Underpriced IPOs, overboard gains

Underpricing is difference between offer price of IPO, prices on day of listing when price discovery happens in market place

The underpricing of Initial Public Offers (IPOs) has helped enrich investors by Rs 22,314 crore over roughly a decade.

Underpricing has been defined as the difference between the offer price of the IPO and on the day of listing, when price discovery happens in the market. Business Standard examined data stretching back across 454 issues, from January 2004 to the present day. Companies raised Rs 1.78 lakh crore during the period.

Each issue raised an average of Rs 394.04 crore. The average gain works out to Rs 49.15 crore. Thus, the average discount on such IPOs translates to 12.47 per cent.

Pavan Kumar Vijay, managing director at financial consultancy Corporate Professionals, suggested underpricing helps market development. “There is a need for an incentive in the Indian IPO market, considering the low degree of equity penetration. A price differential would help to build the capital market. One needs a system  somewhere between the CCI (the erstwhile Controller of Capital Issues) and absolute free-pricing,” he said. The CCI used to decide on IPO pricing. It ceased to exist in the 1990s.  

Kirti Shah, partner, M&A tax and regulatory services, DH Consultants, suggested a longer-term view might alter the picture. “The first day does not give the right picture, as there is a belief that pricing and demand might be artificially maintained,” he said.

The companies gave an average return of 5.45 per cent a year after listing. As many as 279 or a little more than three out of five of these IPOs gave average negative returns of 45.01 per cent in that one year.  A total of 173 companies gave an average positive return of 86.85 per cent in the period. One company was yet to complete a year and another was at the same level as the listing price.  

A study at an American university pegged the figure for money left on the table by US IPOs between 1980 and 2012 at $135 billion. The report, authored by Jay R Ritter, Cordell Professor of Finance at the University of Florida, examined 7,706 IPOs. In America, the amount of underpricing invited scrutiny since investment bankers have the discretion to allot shares to whichever entities they want.

“Investment banks managing an IPO can provide IPO shares to their favoured clients in exchange for future business,” noted a paper titled ‘Anchor investors in IPOs’, authored by Amit Bubna, assistant professor of finance at the Indian School of Business and Nagpurnanand Prabhala, associate professor of finance of the Robert H Smith School of Business at the University of Maryland.

In India, there is no such discretion in the allotment process. Those to institutional investors was done on a discretionary basis before 2005. This was changed in September 2005 and all allottees are now given shares on a proportionate basis.