Impact of Corporate Governance on IPO Underpricing - An Evidence from Indian Stock Market

 

Patel A.¹, B. Suresha²

¹Student, Master of Business Administration Finance Management,

²Associate Professor, Department of Management Studies, CHRIST (Deemed to be University),

 

ABSTRACT:

Corporate Governance influence the companies to manage their organization in such a way to achieve the long term strategic goals to satisfy the shareholders, creditors, employees, customers, suppliers, and complying with the legal and monitoring requirements, apart from meeting environmental and local community needs. Corporate Governance is administered to provide the maximum benefits to the stakeholders. The evaluation on the basis of its listing and its returns, describes the customary valuation of such IPO. There is always an impact of the management on the pricing of IPOs, the status of directors also affects its pricing structure. It also depends upon the policies, norms and legislative structure of the management. This is a pragmatic study that examines the pricing of IPOs and the initial performance of such IPOs in Indian capital market. It also describes the impact of corporate governance on pricing of Initial Public Offers, and also outlines the relationship between corporate governance and underpricing of IPOs. It also attempts to provide new evidence on the first-day IPO market performance using a set of 94 IPOs newly listed between 1 April 2014 to 31 March 2018 on Indian stock exchanges.

 

 

 

INTRODUCTION:

Underpricing is described as the balanced distinction between the price at which the shares consequently trade in the secondary market and offering price. Underwriters consider several factors into attention while pricing an IPO; try to reach an offering price that is low enough to motivate interest in the stock, but high enough to spread an acceptable amount of capital for the company. The process of structuring an ideal price typically includes the underwriters arranging share buying commitments from institutional investors.

 

The literature focused on the initial public offerings (IPOs) underpricing establishes that in a standard IPO the stock price rises above the initial offer price after one trading day. Hence investors who purchase ‘‘underpriced’’ shares directly from issuing firms earn major short-term returns.

 

The major focus of this study is whether corporate governance has any effect on underpricing of shares in the primary market in India.

 

LITERATURE REVIEW:

Jenson (1986) portrayed that at the organization level, great corporate governance guarantees the ideal utilization of the company's capital. It likewise referenced that the top management with free money streams put resources into over-expansion, which frequently brought about organizational inadequacies. This issue is bound to happen when the means of corporate governance are weak. 


According to Byrd and Hickman (1992), the unusual bidder returns on the date of takeover offer declarations are essentially higher when independent directors make choices other than related directors. It is believed that if a market is controlled by independent directors, the controlled boards will have the interests of the shareholders at heart. 


 

According to Yeh and Shu (2004), the reliability of corporate governance structure of the IPO firm dictates the negotiation of the offering price entirely. The researchers conducted an empirical research on 218 Taiwanese IPO firms in a span of ten years and found consistency among the positive entrenchment effect and negative entrenchment effect.

 

According to Cremens and Nair (2005), internal and external mechanisms play a huge role on corporate governance. The external structure alone cannot define corporate governance; there are other internal factors, policies, and structures which contribute to the overall rating of a firm’s corporate governance.

 

According to Ljungqvist (2005), the underpricing of IPOs is significantly dependent on the institutional structure across different nations. There was noticeable difference in underpricing whereby in developed nations underpricing is less whereas in developing nations is high. 


 

OBJECTIVES:

1.     To understand the meaning of IPO underpricing.


2.     To find out whether Corporate Governance has an impact on IPO underpricing in India. 


 

METHODOLOGY:

To show the relationship we have selected 94companies which had their IPO. The data was collected on the basis of the following criteria.

·       The data has been taken for 4 years, viz from 2014 – 2018.

·       The stock listing must have the status of an IPO which means that the firm should have already been listed on any of the stock exchange of India for example National Stock Exchange, Bombay Stock Exchange.

·       The initial public offering is of common stock.

 

Now to establish a relationship between Underpricing and Corporate Governance we have collected the data regarding the issue price and first day closing price of the companies selected and found the listing gains at the end of first day by following formula,

 

 

 

After that we will rate the selected companies for corporate governance on the basis of various parameters and then establish a relationship between underpricing and corporate governance.

So our study can be divided in the following 2 parts:

(A) Underpricing:

Table 1: Table showing the selected companies and their issue price, opening price, closing price and percentage return.

S. No.	Date	IPO Name	Issue Size (in crores)	Issue Price	Listing Open	Listing Close	Listing Gains (%)
1	28/03/18	Hindustan Aeron	4229	1215	1159	1128.35	-7.13
2	27/03/18	Bandhan Bank	4473	375	485	477.2	27.25
3	23/03/18	Bharat Dynamics	960.94	428	360	390.7	-8.71
4	09/03/18	HG Infra Engg	457.7	270	270	270.05	0.02
5	26/02/18	Aster DM Health	980.14	190	182	179.85	-5.34
6	08/02/18	Galaxy Surfacta	937.09	1480	1525	1698.1	14.74
7	30/01/18	Amber Enterprise	600	859	1175	1237.25	44.03
8	29/01/18	Newgen Software	424.62	245	256	253	3.27
9	22/01/18	Apollo Micro Sy	156	275	478	454.1	65.13
10	29/12/17	Astron Paper and	70	50	120.75	119.7	139.4
11	18/12/17	Future Supply	649.69	664	674	685.8	3.28
12	15/12/17	Shalby	504.8	248	237	239.25	-3.53
13	17/11/17	HDFC Life	8695.01	290	313	344.25	18.71
14	14/11/17	Khadim India	493.06	750	727	688.5	-8.2
15	10/11/17	Mahindra Logist	829.36	429	425	429.15	0.03
16	06/11/17	Reliance Nippon	1542	252	289	284	12.7
17	25/10/17	General Insurance	11372	912	870.4	435.2	-52.28
18	23/10/17	IEX	1000.7	1650	1500	162.65	-90.14
19	16/10/17	Godrej Agrovet	1157.31	460	615	595.55	29.47
20	05/10/17	Prataap Snacks	481.94	938	1250	1178.3	25.62
21	03/10/17	SBI Life Insurance	8400	700	735	708	1.14
22	27/09/17	ICICI Lombard	5700.94	661	651	681.55	3.11
23	25/09/17	Capacite Infra	400	250	360	342.4	36.96
24	21/09/17	Matrimony.com	501.07	985	985	901.2	-8.51
25	18/09/17	Dixon Technology	599.28	1766	2725	2892.8	63.81
26	18/09/17	Bharat Road Net	600.65	205	205	208.15	1.54
27	04/09/17	Apex Frozen	152.25	175	202	209.85	19.91
28	11/08/17	Cochin Shipyard	1454	432	461	522	20.83
29	10/08/17	SIS	362.25	815	875	756.7	-7.15
30	25/07/17	Salasar Techno	35.87	108	259.45	272.1	151.94
31	10/07/17	AU Small Finance	1912.51	358	544	541.2	51.17
32	04/07/17	GTPL Hathway	484.8	170	170	171.65	0.97
33	30/06/17	CDSL	523.99	149	250	261.6	75.57
34	29/06/17	Eris Life	1741.1	603	612	601.05	-0.32
35	27/06/17	Tejas Networks	326.69	257	257.7	263.3	2.45
36	06/06/17	IndiGridInvIT	2250	100	99.7	98.45	-1.55
37	29/05/17	PSP Projects	211.68	210	195	208.95	-0.5
38	19/05/17	HUDCO	1224	58	76.5	72.5	25
39	09/05/17	S Chand and Co	325	670	675.85	675.85	0.87
40	05/04/17	ShankaraBuildi	232.96	460	545	632.8	37.57
41	31/03/17	CL Educate	238.95	500	398	417.9	-16.42
42	21/03/17	Avenue Supermar	1870	299	604	640.75	114.3
43	17/03/17	Music Broadcast	488.53	333	413	373.15	12.06
44	03/02/17	BSE Limited	1243	806	1085	1069.2	32.66
45	19/12/16	Laurus Labs	560.7	428	489.9	480.5	12.27
46	09/12/16	Sheela Foam	178.5	730	860	1032	41.37
47	08/11/16	Varun Beverages	1114	445	430	461.9	3.8
48	07/11/16	PNB Housing Fin	3000	775	860	890.6	14.92
49	19/10/16	Endurance Techn	1161	472	572	647.7	37.22
50	04/10/16	HPL Electric and	361	202	190	189.05	-6.41
51	29/09/16	ICICI Prudentia	6057	334	329	297.65	-10.88
52	27/09/16	GNA Axles	130.41	207	252	233.45	12.78
53	23/09/16	L&T Technology	900	860	900	865.1	0.59
54	31/08/16	RBL Bank	1100	225	274.4	299.3	33.02
55	12/08/16	S P Apparels	215	268	275	295	10.07
56	11/08/16	DilipBuildcon	430	219	240	251.95	15.05
57	01/08/16	Advanced Enzyme	60	896	1210	235.66	-73.7
58	21/07/16	L&T Infotech	1242	710	667	697.65	-1.74
59	12/07/16	Quess Corp	400	317	500	503	58.68
60	01/07/16	Mahanagar Gas	1039.64	421	540	519.9	23.49
61	19/05/16	Parag Milk Food	764.3	215	230	247.8	15.26
62	10/05/16	UjjivanFinanci	358.16	210	231.9	231.6	10.29
63	09/05/16	ThyrocareTechn	479.21	446	662	618.1	38.59
64	21/04/16	Equitas Holding	2159	110	145.1	135.25	22.95
65	01/04/16	Bharat Wire Rop	70	45	47.25	45.4	0.89
66	18/02/16	Quick Heal Tech	450	321	305	254.45	-20.73
68	08/02/16	Precision Camsh	410	186	165	177.25	-4.7
69	06/01/16	Narayana Hruda	613	250	291	336.7	34.68
70	23/12/15	Dr. Lal PathLab	638	550	717	824.15	49.85
71	23/12/15	Alkem Lab	1349.6	1050	1380	1381.45	31.57
72	16/11/15	S H Kelkar	200	180	216	207.3	15.17
73	10/11/15	InterglobeAvi	3000	765	868	878.45	14.83
74	02/11/15	offee Day	1150	328	313	270.15	-17.64
75	21/09/15	Prabhat Dairy	300	115	113	116.35	1.17
76	16/09/15	Sadbhav Infra	425	103	111	106.15	3.06
77	10/09/15	Shree Pushkar	70	65	60.05	63	-3.08
78	10/09/15	PennarEng	156.19	178	177.95	157.5	-11.52
79	09/09/15	Navkar Corp	600	155	152	166.4	7.35
80	26/08/15	Power Mech	273.22	640	600	585.75	-8.48
81	11/08/15	Syngene Intl	550	250	295	310.4	24.16
82	09/07/15	ManpasandBever	400	320	291	163.43	-48.93
83	26/05/15	PNC Infratech	488	378	381	72.04	-80.94
84	14/05/15	UFO Moviez	600	625	600	598.8	-4.19
85	06/05/15	MEP Infra	324	63	63	60.95	-3.25
87	09/04/15	Inox Wind	700	325	400	438	34.77
88	06/04/15	Adlabs Ent	467	180	167.95	191.25	6.25
89	19/03/15	OrtelComm	240	181	181	171.95	-5
90	19/12/14	Monte Carlo	342.28	645	585	566.4	-12.19
91	01/10/14	Shemaroo Ent	120	170	180	171	0.59
92	23/09/14	Sharda Crop	352	156	254.1	231.45	48.37
93	12/09/14	Snowman Logist	197.4	47	75	78.75	67.55
94	09/05/14	Wonderla	181.25	125	164.75	157.6	26.08

Source:moneycontrol.com

Table 2: Table showing Under and over price companies from Table-1

Total Companies	94
Underpricing in Companies	29
Overpricing in Companies	65

Source: Author’s calculation

 

As can be seen from the above table, 31% companies were underpriced and 69% companies overpriced at the time of IPO.

 

 

(B) Corporate Governance Score:

For the objective of establishing the relationship between underpricing of IPOs and corporate governance, quantification of corporate governance of the related companies is necessary. Different components have been taken in this study to make the qualitative facts measurable in terms of a common score, by taking significant factors of corporate governance. These components of corporate governance are basically the specifications mentioned by the Ministry of Corporate Affairs and SEBI.

Table 3: Corporate Governance Score

S. no.	COMPONENTS	SCORING	DESCRIPTION
1	Size of Board of Directors	(9-12)      (5-8) (3-4)    3      2           1	The optimum size of the Board of Directors leads to effectiveness in the decision.
2	Percentage of Independent Directors in Composition of Directors	%(50-59/60-69/70-79/80-89/90-99/100) (2/4/6/8/10/12)	According to guidelines, 50% of BOD should be Independent Directors.
3	Chairman of Remuneration Committee	Independent/ Regular (2/0)	Chairman of the committee having the status of independent directors weighs more points for corporate governance standards.
4	Chairman of the Audit Committee	Independent/ Regular (1/0)	Chairman of the committee having the status of independent directors weighs more points for corporate governance standards.
5	Risk Management Policy	Yes/ No (1/0)	Risk Identification, minimization, optimization is the part of risk management policy.
6	Chairman of Investor’s Grievances Committee	Independent/Regular (1/0)	Chairman of the committee having the status of independent director weighs more points for corporate governance standards.

Source: Corporate Governance and IPO Underpricing, by LalitBhalla, Akshay Bhatia, Vijay Kaushal

 

Table 4: Table showing on the basis of the above parameters we have found the corporate governance score of all the companies which are underpriced i.e. 29 companies out of 94 companies.

S.No.	Date	IPO Name	Size of BOD	% of Independent Directors	Chairman of Remuneration Comm.	Chairman of Audit Comm.	Risk Management Policy	Total Score
1	28/03/18	Hindustan Aeron	3	4	2	1	1	11
2	23/03/18	Bharat Dynamics	3	2	2	1	1	9
3	26/02/18	Aster DM Health	3	0	0	0	1	4
4	15/12/17	Shalby	3	2	2	1	1	9
5	14/11/17	Khadim India	3	2	2	1	1	9
6	25/10/17	General Insuran	3	0	0	0	0	3
7	23/10/17	IEX	3	2	2	1	0	8
8	21/09/17	Matrimony.com	2	2	2	1	1	8
9	10/08/17	SIS			2	1	0	3
10	29/06/17	Eris Life	2	2	2	1	1	8
11	06/06/17	IndiGridInvIT			2	1	1	4
12	29/05/17	PSP Projects	2	2	2	1	1	8
13	31/03/17	CL Educate	3	4	2	1	1	11
14	04/10/16	HPL Electric and	3	2	2	1	1	9
15	29/09/16	ICICI Prudentia	3	2	2	1	1	9
16	01/08/16	Advanced Enzyme	2	2	2	1	1	8
17	21/07/16	L&T Infotech	3	2	2	1	1	9
18	18/02/16	Quick Heal Tech	3	2	2	1	0	8
19	08/02/16	Precision Camsh	2	2	2	1	0	7
20	02/11/15	Coffee Day	2	2	2	1	1	8
21	10/09/15	Shree Pushkar	2	4	2	1	0	9
22	10/09/15	PennarEng	3	2	2	1	0	8
23	26/08/15	Power Mech	3	2	2	1	1	9
24	09/07/15	ManpasandBever	3	2	2	1	0	8
25	26/05/15	PNC Infratech	1	2	2	1	0	6
26	14/05/15	UFO Moviez	2	2	2	1	0	7
27	06/05/15	MEP Infra	3	2	2	1	0	8
28	19/03/15	OrtelComm	3	4	2	1	1	11
29	19/12/14	Monte Carlo	3	2	2	1	0	8

Source: Author’s calculation

 

 

As can be seen from table 4, the 29 companies selected have more or less the same corporate governance score. But on analysis of Table 1 the listing returns of all these companies vary over a very wide range. So we can say that Corporate Governance does not have a major impact on IPO pricing in India.

 

Findings:

·       As can be seen from the above tables that in the Indian IPO market, the concept of underpricing exists. Even in the unfavourable economic conditions the Indian market reacted negatively to a certain extent but showed positive quick growth in the form of underpricing of IPOs in the recovery period of the economy.

·       The study also signifies the non-dependency of Underpricing of IPOs in Indian Capital Market on the Corporate Governance mechanism of the companies. This also indicates that even in many of the developed countries the corporate governance reforms and practices have a positive impact on underpricing of IPO but in India, it still requires a long way to find such relationship.

·       There might be other factors on which the underpricing of IPO depends and the investors consider those factors for selecting a stock to subscribe like the age of the company, reputation of the company, size of the issue and mainly the sentiments of the market.

·       It is found that board independence is positively related to the level of underpricing. Further, this study provides evidence that the level of underpricing is negatively associated with both board size and institutional ownership, indicating that these two governance mechanisms play important roles in mitigating information asymmetry between the issuer and potential investors. Ownership concentration is insignificant in explaining the first‐day returns. When the type of corporate control is taken into account, it is revealed that government‐controlled companies tend to experience higher underpricing.

 

REFERENCES:

1.      BhallaLalit, Bhatia Akshay, Kaushal Vijay.(2012, July). Corporate Governance and Ipo Underpricing. Journal of Commerce and Accounting Research.

2.      Boulton Thomas J, Smart Scott B, Zutter Chad J (2010). IPO Underpricing and International Corporate Governance. Journal of International Business Studies.

3.      Byrd,J.andHickman,K.(1992).DoOutsideDirectorsmonitor managers? Evidence from Tender Offer Bids Journal of Financial Economics, 32(2), pp. 195 -221.

4.      Cremers,K.J.andNair,V.B.(2005).GovernanceMechanismsandEquityPrices.JournalofFinance,60(6),pp.2859- 2894.

5.      Jenson, M. C. (1986). Agency Cost of Free Cash Flow, Corporate Finance and Takeovers. American Economic Review, 76(2), pp. 323 - 330.

6.      Ljungqvist, A. (2005). IPO Underpricing. Handbook of Corporate Finance: Empirical Corporate Finance. B. EspenEckbo, (ed.). Elsevier (1, Chapter 7, pp. 375-418).

7.      Yeh, Y. H. and Shu, P. G. (2004). Corporate Governance and Valuation of IPOs. EFMA 2004 Basel Meetings Paper. Retreived from http://dx.doi.org/10.2139/ssrn.496502.

 

 

 

 

 

Received on 28.02.2019            Modified on 18.03.2019

Accepted on 09.04.2019           ©A&V Publications All right reserved