Performance of Indian IPOs: An Empirical Analysis

Abstract

The present research study contributes to the extant literature on underpricing rather uniquely by addressing the under-researched linkage of corporate governance to underpricing. The originality of this effort also lies in being one of the initial efforts of exploring governance in context of initial public offering (IPO) underpricing in Indian settings. The study comprises an empirical analysis of 404 Indian IPOs studied for their board structures and ownership attributes using IPO prospectuses. Drawing support from the signalling theory, the variables board size and board committees exhibit a significant positive relationship to the IPO returns on the listing day. In Indian markets characterized by concentrated family-owned firms, promoter ownership does work as an effective signal for investors who take cues of firm potential from ownership patterns. Corporate governance measures have a miniscule contribution in explaining the underpricing of Indian IPOs and indicating that investors do not incorporate these as a major consideration in their investment decision.

Keywords

Initial public offering underpricing corporate governance board of directors India

Introduction

Initial public offering (IPO) provides an opportunity to the issuing company to tap wider pool of public funds for capital needed to fund its future growth. Due to its inherent characteristics and associated anomalies, IPOs have been attracting interest of researchers’ world over. Pricing of IPOs, and more specifically their underpricing, remains the most contentious issue which is characterized as an IPO anomaly. Underpricing, a performance indicator unique to IPO context, represents the difference between valuations of firm by investment banker and by the stock market at the end of first day of public trading. It is referred to as money that initial shareholders ‘leave on the table’ (e.g., Tully, 1999). IPO underpricing is believed to reduce the capital received by firm through IPO process (Lin & Chuang, 2011) and is regarded as a direct wealth transfer from founders and initial shareholders to new external investors (Filatotchev & Bishop, 2002). The economic magnitude of IPO underpricing is huge and being globally pervasive the phenomenon has been widely documented.

A large number of studies have addressed the underpricing issue and attempted to find explanations to this premium. Several theories have emerged to explain these positive initial returns such as information asymmetry (Baron, 1982), winners’ curse hypothesis (Rock, 1986), underwriters’ reputation theory (Carter & Manaster, 1990) and signalling hypothesis (Allen & Faulhaber, 1989; Grinblatt & Hwang, 1989; Welch, 1989). In spite of the numerous explanations, the anomaly remains far from being resolved. Most of the explanations, however, revolve around information asymmetry between issuing firm and other participants in the IPO process. This asymmetric information is higher for smaller and newer firms and this increases agency costs which manifest as underpricing.

To address the challenges of information asymmetry, firms adopt varied mechanisms to signal firm quality and communicate their true value to investors. This is necessary in the light of prevailing uncertainty in the minds of investors. Signals and signalling mechanisms have been widely studied in finance literature and in relation to IPOs as well. Despite the extant literature on signalling in context of IPO underpricing, little attention has been devoted to association between corporate governance attributes and IPO initial performance particularly in the context of Asian economies (Yong, 2007). Corporate governance has emerged as an explanation to underpricing in the times of shift towards qualitative signals in the backdrop of losing relevance of financial and quantitative information in communicating credibility of new issue firms. The disturbing regularity of corporate upheavals and financial irregularities globally has also stimulated the growing interest in corporate governance mechanisms. Also, Yong (2007) shared the view that corporate governance is the new area of IPO research. The originality of this research effort lies in being one of the initial efforts of exploring effectiveness of governance as signals at the time of IPO and its relationship to listing performance in Indian markets.

The article is structured in sections to achieve the objective. The second section reviews the literature related to the study. The objectives and rationale of the study are discussed in the third section. The fourth section details out the methodology adopted for the study. The data analysis has been put forth in the fifth section. The conclusions arrived at through the study have been presented in the final section.

Review of Literature

Information gaps between the issuers and investors call for initiatives to drive out the fears in the minds of investing public which result in the adoption of signalling mechanisms. At the heart of signalling theory is information asymmetry (Spence, 1973) which results in unsettled doubts in the minds of investors. A variety of signals which have been adopted by new issue firms have been documented in literature. These include retained ownership (Keasey & McGuiness, 1992; Leland & Pyle, 1977), underpricing for seasoned issues (Allen & Faulhaber, 1989; Ibbotson, 1975; Welch, 1989), prestigious underwriters (Booth & Smith, 1986; Carter & Manaster, 1990; Michaely & Shaw, 1994), reputed investment bankers (Carter, Dark & Singh, 1998; Paudyal, Saadouni & Briston, 1998), auditor reputation (Titman & Trueman, 1986) and prestige of venture capitalists (Da Silva Rosa, Velayuthen, & Walter, 2003; Megginson & Weiss, 1991).

IPO provides a unique setting to evaluate effects of governance as effective monitoring is all the more critical for firms going public in the face of aggravated agency conflicts (Brennan & Franks, 1997). It is widely accepted that good corporate governance systems are associated with better corporate value and is also a key element in corporate competitiveness and access to capital (Jensen & Meckling, 1976; Shleifer & Vishny, 1997). Also, Kim and Ritter (1999) argued that the relationship between financial information and equity values is particularly tenuous in the IPO context. Sanders and Boivie (2004) suggest that corporate governance parameters can serve as useful screening and sorting criteria that influence investors’ valuations of the IPO firm when primary information sources are limited or obscure.

The limited prior research exploring the relation of corporate governance to underpricing is largely focused on the developed economies. Some studies have investigated board of directors and IPO underpricing, using data from the USA (e.g., Certo, Daily & Dalton, 2001b; Howton, Howton & Olson, 2001). Evidence from emerging markets is rare, among the few are Chen and Strange (2004), Lin and Chuang (2011) and Yatim (2011), which use a sample of IPO firms in China, Taiwan and Malaysia, respectively. The impact of governance measures on performance of IPOs in small frontier markets of West Africa facing the challenge of adoption of international governance best practices (Hearn 2011, 2012) has also been studied. In the light of the economic significance of Indonesia, the largest economy in Southeast Asia which attracts foreign attention and investments, Darmadi and Gunawan (2012) explored the influence of corporate governance mechanisms on initial returns in this emerging market. Chen and Yang (2013) failed to establish a significant relationship between underpricing and governance and ownership structure for ChiNext IPOs. On the same lines, IPO investors on the Alternative Investment Market (London) were found not to necessarily view the monitoring benefits of board structure and managerial ownership as important signals of firm quality (Wu & Hsu, 2012). Clearly concentration of past efforts has been in developed and established economies of USA (Certo et al., 2001b; Certo, Covin, Daily & Dalton, 2001a; Dempere, 2007; Howton et al., 2001), UK (Chahine, Filatotchev & Zahra, 2009; Filatotchev & Bishop, 2002) and France (Chahine, 2004; Mnif, 2009). However, in light of vibrancy in economies, research efforts have been redirected towards growing and emerging markets of Australia (Ching Yi-Lin, 2005), China (Li, 2005; Li & Naughton, 2007), Indonesia (Darmadi & Gunawan, 2012), Malaysia (Yatim, 2011) and Singapore (Mitchell, Singh & Singh, 2008), though Indian markets remain unexplored for this association.

The literature does highlight various dimensions to the underpricing conundrum but explanations through corporate governance are rather limited. Indian markets which have awakened to the global calls for stringent governance remain an interesting subject in the backdrop of dynamic IPO markets.

Objectives and Rationale of Study

The investigation of Indian markets becomes important in the light of the economic and financial stature of India. The radical reforms in regulations and pricing, exponential growth, global distinctions and upsurge in volumes in IPO market have generated considerable research interest in Indian IPO market. According to Global IPO Trends Report, 2012, India ranks seventh globally in terms of number of deals (making 3.3 per cent of the global total) and the BSE ranks ninth among the global exchanges by number of deals (contributing 3.20 per cent to global total). The study also becomes important because the influences of corporate governance variables on underpricing are expected to be different in emerging markets owing to different institutional environments when compared to developed markets. Being a pervasive phenomenon in India, especially at the time of IPO, the study of information asymmetry and contribution of governance attributes in mitigating this asymmetry becomes an interesting research problem. The present study aims to explore the governance preparedness of the Indian firms at the time of going public and the role these measures play in signalling firm credibility. The study is directed towards finding explanations to the underpricing riddle (after confirming the existence of underpricing through the sample chosen for study) in the Indian contours through corporate governance measures.

Methodology

Sample

In the present study, an effort is made to study the signalling power of governance attributes, as represented by board structures and ownership variables, and the extent to which these are incorporated in the investment decisions of Indian investors. The sample for study is the firms which issued new equity securities between 1 April 2001 and 31 March 2012 and got listed on the Bombay Stock Exchange (BSE). IPOs have been included 2001 onwards as this was the time when SEBI specified principles of Corporate Governance and introduced a new clause 49 in the Listing agreement of Stock Exchanges to be followed by companies seeking listing. The final sample consists of 404 Indian IPOs which was reached at on the basis of availability of prospectus of issuing firms. With respect to some of the variables, information was not available and so the sample had to be trimmed down on those counts as clear from the statistical summary of the variables.

Data Sources

The primary source of data pertaining to corporate governance variables has been obtained from the IPO filing document called prospectus. The IPO prospectus is a compulsory document necessary to file at the time of issue with the capital market regulator, SEBI and also with the public office of companies in respective state called the Registrar of Companies. The IPO prospectus for each of the company has been procured from the SEBI website (www.sebi.gov.in). The companies whose filing documents were not available from SEBI website, the prospectus as available on company’s website were taken. For calculation of returns, the market prices of securities and respective market returns (SENSEX values) have been extracted from the reliable and accurate database of Ace Equity and BSE website (www.bseindia.com). In addition to these, the information relating to firm attributes and issue variables has been collated from Prowess and Capitaline database. Ace Equity, Prowess and Capitaline are reliable databases for detailed information about Indian firms and largely resorted to by researchers and academicians.

Statistical Model

The signalling potential of governance methods and their relationship with IPO’s initial returns has been studied using hierarchical regression modelling with two measures of returns as dependent variable. The model employed is as follows:

Underpricing_i = α + β₁Subscription ratio_i + β₂ Issue size_i + β₃ Issue price_i + β₄ Listing delay_i + β₅ IPO Age_i + β₆ Total Assets_i +β₇ Board Size_i + β₈ Board Committees_i + β₉ Board independence_i + β₁₀ Women director_i + β₁₁ Board Age_i + β₁₂ Related Board Members+ β₁₃ Board Reputation + β₁₄ Promoter ownership_i + β₁₅ Block shareholder_i + β₁₆Top 10 Ownership_i + ε_i.

Before running regressions, the model has been tested for the problems of multicollinearity and heteroscedasticity. The existence of heteroscedasticity was confirmed and as a solution, White’s heteroscedasticity consistent standard errors have been used. VIFs (Variance-Inflating Factors) have been computed for explanatory variables to check the problem of collinearity between variables. However, no violation of this was noticed as all VIF values were found to be below 10 (Gujarati, 2003).

Measurement of Variables

The variables included in the study are categorized as dependent variable and independent variables and control variables. The independent variables have been categorized as firm variables, issue variables and corporate governance proxy variables. Firm and issue variables have been included in the model as control variables to provide for their potential influence on listing day pricing performance. Corporate governance variables are the interest variables which have been represented through board structure variables and ownership-related measures. The details of the variables employed for the study have been presented in Table 1. Two measures of underpricing have been calculated for the study as dependent variables under separate models. As a first measure of return, raw return (RR) has been used, wherein underpricing is measured using initial returns, calculated as the closing price on the first trading day in secondary market minus offer price, divided by offer price (Arthurs, Hoskisson, Busenitz & Johnson, 2008; Certo et al., 2001b). Secondly, market-adjusted excess return (MAER), regarded as adjusted underpricing, has been used. To adjust for the market, movements between prospectus date and the first trading day of the IPO, MAER is calculated by subtracting the market return (as measured by the BSE’s sensitive index) from the initial RR.

Table 1.

Operationalization of Research Variables

Variables	Operationalization
Dependent Variable
Underpricing on listing day	1. Raw return—Closing price on the first trading day on the secondary market minus offer price, divided by offer price 2. MAER—Raw return minus the market return as measured by the BSE’s sensitive index
Independent Variables (Board related)
Board size	Total number of directors on the board
Board committees	Inverse of total number of board committees to assist the board
Board independence	Percentage of independent directors on the board
Women directors	Percentage of women directors on the board
Age of board	Average of the individual age of all board members
Related board members	Number of members on the board who are related to each other
Board reputation	The total number of board directorships held by non-executive directors at other firms
Independent Variables (Ownership related)
Promoter ownership	Percentage of shares held by board of promoters (founders) at the time of issue
Promoter ownership squared	Square term of the percentage of shares held by board of promoters (founders) at the time of issue
Block holder ownership	Number of shareholders holding shares more than 10 per cent of total shares to denote concentrated ownership
Top 10 shareholding	Percentage of shares owned by the 10 largest shareholders of a firm
Top 10 shareholding squared	Square term of percentage of shares owned by the 10 largest shareholders of a firm
Control Variables (Issue and firm related)
Subscription ratio	Number of times the IPO has been subscribed: indicator of over or under subscription
Issue size	Logarithm transformation of proceeds received from issuing new shares (in crores)
Listing delay	Number of days between close of issue and listing on BSE
Issue price	The offer price of shares issued through IPO
IPO age	Logarithm transformation of number of years between date of incorporation and IPO issue date
Total assets	Logarithm transformation of book value of total assets as expressed in crores of rupees

Source: Prepared by authors.

The justification for the control variables has been drawn from the extant IPO literature. The subscription ratio has been included to provide for the demand for the issue. Koh and Walter (1989) proposed that higher the interest and demand of issue (proxy for subscription ratio) higher would be degree of underpricing. Chahine and Tohme (2009) incorporated oversubscription for its use by issuers to increase the likelihood of IPO’s success (Amihud, Hauser & Kirsh, 2003). Issue size has been included to capture the inherent and fundamental risk of an IPO. Ritter (1991) argues that smaller issuers tend to have better initial returns and worse long-term performance compared to larger issuers (Li & Naughton, 2007). Corhay, Teo and Rad (2002) find a negative relation between long-run performance of IPOs and inverse of issue price in contrast to the documented positive relation in Indian context (Sehgal, 2009). In the scenario of information asymmetry characterized by existence of both informed and uninformed investors, on the lines of Lee, Taylor and Walter (1996), the listing delay is a variable to proxy for degree of informed demand. IPO age is included for its reported relationship with IPO performance (e.g., Certo et al., 2001b; Megginson & Weiss, 1991; Mikkelson, Partch & Shah, 1997; Ritter, 1998). Researchers suggest that older firms which have been in the market for larger time are perceived to be less risky and experience less severe uncertainty and hence better expected performance (Bansal & Khanna, 2013; Durukan, 2002; Firth, 1997; Goergen et al., 2007; Mikkelson et al., 1997). IPO firms with larger asset base are shown to have higher survival rate (Jain & Kini, 1999), better long-run performance (Durukan, 2002; Goergen et al., 2007) and positive association with initial returns of IPO firms (Certo et al., 2001b; Hearn, 2011; Ritter, 1984, 1991; Mikkelson et al., 1997; Mnif, 2010).

Board size is a central issue in corporate governance. From the strategic decision-making perspective, smaller boards are associated with group cohesiveness and more effective decision-making (Goodstein, Gautam & Boeker, 1994; Mak & Roush, 2000). Carter et al. (1998), Certo et al. (2001a), Yatim (2011), Darmadi and Gunawan (2012) show that board size and underpricing are negatively related. On the other hand, positive relationship to underpricing has also been reported (e.g., Hearn, 2011; Li & Naughton, 2007; Mnif, 2010; Pfeffer, 1972). Literature regarding the beneficial impact arising from the constitution of board committees on the underpricing levels is almost non-existent. It is perceived that more board committees can provide better monitoring leading to mitigating information asymmetry (Handa, 2014). Independent directors are expected to monitor management more effectively being more objective and independent in approach (Fama & Jensen, 1983). In contrast, boards dominated by outsiders may also lead to over-monitoring and stifle strategic actions (Baysinger & Butler, 1985; Darmadi & Gunawan, 2012; Fama & Jensen, 1983; Goodstein et al., 1994). Hearn (2011), Chen and Yang (2013) and Thorsell and Isaksson (2014) are the limited authors who employed gender diversity as a variable in explaining underpricing keeping scope for further explorations. An experienced board can help substitute for information access and fend off certain problems associated with information asymmetry at the time of offer (Certo, Covin et al., 2001a; Certo, Daily et al., 2001b). If board can serve as signal to communicate to investors the performing potential of firm as argued by researchers (e.g., Certo et al., 2001b; Higgins & Gulati, 2003; Thorsell & Isaksson, 2014), the experience of the boards can strengthen this signal and hence contribute to the performance of the firms. Family ties and connections among board members which are not rare especially in Indian settings may solve manager–owner conflicts of interests, and may also give rise to minority-shareholder expropriation and/or private benefits of control (Chahine & Goergen, 2013). Multiple board appointments are expected to build the reputational capital of firm (Fama, 1980; Fama & Jensen, 1983) and enable access to valuable information and resources (Borch & Huse, 1993; Filatotchev & Bishop, 2002; Pfeffer & Salancik, 1978). This reputational advantage lends legitimacy to the corporation (Higgins & Gulati, 2003) and also can work as signal of effective monitoring (Certo et al., 2001b; D’Aveni, 1990; Shivdasani, 1993).

Other than board structure variables, ownership variables have also been included as ownership distributions are expected to affect the ability of the shareholders to control agency problems (Jensen & Meckling, 1976) and affect firm value (Berle & Means, 1932). Founding family members have more incentive to improve firm performance than non-family decision-makers (Chahine, 2004; Mcconaughy, Metthews & Fialko, 2001). In contrast, the founders as controllers may tend to favour family shareholders at the expense of the public investors (Shleifer & Vishny, 1997) giving way to the risk of non-professional managerial approach (Claessens et al., 2000). The squared term of promoter ownership is also included to check the non-linearity of relationship (as in Chahine et al., 2009). Ownership concentration expressed through block shareholders and ownership percentage of top 10 shareholders has also been studied. Concentrated ownership, where on one side, can work for aligning the interests of management and shareholders and thereby enhance firm value (Li & Simerly, 1998), can also lead to extraction of private benefits leading to additional costs (Shleifer & Vishny, 1997). Total percentage of shares held by top 10 shareholders expresses extent of dispersed or concentrated ownership levels. To understand the exact relationship, the squared term is also included for studying the existence of non-linearity of relationship.

Analysis and Interpretations

At the outset, an insight is attempted into the statistical behaviour of research variables through the summary statistics. Table 2 reports the descriptive statistics of research variables included in the regression model. Of particular interests to the study are the results for the underpricing and the board variables. Average returns (both raw and adjusted) stand at around 22 per cent confirming the existence of underpricing phenomenon among Indian IPOs. The governance variables and their statistics provide a sketch of the relationship which is further probed through regression analysis.

Table 2.

Summary Statistics of Variables Employed in Regression

Variables	Mean	Median	Maximum	Minimum	Std Dev.	N
Raw return	22.90	12.79	323.50	−94.29	55.35	404
Market-adjusted excess return	21.61	9.45	285.44	−101.78	53.57	404
Subscription ratio	19.29	6.94	175.88	0.00	26.50	403
Issue size	386.81	91.70	15475.09	2.16	1276.06	403
Log issue size	4.70	4.52	9.65	0.77	1.35	403
Issue price	175.37	114.00	1310.00	10.00	189.19	404
Inverse of issue price	0.02	0.01	0.10	0.00	0.02	404
Listing delay	23.01	20.00	404.00	12.00	28.61	395
IPO age (years)	15.20	12.29	102.47	0.31	13.14	404
Log IPO age	1.11	1.12	2.01	0.12	0.29	404
Total assets	1728.11	119.99	92522.24	1.09	7831.91	402
Log total assets	5.11	4.79	11.44	0.08	1.79	402
Board size	7.78	8.00	20.00	4.00	2.26	404
Board committees	3.56	3.00	10.00	1.00	1.23	403
Inverse of board committees	0.31	0.33	1.00	0.10	0.09	403
Independent directors	49.63	50.00	80.00	0.00	8.91	404
Women directors	0.38	0.00	3.00	0.00	0.60	404
Age of board	51.76	52.67	66.42	32.57	5.70	403
Related board members	1.90	2.00	7.00	0.00	1.54	388
Board reputation	26.26	13.00	301.00	0.00	35.34	403
Promoter ownership	83.04	89.45	100.00	5.81	18.69	403
Block shareholder ownership	2.59	2.50	6.00	0.00	1.25	404
Top 10 ownership	92.63	98.34	100.00	25.86	11.53	404
Promoter ownership square	7244.17	8001.30	10000.00	33.76	2771.50	403
Top 10 ownership square	8713.64	9670.76	10000.00	668.74	1860.28	404

Source: Prepared by authors after statistical analysis.

These regression results have been presented in Tables 3 and 4. In order to explore the contribution of corporate governance variables in explaining the initial returns, four separate regression models have been built. Model 1 includes only the control variables. Model 2 combines the control variables with the board structure components while Model 3 replaces board composition with ownership variables. These help to bring out the effects of two broad dimensions of governance and thus compare their explanatory power. Model 4, the final model, integrates all the control and governance variables together with the quadratic forms for their plausible non-linear relationship with dependent variable.

Table 3.

Relationship between Corporate Governance Measures and Initial Unadjusted Returns

Independent Variables	Model 1	Model 2	Model 3	Model 4
Constant	31.704 (2.044)**	−20.883 (−0.778)	75.091 (1.283)#	7.214 0.106
Subscription ratio	1.167 (11.568)***	1.106 (11.269)***	1.196 (11.224)***	1.142 (11.064)***
Log (issue size)	−7.059 (−2.190)**	−7.314 (−2.303)**	−7.968 (−2.360)***	−8.566 (−2.547)***
1/Issue price	509.105 (2.383)***	427.342 (2.056)**	530.750 (2.470)***	450.280 (2.200)**
Listing delay	−0.0163 (−0.072)	−0.038 (−0.174)	−0.018 (−0.080)	−0.038 (−0.179)
Log (IPO age)	4.744 (0.5580)	10.609 (1.436)#	6.201 (0.720)	11.534 (1.407)#
Log (total assets)	−2.104 (−1.028)	−2.489 (−1.241)	−1.635 (−0.799)	−2.162 (−1.079)
Board size		2.217(2.147)**		2.775(2.768)***
Board committees		78.705(3.147)***		77.125(3.117)***
Independent directors		0.2428(1.1057)		0.315(1.407)#
Women directors		−2.217(−0.4575)		−3.600(−0.696)
Average age of board		0.0452(0.1009)		0.183(0.4022)
Related board members		−1.924(1.388)		−2.271(−1.499)
Other directorships		0.0523(1.046)		0.055(1.076)
Promoter ownership			2.131(2.805)***	2.364(2.904)***
Block shareholders			−1.391(−0.663)	−0.168(−0.079)
Top 10 ownership			−3.310(−2.561)***	−3.661(−2.659)***
Promoter ownership squared			−0.014(−2.663)***	−0.016(−2.742)***
Top 10 ownership squared			0.022(2.687)***	0.025(2.865)***
R ²	0.3337	0.3511	0.3442	0.3743
Adjusted R²	0.3234	0.3278	0.3318	0.3427
Number of observations	395	377	394	376
F-statistic	32.392***	15.107***	18.744***	11.864***

Source: Prepared by authors after statistical analysis.

Notes: *, ** and *** indicate statistical significance at the level of 10%, 5% and 1%, respectively. T-statistics are provided in the parentheses. # loosely significant at 20% level of statistical significance.

Table 4.

Relationship between Corporate Governance Measures and Initial Market-adjusted Excess Returns

Independent Variables	Model 1	Model 2	Model 3	Model 4
Constant	30.426(2.010)**	−18.765(0.707)	75.625(1.320)	10.4750.159
Subscription ratio	1.135(11.739)***	1.082(11.343)***	1.161(11.444)***	1.114(11.191)***
Log (issue size)	−5.991(−1.910)**	−5.834(−1.925)**	−6.777(−2.066)**	−6.930(−2.173)**
1/Issue price	495.783(2.376)***	435.751(2.176)**	517.046(2.455)***	458.827(2.323)**
Listing delay	−0.075(−0.368)	−0.094(−0.478)	−0.076(0.380)	−0.094(−0.491)
Log (IPO age)	4.502(0.538)	10.492(1.461)#	5.911(0.695)	11.456(1.569)
Log (total assets)	−2.563(−1.277)	−2.994(−1.542)#	−2.147(−1.070)	−2.716(−1.403)
Board size		1.692(1.682)**		2.211(2.264)**
Board committees		70.193(2.768)***		68.586(2.759)***
Independent directors		0.239(1.092)		0.308(1.378)
Women directors		−2.032(−0.432)		−3.264(−0.652)
Average age		0.053(0.123)		0.183(0.412)
Related board members		−1.629(−1.200)		−1.942(−1.311)
Other directorships		0.048(0.969)		0.051(0.995)
Promoter ownership			1.892(2.540)***	2.106(2.646)***
Block shareholder ownership			−1.044(−0.518)	0.141(0.070)
Top 10 ownership			−3.144(−2.489)***	−3.429(−2.543)***
Promoter ownership squared			−0.013(−2.424)***	−0.014(−2.508)***
Top 10 ownership squared			−0.021(2.613)***	0.023(2.740)***
R ²	0.3357	0.3506	0.3506	0.3713
Adjusted R²	0.3254	0.3273	0.3318	0.3395
Number of observations	395	377	394	376
F-statistic	32.595***	15.034	18.695***	11.680***

Source: Prepared by authors after statistical analysis.

The control variables overall explain 32 per cent of the total variations in dependent variable with subscription ratio, issue size and issue price being significant in all four models. The subscription ratio is positive and significant (as in Chahine & Tohme, 2009; Chen & Yang, 2013) indicating that higher subscription ratio reflects demand for the issue which is perceived as a signal of good quality and thus better performance and higher returns. Issue size reflects a negative and statistically significant relationship to underpricing lending support to observations made by Hearn (2012) in sub-Saharan Africa and Li (2005) in Chinese IPO market. The findings confirm that firms with larger offerings contribute to diluting the uncertainties of investing community. Issue price shares a positive significant relationship with underpricing contradicting the findings of Li (2005) and Bédard, Coulombe and Courteau (2008) suggesting that the price at which a firm offers shares is perceived as inherent ability of the firm to command premium for its issue. The variable listing delay gives no significant results like in case of Chinese IPO market (Ching-Yi Lin, 2005; Li, 2005). The negative sign of listing delay coefficients lead to conclusion that longer gap in listing results in lower underpricing possibly because the gap helps investors to gather information and take informed decisions.

The coefficients for IPO age are positive in line with Mitchell et al. (2008) in Singapore, Mnif (2010) in France, Yatim (2011) in Malaysia and Hearn (2012) in Sub Saharan Africa suggesting that firms with longer standing in markets tend to dispel the apprehensions of investors but this lacks statistical significance. Results for total assets show negative association but lacks significance which is supported by previous findings (Bédard et al., 2008; Chen & Yang, 2013; Ching-Yi Lin, 2005; Hearn, 2011). On the same lines, these variables are regressed with MAERs and the results obtained have been presented in Table 4. Moving on to governance variables, Model 2 includes board composition attributes along with the control variables while Model 3 replaces the board components with ownership measures. Results are found to be robust across all models as suggested by the statistically significant F-values.

Board size is found to be an important consideration for investors in India. From the market’s point of view, investors may perceive a large board as a signal of high degree of monitoring and effective decision-making. This relationship finds its support from Li and Naughton (2007), Mnif (2010) and Hearn (2011) though lies in contradiction to Carter et al. (1998), Certo et al. (2001b), Darmadi and Gunawan (2012). The findings for board committees as a component of governance mechanism and its relationship to initial underpricing are consistent with results of Hearn (2011, 2012) which relate to African markets. From signalling perspective, the number of board committees does work as a signal for new issue firms, in the light that larger number of committees reflect the voluntary initiatives by firms for better working of the concern (Handa, 2014). On the other hand, this relationship can also be indicative of the shortcomings as Hearn (2011) conjectured in context of West African region that establishment of committees may be superfluous and lacking in genuine independence which may stand true for the Indian markets as well.

Board independence does not seem to be adopted as an indicator of issue quality by the investors in Indian IPO market (insignificance of coefficient) which may be because board independence remains a contentious issue. Denis and McConnell (2003) and Dahya and McConnell (2005) had proven that higher proportion of outside directors does not assure better performance and Li and Naughton (2007) and Yatim (2011) also found the positive but insignificant impact of board independence on IPO underpricing. The coefficient for percentage of women directors is negative implying that higher percentage of women as directors tends to decrease levels of underpricing and vice versa, but lack of statistical significance of the coefficient leaves the issue unsettled. Positive direction of relationship of age of board members points out that younger boards result in lower underpricing levels indicating that mature boards are taken as indicators of good quality of board and firm’s potential to perform. The coefficient for related members is negative though only loosely significant signifying that larger number of relatives on boards tends to reduce quantum of underpricing providing support for ‘alignment of interests’ hypothesis in contrast to entrenchment tendencies. The lack of statistical validity of these results, however, does not enable reaching a concrete conclusion. Board reputation is found to be positively related to underpricing consistent to the results of Yatim (2011) which provides support to the argument of Filatotchev and Bishop (2002) that outside board memberships create a negative impact on the investors’ assessment of firm quality although insignificance of these coefficients fail to lend complete support to the argument. These findings, however, stand in contrast to conclusions drawn by Thorsell and Issakson (2014) for Swedish IPOs.

Model 2 including board structure variables is a statistically significant model and explains almost 33 per cent of the quantum of underpricing. The variables of board size and board committees support the behaviour of this pricing anomaly with the help of signalling theory and related agency and information asymmetry hypotheses. The contribution of board variables to the model when compared on the basis of increase in value of adjusted R² is very negligible (0.44 per cent) indicating that board composition does not matter much to Indian investors.

The results with MAER as the dependent variable also highlight a similar trend and significance of variables. Model 1 which incorporates the control variables is robust with three of the variables having significant coefficients. Model 2 highlights the low contribution of board variables. Model 3 introduces the ownership variables. Ownership by promoters is included as a measure of family ownership which is likely to impact performance of IPOs under the influence of family interest protection (Shleifer & Vishny, 1997) and alignment of interests (Fama & Jensen, 1983) hypotheses. With the clues of operationalization of both these hypotheses and in accordance with Chahine (2004), efforts to check non-linearity of promoter ownership have been made through introduction of the square term. The significance of coefficients of promoter ownership and its squared term confirm the existence of non-linear relationship highlighting the signalling potential of this ownership variable. The curvilinear relationship explains that increasing ownership levels do address the concerns of information asymmetry but as levels of family ownership increase, the worries of sacrificing general interests for self-interests start dominating. The ownership by the top 10 shareholders is a significant variable in the model which shows the similar trend as promoter ownership indicating the operationalization of entrenchment hypothesis and alignment hypothesis with changing levels of ownership. The present study finds support in the works of Howton et al. (2001), Fan, Wong and Zhang (2007) and Hearn (2012) who proved the existence of negative relationship of measures of ownership concentration with underpricing. The negative relationship between underpricing and levels of block shareholders provides some indication of their role in corporate governance and its enforcement within firms in countries with weaker levels of investor protection. Total shareholding of the top 10 shareholders of the IPO firm shares a large, negative and statistically significant level and remains strongly significant for the square term as well confirming the existence of non-linear relationship. The exploration of this measure holds higher eminence for Indian markets where family-controlled firms and concentrated ownership patterns are pervasive.

A comprehensive model, Model 4, is built to reflect the aggregate effects of corporate governance which is a robust model. The model (for both RR and MAER) is better in its explanatory power when compared to previous literature (Certo et al., 2001b; Chahine et al., 2009; Darmadi & Gunawan, 2012; Filatotchev & Bishop, 2002; Hearn, 2011; Mnif, 2010; Wu & Hsu, 2012; Yatim, 2011). The overall conclusion, however, which is in consonance with past findings is that the explanatory power of governance mechanisms with regard to initial pricing performance is low, the reasons for which need to be further explored for concrete inferences.

Conclusion

In this study, explanations to the underpricing phenomenon are sought through corporate governance mechanisms which the firm puts in place at the time of going public. Board size comes out as a significant variable and a signal to investors of the firm quality. The results also indicate a tendency of larger boards to result in higher underpricing which stems from coordination problems resulting in increased costs. Board committee is the only other board variable which presents explanations to high initial returns. Positive relationship of board committees to underpricing raises doubts as to lacking genuine independence especially in Indian contours which are fighting accusations of weak governance. Results confirm to a non-linear relationship shared by promoter ownership and ownership by top 10 owners with respect to initial pricing performance. The signalling potential of these ownership variables is confirmed highlighting that ownership and control of new issue firms is an important consideration for the investors when taking the investment decision. Another fact which surfaces from these results is that higher ownership in the hands of promoters does dispel uncertainty and problems of information asymmetry but at higher levels tendencies of entrenchment of interests become evident. Findings confirm to tendencies of concentrated ownerships in Indian markets but at higher levels of concentration underpricing tends to increase. These confirm that both alignment of interest and entrenchment hypothesis work in conjunction at different levels of ownership.

On the whole, corporate governance measures have a miniscule contribution (only 2%) in explaining initial returns. There is confirmation of the fact that these do qualify as signals which are frantically resorted to at the time of IPO by the issuers but need is to integrate these into decision criteria by emphasizing on governance in both letter and spirit. Explanatory power of these governance measures can definitely be enhanced when governance parameters evolve as distinguishing criteria among firms and investors realize their worth and potential in enhancing performance. Better governed IPOs should ideally perform better and this realization on the part of Indian investors can add to the eminence of governance mechanisms as effective signals and become a basis for better performance.

Footnotes

Acknowledgements

We are grateful to the anonymous referees of the journal for their extremely useful suggestions to improve the quality of the article. The authors also express their gratitude to the entire editorial team for all help in bringing the submission to the present form. Usual disclaimers apply.

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