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Information content of IPO grading

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  • Deb, Saikat Sovan
  • Marisetty, Vijaya B.
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    Abstract

    In the year 2007, Indian capital market regulator-SEBI, introduced a unique certification mechanism for IPOs whereby all IPOs have to undergo mandatory quality grading by independent rating agencies. In this paper we argue that such objective, independent and exogenous certifying mechanism provides a better opportunity to test the well established certification hypothesis, especially in the context of emerging markets with institutional voids. Using a sample of 163 Indian IPOs we test the efficacy of IPO grading mechanism. We find, grading decreases IPO underpricing and positively influences demand of retail investors. Grading reduces secondary market risk and improves liquidity. However, grading does not affect long run performance of the IPOs. IPO grading successfully capture firm size, business group affiliation and firm's quality of corporate governance. Our findings imply that, in emerging markets, regulator's role to signal the quality of an IPO contributes towards the market welfare.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 34 (2010)
    Issue (Month): 9 (September)
    Pages: 2294-2305

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    Handle: RePEc:eee:jbfina:v:34:y:2010:i:9:p:2294-2305

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    Web page: http://www.elsevier.com/locate/jbf

    Related research

    Keywords: Initial public offering (IPO) Underpricing IPO grading Certification hypothesis;

    References

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    1. Allen, Franklin & Faulhaber, Gerald R., 1989. "Signalling by underpricing in the IPO market," Journal of Financial Economics, Elsevier, vol. 23(2), pages 303-323, August.
    2. Sherman, Ann E, 2000. "IPOs and Long-Term Relationships: An Advantage of Book Building," Review of Financial Studies, Society for Financial Studies, vol. 13(3), pages 697-714.
    3. Koh, Francis & Walter, Terry, 1989. "A direct test of Rock's model of the pricing of unseasoned issues," Journal of Financial Economics, Elsevier, vol. 23(2), pages 251-272, August.
    4. Beatty, Randolph P. & Ritter, Jay R., 1986. "Investment banking, reputation, and the underpricing of initial public offerings," Journal of Financial Economics, Elsevier, vol. 15(1-2), pages 213-232.
    5. Engelen, Peter-Jan & van Essen, Marc, 2010. "Underpricing of IPOs: Firm-, issue- and country-specific characteristics," Journal of Banking & Finance, Elsevier, vol. 34(8), pages 1958-1969, August.
    6. Welch, Ivo, 1989. " Seasoned Offerings, Imitation Costs, and the Underpricing of Initial Public Offerings," Journal of Finance, American Finance Association, vol. 44(2), pages 421-49, June.
    7. Dewenter, Kathryn & Novaes, Walter & Pettway, Richard H, 2001. "Visibility versus Complexity in Business Groups: Evidence from Japanese Keiretsu," The Journal of Business, University of Chicago Press, vol. 74(1), pages 79-100, January.
    8. Chemmanur, Thomas J. & Paeglis, Imants, 2005. "Management quality, certification, and initial public offerings," Journal of Financial Economics, Elsevier, vol. 76(2), pages 331-368, May.
    9. Ritter, Jay R, 1991. " The Long-run Performance of Initial Public Offerings," Journal of Finance, American Finance Association, vol. 46(1), pages 3-27, March.
    10. Amihud, Yakov, 2002. "Illiquidity and stock returns: cross-section and time-series effects," Journal of Financial Markets, Elsevier, vol. 5(1), pages 31-56, January.
    11. Mark Grinblatt & Chuan Yang Hwang, . "Signalling and the Pricing of Unseasoned New Issues," Rodney L. White Center for Financial Research Working Papers 01-89, Wharton School Rodney L. White Center for Financial Research.
    12. Lin, Ji-Chai & Lee, Yi-Tsung & Liu, Yu-Jane, 2007. "IPO auctions and private information," Journal of Banking & Finance, Elsevier, vol. 31(5), pages 1483-1500, May.
    13. Mantecon, Tomas & Poon, Percy, 2009. "An analysis of the liquidity benefits provided by secondary markets," Journal of Banking & Finance, Elsevier, vol. 33(2), pages 335-346, February.
    14. Titman, Sheridan & Trueman, Brett, 1986. "Information quality and the valuation of new issues," Journal of Accounting and Economics, Elsevier, vol. 8(2), pages 159-172, June.
    15. Rajan, Raghuram & Servaes, Henri, 1997. " Analyst Following of Initial Public Offerings," Journal of Finance, American Finance Association, vol. 52(2), pages 507-29, June.
    16. Lee, Peggy M. & Wahal, Sunil, 2004. "Grandstanding, certification and the underpricing of venture capital backed IPOs," Journal of Financial Economics, Elsevier, vol. 73(2), pages 375-407, August.
    17. Bradley, Daniel & Chan, Konan & Kim, Joonghyuk & Singh, Ajai, 2008. "Are there long-run implications of analyst coverage for IPOs?," Journal of Banking & Finance, Elsevier, vol. 32(6), pages 1120-1132, June.
    18. Chemmanur, Thomas J, 1993. " The Pricing of Initial Public Offerings: A Dynamic Model with Information Production," Journal of Finance, American Finance Association, vol. 48(1), pages 285-304, March.
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    Cited by:
    1. Neupane, Suman & Poshakwale, Sunil S., 2012. "Transparency in IPO mechanism: Retail investors’ participation, IPO pricing and returns," Journal of Banking & Finance, Elsevier, vol. 36(7), pages 2064-2076.
    2. Jacob, Joshy & Agarwalla, Sobhesh Kumar, . "Mandatory IPO Grading: Does it Help Pricing Efficiency?," IIMA Working Papers WP2012-12-07, Indian Institute of Management Ahmedabad, Research and Publication Department.

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