ANALYSIS OF FACTORS INFLUENCING UNDERPRICING LEVEL DURING THE INITIAL

PUBLIC OFFERING: A STUDY OF SELECT COMPANIES GOING PUBLIC IN BOMBAY STOCK

EXCHANGE

Dr. Mahesh R.
MBA, Ph. D.,
Associate Professor, DOS in Business
Administration, University of Mysore,
Karnataka
Email: maheshrajgopal@yahoo.com
Mob No: 09886639536

Ms. Melyawaty S. D.
MBA,
Administrative Officer, On Track Wealth
Service and Wealth Axis, Indonesia
Email: melya.bluerose@gmail.com &
s.melyawaty@yahoo.com

ABSTRACT



















Keywords: Under-pricing, Debt to Equity Ratio, Return on Assets, Earning per Share, Company size,
Company Age, and Initial Public Offer

JEL Classification Code: G10, G20, G23, G24

Introduction
Initial Public Offering is expected to make a better prospect for the company for the expansion being
done. The betterment of the future prospect of the corresponding company will increase the share price.
Performance of the company before IPO is the information for the investors about the progress the company
could make after the IPO. Investors expectation is that the companys performance after IPO could be even
better.
The problem which often arises from IPO is under-pricing which indicates that the price of the share
during the IPO is relatively lower than the price of the share when traded in the secondary market. When a
company is going for an IPO, the share price which is sold in the primary market is determined on the
agreement between the company which is going for listing and the underwriter, while the price in the
secondary market is determined by the existing market mechanism through the demand and supply of the
shares in the capital market. If the determination of share price on the IPO is significantly lower than the price
in the secondary market on the first day of listing, then we could say that the share is under priced (Kim,
Krinsky, and Lee, 1995).
This condition could happen because the company which is going for listing for the first time and the
underwriter together arrange for an agreement in deciding the price of the initial share but both of the parties
are having different necessity to be fulfilled. As the party who needs more funding, the company wants a high
initial share price as high price will generate expected fund, but it is not the same for the underwriter.
Underwriters will try to minimize the risk by determining the price which is reasonable for the investors. By
deciding on a relative price which is acceptable by the investors, underwriters expect to sell all the shares
which come under its guarantee.
Underpricing condition creates loss for the companies which are going public because the fund
obtained will not be in the maximum level. On the contrary, if there is an overpricing condition, then investors
Under-pricing is the condition of the pricing of an initial public offering (IPO) which
is below its market value. When the offer price is lower than the price of the first trade, the stock is
considered to be under-priced. A stock is usually only under-priced temporarily because the laws of
supply and demand will eventually drive it toward its intrinsic value.
The objective of this research is to analyse the variables (factors) that affect the under-pricing
level in the companies listed in the Bombay Stock Exchange based on the CRISIL rating for the period of
2007-2011. Those factors are categorized into two parts financial and non-financial factors. The
financial factors are Debt Equity Ratio, Return on Asset, and Earnings per Share. The Non-financial
factors in this study are the data of Company size, Company Age, and Net-Issue of the Shares to the
Public. During that 5-year period, there are 27 companies which fulfil the criteria for the study of
under-pricing issue.
This study is using Generalized Linear Model (GLS) of Multiple Regression and it could be
concluded that in this case none of the factors being analysed has positive significant effect towards the
under-pricing level.
All the variables being under study are not having any influence towards the under-pricing
level. In other words, the under-pricing level of these companies which are studied under specified time
and selection criteria are not determined by all those factors.

will be the party who lose because they will not get positive initial return. Initial return is the profit that the
shareholders get on the margin between the shares purchased in the primary market and the shares sold in the
secondary market. The company owners will try to minimize underpricing situation because underpricing will
cause transfer of wealth from owner to investors (Beatty, 1989).
Study on the underpricing level and the price of the shares which is connected to the information on
the prospectus is an interesting subject for a financial researcher to evaluate investors behavior empirically in
taking investment decision in the capital market. Previous researches regarding to financial and non-financial
information towards initial return or underpricing have been done extensively in various stock exchanges all
over the world but study on this issue is still considered an interesting venture as there has been inconsistency
in the findings of the research and most of the studies are focused on the non-financial information while there
is possibility that financial information such as financial ratios could affect the underpricing level as well.

Objectives
The objectives of this study in analyzing the factors affecting the underpricing level of the companies going
for Initial Public Offering are as follows:
To understand what an IPO is and the mechanism to apply for an IPO in Indian Market
To acquire a basic knowledge in understanding the methods used in determining the IPO price.
To analyze the significant level of the factors influencing the underpricing level of a companys initial
return after the IPO. The factors analyzed in this study are:
a. Debt Equity Ratio
b. Earnings per share
c. Return on Investment
d. Size of the company
e. Age of the company
f. Net Issue (Percentage of shares issued) to the public

Research Hypotheses
1. H1: DER has positive significant effect towards the level of under-pricing.
2. H2: ROA has negative significant effect towards the level of under-pricing.
3. H3: EPS has negative significant effect towards the level of under-pricing.
4. H4: Age of the company has negative significant effect towards the level of under-pricing.
5. H5: Size of the company has negative significant effect towards the level of under-pricing.
6. H6: Share offering percentage to the market has negative significant effect towards the level of under-
pricing.

Scope of the Study
The scope of the study is limited to the analysis of the companies performance of past 5 years which
have been listed in the stock exchanges.
The study will be conducted for different ratings given to the IPO (IPO rating) based on CRISIL
(Credit Rating Information Services of India Limited).
CRISIL rating which is used in this study is the rating of 1 to 5, which indicates as follows:
IPO grade 1: Poor fundamentals
IPO grade 2: Below-average fundamentals
IPO grade 3: Average fundamentals
IPO grade 4: Above-average fundamentals
IPO grade 5: Strong fundamentals
The companies analysed are taken from the national level stock exchanges instead of the regional stock
exchanges.

Research Methodology
The research methodology use in this study is analytical and exploratory research. Historical data
which has been collected will be used to develop the research and to make inferences about the factors
affecting the condition of under-pricing in the companies being under study.
Analytical Research is the method used when the researcher has to use facts or information already
available, and analyze these to make a critical evaluation of the material.
Exploratory Research is investigation into a problem or situation which provides insights to the
researcher.

Sampling Technique
Sampling techniques employed for this research study will be Deliberate Sampling as it will be
chosen as per the CRISIL rating criteria without any further stratification in the sample classification.

Sample Selection
The selection of the samples in this research will be selecting ten (10) companies representing each
rating in the IPO Rating by CRISIL.

Data Collection
A list of companies which had gone public in India from 2007 2011 would be obtained from
websites providing IPO details and stock market performance.

Data Analysis
Corresponding factors which are believed to be part of the significance in the underpricing condition
will be obtained and regressed to see if there is statistically any correlation between each of those factors
toward the underpricing level of the IPO. Multiple Regression technique would be used for the data analysis
process.

Limitation
The study shall focus only on the selected companies for the period of 5 years in Indian context with
the highest capitalization based on the IPO ratings and not other than those due to the limited time.
The study will not analyze the other companies valuation techniques and the correlation with the
pricing condition and hence it might not reveal the true inference of the overall analysis.

Literature Review
Ardiansyah (2004), in his research paper explains that EPS and economic condition have significant
effect towards initial return and return of 15 days post IPO. Financial leverage has significant effect towards
15 days post IPO return. Companys size effect towards initial return and return of 15 days post IPO could not
be decided.
Beatty 1989, explains that certain auditors reputation, underwriter reputation, age, kinds of contract
have significant negative association with initial return. While share allocation percentage and indicators and
certain auditors reputation have significant positive association with initial return.
Chandradewi (2000), in her article reveals that simultaneously all independent variables have
significant effect on share price, while EPS has significant effect on share price partially.
Christy (1996), indicates that Underwriters competition has negative relation with return of 15 days
post IPO. Standard deviation of return, and companys age have positive relation to the return of 15 days post
IPO. The rest of the variables do not have significant relation toward return of shares of 15 days post IPO.
Daljono (2000), in his article says only underwriters reputation and financial leverage have
significant effect on initial return.
Durukan (2002), in his research paper illustrates that company size and share issuance methods have
significant negative effect on initial return while age has significant positive effect towards initial return. The
other variables do not have any significant effect.
Imam Ghozali, in his article indicated that ROA has significantly negative effects towards the level
of underpricing at significant level 5%, while underwriter reputation & financial leverage has significant
negative effects to underpricing at significant level 10%. The rest of the variables do not have significant
effects.
Kim, Kish & Vasconcellos (2002), in their research paper reveal that share issuance method, beta
risk, subscription have significant positive effect towards initial return. Share allocation percentage,
underwriters quality, new share substitute and premium have significant negative relation towards initial
return. While size, age, shares standard error, risk free interest rate, dilution and covariance do not have any
significant effect.
Trisnawati (1999), in his article say companys age is positively related to initial return and financial
leverage is positively related to return of 15 days post IPO.
Yolana and Martani (2004), in their article examine Index and ROE have significantly positive
effect toward initial return. Type of industry, companys size has significantly negative effect towards initial
return. Underwriters quality does not have any significant effect towards initial return.

Techniques Of Analysis
Hypotheses testing in this study has been done in multiple regression model in order to have overall
picture about the influence among dependent variable (under-pricing) and the independent variables (ROA,
DER, EPS, age of the company, size of the company, and percentage of share allotment to the public by the
company). In order to fulfill the requirements to get good regression analysis, it would be necessary to test if
there are any violations toward the Classical Test Assumption.

1. Classic Test Theory (CTT)
Classical test theory (CTT) has been the foundation for measurement theory for over 80 years. The conceptual
foundations, assumptions, and extensions of the basic premises of CTT have allowed for the development of
some excellent psychometrically sound scales. Classical theory may be regarded as roughly synonymous with
true score theory. Generally speaking, the aim of classical test theory is to understand and improve the
reliability of psychological tests. The Classic Test Theory being used in this study is as follows:
a. Normality Test
In statistics, normality tests are used to determine whether a data set is well-modeled by a normal
distribution or not, or to compute how likely an underlying random variable is to be normally
distributed. The test being used in order to see the normality of the data is Kolmogorov-Smirnov (K-
S) test. The K-S test is distribution free in the sense that the critical values do not depend on the
specific distribution being tested. The hypothesis would be:
H
0
: The data follow a specified distribution.
H
a
: The data do not follow the specified distribution.
The distributed data is showing that the significant level is greater than 0.05 with the regression plot
as follows:

Chart 1


Table 1
One-Sample Kolmogorov-Smirnov Test
UP Ratio
N 27
Normal Parameters
a,b
Mean .3733
Std. Deviation .44070
Most Extreme Differences Absolute .215
Positive .215
Negative -.198
Kolmogorov-Smirnov Z 1.116
Asymp. Sig. (2-tailed) .165
a. Test distribution is Normal.
b. Calculated from data.

This normality test is indicating that the distribution of the residual data is already not perfectly normal. This is
shown by the PP Plot which is showing that the individual data (dots) are deviating from the diagonal line. It
indicates that there is no huge anomalies from the distributed data to the expected distribution of the data but
the anomalies are quite significant. Other than that, the Kolmogorov-Smirnov test is giving the value of 1.116
which is greater than the table value of 0.22898 (with alpha = 5% and N = 27). Since the calculated value
(1.116) is greater than the table value (0.22898), the null hypothesis is rejected which means that the data is
not normally distributed.

b. Multicollinearity Test
Multicollinearity is a statistical phenomenon in which two or more predictor variables in a multiple
regression model are highly correlated. In this situation the coefficient estimates may change erratically in
response to small changes in the model or the data. Basically there are two way of detecting multicollinearity
in data being studied, which are:
a. computing correlations between all pairs of predictors. If some R are close to 1 or -1, remove one of the
two correlated predictors from the model.
b. calculating the Variance Inflation Factors (VIF) for each predictor in the data. This could be done by :


Where R
2
is the coefficient of determination of a regression of explanator j on all the other
explanators. A tolerance of less than 0.20 or 0.10 and/or a VIF of 5 or 10 and above indicates a
multicollinearity problem.
The aim of testing the multicollinearity is to know if each independent variable is related to each
other linearly or not and VIF (Variance Inflation Factor) is indicating how much the variance is inflated.
Table 2
Variables
Collinearity Statistics
Tolerance VIF
DER .638 1.567
EPS .312 3.205
ROA .251 3.978
Company Age .424 2.360
Net Issue to Public .482 2.073
Company Size .263 3.802
The result of the test is showing that there is no variable is having VIF value greater than 5. This
indicates that the dependent variables model (predictors) being used in this study do not show any
multicollinearity sign in the regression model.

c. Heteroskedasticity
In statistics, a collection of random variables is heteroskedastic, or 'heteroscedastic, if there are sub-
populations that have different variabilities than others. Here "variability" could be quantified by the
variance or any other measure of statistical dispersion. Thus heteroscedasticity is the absence of
homoscedasticity.
The possible existence of heteroscedasticity is a major concern in the application of regression
analysis, including the analysis of variance, because the presence of heteroscedasticity can invalidate
statistical tests of significance that assume the effect and residual (error) variances are uncorrelated and
normally distributed.
A good regression model is the one which is homoscedastic or which is not heterescedastic.
In order to detect if there is heteroscedasticity or not, it could be done by seeing the graphical plot
between the corresponding variable prediction with its residuals to know if there are any specific patterns or
not. The patterns which could emerge are:
a. If there is any specific pattern, where the data plot a specific arranged pattern (wavy, widespread and
becoming narrowly-spread), then there is heteroscedasticity.
b. If there is no specific pattern and the data is spread above and below 0 (zero coordinate) and Y axis,
then there is no heteroscedasticity.

Chart 2

Chart 3 The histogram of the heterskedasticity

From the scatterplots, it could be seen that the dots are distributed randomly below coordinate of 0
(zero) on the Y axis. From the Glejser test, it is indicating that there is no single independent variable which is
statistically significant in influecing the absolute unstandardize residual variables.
d. Autocorrelation
Autocorrelation refers to the correlation of a time series with its own past and future values.
Existence of autocorrelation could be tested using Durbin Watson test (DW test). This test is designed to
identify the statistical significance of any positive serial correlation within the regression residuals. The
Durbin-Watson test statis tic tests the null hypothesis that the residuals from an ordinary least-squares
regression are not autocorrelated against the alternative that the residuals follow an AR1 process. The
Durbin -Watson statistic ranges in value from 0 to 4. A value near 2 indicates non-autocorrelation; a value
toward 0 indicates positive autocorrelation; a value toward 4 indicates negative autocorrelation.
Certain conditions to be followed in determining whether there is autocorrelation in a series of data
or not are as follows:
1. If DW value lies between the upper bound (dU) and (4-dU), it indicates that autocorrelation
coefficient is equal to zero, which means there is no autocorrelation.
2. If DW value is lower than the lower bound (dL), it indicates that autocorrelation coefficient is
greater than zero, which means there is positive autocorrelation.
3. If DW value is larger than (4-dL), it indicates that autocorrelation coefficient is less than zeore,
which means that there is negative correlation.
4. If DW value lies between lower bound (dL) and upper bound (dU) or lies between (4-dU) and (4-
dL), it indicates that the results of the test are inconclusive at the given level of significance. In
other words, when the Durbin-Watson statistic lies between the two critical values, then we can
neither support nor refute the claim that no statistically significant serial correlation exists within
the regression residuals.
Table 3
Model R R Square Adjusted R Square
Std. Error of the
Estimate Durbin-Watson
1 .625
a
.390 .208 .39231 1.490
a. Predictors: (Constant), Company Size, EPS, DER, Net Issue to Public, Company Age, ROA
b. Dependent Variable: UP Ratio

From the Durbin Watson significance table for 6 independent variables (k=6) and 1 dependent
variable with number of sample (N= 27) for 5% significant point is as follows:
dL = 0.925 and dU = 1.974
(4 dU) = 2.026
This study is giving a result of DW coefficient = 1.49 which lies between the lower bound and the
upper bound which means that the autocorrelation existence is undecided or inconclusive at the particular
significance level.

2. Multiple Regression Analysis
Multiple Regression is a statistical method used to examine the relationship between one dependent
variable Y and one or more independent variables X
i
. The regression parameters or coefficients b
i
in
the regression equation:

Are estimated using the method of least squares.

Table 4 Result of Classic Test:
Classic Test Finding
Normality test Data is not normal
Multicollinearity test No multicollinearity
Heteroskedasticity test Homoskedastic / Not Heteroskedastic
Autocorrelation test Inconclusive
If all the classic test findings are resulting in desired result which are:
- Data is normally distributed,
- No multicollinearity,
- No heteroskedasticity (data is homoskedastic),
- No autocorrelation among the data,
Multiple regressions using OLS (Ordinary Least Square) method could be used but since the data has
violated some of the classic tests, the multiple regression should use GLS (Generalized Least Square) method
in order to give a better interpretation towards the overall data.
In this study we are using Generalized Linear Model as it is a flexible generalization of ordinary
linear regression that allows for response variables that have other than a normal distribution.
Table 5 Result of Generalized Linear Model
Value Std. Error t-Value p-Value
(Intercept) 4.361208 1.4207883 3.069569 0.0060
DER -0.031241 0.0489515 -0.638203 0.5306
EPS 0.000112 0.0002111 0.530007 0.6019
ROA 0.009847 0.0054917 -1.793129 0.0881
Age -0.000011 0.0050198 -0.002150 0.9983
Net Issue -2.883211 0.8156287 -3.534955 0.0021
Size -0.136824 0.0616106 -2.220782 0.0381

There is no significant linear correlation between the DER and the undepricing level because the
calculated t-value is less than the table value (0.638203 < 2.086) and hence, H
0
is accepted.

ROA does not have significant effect on the underpricing level or in other words, there is no
significant linear correlation between the ROA and the underpricing level because the calculated t-
value is less than the table value (1.793129 < 2.086) and hence,H
0
is accepted
EPS does not have significant effect on the underpricing level or in other words, there is no
significant linear correlation between the EPS and the underpricing level because the calculated t-
value is less than the table value (0.53 < 2.086) and hence, H
0
is accepted.
Age of the company does not have significant effect on the underpricing level or in other words, there
is no significant linear correlation between the Age of the company and the underpricing level
because the calculated t-value is less than the table value (0.002150 < 2.086) and hence, H
0
is
accepted.
Net Issue of shares to the public does not have negatively significant effect on the underpricing level
or in other words, there is no significant negative linear correlation between the Net Issue of share to
the public and the underpricing level because the calculated t-value is more than the table value
(3.534955 > 2.086) and hence, H
0
is rejected.
Size of the company does not have negatively significant effect on the underpricing level or in other
words, there is no significant negative linear correlation between the Size of the company and the
underpricing level because the calculated t-value is more than the table value (2.220782 > 2.086) and
hence, H
0
is rejected.

Table 6 Descriptive Statistics
Summary of
Descriptive Statistics N Min Max Mean Std. Deviation
DER 27 0.0000 8.9033 1.1959 1.9559
EPS 27 0.3200 3328.5800 206.9805 677.6470
ROA 27 1.1567 132.2467 23.0781 28.3136
Company Age 27 2.0000 102.0000 23.4074 22.7093
Net Issue to Public 27 0.0900 0.6302 0.2622 0.1346
Company Size 27 18.2062 27.0630 21.8280 2.3644
UP Ratio 27 0.0008 1.8200 0.3730 0.0849

The company which has the highest underpricing level is 1.82 or 182% on Religare Enterprises Limited and
the lowest underpricing level is on Niraj Cement Structurals Ltd for 0.0008 or 0.08%.
The highest DER is 8.9033 on Muthoot Finance Ltd and the lowest DER is 0.00 on eClerx Services
Limited.
The lowest ROA is 1.1567 which is on Punjab & Sind Bank and the highest ROA is 132.2467 which is on
eClerx Services Limited.
The minimum EPS is 0.32 on Religare Enterprises Limited and the maximum EPS is 3328.58 on eClerx
Services Limited.
The youngest company going for IPO is Nu Tek India Limited which is 2 years old and the oldest company
going for IPO is Punjab & Sind Bank which is 102 years old.
The size of the company is determined by the size of the total asset of the company. The average value of
the companies going for IPO under this study is Rs. 52,099,281,481 in the original value and 21.82 in the
natural logarithm.
The lowest percentage of shares offered to public is 9% by Coal India Ltd and the highest percentage of
shares offered to public is 63% by Bhagwati Banquets and Hotels Ltd.

Conclusion
All the variables being under study - Debt Equity Ratio, Earnings per Share, Return on Asset, Age of
the Company, Size of the Company, and Net Issue of the shares to the public are not having any influence
towards the underpricing level. In other words, the underpricing level of these companies which are studied
under specified time and selection criteria are not determined by all those factors.
Even though on this study it is found out that the financial and non-financial variables being analyzed
are not having any significance toward the underpricing level, the past research on the similar situations have
shown significant findings on the effect of the factors toward the underpricing level and hence it is suggested
for the investors to remain taking into account the factors of DER, EPS, ROA, Age of the company, Size of
the company, and Net Issue of the shares to the public and other significant information provided in the
companys prospectus before making any decision regarding the shares of the companies going for Initial
Public Offering.
The agenda for further extensive study on this topic for the writer would be:
1. The time period for the study should be extended more than 5 years with expectation to add more
number of samples to get better data distribution to be analyzed.
2. Independent variables to be studied could be added to factors which are external from the companies,
such as Inflation factor, Exchange rate, Interest rate, and other overall macroeconomic factors.

References

Research Articles:
1. Beatty (1989). Auditor Reputation & Pricing of Initial Public Offerings, The Accounting Review
Vol. 64, No. 4, October, pp 693-707
2. Chandradewi (2000). http://thesis.binus.ac.id/doc/Bab3/Bab%203_26-12_BI.pdf
3. Christy, M., I. Hasan and S.D Smith, (1996). A note on Underwriter Competition and Initial public
offering, Journal of Business and Accounting, 23: pp.905-914
4. Daljono. (2000). "Analisis Faktor-faktor yang Mempengaruhi Initial Return Saham yang Listing di
BEJ." Simposium Nasional Akuntansi 3: 556-572
5. Durukan, M. B. (2002). The relationship between IPO returns and factors influencing IPO
performance: case of Istanbul Stock Exchange, Managerial Finance, 28(2), 18-38
6. Kim, Byung-Ju, Richard J. Kish, and G. M. Vasconcellos, (2002). The Korean IPO Market: Initial
Returns. Review of Pacific Basin Financial Markets and Policies (5:2), 219-253
7. Trisnawati, Rina (1999). Pengaruh Informasi Prospektus pada Return Saham Pasar Perdana,
Simposium Nasional Akuntansi II IAI

Text Books:
1) Budi Santosa, P dan Ashari, Analisis Statistik dengan Microsoft Excel & SPSS, Andi, Yogyakarta,
2005.
2) Greg N. Gregoriou, Initial Public Offerings. An International Perspective, Elsevier, Massachuset,
USA, 2006.
3) Joseph Ogden , Frank C. Jen , Philip F. O'Connor, Advance Corporate Finance, Prentice Hall, ISBN-
10: 0130915688 | ISBN-13: 978-0130915689, Edition: 1, September 30, 2002.
4) M.Y. Khan, Financial Services, Tata Mc Graw Hill, 3
rd
Edition, New Delhi, 2006

Website:
www.chittogarh.com
www.wikipedia.com
www.sebi.gov.in
www.investopedia.com
www.securities.com
www.crisil.com
www.ssrn.com