CHAPTER – 6 RELATIONSHIP BETWEEN CORPORATE GOVERNANCE VARIABLES AND LISTING PERFORMANCE OF INDIAN IPOs IPO provides an opportunity to the issuing company to tap wider pool of public funds in order to provide capital for its future growth. Its inherent nature of penetrating into public pockets breaking the private arenas and the unique setting characterized by information asymmetry has always grabbed attention of researchers and academicians. IPO pricing, timing and performance have been three primary issues which have been dominant areas of research in this field. Pricing of IPOs, however, remains the most contentious issue. Two anomalies related to pricing issues are (1) high initial returns (or underpricing) and (2) long run underperformance (Ching-Yi Lin, 2005). Where IPO underprcing reduces the initial owners’ wealth, long run underperformance results in a wealth loss to all shareholders. Underpricing though used interchangeably with the initial returns, remains the common terminology used in IPO literature (e.g., Ritter, 1998). Greater the extent of underpricing, higher will be the initial returns. IPO underpricing, which refers to stock returns experienced during the initial trading day in the secondary market, reduces the capital received by an IPO firm through IPO process (Lin and Chuang, 2011) and is regarded as a direct wealth transfer from founders and initial shareholders to new external investors (Filatotchev and Bishop, 2002). This performance indicator is unique to the IPO context and represents the difference between investment banker's initial valuation of the firm and stock market's valuation of firm at the end of first day of public trading and hence is referred to as money that initial shareholders "leave on the table" (e.g., Tully, 1999). As noted by Certo, et al. (2001b), underpricing captures both wealth creation for first-day investors and lost (unretained) wealth for initial shareholders who sold their equity to the investment banker at a price below its value in investor market at the end of first day of trading. Economic magnitude of IPO underpricing is formidable and the phenomenon is globally pervasive.
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CHAPTER – 6
RELATIONSHIP BETWEEN CORPORATE GOVERNANCE VARIABLES AND LISTING
PERFORMANCE OF INDIAN IPOs
IPO provides an opportunity to the issuing company to tap wider pool of public funds in
order to provide capital for its future growth. Its inherent nature of penetrating into public
pockets breaking the private arenas and the unique setting characterized by information
asymmetry has always grabbed attention of researchers and academicians. IPO pricing,
timing and performance have been three primary issues which have been dominant areas
of research in this field. Pricing of IPOs, however, remains the most contentious issue.
Two anomalies related to pricing issues are (1) high initial returns (or underpricing) and
(2) long run underperformance (Ching-Yi Lin, 2005). Where IPO underprcing reduces
the initial owners’ wealth, long run underperformance results in a wealth loss to all
shareholders.
Underpricing though used interchangeably with the initial returns, remains the common
terminology used in IPO literature (e.g., Ritter, 1998). Greater the extent of underpricing,
higher will be the initial returns. IPO underpricing, which refers to stock returns
experienced during the initial trading day in the secondary market, reduces the capital
received by an IPO firm through IPO process (Lin and Chuang, 2011) and is regarded as
a direct wealth transfer from founders and initial shareholders to new external investors
(Filatotchev and Bishop, 2002).
This performance indicator is unique to the IPO context and represents the difference
between investment banker's initial valuation of the firm and stock market's valuation of
firm at the end of first day of public trading and hence is referred to as money that initial
shareholders "leave on the table" (e.g., Tully, 1999). As noted by Certo, et al. (2001b),
underpricing captures both wealth creation for first-day investors and lost (unretained)
wealth for initial shareholders who sold their equity to the investment banker at a price
below its value in investor market at the end of first day of trading. Economic magnitude
of IPO underpricing is formidable and the phenomenon is globally pervasive.
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
151
Table 6.1: Equally Weighted Average Initial Returns for 50 Countries
United States Ibbotson, Sindelar & Ritter; Ritter 12,340 1960-2012 16.80%
Note: Where more than one set of authors is listed as a source of information, combined sample sizes have been constructed. Average initial returns are constructed in different manners from study to study. In general, in countries where market prices are available immediately after offerings, the one-day raw return is reported. In countries where there is a delay before unconstrained market prices are reported, market adjusted returns over an interval of several weeks are reported. All of the averages weight each IPO equally.
Source: Loughran, Ritter & Rydqvist published in the June 1994 Pacific-Basin Finance Journal Vol. 2, pp. 165-199 Updated March 1, 2013
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
153
Ample evidence has been documented to highlight the existence and extent of
underpricing across different regions. Table 6.1 presents the prevalence of the
positive initial returns as available on the listing day across different countries. The
table elucidates and validates the existence of underpricing across all economies
differing only in extent. A large number of studies have addressed the underpricing
phenomenon and attempted to find explanations to this premium. Several theories
have emerged to explain these positive initial returns such as information asymmetry
theory (Carter and Manaster, 1990) and signaling hypothesis (Allen and Faulhaber,
1989; Grinblatt and Hwang, 1989; Welch, 1989). Although many theories attempt to
unravel the mystery of IPO underpricing, no one convincing common explanation has
sprang up. However, most of the theories revolve around information asymmetry
between issuing firm and other participants in the IPO process. Asymmetric
information is higher for smaller and newer firms and inherent costs make it difficult
to resolve these problems and this increases agency costs which manifest as
underpricing.
6.1 CORPORATE GOVERNANCE AND UNDERPRICING
Due to information asymmetry problem, wherein issuers have better information about
their firm’s future performance than outside investors, the firms adopt varied mechanisms
to signal firm quality and communicate their true value to investors. Rather, at the heart
of signaling theory is information asymmetry (Spence, 1973). This is necessary in the
light of prevailing uncertainty in the minds of investors. Literature on underpricing, much
of which is based on signaling theory, addresses various signals employed by firms to
dispel the apprehensions of investing public. These include retained ownership (Leland
and Pyle, 1977 and Keasey and McGuiness, 1992), underpricing for seasoned issues
(Ibbotson, 1975; Allen and Faulhaber, 1989; Welch, 1989), prestigious underwriters
(Booth and Smith, 1986; Carter and Manaster, 1990; Michaely and Shaw, 1994) reputed
investment bankers (Carter et al., 1998; Paudyal, et al., 1998), auditor reputation (Titman
and Trueman, 1986) and prestige of venture capitalists (Megginson and Weiss, 1991; Da
Silva Rose et al., 2002).
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
154
Despite the extant literature on signaling in context of IPO underpricing, little attention
has been devoted to association between corporate governance attributes and IPO initial
performance particularly in the context of Asian economies (Yong, 2007). This has
emerged as an explanation to underpricing in the times of shift towards qualitative signals
in the backdrop of losing relevance of financial and quantitative information in
communicating credibility of new issue firms. Kim and Ritter (1999) suggested that the
relationship between financial information and equity values is particularly tenuous in the
IPO context. The disturbing regularity of corporate upheavals and financial irregularities
globally have stimulated the growing interest in corporate governance mechanisms. Also,
Yong (2007) shared the view that corporate governance is the new area of IPO research.
Thus corporate governance emerged as an important area and its relevance is constantly
increasing. It is widely accepted that good corporate governance systems are associated
with better corporate value, and is also a key element in corporate competitiveness and
access to capital (Jensen and Meckling, 1979; Shleifer and Vishny, 1997). Sanders and
Boivie (2004) suggest that corporate governance parameters can serve as useful screening
and sorting criteria that influence investors' valuations of the IPO firm when primary
information sources are limited or obscure. Researchers also believe that certain
governance related signals reduce investor anxiety and contribute in reducing extent of
underpricing. Governance attributes as a signaling device lie consistent with the two key
criteria for an effective signal: they are observable and known in advance (i.e. occur prior
to any transaction offer) and are costly for lower quality IPO firms to utilize due to
difficulty in imitation.
6.2 EMPIRICAL EVIDENCE ON UNDERPRICING AND GOVERNANCE
Investigation of corporate governance mechanisms as signals at the time of IPO, thus,
emerges as an important empirical issue in research. IPO provides a unique setting to
evaluate effects of governance as effective monitoring is all the more critical for firms
going public in the face of aggravated agency conflicts (Brennan and Franks, 1997). Very
limited initiatives in this direction have been documented though literature in Indian
context is almost non-existent. The investigation becomes important given the economic
and financial dimension of India and also because the influences of corporate governance
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
155
variables on underpricing are expected to be different in emerging markets owing to
different institutional environments.
Prior efforts in relation to corporate governance and underpricing have been largely
limited to developed economies and other typical areas but developing markets of India
lack this exploration. Few studies have recently attempted to investigate board of
directors and IPO underpricing (listing day performance) using data from the United
States (e.g., Certo et al., 2001; Howton et al., 2001). Evidence from emerging markets is
quite rare, among the few are Chen and Strange (2004), Lin and Chuang (2011), and
Yatim (2011), which use a sample of IPO firms in China, Taiwan and Malaysia,
respectively. The impact of governance measures on performance of IPOs in small
frontier markets of West Africa facing the challenge of adoption of international
governance best practices (Hearn 2011, Hearn 2012) has also been studied. In the light of
the economic significance of Indonesia being the largest economy in Southeast Asia,
Darmadi and Gunawan (2012) explored the influence of corporate governance
mechanisms on initial returns for this emerging market attracting foreign attention and
investments. Chen and Yang (2013) did not find a significant relationship between
underpricing and governance and ownership structure for ChiNext IPOs. On the same
lines, IPO investors on the Alternative Investment Market (London) were found not to
necessarily view the monitoring benefits of board structure and managerial ownership as
important signals of firm quality (Wu and Hsu, 2012). Clearly concentration of past
efforts has been in developed and established economies of US (Certo et al., 2001a; Certo
et al., 2001b; Howton et al., 2001; Dempere, 2007), UK (Filatotchev and Bishop, 2002;
Chahine et al., 2009), France (Chahine, 2004; Mnif, 2009). However, with the vibrancy
in growth of economies, research efforts have been redirected towards growing and
emerging markets of Australia (Ching Yi-Lin, 2005), China (Li, 2005; Li and Naughton,
2007), Indonesia (Darmadi and Gunawan, 2012); Malaysia (Yatim, 2011); Singapore
(Mitchelle et al., 2008) and now it should be India.
With regards to Indian markets, however, literature on information asymmetry problems
at the time of IPO and contribution of governance attributes in mitigating these and
resulting effect on initial pricing performance is rather scant. This issue, therefore, forms
the main focus of present effort.
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
156
6.3 SAMPLE AND METHODOLOGY
The primary objective of this chapter is to examine the relationship between corporate
governance measures (as measured through board structures and ownership variables)
and listing day performance of newly issued securities. Signaling power of these
attributes and how far are they incorporated and relied on in taking the investment
decisions is attempted to be studied.
Sample for this objective is the firms which issued new equity securities between the time
period April 1, 2001 and March 31, 2012 and got them listed on the Bombay Stock
Exchange (BSE). IPO prospectuses prepared and submitted for the purpose of issue is the
source of culling data on corporate governance systems of IPO firms. For information on
market prices of securities and SENSEX values the ACEEQUITY database and BSE
website (www.bseindia.com) were relied on. Additional information about firm attributes
and issue variables was collected using above sources as well as PROWESS and
Capitaline database.
To analyse the relationship between IPO’s initial returns and corporate governance
mechanisms multiple regression analysis has been employed. As a precursor to regression
analysis relationships between underpricing and governance variables have been explored
using ANOVA and t-tests to investigate if the board structures and ownership patterns
differ across return continuum. Variables of interest, i.e., the governance variables for
analysis have been categorized into those relating to board structures and others
indicating ownership patterns. Other than these, firm specific and issue specific variables
have also been included in study to control for their effects on returns. Listing day returns
have been measured as raw returns (unadjusted) and market returns (those adjusted for
market movements with SENSEX as the barometer). The description of variables as
operationalized in the study is provided in Table 6.2.
With the specified objectives and outlined data and sample the chapter proceeds first to
examine and establish the underpricing phenomenon in India, examine the degree and
direction of governance variables to the listing day returns and then checking for
dependency of returns on these attributes.
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
157
Table 6.2: Operationalization of Research Variables for Study of Corporate Governance and Returns
Variables Operationalization Dependent Variable
Underpricing on listing day
1. Raw return- Closing price on the first trading day on the secondary market minus offer price, divided by offer price
2. MAER- Raw return minus the market return as measured by the BSE’s sensitive index
Independent Variables (Board related)Board size Total number of directors on the board
Board committees Inverse of total number of board committees to assist the board
Board independence Percentage of independent directors on the board Women directors Percentage of women directors on the board Age of board Average of the individual age of all board members
Related board members Number of members on the board who are related to each other
Board reputation The total number of board directorships held by non-executive directors at other firms
Independent Variables (Ownership related)
Promoter ownership Percentage of shares held by board of promoters (founders) at the time of issue
Promoter ownership squared
Square term of the percentage of shares held by board of promoters (founders) at the time of issue
Block holder ownership Number of shareholders holding shares more than 10% of total shares to denote concentrated ownership
Top 10 shareholding Percentage of shares owned by the 10 largest shareholders of a firm
Top 10 shareholding squared
Square term of percentage of shares owned by the 10 largest shareholders of a firm
Control Variables (Issue and firm related)
Subscription ratio Number of times the IPO has been subscribed: indicator of over or under subscription
Issue size Logarithm transformation of proceeds received from issuing new shares (in crores)
Listing delay Number of days between close of issue and listing on BSE Issue price The offer price of shares issued through IPO
IPO age Logarithm transformation of number of years between date of incorporation and IPO issue date
Total assets Logarithm transformation of book value of total assets as expressed in crores of rupees
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
158
6.4 PRESENCE AND EXTENT OF UNDERPRICING IN INDIAN IPOs
It has been adequately documented that underpricing is a pervasive phenomenon
implying that the investors buying new issue securities on offer date have pocketed high
returns on the first trading day suggesting that the securities had been undervalued. Prices
fixed for the shares by the issuers and managers to the issue was lower than the
valuations provided by the market on listing day and this phenomenon is regarded in IPO
context as ‘underpricing’.
Table 6.3: Characteristics of Initial Returns of Indian IPOs
Statistics Raw Return
(RR) (%) Market Adjusted Excess
Return (MAER) (%) Mean 22.90 21.61 Median 12.79 9.45 Std. Deviation 55.35 53.57 Minimum -94.29 -101.78 Maximum 323.50 285.44 N 404 404
Table 6.3 examines the existence of underpricing for the equity issues listed on the
Bombay Stock Exchange during 2003-2012 (for IPO firms relating to year 2001 and
2002, prospectuses could not be procured from all the sources mentioned, so had to be
left out of the sample). Analysis of the initial returns with respect to their statistical
descriptives clearly establishes the existence of underpricing wherein average of both the
raw returns and market returns comes to substantial 22% (approx.) The maximum values
stand at a high of 323% but negative returns bring down the average initial returns to
22.9% (for raw returns) and 21.6% (for market adjusted returns). High values of standard
deviation (more than 50) point out the variations in these listing returns which are also
noted through maximum and minimum values pointing out that Indian IPOs exhibit quite
a variation in their initial returns but are consistent with regards to the phenomenon of
underpricing implying positive initial returns.
An attempt is further made to delve into finer details by taking year of issue into
consideration. Table 6.4 presents the results when sample companies are split as per year
of their issue and their descriptives are studied, categorizing the returns as fair (neither
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
159
underpriced nor overpriced, no returns), positive (underpriced issues) and negative
(overpriced issues). Of the total IPO companies 263 across all years are underpriced
giving positive returns to investors on the listing day while 141 of the 404 IPOs result in
negative returns.
Table 6.4: Summary Statistics of Year-wise IPO Raw Returns
The time which elapses between close of issue and listing date is regarded as the listing
delay wherein it is observed that mean time taken to list by the sample IPOs is 23 days
though for a lone case the time was as long as 404 days. The regulatory regimes and
global practices have worked in reducing this time gap and firms are now attempting to
minimize this listing period and thus the minimum value of 10 days is seen which comes
from IPOs relating to later time periods of the sample. Firms’ standing and experience as
measured through age in years reveals that it is on an average 15 years of existence that
the firms decide to go public. Though instances of very mature (maximum value of 102
years) and too young firms (0.31) are also seen. Total assets of the firm as per the last
financial year preceding the IPO have also been studied to provide for the effect of firm
size. There lies no consistency with regards to total asset base of these firms which is
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
195
noted through high values of standard deviation and huge difference in the minimum and
maximum values. The median value of 120 crores denotes the mid value for sample
indicating the point splitting the sample into two halves. Mean value of 1728 crores
indicates the general trend of firms with larger asset base opting to go public.
Moving on to board structure variables, the mean and median board size stands at 8
indicating the trend of intermediate board size, neither too small nor too big. Sample does
have firm with board as big as 20 members and on the lower size a board size of four is
also observed, the variations being validated by standard deviation of 2. Committees of
the board constituted to assist the board in discharging its functions smoothly and
effectively seem to be governed by the regulatory norms which specify two committees
as compulsory and third one is specified as non-mandatory. IPO firms on an average have
three committees constituted at the time of IPO though the highest value stands at 10.
Variations on this aspect around the mean value of 3 is low indicating inclination to go by
the norms and institute three committees for board’s assistance keeping voluntary aspect
rather low.
Board independence viewed as a dominant aspect of board structures, is investigated
next. Here again, law and regulations have their effect keeping the mean and median
value to 50%. The maximum value of 80 percent signifies a rarity wherein firms induct
larger number of independent directors for greater board quality while the minimum
value of 10 percent highlights the defaulters on this account (relates to an IPO company
of earlier time period when norms were new to land and stricter implementation came
later). Gender diversity and very low number of women directors, as explained at length
in Chapter 5, remains an issue of concern. Maximum number of women directors stands
at three (and that too for a single company of the sample) while minimum is zero into
which a large number of IPOs fall. Low standard deviation and very low mean values
only contribute to confirmation of the fact that women presence on boards is rather
minimal and calls for remedial action. The mean age of board, overall average of age of
individual board members, stands at 52 years indicating an incline for experienced
persons as directors on board. The upper and lower bounds stand at 66 and 33 years
respectively highlighting that very young and very senior directors are not usually
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
196
inducted on boards of young companies seeking to establish their monitoring and
decision making abilities.
Amongst Indian IPOs there is observed a practice of having related family members as
directors where the mean and median values stand at 2. Maximum relatives on one board
was found to be 7 though the information on this variable was missing for many firms (N
here being only 388). Interlocking directorates taken as a measure of board reputation is
also found to be a common practice. A non-executive director was found to have other
directorships as high as 301 which was recorded as the highest value for this variable in
contrast to the minimum value of zero indicating significant variations around the mean,
also as indicated by 33 as standard deviation. Mean holdings of the promoters of the
company stand at a high of 83% with maximum value being just equal to 100 confirming
the pattern of family ownerships and control (which is further strengthened through
appointment of relatives on boards). The shareholdings of all promoters have been
cumulated for this purpose whose values affirm that promoter controlled IPOs is common
sight in Indian markets. The average number of block shareholders (holding more than
10% of total equity) is found to be three which only represents the number of controlling
members and decision makers for IPO firm while the cumulated average holdings of top
10 shareholders stand at almost 93%, both indicating concentrated ownership levels in
the IPO firm. No clues for dispersed ownerships are found in initial investigation and
their impact and implications will be attempted to be sought in next section.
Descriptive statistics as explained above paint an initial rough picture of the variables
under consideration though for their impact and influences on the dependent variable
further investigations have been done. The results of regression analysis have been
presented and explained in the next section.
6.7.3 Regression Results
The present study performs cross sectional regression analysis to explore the impact of
corporate governance measures on the initial underpricing of IPOs in Indian markets the
results for which have been presented in Tables 6.19 and 6.20. Separate regression
models using the variables detailed out in earlier part of this chapter have been run for
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
197
raw returns and market adjusted excess returns. Before running regression analysis, the
models were checked for multicollinearity and heteroscedasticity. The existence of
problem of heteroscedasticity was discovered and to provide for it, White’s
heteroskedasticity Consistent Standard Errors have been used. Multicollienarity was not
an issue of concern as the VIFs (Variance-Inflating Factors) were found to be below 10.
Regression analysis is first done using raw returns as dependent variable and the results
are reported in Table 6.19. In regression analysis, the sample consists of 376 IPOs of the
total of 404 issued during the sample period. The reduced sample size is due to missing
data on estimated dependent and independent variables. In order to explore the
contribution of corporate governance variables in explaining the initial returns and to
segregate this effect from contribution of firm and issue specific variables four separate
regression models have been built. Model 1 includes only the control variables. Model 2
combines the control variables with the board structure components of corporate
governance while Model 3 replaces board composition with ownership variables. These
help to bring out the effects of two broad dimensions of governance and thus compare
their explanatory power. Model 4, the final model, integrates all the control and
governance variables together with the quadratic forms of variables for their plausible
non-linear relationship with dependent variable.
Deriving support from past literature, control variables have been included in the study
for their ability to influence the initial day listing returns and these have been included in
Model 1. These variables overall explain 32% of the total variations in dependent
variable with subscription ratio, issue size and issue price being significant in all four
models. The variable subscription ratio is positive and significant at 1% level of
significance indicating that higher subscription ratio reflects the demand for the issue
which is perceived as a signal of good quality and thus better performance of the issue
and higher returns. This relationship is consistent with Chahine and Tohme (2009) and
Chen and Yang (2013) indicating that investors contemplate this as a measure of firm’s
ability to garner higher demand based on its credentials. Issue size also regarded as offer
size reflects a negative and statistically significant relationship to underpricing leading to
the inference that firms with larger issue size are less underpriced in contrast to those
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
198
having a smaller issue. These findings lie in line with observations made by Hearn (2013)
in Sub Saharan Africa and Li (2005) in Chinese IPO market which confirm that firms
with larger offerings contribute to diluting the uncertainties and extenuating the
apprehensions of investing community. Certo et al. (2001a), however, have empirically
proven positive relationship of offer size to underpricing (for developed and mature IPO
markets of USA) which can be attributed to differences in institutional set ups and
maturity of the markets. Issue price (transformed as its inverse to better decipher the
relationship) shares a positive significant relationship with underpricing contradicting the
findings of Li (2005) and Be’dard et al., (2008). The findings here seem to suggest that
the price at which a firm offers shares is perceived as inherent ability of the firm to
command premium for its issue and only firms with stronger credentials can dare to price
its product in higher grade which works in addressing the uncertainties of investors.
Thus, higher issue price results in lesser costs associated with information asymmetry and
agency and as a result firms underprice less than otherwise they do to compensate their
investors for risks which they associate with firm and their issue.
Listing delay which measures the lapse between issue and listing dates gives no
significant results and the findings are found to be in sync with the findings with regards
to Chinese IPO market (Li, 2005 and Ching-Yi Lin, 2005). The negative sign of the
listing delay coefficients leads to conclusion that longer gap in listing results in lower
underpricing possibly because the gap helps investors to bridge the gaps in information.
Natural logarithmic transformations of age of the firm and total assets have been
incorporated in the model as other control variables and both of these are found to be
insignificant though opposite in direction of relationship. The coefficients for IPO age are
positive in all models sharing consistency with relationships found by Mitchell et al.
(2008) in Singapore, Mnif (2010) in France, Yatim (2011) in Malaysia and Hearn (2012)
in Sub Saharan Africa suggesting that firms with longer standing in markets tend to
dispel the apprehensions and uncertainties of investors but this lacks statistical
significance. Results for total assets show negative association with underpricing across
all models but this association lacks significance which is supported by previous findings
highlighting same nature of relationship (Ching-Yi Lin, 2005; Be’dard et al., 2008;
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
199
Hearn, 2011; Chen and Yang, 2013). Larger asset base of the issuing firm has been found
to be reducing the extent of underpricing amongst the Indian firms.
Of the six firm variables incorporated in the multiple regression model, subscription ratio,
issue size and issue price are found to be statistically significant across all models. The
model with these variables is found to be robust making the regressions meaningful and
reliable. On the same lines, these variables are regressed with market adjusted excess
returns as dependent variable and the results obtained are similar to those with raw
returns which have been presented in Table 6.20. Model 1 in Table 6.20 is also robust
and explanatory power of these variables is again 32% reflecting that results are akin to
unadjusted returns of listing day. For MAER, the relationship of these control variables
lie in the same direction and share same statistical significance and thus are governed by
the logical support provided above.
Moving on to the variables of interest, corporate governance attributes which form the
focus of study are studied in next models. The governance attributes have been studied as
those relating to board structures and others dealing with ownership measures. To bring
out their effects and sift out the influence of each, these have been introduced in separate
models with control variables. Model 2 includes board composition attributes along with
the control variables while Model 3 replaces the board components with ownership
measures. Results are overall found to be robust across all models as suggested by the
statistically significant F-values.
Board size, introduced as an important component of board structures is found to be
significant and positive in Model 2 and in the cumulative Model 4. This signifies that
board size is an important consideration for investors in India. From the market’s point of
view, investors may perceive a large board as a signal of high degree of monitoring and
effective decision making and intention of firms to protect the interests of shareholders
by appointing more members on firm’s board. Within the signaling theory framework,
this also signifies that high-quality IPO firms may choose larger boards to communicate
its quality and credibility to potential investors. This relationship finds its support from
the works of Li and Naughton (2007), Mnif (2010) and Hearn (2011) lying in
contradiction to Carter et al. (1998a), Certo et al. (2001a), Darmadi and Gunawan (2012).
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
200
Table 6.19: Relationship between Corporate Governance Measures and Initial Unadjusted Returns
Independent Variables Model 1 Model 2 Model 3 Model 4
Constant 31.704
(2.044)** -20.883 (-0.778)
75.091 (1.283)#
7.214 0.106
Subscription Ratio 1.167
(11.568)*** 1.106
(11.269)*** 1.196
(11.224)*** 1.142
(11.064)***
Log (Issue Size) -7.059
(-2.190)** -7.314
(-2.303)** -7.968
(-2.360)*** -8.566
(-2.547)***
1/Issue Price 509.105
(2.383)*** 427.342
(2.056)** 530.750
(2.470)*** 450.280
(2.200)**
Listing Delay -0.0163 (-0.072)
-0.038 (-0.174)
-0.018 (-0.080)
-0.038 (-0.179)
Log (IPO Age) 4.744
(0.5580) 10.609
(1.436)# 6.201
(0.720) 11.534
(1.407)#
Log (Total Assets) -2.104
(-1.028) -2.489
(-1.241) -1.635
(-0.799) -2.162
(-1.079)
Board Size 2.217
(2.147)**
2.775 (2.768)***
Board Committees 78.705
(3.147)***
77.125 (3.117)***
Independent Directors 0.2428
(1.1057)
0.315 (1.407)#
Women Directors -2.217
(-0.4575)
-3.600 (-0.696)
Average Age of Board 0.0452
(0.1009)
0.183 (0.4022)
Related Board Members -1.924 (1.388)
-2.271
(-1.499)
Other Directorships 0.0523 (1.046)
0.055
(1.076)
Promoter Ownership 2.131
(2.805)*** 2.364
(2.904)***
Block Shareholders -1.391
(-0.663) -0.168
(-0.079)
Top 10 Ownership -3.310
(-2.561)*** -3.661
(-2.659)***
Promoter Ownership Squared -0.014
(-2.663)*** -0.016
(-2.742)***
Top 10 Ownership Squared 0.022
(2.687)*** 0.025
(2.865)***
R2 0.3337 0.3511 .3442 .3743
Adjusted R2 0.3234 0.3278 .3318 .3427
Number of Observations 395 377 394 376
F Statistic 32.392*** 15.107*** 18.744*** 11.864***
Note: One*, two** and three asterisks*** indicate statistical significance at the level of 10%, 5% and 1%, respectively. T-statistics are provided in the parentheses.
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
201
Table 6.20: Relationship between Corporate Governance Measures and Initial Market Adjusted Excess Returns
Independent Variables Model 1 Model 2 Model 3 Model 4
Constant 30.426
(2.010)** -18.765 (0.707)
75.625 (1.320)
10.475 0.159
Subscription Ratio 1.135
(11.739)*** 1.082
(11.343)*** 1.161
(11.444)*** 1.114
(11.191)***
Log (Issue Size) -5.991
(-1.910)** -5.834
(-1.925)** -6.777
(-2.066)** -6.930
(-2.173)**
1/Issue Price 495.783
(2.376)*** 435.751
(2.176)** 517.046
(2.455)*** 458.827
(2.323)**
Listing Delay -0.075
(-0.368) -0.094
(-0.478) -0.076 (0.380)
-0.094 (-0.491)
Log (IPO Age) 4.502
(0.538) 10.492
(1.461)# 5.911
(0.695) 11.456 (1.569)
Log (Total Assets) -2.563
(-1.277) -2.994
(-1.542)# -2.147
(-1.070) -2.716
(-1.403)
Board Size 1.692
(1.682)**
2.211 (2.264)**
Board Committees 70.193
(2.768)***
68.586 (2.759)***
Independent Directors 0.239
(1.092)
0.308 (1.378)
Women Directors -2.032
(-0.432)
-3.264 (-0.652)
Average Age 0.053
(0.123)
0.183 (0.412)
Related Board Members -1.629
(-1.200)
-1.942 (-1.311)
Other Directorships 0.048
(0.969)
0.051 (0.995)
Promoter Ownership 1.892
(2.540)*** 2.106
(2.646)***
Block Shareholder Ownership -1.044
(-0.518) 0.141
(0.070)
Top 10 Ownership -3.144
(-2.489)*** -3.429
(-2.543)***
Promoter Ownership Squared -0.013
(-2.424)*** -0.014
(-2.508)***
Top 10 Ownership Squared -0.021
(2.613)*** 0.023
(2.740)***
R2 0.3357 0.3506 0.3506 0.3713
Adjusted R2 0.3254 0.3273 0.3318 0.3395
Number of Observations 395 377 394 376
F Statistic 32.595*** 15.034 18.695*** 11.680***
Note: One*, two** and three asterisks*** indicate statistical significance at the level of 10%, 5% and 1%, respectively. T-statistics are provided in the parentheses.
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
202
The findings find theoretical support in the propositions of Pfeffer (1972) based on
resource dependency theory. In Indian markets, therefore, larger board size is used as a
signal and is perceived as a positive signal by investors thus drawing them towards the
new issue. It, however, can also be conjectured that larger boards act to reduce
coordinative efficiency and effective communication between directors and accentuate
the problem of asymmetric information and agency issues which is reflected in higher
underpricing.
Board committees constituted for effective decision making and enhancing the
effectiveness of boards are also found to have a highly significant (at 1% level of
significance) and positive association with the dependent variables (both raw returns and
market adjusted excess returns). The investigation of board committees as a component
of governance mechanism and its relationship to initial underpricing is rather limited in
literature and thus calls for more empirical efforts. Findings here, however, are in line
with results of Hearn (2011 and 2012) which relate to African markets. From signaling
perspective, the number of board committees do work as signals for new issue firms, in
the light that larger number of committees reflects the voluntary initiatives by firms as
regulations specify two committees as mandatory and third as non-mandatory. Increase in
quantum of underpricing with larger number of board committees, on the other hand, also
can be taken to indicate shortcomings in application of corporate governance
mechanisms. As Hearn (2011) explains that establishment of committees being deemed
superfluous and tend to lack in genuine independence. His explanations tend to hold true
for world markets marked by weak levels of legal enforcement and Indian markets have
provided many reasons to be a fit case for it. Board independence or proportion of
independent directors is next pertinent attribute of corporate governance which has been
included in many studies only to provide equivocal results. Percentage of independent
directors has a positive association with level of underpricing as measured on listing day
though this relationship does not have statistically significance. Board independence does
not seem to be adopted as an indicator of issue quality by the investors in Indian IPO
market which may be because board independence remains a contentious issue more so
in the light of serious corporate gaffes in the recent past. Denis and McConnell (2003)
and Dahya and McConnell (2005) had proven that higher proportion of outside directors
Relationship Between Corporate Governance Variables and Listing Performance of Indian IPOs
203
does not assure better performance. Li and Naughton (2007) and Yatim (2011) also found
the positive but insignificant impact of board independence on IPO underpricing in the
markets chosen for study. Gender diversity on boards has not been directly investigated
with regards to IPO underpricing and thus support on this account is almost non-existent.
It is expected that more women on boards would imply adding more sensitivity to
corporate issues and this is expected to contribute to effectiveness and thus reduce
underpricing. The coefficient for percentage of women directors is negative implying that
higher percentage of women tends to decrease levels of underpricing and vice versa but
lack of statistical significance of the coefficient does not leave the issue settled. For
Indian markets, women directors does not qualify as a signal of monitoring though it
could be because of women being a rare sight on boards and thus investors not attaching
value to this parameter in their investment decision.
Age of board members is also expected to have an influence on monitoring capabilities of
the new issue firms and thus on pricing performance of IPOs. The variable is found to be
insignificant across both Model 2 and Model 4 refuting its role as important governance
attribute and its effect on underpricing, the dependent variable as checked for by Wu and
Hsu (2012) only to be found insignificant. Positive direction of relationship, though,
points out that younger boards result in lower underpricing levels indicating that mature
boards are taken as indicators of good quality of board and firm’s potential to perform.
The variable has hardly been covered in the governance attributes in earlier research
works on the subject and thus calls for comprehensive and thorough analysis in the light
of non-existent literature and insignificance of coefficients. Related board members does
constitute an essential attribute in study of board structures given the practice of family
controlled businesses resulting in family dominated boards, especially in Indian settings.
Lack of research in Indian context on specific issue of governance and underpricing
leaves this as an untouched dimension of governance literature. The coefficient for
related members is negative though only loosely significant (in Model 3 at 20%)
signifying that larger number of relatives on boards tends to reduce quantum of
underpricing providing support for alignment of interests hypothesis in contrast to
entrenchment tendencies. The lack of statistical validity of these results, however, does
not enable reaching a firm conclusion.
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Board reputations measured through interlocking directorships of non-executive directors
is found to be positively related to underpricing consistent to the results of Yatim (2011).
This seems to be also supporting the argument of Filatotchev and Bishop (2002) who
argued that outside board memberships create a negative impact on the investors’
assessment of firm quality although insignificance of these coefficients fail to lend
complete support to the argument. These findings stand in contrast to conclusions drawn
by Thorsell and Issakson (2014) which prove a positive and significant relationship
between interlocking directorates and underpricing for Sweden IPOs. Model 2 including
board structure variables is a statistically significant model and explains almost 33
percent of the quantum of underpricing. Amongst these variables board size and board
committees are found to be significant providing explanations to the phenomenon and
support the behavior of this pricing anomaly with the help of signaling theory and related
agency and information asymmetry hypotheses. The contribution of board variables to
the model when checked through the adjusted R2 is very negligible (0.44 percent increase
in adjusted R2) indicating that to Indian investor board composition does not seem to
matter much.
For MAER as dependent variable, the adjusted R2 value is almost the same as for raw
returns and the relationship of individual variables to the adjusted underpricing shows no
difference to the patterns observed for raw returns. Model 2 in Table 6.20 denoting
control and board structure variables is significant and robust with N standing at 377
IPOs. When compared to the raw returns model the contribution of board variables is a
notch lower (0.20 percent increase in value of R2 from the value in Model 1). The
justifications and supports built for RR model hold true for regressions run with MAER
as the results do not come up with any remarkable differences in direction and nature of
relationships. The conclusion that board variables do not qualify as significant explainers
to underpricing phenomenon and negligible consideration by investors while making
their investment decision stand very much true here also.
Model 3 introduces the ownership variables, other component of governance methods
together with the control variables. Ownership by promoters is included as a measure of
family ownership by the founders of the concern which is likely to impact performance of
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IPOs under the influence of family interest protection (Shleifer and Vishny, 1997) and
alignment of interests (Fama and Jensen, 1983) hypotheses. With the clues of
operationalization of both these hypotheses and in accordance with Chahine (2004)
efforts to check non-linearity of promoter ownership have been made through
introduction of the square term. The significance of coefficients at 1% level of
significance for promoter ownership and its squared term confirm the existence of non-
linear relationship of this ownership attribute to underpricing. The significant coefficients
highlight the signaling potential of this ownership variable confirming that investors do
discount this attribute while putting in their money into a new issue. The curvilinear
relationship explains that increasing ownership levels do address the concerns of
information asymmetry and associated uncertainties but at higher levels of family
ownership the concerns for entrenchment and sacrificing general interests for self-
interests start dominating. Other two ownership measures relate to concentrated
ownership expressed through block shareholders and total shareholding of top 10 owners.
These again are largely governed by the two hypothesis mentioned above. Howton et al.
(2001), Fan et al. (2007) and Hearn (2012) proved the existence of negative relationship
of measures of ownership concentration with underpricing and same has been observed
for the present study. The negative relationship between underpricing and levels of block
shareholders provides some indication of the role of block holders in corporate
governance and its enforcement within firms in countries with weaker levels of investor
protection. However, not being statistically significant the relationship does not lead to a
concrete conclusion on this account. Total shareholding of the top 10 shareholders of the
IPO firm, a reflection of extent of concentrated ownership levels, shares a large, negative
and statistically significant relationship at 99% confidence level and remains strongly
significant for the square term as well confirming the existence of non-linear relationship.
The results find support in the findings of Chen and Yang (2013) in Chinese markets
though the results there lacked statistical significance. The exploration of this measure
holds higher eminence for Indian markets where family controlled firms and concentrated
ownership patterns are pervasive. The results confirm the role of ownership patterns in
mitigating information asymmetry and diluting the concerns of uncertainty dominant
among potential investors. Though this relationship does not confirm linearity indicating
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that with higher ownership concentration underpricing does decrease but after a point it
starts working in opposite direction indicating that beyond a level the concentrated trends
of ownership accentuate new issue problems and hence larger extent of underpricing.
Ownership variables when regressed against the MAER as shown in tabulations in Table
6.20 also confirm significance of promoter ownership and cumulative ownership of top
10 shareholders at 1% significance level and evidence of quadratic relationship of these
variables to underpricing levels. The model confirms to test of robustness and gives
results for the sample size of 394. Overall, the results in no way contradict the findings
noted with respect to raw returns rather corroborate the results showing that market
movements have not been very drastic on either side to bring changes to variables, their
coefficients and significance of these coefficients. Model 3 and its variables, i.e. the
control and ownership variables together explain 33.18% variations (with both RR and
MAER) which is higher than the explanatory power of model with board structure
variables (which was 32.7%). When analyzed for individual effects, the influence of
ownership variables is higher and stronger than board structure variables though the
difference lies of a few basis points only.
To build a comprehensive model and to reflect the aggregate effects of corporate
governance attributes Model 4 is constructed where all corporate governance variables
together with the controls identified have been introduced. The regression model is found
to be a good fit at 99% confidence and qualifies the tests of robustness. The adjusted R2
value of 0.34 (for both RR and MAER) shows that the variables explain 34% of
variations in the model which is better in its explanatory power when compared to
previous literature reportings (Certo et al., 2001a; Filatotchev and Bishop, 2002; Mnif,
2010; Chahine et al., 2011; Hearn, 2011; Yatim, 2011; Wu and Hsu, 2012; Darmadi and
Gunawan, 2012) where the reported R2 was maximum 20% for regression models
employing governance attributes to explain underpricing levels for different economic
and institutional settings. The overall conclusion, however, which resonates in majority
of the past findings remains that the explanatory power of governance mechanisms with
regards to initial pricing performance remains low the reasons for which need to be
further explored in respect of different market set ups for concrete inferences.
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6.8 CONCLUSION
The primary purpose of this chapter is to study the relationship of listing day
underpricing with the corporate governance attributes of IPO firms when they go public.
Explanations to the underpricing phenomenon which have been diverse and
comprehensive in literature yet equivocal are sought through corporate governance
mechanisms which the firm puts in place at the time of reaching out to the investors.
Investigations made in the study confirm the existence of underpricing regarded as an
anomaly necessitating the need for understanding the reasons from newer perspectives.
IPO investors garner positive returns on listing day indicating mispricing of the securities
in the light of their market performance. Evident diminution in severity of underpricing is
noticed over the years in the quest for efficient markets in the wake of global
competition. Probing the differences in structuring of firms with positive and negative
returns, no differences are noticed across governance attributes. This indicates that
positive and negative return firms do not differ on account of their board structures and
ownership patterns rather differences lie in other factors which can be dug into through
separate explorations. In finding explanations to underpricing using governance
mechanisms, board size comes out as a significant variable confirming as a signal to
investors of the firm quality. The results also indicate a tendency of larger boards to result
in higher underpricing which creeps up from coordination problems resulting in increased
costs. Board committee is the only other board variable which presents explanations to
high initial returns with the logic of working as a signal for investing community.
Positive relationship of this variable to underpricing also raises doubts as to lacking
genuine independence especially in Indian contours which are proven to be characterized
by weak governance. Results confirm to a non-linear relationship shared by promoter
ownership and ownership by top 10 owners w.r.t. initial returns of IPOs. The signaling
potential of these ownership variables is confirmed highlighting that ownership and
control of new issue firms is an important consideration for the investors when taking the
investment decision. Another fact which surfaces from these results is that higher
ownership with the promoters does dispel uncertainty and problems of information
asymmetry but at higher levels tendencies of entrenchment of interests become evident.
Findings confirm to tendencies of concentrated ownerships in Indian markets but at
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208
higher levels of concentration underpricing tends to increase in contrast to that at lower
levels. These confirm that both alignment of interest and entrenchment hypothesis work
in conjunction at different levels of ownership with their allied benefits and costs in terms
of initial returns.
The regression models stand the tests of robustness and confirm to past findings. On the
whole, models incorporating governance parameters explain 34% of variations in initial
returns of the IPOs as on listing day. A major portion of this variability is, however,
attributed to control variables introduced on the lines of past literature. Corporate
governance measures have a miniscule contribution (only 2%) indicating the emphasis
and attention on these dimensions in initial offers is not enough and thus investors do not
incorporate these as a major consideration in their investment decision. There is
confirmation of the fact that these do qualify as signals which are frantically resorted to at
the time of IPO by the issuers but need is to integrate these into decision criteria by
emphasizing on governance both in letter and spirit. Explanatory power of these
governance measures can definitely be enhanced when governance parameters evolve as
distinguishing criteria amongst firms and investors realize their worth and their potential
to help a firm perform better. Better governed IPOs should definitely perform better and
this realization on the part of Indian investors can add to the eminence of governance
mechanisms as effective signals and evolve as a basis for better performance.