CHAPTER 1 INTRODUCTION
2.4. Evidence of IPO Underpricing and Underpricing Determinants
corporate governance and its influence on underpricing and firm performance. The qualitative phase of Kwan’s study involves interviews of IPO issuers, underwriters, and investors.
Meanwhile, the quantitative phase is an examination of underpricing and long term performance’s relationship with corporate governance attributes, lock-up period, and venture capitalist (VC) involvement for the IPOs. The findings revealed that the corporate governance index (CGI) is positively associated with IPO underpricing. Also, a higher level of underpricing is evident in firms found on the Main Board of SGX. When it comes to long-run performance, these offerings tend to perform better than those from IPOs listed in the Stock Exchange of Singapore Dealing and Automated Quotation System (SESDAQ). Furthermore, the study found family directorship and the level of underpricing to have a significant relationship. Additionally, the VC involvement was included in the study because earlier research on the ownership structure and IPO performance found that the involvement of VC can remedy problems on asymmetric information between the investors, issuers, and underwriters. The findings in this study, however, found that there was no supporting evidence that VC-backed IPOs incur lower levels of underpricing, and instead found that VC-backed IPOs have a higher level of initial returns compared to those that are not VC-backed, but the difference is not significant.
Researchers Khin et al. (2017) analyzed the magnitude of underpricing in Bursa Malaysia. They examined the possible influence of the IPO offering size, market volatility, reciprocal IPO subscription price, and the underwriter reputation to the level of IPO underpricing. They did this by investigating 313 IPO listed on the Main Board of Bursa Malaysia from 1998 to 2008. With this, they found that the initial underpricing is at 13.4% whereas the adjusted return considering the market return is at 9.4%. The level of underpricing is consistently evident days after the IPO wherein it is at 19% on the twentieth day.
Yar and Javid (2014) studied liquidity benefits from the underpricing of IPOs in Pakistan listed at the Karachi Stock Exchange (KSE). This study clarifies the underpricing anomaly of IPOs through the relationship of ownership structure, underpricing, and after-market liquidity. It is stated that issuers underprice IPO shares to attain two benefits, namely after-market liquidity and dispersed ownership structure. To attain a dispersed ownership structure, issuance of underpriced IPO shares leads to a broader shareholder base, which results in oversubscription of shares, and this allows companies to be more in favor of small shareholders, thus broadening the shareholder base. Through the broadening of the shareholder base, the secondary market becomes more liquid, according to Demsetz (1968) which states that an increase in the number of shareholders results in an increase in market liquidity. Yar and Javid (2014) used 59 IPO samples which are issued from 2000 to 2012 and followed three steps after gathering the sample data: First, the researchers checked the level of underpricing; Second, they examined how underpricing affects other factors such as share allocation and secondary market liquidity;
and lastly, they looked into the effects of underpricing on market liquidity. The descriptive statistics showed that IPOs listed at KSE are underpriced for up to 51%. Meanwhile, the logit model shows that companies with higher price volatility are more likely to underprice their IPO shares, and companies with no or less abnormal initial returns are less likely to underprice their IPO shares.
Singgih et al. (2018) analyzed the drivers of underpricing in the Indonesian Stock Exchange from 2007 to 2016. The study used a sample of 173 IPOs and did a regression analysis to derive its conclusions. The researchers ensured that their sample would have necessary financial statement data and that their company prospectus is accessible. To calculate the initial returns of the IPO stock, the researchers used the market-adjusted return (MAR). As a result, the researchers concluded that underpricing exists in the Indonesian Stock
Exchange. In addition, firm size, along with the market to book ratio, has a significant and negative influence on the measures of initial return which is associated with underpricing.
Additionally, researchers Zhou and Lao (2012) examined factors that have an impact on IPO underpricing using 65 companies and compared this between the small and medium enterprises (SMEs) board and ChiNext. One of their findings suggests that between the firm age and IPO underpricing, there is a negative correlation in ChiNext but a positive correlation in the SMEs board. Thus, the older the firm is, the lower the underpricing rate is for those in ChiNext, the NASDAQ-style subsidiary of the Shenzhen Stock Exchange.
In the US, researchers Ibbotson et al. (1994) examined 2439 IPOs listed from 1975 to 1984 with the objective of determining the market problems that occur during the book building of IPOs. Upon assessing potential patterns in initial returns of the stock, they concluded that between the offering price and underpricing, there is a negative relationship as IPOs that are priced lower than USD3.00 is 42.8% underpriced whereas those that are priced higher than USD3.00 is only 8.6% underpriced.
Sochi and Islam (2018) observed the determinants of IPO underpricing in the Dhaka Stock Exchange (DSE) from June 2011 to June 2016. Using an ordinary least square (OLS) regression model, the researchers found out that offer size has a significant level of underpricing. Meanwhile, there seems to be no influence on the level of underpricing based on offer time and firm size seem. The researchers attributed their findings to underpricing theories such as information asymmetry and agency cost theory. Meanwhile, Heerden and Alagidede (2012) examined whether short-run underpricing exists in the Johannesburg Stock Exchange (JSE). Using the data gathered from 138 South African IPOs from 2006 to 2010, the researchers concluded that short-run underpricing is present especially in the financial sector shortly before the financial crisis in 2007. Size-wise, the findings illustrate that underpricing is
larger on smaller offerings as compared to larger offerings. Lastly, in terms of volume, larger share issues, companies with more than 200,000,000 shares, are more underpriced.
Similarly, Mahatidana and Yunita (2017) analyzed the determinants of the level of underpricing of IPOs in the Indonesia Stock Exchange. One of the variables examined include financial leverage. Using the multiple linear regression, the researchers claimed that both variables, financial leverage and level of underpricing have a positive but insignificant relationship with each other. Other factors such as financial leverage, firm age, ownership concentration and ROA failed to show a significant effect.
In addition, the findings of Yuliani et al. (2019) showed that Return on Equity (ROE) can also be a determinant of underpricing when they examined underpricing in the Indonesian Stock Exchange. Specifically, the findings in the specified research reveal that the relationship between ROE and the level of underpricing in IPOs is significantly negative. Thus, the more profitable the firm is as reflected by the high ROE, the lower the underpricing is as there is low IPO uncertainty. Meanwhile, the Debt to Equity Ratio (DER) and the percentage of stocks offering does not have a significant effect.
Islam et al. (2010) examined the levels and determinants of underpricing in the Chittagong Stock Exchange (CSE) from 1995 to 2005. In the Bangladesh market, the level of underpricing is relatively higher than in Asian and other developed and advanced markets.
Correspondingly, the researchers collected a total sample of 191 IPO firms from the years 1995 to 2005 which resulted in 87.18% being underpriced, 11.11% were overpriced and 1.71% were fairly priced. These IPO firms were categorized based on their respective industry where the manufacturing, food and allied products, and service and miscellaneous sectors had high levels of underpricing. This mainly shows that the classification of industries is negatively correlated to
the level of underpricing. Hence, with the multiple regression model used, the industry of a firm is significant as it influences the firm’s level of underpricing.