWLEDGEMENTS

This work of mine would not seen the light of the day had the blessings,

cooperation, encouragement, guidance, precious time and views of good many not

have been there with me all along in bringing out it and therefore my heart knows no

bounds in acknowledging so indispensable.

At first I would thank providential powers who bestowed on me the incessant

inspiration and sustained strength in the form of life blood to carry out this project. I

am heartily thankful from the heart’s bottom to my supervisor, Dr. B D Kavidayal,

Professor, Department of Commerce, DSB Campus, Kumaun University, Nainital

whose able guidance, high standard commitments, rigorous approach, stimulating

support and encouragement, beyond repayment, from the initial to the final level

enabled and motivated me to complete the thesis and develop an understanding of the

subject. I am also thankful to Prof. B. D Awasthi, Head, Department of Commerce

and other members of Commerce department for having given me the opportunity to

pursue Doctoral Programme at the Department and for the support during the period

of research.

My heartfelt thanks, gratitude and regards are due to Dr. Keval Badhani,

Associate Professor, Department of Commerce who has obliged me by readily

extending scholastic hand, unflinching co-operation and motivation whenever

required. I am also indebted to the officials of National Stock exchange, SEBI, and

other institutions for providing the valuable information in their official website that

helps in conducting the research work.

I am indebted to my mother and father, who have been the lifelong source of

inspiration in my endeavors and other family members. I would be remiss if I failed to

thank my gracious wife Vartika Chauhan who extended exceptional support and

encouragement.

I would like to thank all the librarians, respondents and individuals whose

contribution directly or indirectly resulted in this thesis being materialized as the

thesis sought assistance from analysis of experts, academic works and reports etc.

Place: (Ajay Kumar Chauhan)

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CONTENTS

Chapteriszation Topic Name Page No.

v Certificate

v Preface

v Acknowledgements

CHAPTER-1: Initial Public Offerings (IPOs) In Indian Stock Market 1

1.1 Capital Market 2

1.2 Primary market in India 2

1.3 Initial Public Offerings (IPOs) 5

1.4 Different kinds of issues 9

1.5. Offer Documents (ODs) 11

1.6. Issue Requirements 12

1.7. Pricing of an Issue (IPO) 17

1.8. Book Building Process 18

1.9. Categories of Investors 19

1.10. Intermediaries involved in the Issue Process 24

1.11. The Offer Document 26

1.12. SEBI’s Role in an Issue 28

1.13. IPO Grading in India 32

1.14. New Provisions in Initial Public Offerings (IPO) 34

1.15. Basis of Allocation/Basis of Allotment 35

1.16. The Market Index (S&P CNX NIFTY) 36

1.17. Statement of the problem 39

Chapter-2: Review of the Literature , Objective and Research Methodology 42

2.1 Review of the literature 43

2.2 Research Methodology 60

2.2.1Rationale of the study 61

2.2.2 Statement of the problem 62

2.3 Objective of the study 62

2.4 Research design 62

2.4.1 Sampling 62

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2.4.2 Description of the variables 63

2.4.3. Data Collection 64

2.5 Statistical tools to be used 65

2.6 Hypothesis to be tested 68

2.7 Software used 69

Chapter- 3: Performance of Initial Public Offerings (IPOs) in Short Run and in

Long Term in Indian Stock Market 73

3.1 Frequency distribution of Initial Public Offerings (IPOs) 74

3.2 Age profile of the companies came with IPOs 78

3.3 Ownership group 82

3.4 Industry Profile of the companies came with IPOs 82

3.5 Returns of IPOs on the listing day 83

3.6 Categories wise returns 86

3.7 Abnormal Returns of IPOs on the listing day using

Event study methodology 88

3.8 Returns on the application money 92

3.9 Long term performance of IPOs over the market 93

Chapter- 4: Factors Contributing IPO Performance 101

4.1 Correlation between the subscription, the return on the 102

listing day and the abnormal return.

4.2 Subscription and the returns 103

4.3 Factors influencing the short term return of IPOs on 104

the listing day

4.4 Significance of IPO Grading in Indian Stock Market 109

4.4.1 Frequency Distributions of the IPO 111 Grading of the Companies

4.5 IPO grading and category wise subscription 113

4.6 IPO grading and the underpricing (short term returns of IPOs) 115

4.7 IPO grading and the long term performance of IPOs 116

4.8 IPO Grading and liquidity on the listing day 118

4.9 Impact of IPO grading on IPO performance 119

4.10 Criticism of IPO Grading 120

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CHAPTER-5: Conclusions and Suggestions 123

Bibliography 135

Appendix 142

List of companies

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LIST OF TABLES

Table No. Title of the Table Page No.

Table 1.1 Industry wise classification of capital raised 8

Table 1.2 Listing criteria for companies on the cash market segment of NSE

15

Table 1.3 Difference between Book building issue and fixed price issue

19

Table 3.1(a) Number of IPOs in different years 75

Table 3.1(b) Frequency of IPOs indifferent scenarios 77

Table 3.2 Frequencies of the companies issuing IPOs with respect to different age group

80

Table 3.3 Frequency of companies that belongs to the different ownership groups

82

Table 3.4 Frequency of companies that belongs to different industries

83

Table 3.5.1 Descriptive statistics of the return on the listing day 84

Table 3.5.2 Independent Sample T test 86

Table 3.6(a) Age group and returns 87

Table 3.6(b) Issue size and returns 87

Table 3.6(c) Ownership groups and returns 87

Table 3.6(d) Promoter’s holding after the issue and returns 88

Table 3.7.1 Abnormal returns 89

Table 3.7.2 Independent sample t test between fixed issue and book building issue

92

Table 3.8 Descriptive statistics of returns on the application money on the listing day

93

Table 3.9(a) Long term performance of IPOs 95

Table 3.9(b) Long term market adjusted performance of IPOs. 96

Table 3.9(c) Independent sample T test 100

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Table 4.1(a) Correlation between the subscription, the returns on the listing day and the abnormal return

103

Table 4.2 Subscription wise returns 103

Table 4.3.1 Simple regression models 106

Table 4.3.2 Multiple regression model with abnormal return as a dependent variable

107

Table 4.3.3 Independent sample t test between IPOs and other similar company after one year of listing.

108

Table 4.4.1 Frequency distribution of the IPO grading of the companies

111

Table 4.4.2 IPO grades and the age of the companies 112

Table 4.5.1 IPO grading and subscription in different categories 113

Table 4.6 IPO grading and listing day returns 115

Table 4.7 IPO grading and long term returns 117

Table 4.8 IPO grades, liquidity and price to book value ratio on the listing day

118

Table 4.9 Impact of IPO grading on different output variables 120

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LIST OF FIGURES

Figure No. Title of the Figure Page No.

Figure 1.1 Resources mobilized from the primary market (Rs. in Crores)

7

Figure 1.2 Types of issues 10

Figure 1.3 Life cycle of an IPO 30

Figure 3.1(a) Number of IPOs in different years 75

Figure 3.1(b) The behavior of the market index (S & P CNX NIFTY) during the period Jan 2000 – Dec 2010

76

Figure 3.1(c) Number of IPOs in different scenarios 78

Figure 3.2(a) Frequency distribution of the age of the companies came with IPOs

80

Figure 3.2(b) Frequencies of the companies issuing IPOs according to the age group

81

Figure 3.5 Frequency distribution of the returns on the listing day. 85

Figure 3.7 Frequency distribution of the abnormal returns on the listing day.

90

Figure 3.9(a) Long term performance of the IPOs 97

Figure 3.9(b) Market adjusted returns of IPOs in long run 98

Figure 4.4.1 Frequency distribution of the IPO grading of the companies

112

Figure 4.4.2 IPO grading and subscription in different categories of investors

114

Figure 4.6 IPO grading and listing day returns 116

Figure 4.7 IPO grading and long term returns 117

Figure 4.8 IPO grading, list price to book value ratio and liquidity on the listing day

119

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List of Abbreviations

ASBA Applications supported by blocked amount

BHAR Buy and Hold Abnormal Rate of Return

BRLM Book Running Lead Manager

BSE The Stock Exchange, Mumbai

CAAR Cumulative Average Abnormal Return

CAR Cumulative Abnormal Return

CC Clearing Corporation

CCI Controller of Capital Issues

CCIL Clearing Corporation of India Limited

CDSL Central Depository Services (India) Limited

CM Clearing Member

CM Segment Capital Market Segment of NSE

CMIE Centre for Monitoring Indian Economy

CRAs Credit Rating Agencies

CRISIL Credit Rating Information Services of India Limited

DIP Disclosure and Investor Protection

DPs Depository Participants

ECS Electronic Clearing Service

NEFT National Electronic Funds Transfer

EFT Electronic Fund Transfer

ELSS Equity Linked Saving Schemes

EPS Earning Per Share

ETFs Exchange Traded Funds

FDI Foreign Direct Investment

FDRs Foreign Deposit Receipts

FDs Fixed Deposits

FIBV International World Federation of Stock Exchanges

FIIs Foreign Institutional Investors

FIs Financial Institutions

FPO Further Public Offer

GDP Gross Domestic Product

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IPO Initial Public Offer

IRDA Insurance Regulatory and Development Authority

IISL India Index Services & Products Limited

IRDA Insurance Regulatory and Development Authority

MFs Mutual Funds

NIIs Non-Institutional Investors

NSE National Stock Exchange

OCBs Overseas Corporate Bodies

OD Offer Document

PAN Permanent Account Number

PSU Public Sector Unit

PUEC Paid Up Equity Capital

QIB Qualified Institutional Buyers

QIP Qualified Institutional Placement

RBI Reserve Bank of India

RI Right Issue

RIIs Retail Individual Investor

ROC Registrar of Companies

RTGS Real Time Gross Settlement

S&P Standard and Poor’s

SAD Seasonal Affective Disorder

SEBI Security and Exchange Board of India

SEO Seasoned Equity Offerings

VC Venture Capitalist

WR Wealth Relative

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