Underwriter Allocation Discretion, Investor Participation and IPO Pricing: Evidence from the Indian IPO market A thesis submitted in fulfilment of the requirements for the degree of Doctor of Philosophy Nirav Parikh Masters of Finance School of Economics, Finance and Marketing College of Business RMIT University June 2017 Declaration I certify that except where due acknowledgement has been made, the work is that of the author alone; the work has not been submitted previously, in whole or in part, to qualify for any other academic award; the content of this thesis is the result of work which has been carried out since the official commencement date of the approved research program; and, any editorial work, paid or unpaid, carried out by a third party is acknowledged. Nirav Parikh 01/06/2017 ii Dedicated to the dear memory of my late father and to my gracious mother and a wonderful wife iii Acknowledgements I should begin by expressing gratitude to my supervisors, Dr Vijaya Marisetty and Dr Monica Tan for their guidance and advice throughout my PhD journey. My discussions and shared ideas with Dr Marisetty have provided the framework for my thesis. Right to the end, Dr Tan continued to monitor and encourage my efforts and was always available with valuable suggestions, critical direction and sound advice.
For this, I will always be grateful to her. My supervisors’ intellect and passion for excellence have motivated me to discover my potential as a researcher and as an independent thinker. I would like to thank Prof Michael Dempsey for critical comments on my draft thesis. I would also like to express my gratitude to Dr Meg Elkins and Dr Trevor Kollmann with whom I had important discussions on research methods.
I wish to acknowledge the managing editor of Smart Investment, Mr Dilip K. Shah for providing the grey market data for my thesis. I am grateful to Dr Michael Gangemi, Dr Silvia Islam, Dr Kaleel Rehman and Dr Sivagowry Sriananthakumar for offering me additional research and teaching opportunities. A special thanks to my fellow PhD student Gaurangi Laud with whom I shared many, many insightful and invigorating discussions.
I am also thankful to my HDR friends Vineet Tawani, Girija Chowk and Jeff Fang, who were always a great source of positive energy and enthusiasm through the years of my endeavour. I would like to thank my wife Avani for her patience and support through this journey. I would also like to thank my brother Brijal, and uncle Nailesh Kadakia, for also being the source of my strength and endurance. And in this, I must also take this opportunity to express my gratitude to my mother for so many things.
Finally, I acknowledge the support I have received for my research through the provision of an Australian Government Research Training Program Scholarship. I extend my gratefulness to RMIT University for providing financial support for my doctoral study and also Ms Rilke Muir who offered her copy editing services. iv Table of Contents Declaration. iv Table of Contents.
v List of Tables. ix List of Figures. x List of Thesis Related Definitions .2 The Setting: Indian IPO Market .3 Motivation and Aim for Thesis .1 Study 1-Conceptual Framework (Chapter 3) .2 Study 2-Underwriter Signaling (Chapter 4) .3 Study 3-Underwriter Syndication (Chapter 5) .4 Outline of the Thesis. 17 Chapter 2 Institutional Features 2.2 Indian IPO Market .1 Investor Classification and Allocation Proportion .3 Transparency in the Indian IPO Market .3 Institutional Features of the Grey Market .1 Grey Market Timeline .2 Grey Market Instruments and Pricing .3 Settlement of Grey Market Trades .4 Grey Market Information .5 Indian Grey Market versus the American and European Markets .4 IPO Underwriting Market in India .1 Example of an Underwriting Syndicate.
35 v Chapter 3 (Study 1) Conceptual Framework of Information Sharing in the Presence and Absence of Allocation Discretion Abstract .2 Introduction to Conceptual Framework .3 Allocation Discretion, Information Sharing and IPO Pricing .1 Allocation Discretion and Information Sharing .2 Positive Effect of Allocation Discretion on IPO Pricing .3 Negative Effect of Allocation Discretion on IPO pricing .4 Allocation Discretion and IPO Underpricing .4 Allocation Discretion, Quality of Information Sharing and Signaling .1 Information Asymmetry between IPO Investors .2 Effect of Information Asymmetry on IPOs: Signaling Theory Perspective .3 Effect of the Grey Market Signal on Retail Subscription and Underpricing .4 Effect of Allocation Discretion on Underwriter Signaling .5 Regulating Allocation Discretion and Underwriter Syndication .1 Regulating Allocation Discretion .2 Reputation-based Syndication and IPO Pricing.3 Regulating Discretion, Reputation-based Syndication and IPO Pricing. 77 Chapter 4 (Study 2) Allocation Discretion, Quality of Information Sharing and Signaling Theory Abstract .2 Key Institutional features of the Indian IPO market.2 The Grey Market .3 Background Literature and Hypothesis Development .1 Allocation Discretion and Information Sharing .2 Allocation Discretion and Quality of Information Sharing .3 Signaling Theory and the Key constructs for an IPO market.4 Grey Market Price Signal, Retail Subscription and Underpricing .5 Allocation Discretion and Underwriter Signaling .4 Data Sources and Summary Statistics .2 Description of Variables used in the Study .5 Empirical Results and Discussion.1 Grey Market Price Signal and Retail Subscription .2 Allocation Discretion and Effect on Grey Market Premium .3 Allocation Discretion, Retail Investor Participation and IPO Underpricing. 135 Chapter 5 (Study 3) Allocation Discretion, Information Sharing and Underwriter Syndication Abstract .2 Information Sharing Hypothesis and Related Literature .1 Allocation Discretion, Information Sharing and IPO Pricing .3 Regulatory Intervention in Allocation Discretion .4 Underwriter Syndication and Related Literature .1 Regulating Allocation Discretion and Underwriter Syndication .2 Determinants of Underwriting Syndicate.3 Motivation for Syndication: Risk Mitigation or Price Manipulation .4 Reputation-based Syndication and IPO Pricing.5 Regulating Discretion, Reputation-based Syndication and IPO Pricing .5 Data Sources and Description of Variables .2 Description of Variables used in the Study .1 Annual Descriptive Statistics .2 Low-High UW Syndicate Effort and Pre-Post Regulation sample .3 Underwriter Syndication Matrix and Participation Characteristics .7 Empirical Results and Discussion.1 Determinants of Underwriting Syndicate and Syndication Hypothesis .2 Reputation-based Syndication and Institutional Participation .3 Information Sharing, Underwriter Syndication and IPO Underpricing. 206 vii Chapter 6 Overall Conclusion 6.1 Summary of Findings .1 Study 1 Conceptual Framework .2 Study 2 Underwriter Signaling .3 Study 3 Underwriter Syndication .3 Limitations and Avenues for Future Research.
214 References viii List of Tables Table 2.1: List of Qualified Institutional Buyers (QIBs).3: The US versus Indian IPO Bookbuilding mechanisms .4 : Underwriting Syndicate members for GMR Infrastructure Ltd .5: Inter Se Allocation of Responsibilities of the Underwriting Syndicate Members for GMR Infrastructure Ltd .1: Description of Variables used in Study 2 .2: Descriptive Statistics by Year of IPO .4: IPO details as per Regulation Period and Grey Market Premium .5: Grey Market Price Signal and Retail Investor Participation.6: Allocation Discretion and Grey Market Price Signal.7: Allocation Discretion, Retail Participation and IPO Underpricing .8: List of Underwriters and Underwriter Reputation (Study 2) .1: Description of Variables used in Study 3 .2 Part 1: IPO Details for the Year 2001 .3: Year-wise IPO details .4: Low-High UW Syndicate Effort and Pre-Post Regulation sample .5: Underwriter Syndication Matrix .6: Year-wise Concentration Ratios and Ranking of Top 10 Underwriters 177 Table 5.7: List of most Active Underwriters .8: No of IPOs managed by Underwriters .9: Underwriting Syndicate Determinants and Syndication Hypothesis .10: Reputation-based Syndication and Institutional Subscription.11: Reputation-based Syndication and IPO Underpricing .12: List of Underwriters and Underwriter Reputation (Study 3). 206 ix List of Figures Figure 1.1: IPO Underpricing and Money left on the table in the US.2: Initial IPO returns in European IPOs.3: Initial IPO returns in non-European IPOs.2: Pre- and Post-Regulation period .3: Timeline of events for an IPO .1: An Integrated Conceptual Framework of Information Sharing with and without Allocation Discretion to Underwriters .1: Information Sharing and Signaling Hypotheses .2: Indian Mobile Subscribers .1: Information Sharing and Syndication Hypotheses .2: Year Wise Concentration Ratios. 178 x List of Thesis Related Definitions 1. IPO, an Initial Public Offering: the process by which a private firm is made public by an initial sale of its shares to investors.
Final Issue/Offer Price, the final price at which the shares are sold to investors in an IPO. Retail Investor Participation represents the subscription from retail investors in an IPO and is calculated as the total number of shares subscribed by retail investors as a proportion of the total shares available to them for allocation. Underpricing is measured as the percentage change in price between the final issue price and the closing price of the IPO at the end of the first day of trading. Initial return or first-day return are both used to represent underpricing in an IPO.
Discretionary Allocation Mechanism, an allocation mechanism whereby underwriters have discretionary power to allocate shares to institutional investors. Proportionate Allocation Mechanism, an allocation mechanism whereby the shares to institutional investors are allocated on a proportionate (pro-rata) basis. Pre-Regulation Period IPOs (Discretionary Allocation Regime) are the IPOs that were issued in the regime where underwriters’ have discretionary power to allocate shares to institutional investors. Post-Regulation Period IPOs (Proportionate Allocation Regime) are the IPOs that were issued in the regime where underwriters’ discretionary power to allocate shares to institutional investors has been regulated, and the shares were allocated to institutional investors on a proportionate basis.
Underwriter (UW) Reputation is a proxy for the reputation of the underwriter. Grey Market Price is the average of the weekly grey market prices quoted for an IPO during the grey market trading period. Grey Market Premium (GMP) is the difference between the grey market price and the final issue price of an IPO. Grey Market Price Underpricing (GMP Underpricing) represents price manipulation in an IPO and is measured as the percentage change in price between the grey market price and the final issue price of an IPO.
Total UW Syndicate Effort represents the cumulative effort by the underwriting syndicate members. It is calculated as the sum of the ratios of the expected issue size of an IPO per underwriter to the total amount of proceeds raised by the underwriter during that year. UW Syndicate Effort is the ratio of Total UW Syndicate Effort to the total number of underwriters in a syndicate. Concentration Ratio is the market share of the largest underwriters in the underwriting industry for that year.
For example, CR4 represents the four-firm concentration ratio that measures the total market share of the four largest firms in the underwriting industry for that year. IPO Risk represents the market risk of an IPO and is measured as the aftermarket standard deviation, which is estimated using continuously compounded daily returns from day 21 through to 125 days after the IPO is listed on the stock exchange. xii Abstract In the US and other world markets, book building is a dominant mechanism for the issue of shares in initial public offerings (IPOs). A distinguishing feature of the book building mechanism is the discretionary power granted to underwriters to allocate shares to investors.
We find that IPOs are generally underpriced in most countries. It is therefore of interest to financial economists and regulators to understand the role of underwriters as a financial intermediary in the allocation of IPO shares to IPO subscribers in this wealth transferring mechanism. Allocation discretion assists underwriters to develop and maintain information sharing relationships with institutional investors. This has a significant bearing on the richness of private information extracted from these investors that is used by the underwriters to price the IPO.
This benefits the issuer through lower underpricing. However, granting allocation discretion to underwriters is also controversial as it can result in increased rent-seeking activity by underwriters, thereby leading to higher underpricing in the IPO. On the other hand, imposing constraints on underwriters by regulating allocation discretion and enabling proportionate allocation of shares to institutional investors can have adverse implications for underwriters because of the difficulty in maintaining information sharing relationships with informed institutional investors.