Impact of Auditor and Underwriter Reputation on Underpricing of SME IPOs in India

Abstract

Small and medium enterprises (SMEs) being relatively new, young and with little operating history tends to suffer from the problem of information asymmetry and ex ante uncertainty. This problem can be reduced through the use of various signals in the initial public offering (IPO) process. Hence, this study attempts to shed some light on the signalling role of prestigious auditors and underwriters and their interacted effects on IPO returns in an emerging market like India. Cross-sectional data comprising of final 286 SME IPOs issued during February 2012–March 2018 listed on the BSE SME platform and NSE EMERGE have been taken into consideration. Multiple regression analysis has been used to empirically test the signalling role. The results reveal that underwriter reputation helps in reducing information asymmetry and signals firm quality to investors. Underwriter reputation documents a positive relationship while auditor reputation lacks statistical significance. The negative relation of interaction effect of auditors and underwriters reveal that underwriter reputation plays a significant role in positively influencing investors’ perception and assisting them in taking investment decisions.

Keywords

Information asymmetry underwriter reputation auditor reputation signalling role IPO returns

Introduction

Small and medium enterprises (SMEs) are cornerstone of economic growth in all countries because they account for 80 per cent of global economic growth (Jutla, Bodorik and Dhaliwal, 2002). Like any other major economy, India too enjoys its fair share of SMEs contributing significantly to the exports and GDP. SME segment has been a key engine of growth, employment, wealth distribution and effective mobilization of resources (both capital and skills) in India. Statistically, SME segment contributes to 45 per cent of the manufactured output, 40 per cent of exports, and is among the largest generator of employment in the Indian economy. Ministry of Micro, Small and Medium Enterprises reported the lack of availability of adequate and timely credit, high cost of credit, collateral requirement and limited access to equity capital as the top four major issues concerning the sector. To overcome this concern, various efforts in the form of small exchanges such as Over The Counter Exchange of India, popularly known as OTCEI, Inter Connected Stock Exchange of India, BSE IndoNext were made. Unfortunately, they all failed to get the attention. Consequently, BSE SME platform and NSE EMERGE was launched in 2012 enabling the firms to raise capital.

SMEs being relatively new, young and with little operating history tends to suffer from the problem of information asymmetry and ex ante uncertainty. This issue can be resolved through various disclosures in prospectus. These disclosures includes information on assets, historical profitability, profits and dividend forecasting, company’s growth plans. In addition to basic information, entrepreneurs send the private information about the firm through the use of various signals such as retained ownership, lead manager’s prestige, auditor reputation and underwriter reputation in the initial public offering (IPO) process. These signals help in bridging the information gaps between issuers and investors reducing the so called ‘winner’s curse’ and consequently underpricing. The term underpricing interchangeably used with the term initial returns represents the difference between subscription price and price at which shares are traded on the first day of trading in secondary market. It reduces the ‘money being left on the table’ and leads to decrease in shareholder’s wealth (Filatotchev & Bishop, 2002; Tully, 1999).

The phenomenon of underpricing has been widely researched across different markets and documented in various studies. Many theories such as information asymmetry (Baron, 1982), winners’ curse theory (Rock, 1986), signalling theory (Allen & Faulhaber, 1989; Welch, 1989) have emerged trying to explain the phenomenon of underpricing but most of the researchers viewed the information asymmetry as a premise for underpricing (Beatty & Ritter, 1986; Benveniste, Busaba, & Wilhelm, 1996; Firth & Liau-Tan, 1998; Loughran & Ritter, 2004; Ritter & Welch, 2002). This problem of information asymmetry reduces the wealth of existing shareholders, therefore challenge for IPO firm is to lessen this problem by signalling the firm quality to them. One of the ways to effectively communicate this value to investors is to appoint reputed professional advisors, that is, underwriters and auditors. Since these third party professional advisors involved with issue process have huge reputational capital at stake (Megginson & Weiss, 1991), so they associate themselves with good-quality issues thereby certifying the issue and mitigating the investors’ uncertainty regarding the issue, enabling them to fetch higher issue price for the issue. Many researchers have claimed that association of reputed auditors with firm enhances the credibility of IPO among investors, thereby reducing underpricing (Balvers, McDonald, & Miller, 1988; Beatty, 1989; Gao, Cong, & Evans, 2015; Menon & Williams, 1991; Pratoomsuwan, 2012). However, the increase in credibility may increase the investors’ demand for the issue surging the closing price upwards on the first day of trading (Sundarasen, Khan, & Rajangam, 2018). It has also been revealed that good-quality auditors reduce uncertainty and information asymmetry more than lower-quality auditors (Balvers et al., 1988; Beatty, 1989; Datar, Feltham, & Hughes, 1991). Along with reputed auditors, issuing firm would also appoint reputed underwriters as they act as a consultant to the firm along with guarantor of full subscription. Hiring a reputable underwriter portrays the signal of good quality to firm. In fact, Balvers et al. (1988), Jacobs (1983) and Sutton and Benedetto (1988) argued that reputed underwriters would entice firm to appoint good-quality auditors because they are cautious with their reputation.

Emphasizing the role of an underwriter in issue process, SEBI Rules 1993 highlights that company needs to appoint an underwriter in order to bring an IPO in the market. Underwriter helps the company to sell its shares through various underwriting arrangements made available to the issuing company. This financial advisor role is not only confined to underwriting but also has a primary role in price fixation, ensuring the compliance of regulatory requirements, providing analysts recommendation and creating a market for the stock after an IPO. In depth due diligence on prospectus including discussion with senior management, inspecting the company’s operating policies, reviewing the material arrangements, conducting the background check on board members is performed by underwriter to protect the investors’ interest. Another financial specialist, that is, auditor is also regulated by SEBI to conduct the independent audit of all financial statements to ensure that these have been prepared in accordance with GAAP and that all the relevant disclosures have been duly made. Even the non-financial aspects of prospectus, such as the description of the firm’s products or the firm’s prospects need to be audited by the auditor to confirm that there is no misleading or fraudulent information in the prospectus. Finally, auditor also provides comfort letter to the regulator providing the information on the statements contained in prospectus and informing his examination of company documents to the best of his knowledge. Thus, the due diligence process is carried out in detail by both advisors to intact their reputational capital by mitigating their liability arising out of misrepresentation in prospectus.

Based on the aforementioned discussion, this study attempts to discuss two important objectives. First, the relationship between auditor reputation, underwriter reputation and underpricing is examined. Second, the interaction effect of underwriter and auditor reputation on IPO initial returns is examined. The results indicate that although auditor reputation does not influence underpricing, their interaction effect reduces the underpricing indicating that they play significant role in influencing investors while making investment decisions.

The article is structured in sections to achieve the objective. The second section reviews prior studies in the literature. The third section details out the methodology employed in study. Data analysis and interpretations have also been made in this section. The conclusions arrived at through the study have been presented in the fourth section followed by implications in the final section.

Review of Literature

Auditor Reputation

Auditor’s primary role is not only to ensure that financial statements are prepared in accordance with accounting principles but also taking care of the integrity of management and overall organization. Highly reputed auditors enhance the firm quality by attesting the fact that overall integrity of management is retained. Therefore, auditor reputation has been included in present study. Auditor reputation although measured using different proxies, that is, size of accounting firms (DeAngelo, 1981), aggregate sales revenue of audit firms (Francis & Wilson, 1988), auditor’s brand name (Dopuch & Sumunic, 1982), market share of auditing firm (Bulut, Cankaya, & Er, 2009). However, size of accounting firms is being widely used in various empirical researches concerning large IPOs. Large audit firms have higher reputational capital at stake, therefore they maintain higher audit quality. Small- and medium-sized IPOs use market share of auditors to measure auditor reputation (Velamuri & Liu, 2017).

The extant empirical literature dealing with the auditor reputation revealed that firms have an economic incentive in employing reputed auditors in the sense that investors associate this reputation with firm’s reputation and are willing to pay higher price for the shares offered in primary market (Klein & Leffler, 1981; Shapiro, 1983). Moreover, financial statements audited by auditors ensure the investors that there are least chances of intentional and unintentional errors in audited financial statements (Moizer, 1997). Hence, most of the studies use Big eight/Big six auditors as a measure of auditor reputation for two reasons—first to signal the firm quality to investors and second to reduce the monitoring cost. Choosing big auditors to signal firm value is based on Titman and Trueman’s (1986) signalling model that suggests that when company goes public, there is lot of uncertainty and information asymmetry surrounding the IPO. This information asymmetry can be reduced through the signal of choosing big auditors for IPO firm. Choice of auditors also help in reducing monitoring cost as the financial statements audited by reputed auditors are more credible that ultimately reduce its monitoring costs (Firth & Smith, 1992). Also, as the companies coming up with IPOs are relatively small, young and have limited operating histories, investors rely heavily on the issuing firm’s disclosures in order to gauge the firm’s value and evaluate the firm’s performance (Menon & Williams, 1991). The investors react positively to the information supplied by IPO firm associated with reputed auditors (Jang & Lin, 1993). Therefore, issuers send signal through the choice of big auditors. Hence, most of the studies use Big Eight/Big Six auditors as a measure of auditor reputation.

The relationship between auditor reputation and IPO returns have been examined in various studies (Beatty, 1989; Dhamija & Arora, 2017; Feltham et al., 1991; Menon & Williams, 1991). Utilization of prestigious advisors, that is, underwriter and auditor lends the legitimacy to IPO firm as they help in mitigating uncertainty about future cash flows and therefore reducing underpricing. The study conducted by Misnen (2003) revealed that investors trust financial statements audited by reputed auditors more than non-reputable auditors. This investors’ confidence helps in enhancing the firm’s value by reducing the information asymmetry and uncertainty regarding IPO. The negative relation between auditor’s reputation and underpricing is demonstrated by various studies such as Simunic and Stein (1987), Beatty (1989), Menon and Williams (1991), Balvers et al. (1988), Gao et al. (2015), Sundarasen et al. (2018), and Pratoomsuwan (2012). The reason being that financial statements audited by reputable auditors build investor’s trust and confidence in the issue, enabling the company to fix higher issue price for its offerings leading to reduction in underpricing. Studies by Titman and Trueman (1986), Feltham et al. (1991) reported that reputation of auditors reflects the good quality of IPO firms, reducing ex ante uncertainty and consequently the underpricing of IPO firms.

Titman and Trueman (1986) developed a framework showing that reputable auditors associate themselves with low-risk firms as their association with risky firms may entangle them in lawsuits. This framework was further empirically supported by Simunic and Stein (1987), Beatty (1989) and Feltham et al. (1991). In contrast, Datar et al. (1991) not only reported positive relationship between audit quality and IPO risk but also positive relation between firm’s valuation and audit quality. Several studies such as Ammer and Zaluki (2016), Velamuri and Liu (2017), Sundarasen et al. (2018), Alvarez-Otero and Lopez-Iturriaga (2018) have also documented positive relationship between auditor reputation and IPO valuation. The results explain that firms with reputable auditors intentionally underprice their issues in order to signal good quality to investors and to ensure the subsequent sale of seasoned equity offerings (Alvarez-Otero & Lopez-Iturriaga, 2018; Datar et al., 1991). In addition, Sundarasen et al. (2018) argued that since reputable auditors reduce ex ante uncertainty and information asymmetry regarding IPO, investors are induced to buy shares thereby increasing their demand even in secondary market. This increased demand tends to increase closing price leading to higher underpricing. In fact, various studies such as Balvers et al. (1988), Jacobs (1983) and Sutton and Benedetto (1988) reported that reputable underwriters encourage their clients to appoint reputable auditors because of their belief that reputed auditors would accurately report the discrepancies in firm and thus prevent them eroding their reputational capital. Even few findings, such as Vong and Zhao (2008), Badru and Ahmad-Zaluki (2018), reported insignificant relationship. Based on literature review, positive relation between auditor reputation and underpricing has been hypothesized in present study.

Underwriter Reputation

IPO is usually one of the make or break moments in the life of a firm and every company going public needs a specialized staff in helping it go public. Moreover, since newly issued companies may not have their own reputation, they need the reputation of professional advisors to sell shares efficiently (Logue, Rogalski, Seward, & Foster-Johnson, 2002). Besides the marketing skills of underwriters, their financial and technical expertise also comes in handy for issuing firms. Their expertise is a guarantee to the investors that company is sound for making investments. Underwriter is usually financial specialist who ensures that firms meet all regulatory requirements and shares are fully subscribed. Therefore, underwriter reputation has been used in present study. Carter and Manaster (1990) measured underwriters’ reputation based on rankings in tombstone announcement. Later on, Megginson and Weiss (1991) used a relative market share of underwriter—a modified form of Carter and Manaster’s method as a proxy for underwriter reputation. The firms going public suffer from the liability of market newness and this liability can be reduced through the information disclosures in prospectus. One of such disclosures is reputation of third party specialist in prospectus. Prestigious underwriters are expert in estimating true value of firm to investors, thereby reducing uncertainty regarding the firm and consequently ‘adverse selection problem’ (Carter & Manaster, 1990). Also, reputable underwriters associate themselves with low-risk firms because the value of low-risk firm can be precisely estimated and this precise estimation builds investor confidence in firm thereby reducing underpricing. This also helps in maintaining reputational capital (Carter, Dark, & Singh, 1998; Carter & Manaster, 1990; Megginson & Weiss, 1991).

Several studies have reported negative relationship between underwriter reputation and underpricing. Dhamija and Arora (2017) used a sample of 399 IPOs from April 2005 to March 2015 to reveal that underwriter reputation negatively influences IPO underpricing. Similar findings were reported by Sundarasen et al. (2018), Beatty and Ritter (1986), Johnson and Miller (1988), Reutzel and Belsito (2015).

The positive relationship between underpricing and underwriter reputation has been documented in studies such as Beatty and Welch (1996), Mitchell Van der Zahn, Singh, and Singh (2008), Chahine and Tohmé (2009), Liu and Ritter (2011), Gao et al. (2015), Thorsell and Issakson (2014). The explanation for positive relation is that reputed underwriters help in reducing the information asymmetry and uncertainty regarding the IPO. This further enhances the firm’s quality and consequently demand for IPO shares is increased on the first day of trading leading to higher closing price and consequently higher underpricing (Sundarasen et al., 2018). Alvarez-Otero and Lopez-Iturriaga (2018) using a sample of 72 IPOs in Spain argued that underwriters intentionally underprice their shares to signal good quality to investors and to prevent the shares from being unsubscribed. Beatty and Welch (1996), Liu and Ritter (2011) empirically tested that underwriters are used as a marketing tool to create publicity in the market. Also, underwriters and firms set their prices of their shares below market value in order to protect themselves from various litigation cases and risk of insolvency if IPOs are not fully subscribed.

In contrast to Beatty and Ritter (1986), Johnson and Miller (1988), Reutzel and Belsito (2015), Dhamija and Arora (2017), Sundarasen et al. (2018) which reported negative relationship and Beatty and Welch (1996), Mitchell Van der Zahn, Singh, and Singh (2008), Chahine and Tohmé (2009), Liu and Ritter (2011), Thorsell and Issakson (2014),Gao et al. (2015), Alvarez-Otero and Lopez-Iturriaga (2018) which reported positive relationship between underwriter reputation and underpricing, various other studies such as Shin (2010), Tian (2012), Anderson, Chi, and Wang (2015), Velamuri and Liu (2017), Bhattacharya (2017), Badru and Ahmad-Zaluki (2018) reported insignificant relation between the two. In the context of our study in Indian setting in case of SMEs, the positive relation between underwriter reputation and underpricing has been hypothesized in present study.

Research Gap

Most of the studies focusing on signalling role of prestigious professional advisors, that is, underwriters and auditors have been undertaken in developed countries with stronger investor protection and legal enforcement. India, being an emerging economy is of interest in the study to check if the established relationships between underwriter/auditor reputation and underpricing holds true in a country with different institutional background. Moreover, very few studies to the best of knowledge have been undertaken exploring the interaction effect of underwriter and auditor reputation on IPO initial returns. Hence, present research attempts to fill the gap by focusing on signalling role of auditors and underwriters in emerging markets like India.

Research Methodology

Data Collection

The study examines the IPOs listed on BSE SME platform and NSE EMERGE issued during February 2012–January 2018. Data related to variables under the study have been taken from prospectuses and official websites of BSE and NSE. The sample comprises of 328 IPOs that were further reduced to 286 IPOs due to non-availability of information on certain variables and presence of extreme observations.

Statistical Analysis and Variable Measurement

The present research attempts to identify the signalling role of prestigious underwriters and auditors and their impact on underpricing of SME IPOs. Multiple regression has been used to study the signalling effect on IPO initial returns in India. The regression model was checked for the assumptions of heteroscedasticity and multicollinearity. The problem of heteroscedasticity was discovered using Harvey test and it was contained using White test. Variance inflation factors for all variables were found to be below 10, hence the problem of multicollinearity was not discovered.

₊₁₂₃₄₅₆₇₈ε_i

For measuring IPO performance in terms of underpricing, market-adjusted excess return (MAER, dependent variable), regarded as underpricing has been used. MAER has been calculated by subtracting market return from initial raw return. The purpose to compute MAER is to adjust market movements between issue close date and listing date. As proposed by Carter et al. (1998) and Certo, Daily, & Dalton (2001), level of underpricing is calculated as the percentage increase from offering price to closing price on the first day of trading.

MAER = ((P1–P0) / P0 – (M1 – M0) / M0) × 100

MAER = Market-adjusted excess return

P₁ = Closing price of the securities on the first day of trading

P₀ = Offer price of security

M₁ = BSE SME IPO index on the first day of trading

M₀ = BSE SME IPO index on offer closing date of IPO

Relative market share of underwriters is computed to measure underwriter reputation using Megginson and Weiss’ (1991) methodology:

Underwriter reputation = (IPO proceeds underwritten by underwriter / total IPO proceeds in the sample) × 100

As far as auditor reputation is concerned, the study adopts the methodology used by Velamuri and Liu (2017) to compute auditor market share.

Auditor reputation = (IPO proceeds of the firms (in the sample) of the auditor / total IPO proceeds in the sample) × 100

After computing auditor market share, auditor dummy variable is constructed which takes the value 1 for auditors who have above median market shares and 0 otherwise. Since the control variables have been shown to be the good predictors of dependent variable in the previous researches, they have been included in the present study to ensure that the impact of auditor reputation and underwriter reputation on underpricing is unbiasedly captured. Issue price reflecting the stronger fundamentals of the company is expected to show a positive relationship with underpricing (Su & Fleisher, 1999). The negative relation of firm age (referring to number of years firm has been incorporated) with underpricing suggest that younger firms are expected to have higher underpricing due to higher information asymmetry surrounding the IPO (Certo et al., 2001., Darmadi & Gunawan, 2013). Isobe, Ito, and Kairys (1998) reported that larger issue size signals firm’s good quality to investors thereby generating higher initial returns. Firms with larger asset base are reported to not only have better long-run performance but also higher initial returns (Certo et al., 2001; Hearn, 2011). Longer time lag is expected to increase various risks faced by investors thereby leading to higher underpricing (Chahine & Tohmé, 2009; Chowdhry & Sherman, 1996; Mok & Hui, 1998). Higher oversubscription reflecting higher demand signals higher returns on the first day of trading (Koh & Walter, 1989). The details of variables under study and control variables are shown in Table 1.

Table 1.

List of Variables Under Study and Returns

Variables	Description
Underpricing on listing day	Market-adjusted excess return – Raw return – Market return as measured by the BSE Sensitive Index
Independent variables
Underwriter reputation	(IPO proceeds underwritten by underwriter / Total IPO proceeds in sample) × 100
Auditor reputation	Dummy variable is constructed with 1 for above median market shares and 0 otherwise.
Control variables
Oversubscription	No. of times issue has been oversubscribed
Issue size	Natural logarithm transformation of proceeds received from issuing new shares
Listing delay	No of days between close of issue and listing on BSE/NSE
Issue price	Inverse of price at which shares are issued through IPO
Firm age	Natural logarithm transformation of number of years between date of incorporation and IPO issue date
Total assets	Natural logarithm transformation of book value of total assets as expressed in lakhs

Source: The authors.

Data Analysis and Interpretation

Variations in MAER of SME companies across independent variables included in our present study have been shown in Tables 2 and 3. The results show that average MAER is as high as 7.067 per cent when reputed auditor is hired (auditor dummy = 1) as compared to auditor when reputed auditor is not hired (auditor dummy = 0). Also, average returns are highest when underwriter market share increases beyond 9.18 per cent. This is only rough sketch of relationship that has been probed further through regression.

Table 2.

Table Analysing Changes in MAER on the Basis of Auditor Reputation

Auditor Dummy	No. of Observations	MAER (%)
0	154	6.494038
1	157	7.066173

Source: The authors.

Table 3.

Table Analysing Changes in MAER on the Basis of Underwriter Reputation

Underwriter Market Share	No. of Observations	MAER (%)
UMS ⇐ 990	77	9.014672
0.990 < UMS ⇐ 4.935	62	1.873113
4.935 > UMS ⇐ 9.180	80	4.687085
Above 9.180	87	9.611062

Source: The authors.

Table 4 highlights the descriptive statistics of all variables used in present study. It shows mean, median, minimum, maximum, standard deviation, skewness and kurtosis of IPOs listed in BSE SME platform and NSE EMERGE.

Table 4.

Descriptive Statistics of Variables

Variables	Mean	Median	Maximum	Minimum	Std Dev.	Skewness	Kurtosis	Observations
MAER	6.206814	2.255238	115.75	–22.76989	16.21987	2.600187	16.19297	300
1_Issue price	0.038367	0.028571	0.1	0.001087	0.028067	1.037763	2.954589	306
Ln(Firm age)	2.251593	2.310492	4.760721	–0.729413	0.80508	–0.709055	4.045753	306
Ln(Issue value)	6.651163	6.506681	9.134927	4.442651	0.842091	0.192701	2.553045	305
Ln(Total assets)	7.800423	7.80366	10.82226	0.21188	1.17083	–0.811077	7.671659	305
Listing delay days	11.6634	10	240	0	14.67599	13.00172	195.5951	306
Total oversubscription	10.63115	1.6	255.958	0.7366	29.4368	4.996107	32.26934	293
Auditor dummy	0.488746	0	1	0	0.500679	0.045027	1.002027	311
Underwriter market share	7.136588	5.569192	19.05203	0.04254	6.423283	0.6777	2.339141	306

Source: The authors.

As documented in Table 3, most IPO firms are underpriced with average underpricing stood around at 6.206814 (mean), minimum initial return at –22.76989, maximum initial return at 115.75 and standard deviation at 16.21987. Underwriter reputation has mean value of 7.136588 meaning that average market share of underwriters is 7 per cent. The minimum share is 0.04254 per cent while the maximum share is 19.05203 per cent. Auditors’ reputation has highest value of 1 and lowest value of 0 as dummy variable is used to capture auditor reputation. Skewness and Kurtosis tests the deviations from normality. Skewness of majority variables is low indicating normality of variables. Moreover, deviations from normality is not a cause of serious concern in our data due to larger sample size. In nutshell, descriptive statistics of variables shows that IPO firms do have variation in variables tested.

Correlation Analysis

Table 5 shows the correlation between MAERs, independent variables and control variables. Since none of the correlation estimates in the table is above the threshold limit of 0.90, there is no problem of multicollinearity.

Relationship Between Auditors’/Underwriters’ Reputation and Initial Return

In order to explore the impact of prestigious auditors and underwriters on underpricing of SME IPOs, the following multivariate regression equation has been used: ₁₂₃₄₅₆₇₈ε_i

The study uses MAER as dependent variable to examine the impact of auditor reputation and underwriter reputation on initial adjusted raw return. Table 6 reports the regression outcome.

The empirical results indicate that among control variables, inverse of issue price, firm age, listing delay and total oversubscription are positive and significant at 5 and 1 per cent levels, respectively. Issue price reflecting the stronger fundamentals of the issue leads to better pricing performance (Su & Fleisher, 1999). Listing delay positively influences underpricing meaning that investors do not perceive longer time lag to be a signal of good quality, thereby leading to high underpricing (Chahine & Tohmé, 2009; Chowdhry & Sherman, 1996; Mok & Hui, 1998). Oversubscription is also highly significant at 1 per cent level and positively influences underpricing. The positive relationship indicates that issues with higher demand fetch higher price, thereby leading to higher underpricing (Koh & Walter, 1989). The negative coefficient of firm age in line with Certo et al. (2001), Darmadi and Gunawan (2013), Thorsell and Issakson (2014) indicates that older firms have good disclosure of longer track record thereby mitigating information asymmetry and reducing underpricing.

Table 5.

Correlation Data Matrix

	MAER	1_IssuePrice	Ln Firm Age	Ln Issue Value	Ln Total Assets	Listing Delay Days	Total Oversubscription	Auditor Dummy	Underwriter Market Share
MAER	1	–	–	–	–	–	–	–	–
1_Issue Price	0.104633242*	1	–	–	–	–	–	–	–
Ln(Firm age)	–0.109211713**	–0.182160868***	1	–	–	–	–	–	–
Ln(Issue value)	–0.047543137	–0.639768487***	0.229764716***	1	–	–	–	–	–
Ln(Total assets)	0.06824951	–0.283306385***	0.289812412***	0.57609233***	1	–	–	–	–
Listing delay days	0.335138983***	0.125164519**	–0.057822615	–0.120886446**	0.011625354	1	–	–	–
Total oversubscription	0.230867857***	–0.15302271***	0.107931669*	0.137679446***	0.10936759*	–0.050914319	1	–	–
Auditor dummy	–0.068452679	–0.452016347***	0.16263***	0.7452590***	0.4743333***	–0.078366924	0.068872652	1	–
Underwriter Market share	0.222883075***	–0.077173749	0.066943149	0.019557974	0.206693635***	0.039257377	0.036773918	0.045709021	1

Source: The authors.

Note: ***, ** and * indicate significance at 1, 5 and 10%, respectively.

Among independent variables, underwriter market share is positive and significant at 1 per cent level. The results reveal that underwriter reputation positively influence IPO returns. The justification behind positive relation is that since reputed underwriters are concerned about their reputation they associate themselves with low-risk firms so that they can easily and correctly estimate true value of firm. Estimation of true value of firm thus helps in reducing uncertainty and information asymmetry among issuers and potential investors. This low uncertainty signals firm’s good quality to investors thereby inducing the investors demand in the secondary market, consequently pushing the closing price upwards and hence higher initial returns. These findings are in line with Beatty and Welch (1996), Mitchell et al. (2008), Chahine and Tohmé (2009), Liu and Ritter (2011), Gao et al. (2015). As far as auditor reputation is concerned, results indicate that though the coefficient of auditor reputation is negative, it is insignificant. Although insignificant, negative relationship implies that firm’s association with reputed analysts increases the investors’ confidence in firm, thus enabling the firm to fetch higher issue price. Moreover, auditors’ reputation is an attestation to the fact that information provided is true, accurate and duly certified. The findings of insignificant relation are corroborated by Vong and Zhao (2008), Badru and Ahmad-Zaluki (2018), Sundarasen et al. (2018).

Table 6.

Relation Between Signalling Variables (Underwriter and Auditor Reputation) and IPO Initial Return

Independent Variables	Coefficient	P-Values
Constant	–14.69975	0.1261
1_Issue price	64.51655**	0.0442
Ln(Firm age)	–2.155105**	0.0165
Ln(Issue size)	1.720698	0.2645
Ln(Total assets)	0.558567	0.4652
Listing delay	0.276121***	0.0000
Total oversubscription	0.113915***	0.0000
Auditor dummy	–2.419061	0.2366
Underwriter market share	0.426127***	0.0001
R ²	0.248514	–
Adjusted R²	0.226810
No. of observations	286
F-statistic	11.45037***

Source: The authors.

Note: ** and *** indicates significance at 5% and 1% level respectively.

Relationship Between Interacted Independent Variables (Underwriter Reputation and Auditor Reputation) and Initial Return

Independent variables are interacted in the regression model in order to know the combined effect of auditor and underwriter reputation on underpricing. Therefore, the main effects (underwriter reputation and auditor reputation) are controlled for in this regression model. Table 7 reports the result of interaction effect of professional advisors on IPO initial returns. The equation is specified below: ₁₂₃₄₅₆₇₈₈ε_i

The variables representing interaction effect of auditor reputation and underwriter reputation are regressed against MAER. As documented in table, empirical results show the outcome of interacted independent variables on initial returns. Underwriter reputation variable is interacted with variable used for measuring auditor reputation. The explanation for interaction effect is that reputed underwriters have tendency to recommend reputed auditors to the firms because of their huge reputational capital involved. The results indicate that coefficient of interaction of underwriter reputation and auditor reputation is negative and significant at 5 per cent level. The findings in line with Sundarasen et al. (2018) suggest that combined effect of both professional advisors’ reputation depresses initial returns. The justification for the aforementioned result is that since reputed underwriters have huge reputational capital at stake, they entice the company to appoint prestigious auditors. This may build the confidence among investing fraternity regarding underwriters’ capability in pricing the issue fairly. Underwriters association with reputed auditors may positively impact the investors’ perception that accounting standards are properly adhered to and financial statements reflect true and fair view of firm performance, thereby reducing uncertainty surrounding the IPO and consequently underpricing.

Table 7.

Relationship Between Interacted Independent Variables and IPO Initial Returns

Independent Variables	Coefficient	P-values
Constant	–17.64476	0.0602
1_Issue price	70.42693*	0.0601
Ln(Firm age)	–2.153251**	0.0433
Ln(Issue size)	1.971838	0.2126
Ln(Total assets)	0.527216	0.5046
Listing delay	0.274828***	0.0000
Total oversubscription	0.111410***	0.0000
Auditor dummy	0.490653	0.8515
Underwriter market share	0.627148***	0.0001
Underwriter market share # auditor dummy	–0.419603**	0.0394
R ²	0.259216
Adjusted R²	0.235060
No. of observations	286
F-statistic	10.73091***

Source: The authors.

Note: *, ** and *** indicate significance at 1, 5 and 10%, respectively.

Conclusion

The present study sheds some light on the signalling roles of underwriters and auditors in case of SME IPOs in emerging market like India. Owing to the distinctive capital market regulations, the study in Indian settings holds much more importance. Moreover, being relatively young and due to lack of track record of operating profits, SMEs tend to suffer from the problem of information asymmetry. Hence, they need to overcome the ‘liability of market newness’ (Certo, 2003). The way to reduce this liability is by effectively communicating the firm value to investors through the use of various signals in IPO process. Auditor’s reputation and underwriter’s reputation are such signals that entrepreneur use to portray firm quality to investors. Since, auditors attest the accuracy of financial statements, the firms association with reputed third party specialists would send a strong signal of firm quality to investors, thereby reducing the information asymmetry among issuers and potential investors. However, the results report lack of statistical relationship. For the underwriter reputation, positive relationship is documented. The positive relationship suggest the increase in investors’ demand of issues on the first day of trading due to portrayal of good firm quality to investors. Underwriter’s reputation plays a significant role among SME firms in emerging market like India due to presence of information asymmetry among investors regarding new issues. Negative relationship of interacted variables with initial returns further strengthen the fact. The relationship indicates that good-quality underwriters induce the firm to appoint good-quality auditors because they are overly cautious about their reputational capital and therefore avoid being associated with poor quality auditors. This association leaves the good impression in investors’ mind thereby leading the company to command higher issue price, reducing the initial returns.

Implications

The present study is valuable for issuers, investors and regulators. The findings have implications for various stakeholders. First, the newly issued firm should keep in mind the reputation of underwriters while appointing them if they want their IPOs to be highly demanded in secondary market. As against, if issuers have no qualms in leaving more money on the table, they may work with non-reputable underwriters as their fees is much lower than reputed underwriters. Second, the findings implicate that if the issuers want to leave less money on the table, then they should hire reputed underwriters as it would signal the investors that firm is confident about its financial performance. This would also help them to maximize the shareholders’ wealth. Third, since the good-quality underwriters associate themselves with reputed auditors, this would assure the investors that financial statements reflect true and fair view of firm position. Thus, these findings act as a guiding tool to both issuers and investors in raising capital and taking investment decisions in SME IPOs in India. Fourth, the regulators like SEBI can use these results in including the regulations pertaining to auditors and underwriters in IPO process in India.

Declaration of Conflicting Interests

The authors declared no potential conflicts of interest with respect to the research, authorship and/or publication of this article.

Funding

The authors received no financial support for the research, authorship and/or publication of this article.

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