Chapter 26

IPOs in a Major Emerging Market Economy—India

Rajesh Chakrabarti

26.1. The IPO Market in India

Abstract

Given India’s growing importance as a major emerging market, understanding the initial

public offering (IPO) market in India is important in itself for the global investor. In

addition, by providing an institutional context that is largely similar to the US setting but

different in a few small yet critical ways, as well as by changing the regulations related to

IPO offerings, the Indian IPO market provides a testing ground for broader finance

questions. Over the last couple of decades a growing body of empirical research has

focused on the Indian IPO market with occasionally interesting findings. This chapter

attempts an eclectic survey of this literature, stringing together a set of diverse inquiries

relating to IPOs in India. initial public offering, IPO, emerging market, India, regulation,

market

A very large part of the research on initial public offerings (IPOs) focuses on the US

markets. This is both understandable and justified given the massive dominance of capital

markets in terms of volume by the US markets. Other Organisation for Economic Co-

operation and Development (OECD) markets follow, but research on IPO characteristics

of emerging market economies is relatively scanty. And yet, sometimes, interesting

inferences can be drawn from the institutional idiosyncrasies of certain emerging market

stock markets. India is a case in hand. As currently the fastest growing large economy in
the world and the most favored foreign direct investment (FDI) destination according to

some surveys,1 India’s stock markets are 1of increasing interest to international investors.

According to Ernst & Young (E&Y) reports on IPO, India climbed from a global rank of

fifth by volume in the first quarter of 2016 (Q1) to third in the following quarter, which it

retained in Q3.

Home to the oldest stock market in Asia, India has also had a long tradition of

capital-raising through markets and a somewhat active IPO market for a couple of

decades. However, the IPO market in India really took off in the 1980s and continued to

climb with the economic reforms of the 1990s. Thus average annual capital mobilization

by nongovernmental public companies rose from a virtually negligible rupees (INR) 0.7

billion in the 1960s and a marginally higher INR 0.9 billion in the 1970s to a sharply

higher figure of over INR 43 billion in 1990–1991 when the reforms began. It climbed

fast to cross INR 264 billion in 1994–1995 before going into a long lull from 1995–

1996.2 However, in 2015, the Indian markets raised over INR 138 billion (over US$2

billion) through IPOs, a ninefold increase in volume over the previous year.3 This was in

sharp contrast to its BRIC peers (Brazil stagnating at a 1.3% drop; Russia, a precipitous

drop of 58%; and China, a relatively modest growth of just below 1.5 times).4

And yet IPOs remain far from the dominant avenue of capital raising in the

country. An article in a leading Indian newspaper points out an interesting and possibly

puzzling aspect (Krishan, 2016 (page 1)): “Between 2006 and 2014, PE/VC firms poured

capital of over $60 billion into over 3,000 small and medium businesses. This is more

“IPOs in India” in Douglas Cumming and Sofia Johan (eds.) Oxford Handbook of IPOs, Oxford, University
Press, UK, forthcoming.
than three times the money raised in the primary markets, where just 350 firms were able

to float IPOs in six years. This trend has accelerated over the last four years, with

VCs/PEs pumping in over seven times the funds raised from IPOs.” This indicates both

the growth potential as well as existing challenges of the Indian IPO market.

IPO numbers and volumes around the world are available from the World

Federation of Exchanges. Figure 26.1 attempts to summarize this information for the

period since January 2014, comparing India’s IPO raisings (scaled up 10 times for

visibility) with other regions of the world. With the caveat of focusing on very short-term

estimates in an area particularly open to large temporal variations, the IPO market India

appears to be well-positioned to grow both in absolute and relative terms.

<Insert Figure 26.1 here>

However, it is not just the size and growth of the IPO market that gives India a

claim to a place in a volume on IPO research. A few key regulatory changes in the Indian

IPO regime have set it up as an ideal testing ground for market microstructure theories

relating to effects of book building relevant to the broader IPO literature. Data

availability on individual portfolio investment allow for testing behavioral finance

hypotheses. Researchers have probed these questions, and we hope the inclusion of such

work adds to the appeal of this current survey of the research on the Indian IPO markets

for a broader audience.

There is a third argument for studying the Indian IPO market. While no emerging

market can claim to be representative of this exasperatingly variegated segment, an in-

depth study of the IPO market in a major emerging market flags institutional

characteristics and concerns that may be common to multiple members of the class. As
such, if one remains conscious of the dangers of overgeneralization, a study of the Indian

IPO reality can shed considerable light on the primary market drivers in other emerging

markets.

This chapter is structured in the following manner. The section 26.2 gives a broad

regulatory background and the historical evolution of the IPO market in India. Section

26.3 provides an overview of a few key papers studying a few select aspects—like

underpricing, effect of group membership, and informativeness of IPO grading—from

among the extant IPO research in the Indian context. The research on two broader

issues—effect of book building in IPOs and testing broad behavioral finance questions

using the Indian IPO setting—are discussed in section 26.4. Section 26.5 concludes with

an attempt at summarizing the major points.

26.2. Regulatory Architecture and Processes

The Indian IPO market has witnessed a bevy of major changes since the beginning of

economic reforms in the country in 1991. The regulations for raising capital changed

significantly in 1992 when the newly empowered market regulator, the Securities and

Exchanges Board of India (SEBI), issued its Disclosure and Investor Protection (DIP)

Guidelines that formed the basis for the regulation of primary issuances in the Indian

capital market. Most important, it abolished the control on pricing of capital issues that

was previously used by the now defunct Controller of Capital Issues (CCI). Firms with a

history of over a year of activity were allowed free pricing of new issues; younger firms

were stipulated to be priced at par.

Until 1999 IPOs were required to be offered via a fixed-price mechanism wherein

the firm and its lead manager set the offer price. Investors then bid for the number of
shares. Allocations were made on a pro-rata basis at the predetermined offer price. In

September 1999, book building was allowed for the first time in the Indian market. The

next few years witnessed relatively muted action in the IPO space in India, largely as a

consequence of the dot-com bust.

The Indian financial markets are evolving and flexible. For all practical purposes,

Indian markets, notwithstanding hosting Asia’s oldest stock exchange, arguably only

came of age following the liberalization process of the 1990s. Consequently, and also

because of the tumultuous global experience of financial markets, financial markets in

India have witnessed almost continuous regulatory changes in virtually every aspect of

the markets. The IPO market has been no exception.

In 2003, SEBI made several major changes in the IPO process. One of this was

the introduction of the Green Shoe (or over-allotment) option in IPOs using the book-

building method, which was extended to all IPOs regardless of offering methods the

following year. Like in the United States, the Green Shoe option covered 15% of the

issue. The width of the price band was also stipulated not to exceed 20% of the floor.

Another important change was the removal of the book builder’s right to determine

allotments, the implications of which we shall discuss in some details in section 26.4.

By global comparison, India has a relatively lower size requirement to list. The

current size requirement to list in the National Stock Exchange is a paid-up capital of

INR 250 million, which is well below US$4 million. By comparison, listing in the

NASDAQ Small Cap market requires a capitalization of US$50 million and that in the

NYSE an IPO capitalization of US$60 million. In the London Stock Exchange, while the

formal requirement of listing in the main market is a mere GBP 700,000 the realistic
figure is above GBP 100 million and the AIM, which has no formal listing requirement,

rarely sees a scrip trading below the capitalization of GBP 10 million.5

Foreign listing has remained a sticky regulatory issue for India. India has not yet

adopted full convertibility on the capital account, and hence cross-border capital flows

remain regulated. This restricts foreign listing by Indian companies. Dual listing is

prohibited, though India remains a leading source of companies tapping the global

markets through American depository receipts (ADRs) and global depository receipts

(GDRs). Some temporary restricted access to foreign capital was granted to unlisted

Indian firms in the 2013–2015 period.

Reverse takeovers are allowed in India but are not particularly common. The

takeover of the development financial institution, ICICI, by its subsidiary ICICI Bank in

2002 remains the best known case, even after a decade and a half.

At the end of the day, the credibility and attractiveness of a financial market

depend on the reliability of its processes. With the emergence of online trading and

automated trading, and in the wake of several market-related scams, large and small,

including those pertaining to IPOs, the surveillance system in India has been undergoing

almost continuous change. The market regulator SEBI’s Integrated Market Surveillance

System (IMSS) and Data Warehousing and Business Intelligence System (DWBIS), for

instance, are relatively new systems that are being continually tweaked to stay in step

with market changes.6

26.2.1. Broad Steps in the IPO Process

IPOs in India can be of two kinds—fixed price and book-built (current details of the IPO

process, i.e., valid as of April 2016, are provided in Appendix 26.1). The “price band”
regulations have been in effect in India since 2003. The book-runner (“book-running lead

manager”) sets a “price band” within stipulations—for instance, the width of the price

band cannot exceed 20% of the floor price—and publishes it. Bidders then bid at price

points in that band, indicating their depths at price points. The bid details are

electronically shared with the book-runner who fixes the final price. The bidding must

stay open for at least three days. In the unusual case when the final price has to be set

outside the band, at least three days should be allowed after the new price is set. But the

entire bidding process must close within thirteen days. In case of range revision, investors

are free to modify or cancel their earlier bids.

Bidding rules depend on investor type. Investors are classified into two

categories—small/retail and non-retail/institutional/high net worth individuals. The

current threshold is INR 200,000 (about US$3,000). The threshold was initially set as

1,000 shares, but that was changed to a value (INR 50,000) in 2003 and progressively

doubled in 2005 and again in 2010. Retail investors can place market orders or limit

orders while the non-retail bidders must place limit orders. Bids, of either kind, are

legally binding contracts, and bidders are obligated to pick up their allocations.

Allocation, which obviously follows bidding, involves somewhat complex rules

in which there have been changes providing researchers with a natural experiment to test

theories. We discuss this research in some detail in section 26.4. The allocation of shares

depends on the IPO mechanism—fixed price or book-built—and the bidder category.

Individual bidders, whether retail or high net worth, must be treated in a

nondiscriminatory manner. In fixed price IPOs, the retail share cannot exceed 40%. For

book-built IPOs the share is usually 35%, while another 15% is reserved for other non-
institutional bidders and the remaining 50% for “qualified institutional buyers” (or QIBs).

Adjustments in these allocations across categories can be done in case of under-

subscription.

The allocation rules for institutional investors (QIBs), on the other hand, allowed

for some discretion to the book-runner until November 2005. After November 2005, the

discretion was withdrawn and they too had to face proportionate allocations. In July

2009, SEBI allowed for a set of “anchor” institutional investors who could be made firm

allocations at a pre-IPO price provided they all bought at the same price and had a 30-day

lock-in to avoid “flipping.” If the final IPO price ends up above the anchor price, then the

anchor investors must pay the difference. But they could not collect the difference in the

opposite case. The share for the anchor investors was restricted to 60% of the share of the

QIBs (i.e., 30% of the total issue).

26.3. A Few Empirical Results about the Indian IPO Market

IPOs in India have attracted a reasonable amount of research attention, and we survey the

broad findings of this research in this section and the following one. We categorize the

research surveyed in this section by the primary research focus in three subsections:

underpricing, effect of business group affiliation, and the information content of IPO

grading. In the following section we cover two more strands of research—one seeking to

infer the value of discretionary power in allocation, and the other about investor behavior.

Our reasoning for grouping the research in the two sections is as follows: in this section

we cover the research that brings out features of the Indian IPO market, while in the

following section (26.4) we cover the research that seeks to draw broader, more general

inferences using the Indian IPO market.

26.3.1. Underpricing

IPOs have been inextricably connected to the topic of underpricing thanks to the path-

breaking work of Jay Ritter and others. Loughran et al. (1994) show that the phenomenon

is not restricted to the United States, but rather is a universal phenomenon, presumably

owing to information asymmetry between issuer and investor. The typical magnitude is in

the upper teens (16%–20%) though it could be as high as 80% in certain periods and

countries (Malaysia, 1980–1991, for instance). Unsurprisingly then, the subject of

underpricing of Indian IPOs has received its due attention from researchers, and several

attempts have been made at estimating the magnitude.

Shah (1995) estimated that in the 1991–1995 period, the listing price was more

than twice the offer price. Madhusoodan and Thiripalraju (1997) studied almost an

equally large sample (1922) and arrived at an underpricing estimate of slightly over 75%.

Ranjan and Madhusoodan (2004) focused on the 1999–2003 period, when book-built

IPOs were in effect and found that they were associated with a lower level of

underpricing. Also size of the issue seemed to matter, with smaller issues likely to have

greater underpricing (consistent with information asymmetry explanation). Pandey

(2005) estimated it to be in excess of 20% on the listing day for the 1999–2002 period.

He too reached the same conclusion—that book building lowers underpricing,

particularly in the long run. Ghosh (2004) studied a longer period (1993–2001; 1,842

IPOs) to find a negative relationship between underpricing and volatility of stock return

immediately after listing.

More recently, Singh and Kumar (2008) studied the January 2006 to October

2007 period, covering a sample of 116 companies across 20 sectors to estimate the
underpricing in the short run and long run to be 18% and 11.5%, respectively. They

estimate that “money left on the table” for the average issue was to the tune of INR 600

million. More interesting, the authors use the likely variation in information asymmetry

across industries. Oversubscription was linked positively to underpricing and institutional

(informed) oversubscription to long-run performance. The better performing sectors

appeared to experience greater short-run as well as long-run underpricing.

Some of the listing gains are likely to be transitory. Pande and Vaidyanathan

(2007), using a sample of 55 firms in the 2004–2006 period, point out that over half of

their sample experienced a negative one-month return. Even for their entire sample, the

return made by a buy-and-hold investor with allocation in all issues would be less than

the market return.

26.3.2. Group Affiliation

A key feature of the Indian economy—indeed, of many emerging market economies—is

the prevalence of “business groups” or conglomerates, predominantly family-controlled,

in the corporate sector. Conglomerates have their advantages and governance drawbacks,

and present interesting questions for minority shareholders. Marisetty and Subramanian

(2008) investigate these questions by analyzing the relative underpricing of IPOs

belonging to business groups vis-à-vis other IPOs. Specifically, they seek to find out

whether business group affiliation has a “certification effect” on the company as reflected

in the extent of IPO underpricing; whether such affiliation affects long-run performance

of the firms vis-à-vis stand-alone companies; and how investors in group IPOs fare as

compared to their counterparts in other IPOs in the long run.

 The query assumes significance owing to two opposing effects that such group

membership may bestow on an IPO—a positive signal of being backed by seasoned

promoters with a visible record of success with other ventures; and in the opposite

direction, of the possibility of “tunneling,” or siphoning away of profits to other group

companies, thereby cheating the minority shareholder. If the first effect dominates, one

should expect to see lower underpricing. The opposite effect should be visible if the latter

effect is stronger. Dewenter et al. (2001) addressed the same question in Japan and found

that the net effect is negative; in other words, group affiliation worsens underpricing,

presumably since the investor also has to analyze the other group companies.

Though the Indian situation is quite different from that of Japan, Marisetty and

Subramanian (2008) reach similar conclusions for India as well. Analyzing over 2,700

IPOs in the 1990–2004 period, they conclude that group membership is a cost rather than

a benefit for the average group firm going public. However, noticing that this higher

underpricing is true also for IPOs of firms belonging to foreign groups, they argue that

the driving factor behind it is the fear of “tunneling,” rather than the complexity of fellow

group-companies. They also find, unsurprisingly perhaps, that government group-

company IPOs have the least underpricing.

26.3.3. IPO Grading

Fraudulent IPOs have been scarily common in India, particularly in the 1990s. A Joint

Parliamentary Committee investigating the issue remarked in its report in June 2002

(page 328),

In the year immediately after liberalization, 1.5 crore new investors, small

investors as we call them, came into the market between 1992 and 1996
 through IPOs. They were duped. At the time (INR) 86,000 crore were

raised in four years through public issues and right by issues by four

thousand odd companies. Most of these 1.5 crores investors who came in

for the first time in the stock market were duped. . . . Till date 229

companies (only) have been identified by the Government appointed

monitoring committee, as having made public issues and disappeared. No

one has been arrested and no money has been recovered. There has not

been even an action plan as to how to recover that money.

Largely in reaction to these developments, the market regulator SEBI made

“grading” of IPOs by credit-rating companies mandatory in India. “Grading” happens on

a scale of 1 to 5 and is based on five fundamental factors: the firm’s future earnings,

accounting practices, management of the firm, foreseeable financial risks, and the quality

of corporate governance. It is not a valuation or investor recommendation, but rather a

basic certification of minimum requirements that are difficult for small investors to

verify. However, it makes issuance costly and is likely to biased against small

entrepreneurs. Finally, since the underlying instrument is equity, not debt, the

implications of grading are harder to define, particularly in a longer horizon. Nevertheless

it serves as a signal to investors, providing likely clues about post-listing liquidity.

Deb and Marisetty (2008) investigate the questions of whether IPO grading

succeeded in lowering the information asymmetry; whether retail investors respond to the

IPO grading; and whether the grading had any predictive power over post-IPO secondary

market liquidity and risk. Analyzing a sample of 159 IPOs during 2006–2008, straddling

the introduction of mandatory grading, they find that the answers to all three questions
are positive. They also find that the drivers of retail and institutional investors in a typical

IPO are quite different. While retail investors are influenced by the grade the IPO

received, institutional investors, who are likely to be more informed, are driven more by

the firm’s leverage and return on net worth. Presumably the institutional investors are

already aware of the information revealed by the IPO grading. On the whole, they

conclude that in emerging market situations with less developed institutions and greater

retail participation in IPOs, regulatory measures like IPO grading improves market

welfare.

26.3.4. IPO Survival

What happens post-IPO? Raju and Prabhudesai (2012) and Baluja and Singh (2016)

analyze the IPO data over almost identical windows (1990–2010 and 1990–2011,

respectively) to study this question. The modal duration appears to lie between five and

six years. The latter study indicates that IPOs of older firms, backed by reputed lead

managers and with high demand, are more likely to survive longer, whereas IPOs with

high initial returns, higher risk, and more delay in listing are less likely to survive longer

in the market. The size of IPOs appears to raise survival duration, whereas high market

level and high IPO activity reduce it. There are also significant industry variations in

survival rates of IPO firms.

26.4. Insights from Indian IPOs for General Research Questions

In this section we survey two strands of research that have sought to use the Indian IPO

market to address research questions relevant to a broader audience, regardless of

nationality. The institutional features and data availability of Indian IPOs have spurred

research using the Indian IPO data to answer questions of general interest to the finance
literature. The first involves measuring the implications of the book-runner’s discretion

over the IPO allocation process, while the second uses the IPO setting to shed light on an

even broader question about the effect of investor experience on their future behavior.

26.4.1. The Impact of Discretion over Allocation

The book-building process has remained the most prevalent method of pricing IPOs the

world over. There are, however, divergent views about its implications on the IPO price.

On the one hand, the method approximates a classical auction method to match demand

to supply. On the other, it also leaves room for cronyism and a cozy relationship between

the book-runner and the bidders in a repeated games setting, which may exacerbate IPO

underpricing and related inefficiencies. It is difficult to settle this issue empirically in

advanced markets since the alternative arrangement remains a counterfactual. However,

an interesting set of regulatory changes in the India markets has opened up the possibility

of empirically investigating this question, and indeed researchers have exploited the

opportunity to draw inferences about the price implications of book building that are

fairly general in nature and applicable across countries. In this section we focus on the

book-building process itself, the regulatory changes in India that have presented us with a

natural experiment to test its implications and review the resulting evidence itself.

26.4.2. The Book-Building Process

The book-building exercise has been an increasingly common process to sell IPOs around

the world. This involves the book-runner (issue manager, usually a broker/ investment

bank) deciding on a price band rather than a specific price for the issue and inviting

quotes from investors. In India this price band is allowed to have a width of no more than

20% (of the floor price). Institutional investors, financial intermediaries that aggregate
demand, would then provide their price bids and depth of demand at various price points

within the indicated price band. Aggregating this information helps the book-runner

create the order book (or demand curve) for the issue. Placing this order book on the

number of shares that need to get sold (which, in turn, is determined by the amount of

capital that needs to be raised through the IPO) enables the book-runner to figure out the

market clearing price for the issue, which then becomes the final issue price of the IPO.

The issue manager then allocates the issue to the various bidders above the issue.

While in principle this is an approximation of the Walrasian auctioneer model (at

least on the demand side), the fact is that issue managers develop a network of financial

intermediaries who bid on these IPOs on a quid pro quo basis (getting sweet deals and

allocations on issues that are virtually guaranteed to appreciate significantly on listing in

exchange for their participation in other, less attractive, issues). The resulting effect of

this on the bids and the final issue price is complex, but likely on the negative side

contributes to underpricing. It has been difficult to untangle and measure the effects since

the alternative to book building has not been observable in most settings.

26.4.3. The “Natural Experiment” Setting in the Indian IPO Context

As noted in section 26.2, in 2003, the regulators revised the IPO rules to take away the

discretionary powers of book-builders to allocate shares among the QIBs, and made it

compulsory to follow a proportional allocation method (i.e., allotted shares ought to be in

the same ratio as the application amount). This reduced, if not eliminated, the inducement

that book-runners could give their favored clients for participation in other, not

oversubscribed, deals or other benefits. It also presented analysts with a natural

experiment to investigate the effect of such discretionary powers—an inference that is of

importance not just for India, but across regimes.

Bubna and Prabhala (2011) have studied this phenomenon and their conclusions

are quite interesting. Using a proprietary data set, they examine the allocation policies

followed by the underwriters. They find discrimination to be “pervasive and

economically significant.” Allocation depends upon the bidder identity, issue

characteristics, and other soft information available to the issue manager. In the post-

2005 period without the discretionary allocation power, the nature of the market itself

changes. While frequent bidders continue to stay, infrequent ones—both those who

received high allocations and those with the lowest allocations—exit the market. The

authors find clear evidence of non-bid determinants of allocation to the extent that they

wonder whether it is this discretionary power that holds the secret to the popularity of the

book-building process.

Of course, ridding the discretionary powers of underwriters is hardly a panacea.

Soon after the proportional allocation rule was imposed, the Yes Bank IPO in India

featured a case where a person applied in 6,315 different names (but the same address) to

enhance chances of allocation. Also access and use of non-bid information in determining

allocation need not always and everywhere be a bad thing, but the possibility and

prevalence of abuse is marked.

As we saw in section 26.2, in June 2009 SEBI reintroduced some degree of

allotment discretion for the underwriters in the form of “anchor” investors. These QIBs

with a 30-day lock-in period (i.e., avoiding “flipping”) could be allotted about half of the

share of QIBs (which in turn is roughly half of the total IPO) before the issue is opened
up for retail investors. They were subject to a few price and quantity restrictions,

however. They all had to buy shares at a single fixed price, to be disclosed before the

issue opened. If the eventual IPO price is above the anchor offer price, they would have

to pay up the difference. But they do not get a refund if the opposite happens. While the

anchor investor system in India is similar to the US system in terms of the discretion of

underwriters in allocation as well as banning or discouraging of flipping, there are

important differences as well. The Indian anchor allocation is public knowledge, whereas

in the United States it is confidential (signaled but not explicitly disclosed by

underwriters). Also the two-stage pricing of anchor participation makes the terms stiffer

for anchor investors in India than in the United States.

Bubna and Prabhala (2014) analyze 129 IPOs, including 49 offered under the

anchor investor option between 2009 and 2012. They find that while on average there are

11 anchor investors, once one considers fund families, the average issue has about seven

families anchoring it; 55% of the anchor issues are priced at the top of the band, as

opposed to 78% of non-anchor issues.

On the question of underpricing, adjusted for BSE Sensex returns, the average

underpricing across both categories is 3.6%. The underpricing for anchor issues is 5.9%,

however, as compared to 2.3% for non-anchor issues. This difference, however, does not

hold up in multivariate regressions. The kind of anchor investors appear to matter as well.

Anchor-backed IPOs with a greater share of FII investors experience lower underpricing.

Anchor-backed offerings are more oversubscribed. There is no evidence of flipping by

anchor investors on the expiry of the 30-day lock-in period.

 Bubna and Prabhala (2014) point out that the underwriter’s power in an IPO

comes from discretion over allocation and the ability to keep it secret. In most cases these

two powers come as a package. The Indian setting, by removing the secrecy part, helps

untangle the two effects and bring to fore the effects of the allocative discretion alone.

However, more research is needed to understand these effects clearly.

26.4.4. Inferring Investor Behavior

An interesting recent paper by Anagol et al. (2015) uses a feature of the Indian IPO

market to shed light on a general behavioral finance question—that of the effect of

investors’ experiences on their future behavior.

The feature that they exploit is the allocation of shares to retail investors in case

of oversubscription of IPOs. While allocation within investor categories is proportional, a

different approach is used when the application of the proportional allocation rule would

violate the minimum lot size specified by the firm. In that case, a lottery is used by which

some of the investors receive allocations while others do not, so as to fulfill the stipulated

quota of retail investors (30% or 35%, depending upon the type of IPO) as set by the

regulator, SEBI. Anagol et al. (2015) exploit their ability to observe the investment

behavior of candidates of such lotteries—recipients as well as disappointed applicants—

before and after the lottery allocations to address the questions they seek to answer. They

track over 1.5 million investors who were affected (allocated or denied shares) by these

lotteries in 54 IPOs during the period 2007–2012. They observe the investment behavior

of 469,288 recipients (“treatment group”) and 1,093,422 unfulfilled applicants (“control

group”) both before and after the lottery events.

 Retail investors can apply for IPOs by submitting one of two kinds of bids. They

can place a simple “cutoff” bid specifying a limit price and the number of shares they

would like to buy if the final price is below the limit price. In order to place such a bid,

they have to deposit a sum of money equal to the limit price times the applied number of

shares in an escrow account, part or all of which will be used in case the investors get

share allotment. About 93% of retail applicants in their sample use this bid.

The other option is to provide a “full demand schedule”—that is, a schedule of

numbers of shares the investor would be buying if the price is in various ranges

(effectively a bundle of “cutoff” bids). The deposit in this case would be the maximum

possible expense he could incur if he is allotted shares; 7% of applicants submit such

bids.

Anagol et al. (forthcoming) obtain the details of the monthly investment in equity

portfolios of these over 1.5 million investors both before and after their relevant IPO

allocations. They find that conditional on making IPO applications, “winners” (i.e.,

investors who receive IPO allotments with positive returns) are significantly more likely

to apply for future IPOs, while “losers” (i.e., those who are allotted negative shares) are

significantly less likely to apply to future IPOs.

They also find that the “winners” exhibit a higher propensity to trade stocks; show

an exacerbated “disposition effect” (i.e., the tendency to sell winning stocks and holding

on to losing stocks); tend to tilt the portfolio slightly toward the sector of the winning IPO

stock; and to tend to increase the number of stocks in their portfolio. This constitutes

interesting and potentially powerful evidence in support of various behavioral finance

conjectures that are generally difficult to establish empirically owing to identification

challenges. The findings also suggest that experiences with stocks in one part of the

portfolio have effects on other stocks—in contrast to behavioral models that hold stocks

as being evaluated individually by investors with no cross-security holding effects. The

authors find their observations difficult to explain with fully rational economic theories.

26.5. Concluding Remarks

Given India’s growing importance as a major emerging market, understanding the IPO

market in India is important in itself for the global investor. In addition, by providing an

institutional context that is largely similar to the US setting yet different in a few small

but critical ways, as well as by changing the rules related to IPO offerings, the Indian IPO

market provides a testing ground for broader finance questions as well. Over the last

couple of decades a growing body of empirical research has focused on the Indian IPO

market, with occasionally interesting findings. This chapter has attempted to survey this

literature, stringing together a set of varied inquiries.

Some findings—like evidence of IPO underpricing—are universal and

unsurprising, but important nonetheless in estimating the magnitude as well as its

evolution over the years. It seems, broadly speaking, that the extent of underpricing is

diminishing in India, which could be in line with improving information dissemination

and transparency.

Some other questions are quite country-specific but with wider market and policy

implications for other countries. For instance, the recent proposition of Gao, Ritter, and

Zhu (2013) that IPOs have declined in the face of the emergence of increased sell-out of

unlisted firms to larger players appears, at least at a first glance, to find little evidence in

India. Mergers and acquisitions (M&A) data indicate a sharp rise in activity in India post-
2004 but do not reflect any pattern vis-à-vis the IPO volume. However, this connection

between the IPO market and the M&A volume in India remains an important area to

explore empirically.

The fact that membership in business groups is a cost rather than an asset for an

IPO is another example. Similarly, the fact that the regulator-imposed practice of IPO

grading is actually effective in helping retail investors make better choices may have

policy implications elsewhere.

Finally, the evidence that the Indian IPO market can provide for broader

questions, like the implications of allocative discretion for underwriters or the impact of

past experiences in determining investor behavior going forward, represents important

findings for the field in general.

The Indian IPO market, like several other major emerging markets, is likely to see

more activity in the years to come, an increasing share of it driven by or at least involving

global investors. A better understanding of this market and other similar emerging

markets would help researchers, practitioners, and policymakers alike.

Appendix 26.1

IPO Process Rules in India as of April 2016

(extract from Ministry of Corporate Affairs, Government of India

Website, http://iepf.gov.in/IEPF/Types_of_Issues.html, accessed

April 29, 2016)

Types of Issues: Fixed Price and Book Building

Fixed-Price Issues

When the issuer at the outset decides the issue price and mentions it in the offer

document, it is commonly known as a fixed price issue.

Book-Built Issues

When the price of an issue is discovered on the basis of demand raised from the

prospective investors at various investors at various price levels, it is called a book-built

issue.

Price Discovery through a Book-Building Process

Book building means a process undertaken by which a demand for the securities proposed

to be issued by a body corporate is elicited and built up and the price for the securities is

assessed on the basis of the bids obtained for the quantum of securities offered for

subscription by the issuer. This method provides an opportunity for the market to

discover the price for securities.

The process is so named because it refers to collection of bids from investors,

which is based on a price range. The issue price is fixed after the closing date of the bid.

A company planning an IPO/FPO appoints a merchant bank as a book-runner. A

particular time frame is fixed as the bidding period. The book-runner then builds an order

book that collates bids from various investors. Potential investors are allowed to revise

their bids at any time during the bidding period. At the end of bidding period the order

book is closed and consequently the quantum of shares ordered and the respective prices

offered are known. The determination of the final price is based on demand at various

prices.

Open Book Building

In book-built issues, it is mandatory to have an online display of the demand and bids

during the bidding period. This is known as an open book system. (Under closed book

building, the book is not made public and the bidders have to take a call on the price at

which they intend to make a bid without having any information on the bids submitted by

other bidders). As per SEBI, only electronic facility (i.e. open book system) is allowed to

be used in the case of book building.

Price Band

The offer document may have a floor price for the securities or a price band within which

the investors can bid. The spread between the floor and the cap of the price band cannot

be more than 20%. In other words, it means that the cap should not be more than 120% of

the floor price.

The price band can have a revision. SEBI requires that any revision in the price

band has to be widely disseminated by informing the stock exchanges, by issuing press

release, and also by indicating the change on the relevant website and the terminals of the

syndicate members. When the price band is revised, the bidding period has to be

extended for a further period of three days, subject to the total bidding period not

exceeding 13 days.

Floor Price

Floor price is the minimum price at which bids can be made.

Cutoff Price

In book-building issue, the issuer is required to indicate either the price band or a floor

price in the red herring prospectus. The actual discovered issue price can be any price in

the price band or any price above the floor price. This issue price is called the cutoff
price. This is decided by the issuer and Lead Manager after considering the book and

investors’ appetite for the stock. SEBI ICDR Regulations 2009 permit only retail

individual investors to have an option of applying at the cutoff price.

Final Issue Price

The demand at various price levels within the price band is made available on the

websites of the designated stock exchanges during the entire tenure of the issue and once

the issue closes, the final price is determined by the issuer and made known to the

investors.

Minimum Number of Days for Which an IPO/FPO Subscription List

Has to Remain Open

Except as otherwise provided in the SEBI ICDR Regulations 2009, public issue shall be

kept open for at least three working days but not more than 10 working days, including

the days for which the issue is kept open in case of revision in price band.

In case the price band in a public issue made through the book-building process is

revised, the bidding (issue) period disclosed in the red herring prospectus shall be

extended for a minimum period of three working days, provided that the total bidding

period shall not exceed 10 working days.

Pure Auction (Additional Book-Building Mechanism)

SEBI has decided to introduce an additional method of book building, to start with, for

FPOs, in which the issuer would decide on a floor price and may mention the floor price

in the red herring prospectus. If the floor price is not mentioned in the red herring

prospectus, the issuer shall announce the floor price at least one working day before
opening of the bid in all the newspapers in which the pre-issue advertisement was

released.

Qualified institutional buyers shall bid at any price above the floor price. The

bidder who bids at the highest price shall be allotted the number of securities that he or

she has bid for, and then the bidder who has bid at the second highest price, and so on,

until all the specified securities on offer are exhausted. Allotment shall be done on price

priority basis for qualified institutional buyers. Allotment to retail individual investors,

non-institutional investors, and employees of the issuer shall be made proportionately as

illustrated in Schedule XI of SEBI ICDR Regulations 2009. Where, however, the number

of specified securities bid for at a price is more than available quantity, then allotment

shall be done on a proportionate basis. Retail individual investors, non-institutional

investors, and employees shall be allotted specified securities at the floor price subject to

provisions of Clause (d) of Regulation 29 of SEBI ICDR Regulations 2009. The issuer

may

(a) place a cap either in terms of number of specified securities or percentage of

issued capital of the issuer that may be allotted to a single bidder;

(b) decide whether a bidder be allowed to revise the bid upward or downward in

terms of price and/or quantity;

(c) decide whether a bidder should be allowed single or multiple bids.

Fast Track Issues (FTI)

SEBI has introduced FTI in order to enable well‐established and compliant listed

companies satisfying certain specific entry norms/conditions to access the Indian Primary

Market in a time-effective manner. Such companies can proceed with FPOs/Right Issues
by filing a copy of RHP/Prospectus with the RoC or the Letter of Offer with designated

Stock Exchanges and SEBI. Such companies are not required to file a Draft Offer

Document for SEBI comments and to Stock Exchanges. Entry norms for companies

seeking to access Primary Market through the Fast Track route are as follows:

(i) The shares of the company have been listed on any stock exchange having

nationwide terminals for a period of at least three years immediately

preceding the date of filing of offer document with ROC/SE.

(ii) The “average market capitalisation of public shareholding” of the company is

at least INR 3000 crore;

(iii) The annualized trading turnover of the shares of the company during six

calendar months immediately preceding the month of filing of offer

document with ROC/SE has been at least two percent of the weighted

average number of shares listed during the said six months period:

Provided that for issuers, whose public shareholding is less than 15 per cent of its

issued equity capital, the annualised trading turnover of its equity shares

has to be at least two per cent of the weighted average number of equity

shares available as free float during such six months period.

(iv) The company has redressed at least 95 per cent of the total

shareholder/investor grievances or complaints received till the end of the

quarter immediately preceding the month of the date of filing of offer

document with ROC/SE.

 (v) The company has complied with the listing agreement for a period of at least

three years immediately preceding the filing of offer document with

ROC/SE.

(vi) The impact of auditors’ qualifications, if any, on the audited accounts of the

company in respect of the financial years for which such accounts are

disclosed in the offer document does not exceed 5 per cent of the net

profit/loss after tax of the company for the respective years.

(vii) No prosecution proceedings or show cause notices issued by the Board are

pending against the company or its promoters or whole time directors as

on the date of filing of offer document with RoC/ SE; and

(viii) The entire shareholding of the promoter group is held in dematerialised form

as on the reference date .

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Figure 26.1.

Cumulative IPO values since January 2014.

Data source: World Federation of Exchanges

Notes
1
See http://www.financialexpress.com/article/economy/india-most-attractive-

investment-destination-globally-ey-survey/151057/.

2
See Ramkrishna and Sahoo (2009).
3
See Machado (2015).
4
Anand and Machado (2015).
5

https://www.google.co.in/url?sa=t&rct=j&q=&esrc=s&source=web&cd=6&cad=

rja&uact=8&ved=0ahUKEwiXiI-
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market--

2.pdf&usg=AFQjCNHqN0rP3gv6hBh9tV5Yn1Kjfqf3DQ&sig2=wcpy8LTiz-

phjUHB6EA6jw.

6
http://www.sebi.gov.in/cms/sebi_data/attachdocs/1471609638850.pdf.