Final Report On

Factors Affecting First Day returns from

an IPO
In partial fulfillment of course

Econometrics for Finance

SUBMITTED TO Prof. Mallikarjun

SUBMITTED BY: Hiren Haria (061114) Ajay Hingane (061204) Mohit Bansal (061228) Nikhil Gore (061232)

Introduction
The number of IPOs that are flooding the streets are increasing day by day. In spite of this they are commanding a substantial price premium on their offer price. The first day returns of IPOs like Vishal Retail, RPL and DLF are no long history. The investors are taking out money from the secondary markets and are investing into the primary markets. These IPOs suck a lot of liquidity from the markets, for ex. the recent IPOs of DLF and ICICI Bank suck nearly Rs. 9000 cr. each from the market. In spite of all this investors are showing tremendous faith in them and the result is the over-subscription rates and the listing prices. Whether the premium that these IPOs command is because of the under-pricing of the IPOs or some other factors is yet to be determined. In fact SEBI is thinking of putting a cap on the prices of these IPOs on the listing days to have a control on the volatility. In order, to understand the factors that influence the first day returns of an IPO, number of theories has been put forward. The literature that is cited below is one amongst them which tries to determine the factors that influence the price premium of IPOs in the Medical Diagnostics and Device industry. We would like to extend this study to the Indian markets covering a sample of all the industries and companies which have come up with an IPO since 2005, as it marks the boom phase of the Indian markets. Also, some additional variables which were not covered under this literature have been checked to determine whether they influence the price premiums these IPOs command.

Literature Review
The study examines the factors that influence the extent of price premium over book value in Initial Public Offerings (IPO). The study focuses on the Medical Diagnostics and

Devices industry only. The author has cited two reasons for limiting himself to this industry only. First, there has been increasing awareness in recent years of the need to control for industry effects in management research. And secondly, there is often a significant association between industry affiliation and initial returns in IPOs. According to the author the variables that affect the price premium on the IPO are basically dependent on the risk related factors of the company going for an IPO. Factors such as the Debt to Equity ratio of the company (D/E ratio), promoter holdings in the company prior and after the IPO, underwriter reputation, stage of development of the company and number of risk related factors mentioned in the prospectus affect the price premium. The findings of the study state that there is positive correlation between firms stage of development and price premium, whereas, there is negative relationship between leverage i.e. the D/E ratio, and the extent of managements reduction in stock holdings. Also, as per the findings the relationship between underwriters reputation and price premium is not significant due to the low t-value.

Methodology
We took a simple random sample of 50 from all the companies that have come up with an IPO since 2005. Four dependent variables have been identified to test the model. Closing price is chosen as it takes into account the sentiments of the investors who have been denied the shares in the initial allotment. The independent variables in our case are D/E ratio, reduction in Promoters holding, underwriter reputation, age of the company, number of uses of proceeds and issue size. Out the sample 50 firms selected for developing the model, 9 firms had to be dropped. The reason was non-availability of data for those firms. The reasons are enumerated as follows: The company is yet to be listed. The issue was a follow-on issue.

The company was de-listed. The financial leverage for Deccan Aviation was negative.

Therefore new 9 firms were randomly selected from the population (excluding firms those were already selected) to account for loss of data. A multiple regression was run to develop a model and determine how much these factors influence the premiums that the IPOs command. Each dependent variable was separately regressed against the independent variables.

Variables
Dependant Variables: Four variables have been identified as follows: (Listing Price/Issue Price) (Closing Price on the Day of Listing/Issue Price) (Listing Price - Issue Price)/Issue Price (Closing Price on the Day of Listing - Issue Price)/Issue Price

The data for listing price, issue price and the closing price on the first day has been obtained from the NSE website. Independent Variables: Underwriter Reputation: It is treated as a categorical variable. The reputation of the underwriter has been decided on the basis of the credit rating given by leading credit rating firms like CRISIL and S&P for Indian and Foreign firms respectively. The rating criteria for CRISIL and S&P have been assumed to be same as CRISIL is part of S&P. If the rating of some firm was not available, it was judged on the basis of its past record like loan defaults. The firm with bond rating of AAA has been assigned a value of 1, below AAA has been assigned a value of 0 and the firms having more than one lead underwriter have been assigned a value on the basis of the underwriter with higher credit rating.

Financial Leverage: The Debt-Equity ratio as on the date of filing the prospectus has been calculated from the information available in the prospectus. Issue size: The issue size in Rs. million has been obtained from the red herring prospectus of each firm. Age of the company: The age of the company in years is the number showing the difference between the year of listing and the year of founding. The data has been obtained from the red herring prospectus. Number of uses of proceeds: It has been obtained from the red-herring prospectus. Change in the stock ownership of the promoter: It is calculated as the ratio of promoters holding after and before the issue of the IPO. The pre-IPO and post-IPO promoters holdings have been obtained from the red herring prospectus. Hypothesis Let 0 = Constant term in the regression (c) i = Coefficients of independent variables, i = 1,2,3,4,5,6. The hypothesis that we are testing in this paper are: H.1a) Ratio of first day closing price to issue price depends upon all the factors detailed above. i.e. All is are not equal to zero H.1b) Ratio of first day closing price to issue price depends upon one or more of the factors detailed above. i.e. At least one i is not equal to zero

H.2a) Ratio of listing price to issue price depends upon all the factors detailed above. i.e. All is are not equal to zero H.2b) Ratio of listing price to issue price depends upon one or more of the factors detailed above. i.e. At least one i is not equal to zero H.3a) Percentage change from issue price to first day closing price depends upon all the factors detailed above. i.e. All is are not equal to zero H.3b) Percentage change from issue price to first day closing price depends upon one or more of the factors detailed above. i.e. At least one i is not equal to zero H.4a) Percentage change from issue price to listing depends upon all the factors detailed above. i.e. All is are not equal to zero H.4b) Percentage change from issue price to listing depends upon one or more of the factors detailed above. i.e. At least one i is not equal to zero

Regression Run for testing of above mentioned hypothesis Independent Variables: Age of the Company (age) Financial Leverage i.e. Debt/Equity Ratio (FL) Underwriters Reputation (gradin) Issue Size in Rs. Million (IS) Number of Uses of Proceeds (NOUP) Ratio of Promoters holding after IPO/ Promoters holding before IPO (PSAPSB)

Model I
Dependent Variable: First Day Closing Price/Issue Price of the IPO (CPIP) For this regression CPIP is first regressed with all the independent variables that are age of the company, financial leverage, size of the issue, grading of the underwriter, objects of the issue, and the ratio of promoters holding before and after the issue. The results of this regression are shown in Table 1- Run 1. One can clearly see that the results of this step are not significant statistically. Further we dropped variables one-by-one on the basis of their t-values to get a better picture. Even this exercise doesnt yield any statistically significant independent variable till Run 5.

Run 6 that take only underwriters grading as an independent variable produces t-stat that is statistically significant and also Fstat for the model comes out to be statistically significant. It must be noted that underwriters reputation in our case is a dummy variable and is used as one for reputed underwriter and zero for not very reputed underwriter. Hence, we reject the null hypothesis H1a and accept the null Hypothesis H1b.

Table 1:Regression Run For Dependent variable CPIP

VARIABLE COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. C 1.2246 0.7150 1.7128 1.2573 0.6808 1.8468 1.2544 0.6731 1.8637 1.4620 0.2493 5.8641 1.4407 0.2432 5.9236 1.5529 0.1530 10.1513 AGE 0.0022 0.0104 0.2146 0.0012 0.0082 0.1418 FL -0.0161 0.0373 -0.4318 -0.0174 0.0361 -0.4834 -0.0174 0.0357 -0.4881 -0.0167 0.0353 -0.4744 GRADIN -0.4253 0.1907 -2.2303 -0.4296 0.1869 -2.2990 -0.4284 0.1846 -2.3203 -0.4262 0.1827 -2.3324 -0.4387 0.1793 -2.4461 -0.4326 0.1778 -2.4326 IS 0.0000 0.0000 -0.1696 NOUP 0.0278 0.0486 0.5723 0.0285 0.0479 0.5951 0.0287 0.0474 0.6051 0.0268 0.0466 0.5760 0.0275 0.0462 0.5961 PSAPSB 0.2694 0.8422 0.3198 0.2411 0.8163 0.2953 0.2634 0.7922 0.3325 R-squared 0.1239 Adjusted R-squared 0.0016 F-statistic 1.0133

Run 1

0.1233

0.0237

1.2375

Run 2

0.1229

0.0449

1.5762

Run 3

0.1207

0.0634

2.1054

Run 4

0.1164

0.0788

3.0966

Run 5

0.1098

0.0912

5.9175

Run 6

Variable have been dropped

Model II
Dependent Variable: Listing Price of the IPO/Issue Price of the IPO (LPIP) For this regression LPIP is first regressed with all six independent variables.
Table 2: Regression Run For Dependent variable LPIP
VARIABLE COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR C 1.0460 0.4669 2.2401 1.0733 0.4318 2.4858 1.0885 0.4159 2.6170 1.3024 0.1008 12.9227 1.3008 0.0999 AGE 0.0019 0.0068 0.2774 0.0020 0.0067 0.2927 FL -0.0071 0.0244 -0.2907 -0.0071 0.0241 -0.2950 GRADIN -0.1520 0.1245 -1.2208 -0.1505 0.1228 -1.2255 -0.1567 0.1195 -1.3116 -0.1572 0.1186 -1.3257 -0.1655 0.1161 IS 0.0000 0.0000 -0.5517 0.0000 0.0000 -0.5739 0.0000 0.0000 -0.5758 0.0000 0.0000 -0.4463 NOUP 0.0052 0.0317 0.1651 PSAPSB 0.2884 0.5500 0.5243 0.2794 0.5412 0.5162 0.2813 0.5304 0.5303 R-squared 0.0553 Adjusted R-squared -0.0765 F-statistic 0.4195

The results of this regression are shown in Table 2- Run 1. One can clearly see that the results of this step are not significant statistically. Further we dropped variables one-by-one on the basis of their t-values to get a better picture. This exercise doesnt yield any statistically significant independent variable for all runs. . Hence, we reject both the null hypothesis H2a and H2b.

Run 1

0.0547

-0.0527

0.5093

Run 2

0.0505

-0.0115

0.8149

Run 3

0.0446

0.0040

1.0980

Run 4 Run 5

0.0406

0.0206

2.0318

T-STAT.

13.0241

-1.4254

Model III
Dependent Variable: CPIPIP = (First day closing price Issue Price) / Issue Price For this regression CPIPIP is first regressed with all six independent variables. The results of this regression are shown in Table 3- Run 1. One can clearly see that the results of this step are not significant statistically. Further we dropped variables one-by-one on the basis of their t-values to get a better picture. This exercise yields only gradin as statistically significant independent variable for first five runs. For Run1 to Run 5 coefficient of gradin is statistically significant yet the F-stat for all these runs is not significant. Run 6, in this case show some relation of independent variable underwriters reputation with the dependent variable. Also Fstat for the model comes out to be statistically significant. . Hence, we reject the null hypothesis H3a and accept the null Hypothesis H3b.
Regression Run For Dependent variable CPIPIP
VARIABLE COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. C 1.2246 0.7150 1.7128 1.2573 0.6808 1.8468 1.2544 0.6731 1.8637 1.4620 0.2493 5.8641 1.4407 0.2432 5.9236 1.5529 0.1530 10.1513 AGE 0.0022 0.0104 0.2146 0.0012 0.0082 0.1418 FL -0.0161 0.0373 -0.4318 -0.0174 0.0361 -0.4834 -0.0174 0.0357 -0.4881 -0.0167 0.0353 -0.4744 GRADIN -0.4253 0.1907 -2.2303 -0.4296 0.1869 -2.2990 -0.4284 0.1846 -2.3203 -0.4262 0.1827 -2.3324 -0.4387 0.1793 -2.4461 -0.4326 0.1778 -2.4326 IS 0.0000 0.0000 -0.1696 NOUP 0.0278 0.0486 0.5723 0.0285 0.0479 0.5951 0.0287 0.0474 0.6051 0.0268 0.0466 0.5760 0.0275 0.0462 0.5961 PSAPSB 0.2694 0.8422 0.3198 0.2411 0.8163 0.2953 0.2634 0.7922 0.3325 R-squared 0.1239 Adjusted R-squared 0.0016 F-statistic 1.0132

Run 1 Run 2 Run 3 Run 4 Run 5 Run 6

0.1233

0.0237

1.2375

0.1229

0.0449

1.5761

0.1207

0.0634

2.1054

0.1164

0.0788

3.0966

0.1097

0.0912

5.9175

Model IV
Dependent Variable: LPIPIP = (Listing Price of the IPO Issue Price of the IPO) / Issue Price of the IPO For this regression LPIPIP is first regressed with all six independent variables. The results of this regression are shown in Table 4- Run 1. One can clearly see that the results of this step are not significant statistically. Further we dropped variables one-by-one on the basis of their t-values to get a better picture. This exercise doesnt yield any statistically significant independent variable for all runs. . Hence, we reject both the null hypothesis H4a and H4b.
Regression Run For Dependent variable LPIPIP
VARIABLE COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. COEFFICIENT STD. ERROR T-STAT. C 0.0460 0.4669 0.0985 0.0733 0.4318 0.1698 0.0958 0.4206 0.2277 0.0885 0.4159 0.2128 0.3024 0.1008 3.0004 0.3008 0.0999 3.0117 AGE 0.0019 0.0068 0.2774 0.0020 0.0067 0.2927 FL -0.0071 0.0244 -0.2907 -0.0071 0.0241 -0.2950 -0.0080 0.0237 -0.3377 GRADIN -0.1520 0.1245 -1.2208 -0.1505 0.1228 -1.2255 -0.1520 0.1214 -1.2517 -0.1567 0.1195 -1.3116 -0.1572 0.1186 -1.3257 -0.1655 0.1161 -1.4254 IS 0.0000 0.0000 -0.5517 0.0000 0.0000 -0.5739 0.0000 0.0000 -0.5037 0.0000 0.0000 -0.5758 0.0000 0.0000 -0.4463 NOUP 0.0052 0.0317 0.1651 PSAPSB 0.2884 0.5500 0.5243 0.2794 0.5412 0.5162 0.2830 0.5356 0.5284 0.2813 0.5304 0.5303 R-squared 0.0553 Adjusted R-squared -0.0765 F-statistic 0.4195

Run 1 Run 2 Run 3 Run 4 Run 5 Run 6

0.0547

-0.0527

0.5093

0.0529

-0.0313

0.6279

0.0505

-0.0115

0.8149

0.0447

0.0040

1.0985

0.0406

0.0206

2.0318

The tabulated values of t-stat and F-stat used for our purpose are given in the table below:
Used Tabulated Statistics Confidence Interval 95% t-Stat F-Stat for n = 50 2.01 4.4 2.01 3.2 2.01 2.8 2.01 2.57 2.01 2.34 2.01

K 1 2 3 4 5 6

Conclusion: After analyzing various factors that might influence the first day returns from an IPO, it can be safely said that the IPO returns mostly depend on the sentiments of the public and the market moreover follows a random walk. Though, after running various regression models, the only variable that had some influence on the returns was the reputation of the Underwriter responsible for the proceedings of an IPO. The variables such as Financial Leverage, Age, Issue Size, Number of uses of Proceeds, and the promoters stake dilution has practically no influence on the returns of an IPO in the Indian context for the selected period. Due to the time constraint other variables like the state of the market i.e. either a bull or a bear run were not included in the regression model. For further studies, this aspect can be taken into consideration by using proxies like the market turnover, F&O turnover, etc for determining the state of the market. The period for monitoring would be right from the first day of the issue to the listing day. The effect of inclusion of this variable in the model should then be studied to see if it influences the returns.

Reference Research Papers Abdul M.A. Rasheed, Deepak K. Datta, and Ravi R. Chinta (October 1997). Determinants of Price Premiums: A study of Initial Public Offerings in the Medical Diagnostics and Devices Industry, Journal of Small Business Management, p11-23.

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