Article

Impact of Auditor and Underwriter Management and Labour Studies

1–16
Reputation on Underpricing of SME © 2019 XLRI Jamshedpur, School of
Business Management
IPOs in India & Human Resources
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DOI: 10.1177/0258042X19829285
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Nischay Arora1
Balwinder Singh1

Abstract
Small and medium enterprises (SMEs) being relatively new, young and with little operating history
tends to suffer from the problem of information asymmetry and ex ante uncertainty. This problem
can be reduced through the use of various signals in the initial public offering (IPO) process. Hence,
this study attempts to shed some light on the signalling role of prestigious auditors and underwriters
and their interacted effects on IPO returns in an emerging market like India. Cross-sectional data
comprising of final 286 SME IPOs issued during February 2012–March 2018 listed on the BSE SME
platform and NSE EMERGE have been taken into consideration. Multiple regression analysis has been
used to empirically test the signalling role. The results reveal that underwriter reputation helps in
reducing information asymmetry and signals firm quality to investors. Underwriter reputation documents
a positive relationship while auditor reputation lacks statistical significance. The negative relation of
interaction effect of auditors and underwriters reveal that underwriter reputation plays a significant
role in positively influencing investors’ perception and assisting them in taking investment decisions.

Keywords
Information asymmetry, underwriter reputation, auditor reputation, signalling role, IPO returns

Introduction
Small and medium enterprises (SMEs) are cornerstone of economic growth in all countries because they
account for 80 per cent of global economic growth (Jutla, Bodorik and Dhaliwal, 2002). Like any other
major economy, India too enjoys its fair share of SMEs contributing significantly to the exports and
GDP. SME segment has been a key engine of growth, employment, wealth distribution and effective

1
Guru Nanak Dev University, Amritsar, Punjab, India.

Corresponding author:
Nischay Arora, Guru Nanak Dev University, Grand Trunk Road, Off NH 1, Amritsar, Punjab 143005, India.
E-mail: aroranischay008@gmail.com
2 Management and Labour Studies

mobilization of resources (both capital and skills) in India. Statistically, SME segment contributes to
45 per cent of the manufactured output, 40 per cent of exports, and is among the largest generator of
employment in the Indian economy. Ministry of Micro, Small and Medium Enterprises reported the lack
of availability of adequate and timely credit, high cost of credit, collateral requirement and limited access
to equity capital as the top four major issues concerning the sector. To overcome this concern, various
efforts in the form of small exchanges such as Over The Counter Exchange of India, popularly known as
OTCEI, Inter Connected Stock Exchange of India, BSE IndoNext were made. Unfortunately, they all
failed to get the attention. Consequently, BSE SME platform and NSE EMERGE was launched in 2012
enabling the firms to raise capital.
SMEs being relatively new, young and with little operating history tends to suffer from the problem
of information asymmetry and ex ante uncertainty. This issue can be resolved through various disclosures
in prospectus. These disclosures includes information on assets, historical profitability, profits and
dividend forecasting, company’s growth plans. In addition to basic information, entrepreneurs send the
private information about the firm through the use of various signals such as retained ownership, lead
manager’s prestige, auditor reputation and underwriter reputation in the initial public offering (IPO)
process. These signals help in bridging the information gaps between issuers and investors reducing the
so called ‘winner’s curse’ and consequently underpricing. The term underpricing interchangeably used
with the term initial returns represents the difference between subscription price and price at which
shares are traded on the first day of trading in secondary market. It reduces the ‘money being left on the
table’ and leads to decrease in shareholder’s wealth (Filatotchev & Bishop, 2002; Tully, 1999).
The phenomenon of underpricing has been widely researched across different markets and docu-
mented in various studies. Many theories such as information asymmetry (Baron, 1982), winners’ curse
theory (Rock, 1986), signalling theory (Allen & Faulhaber, 1989; Welch, 1989) have emerged trying to
explain the phenomenon of underpricing but most of the researchers viewed the information asymmetry
as a premise for underpricing (Beatty & Ritter, 1986; Benveniste, Busaba, & Wilhelm, 1996; Firth &
Liau-Tan, 1998; Loughran & Ritter, 2004; Ritter & Welch, 2002). This problem of information asym-
metry reduces the wealth of existing shareholders, therefore challenge for IPO firm is to lessen this
problem by signalling the firm quality to them. One of the ways to effectively communicate this value to
investors is to appoint reputed professional advisors, that is, underwriters and auditors. Since these third
party professional advisors involved with issue process have huge reputational capital at stake (Megginson
& Weiss, 1991), so they associate themselves with good-quality issues thereby certifying the issue and
mitigating the investors’ uncertainty regarding the issue, enabling them to fetch higher issue price for the
issue. Many researchers have claimed that association of reputed auditors with firm enhances the credi-
bility of IPO among investors, thereby reducing underpricing (Balvers, McDonald, & Miller, 1988;
Beatty, 1989; Gao, Cong, & Evans, 2015; Menon & Williams, 1991; Pratoomsuwan, 2012). However,
the increase in credibility may increase the investors’ demand for the issue surging the closing price
upwards on the first day of trading (Sundarasen, Khan, & Rajangam, 2018). It has also been revealed that
good-quality auditors reduce uncertainty and information asymmetry more than lower-quality auditors
(Balvers et al., 1988; Beatty, 1989; Datar, Feltham, & Hughes, 1991). Along with reputed auditors,
issuing firm would also appoint reputed underwriters as they act as a consultant to the firm along with
guarantor of full subscription. Hiring a reputable underwriter portrays the signal of good quality to firm.
In fact, Balvers et al. (1988), Jacobs (1983) and Sutton and Benedetto (1988) argued that reputed
underwriters would entice firm to appoint good-quality auditors because they are cautious with their
reputation.
Emphasizing the role of an underwriter in issue process, SEBI Rules 1993 highlights that company
needs to appoint an underwriter in order to bring an IPO in the market. Underwriter helps the company
Arora and Singh 3

to sell its shares through various underwriting arrangements made available to the issuing company.
This financial advisor role is not only confined to underwriting but also has a primary role in price
fixation, ensuring the compliance of regulatory requirements, providing analysts recommendation and
creating a market for the stock after an IPO. In depth due diligence on prospectus including discussion
with senior management, inspecting the company’s operating policies, reviewing the material arrange-
ments, conducting the background check on board members is performed by underwriter to protect the
investors’ interest. Another financial specialist, that is, auditor is also regulated by SEBI to conduct the
independent audit of all financial statements to ensure that these have been prepared in accordance with
GAAP and that all the relevant disclosures have been duly made. Even the non-financial aspects of
prospectus, such as the description of the firm’s products or the firm’s prospects need to be audited by
the auditor to confirm that there is no misleading or fraudulent information in the prospectus. Finally,
auditor also provides comfort letter to the regulator providing the information on the statements
contained in prospectus and informing his examination of company documents to the best of his know-
ledge. Thus, the due diligence process is carried out in detail by both advisors to intact their reputational
capital by mitigating their liability arising out of misrepresentation in prospectus.
Based on the aforementioned discussion, this study attempts to discuss two important objectives.
First, the relationship between auditor reputation, underwriter reputation and underpricing is examined.
Second, the interaction effect of underwriter and auditor reputation on IPO initial returns is examined.
The results indicate that although auditor reputation does not influence underpricing, their interaction
effect reduces the underpricing indicating that they play significant role in influencing investors while
making investment decisions.
The article is structured in sections to achieve the objective. The second section reviews prior studies
in the literature. The third section details out the methodology employed in study. Data analysis and
interpretations have also been made in this section. The conclusions arrived at through the study have
been presented in the fourth section followed by implications in the final section.

Review of Literature

Auditor Reputation
Auditor’s primary role is not only to ensure that financial statements are prepared in accordance with
accounting principles but also taking care of the integrity of management and overall organization.
Highly reputed auditors enhance the firm quality by attesting the fact that overall integrity of manage-
ment is retained. Therefore, auditor reputation has been included in present study. Auditor reputation
although measured using different proxies, that is, size of accounting firms (DeAngelo, 1981), aggregate
sales revenue of audit firms (Francis & Wilson, 1988), auditor’s brand name (Dopuch & Sumunic,
1982), market share of auditing firm (Bulut, Cankaya, & Er, 2009). However, size of accounting firms is
being widely used in various empirical researches concerning large IPOs. Large audit firms have higher
reputational capital at stake, therefore they maintain higher audit quality. Small- and medium-sized IPOs
use market share of auditors to measure auditor reputation (Velamuri & Liu, 2017).
The extant empirical literature dealing with the auditor reputation revealed that firms have an
economic incentive in employing reputed auditors in the sense that investors associate this reputation
with firm’s reputation and are willing to pay higher price for the shares offered in primary market
(Klein & Leffler, 1981; Shapiro, 1983). Moreover, financial statements audited by auditors ensure the
investors that there are least chances of intentional and unintentional errors in audited financial statements
4 Management and Labour Studies

(Moizer, 1997). Hence, most of the studies use Big eight/Big six auditors as a measure of auditor reputa-
tion for two reasons—first to signal the firm quality to investors and second to reduce the monitoring
cost. Choosing big auditors to signal firm value is based on Titman and Trueman’s (1986) signalling
model that suggests that when company goes public, there is lot of uncertainty and information asym-
metry surrounding the IPO. This information asymmetry can be reduced through the signal of choosing
big auditors for IPO firm. Choice of auditors also help in reducing monitoring cost as the financial state-
ments audited by reputed auditors are more credible that ultimately reduce its monitoring costs (Firth &
Smith, 1992). Also, as the companies coming up with IPOs are relatively small, young and have limited
operating histories, investors rely heavily on the issuing firm’s disclosures in order to gauge the firm’s
value and evaluate the firm’s performance (Menon & Williams, 1991). The investors react positively to
the information supplied by IPO firm associated with reputed auditors (Jang & Lin, 1993). Therefore,
issuers send signal through the choice of big auditors. Hence, most of the studies use Big Eight/Big
Six auditors as a measure of auditor reputation.
The relationship between auditor reputation and IPO returns have been examined in various studies
(Beatty, 1989; Dhamija & Arora, 2017; Feltham et al., 1991; Menon & Williams, 1991). Utilization of
prestigious advisors, that is, underwriter and auditor lends the legitimacy to IPO firm as they help in
mitigating uncertainty about future cash flows and therefore reducing underpricing. The study conducted
by Misnen (2003) revealed that investors trust financial statements audited by reputed auditors more than
non-reputable auditors. This investors’ confidence helps in enhancing the firm’s value by reducing the
information asymmetry and uncertainty regarding IPO. The negative relation between auditor’s reputation
and underpricing is demonstrated by various studies such as Simunic and Stein (1987), Beatty (1989),
Menon and Williams (1991), Balvers et al. (1988), Gao et al. (2015), Sundarasen et al. (2018), and
Pratoomsuwan (2012). The reason being that financial statements audited by reputable auditors build
investor’s trust and confidence in the issue, enabling the company to fix higher issue price for its offerings
leading to reduction in underpricing. Studies by Titman and Trueman (1986), Feltham et al. (1991)
reported that reputation of auditors reflects the good quality of IPO firms, reducing ex ante uncertainty and
consequently the underpricing of IPO firms.
Titman and Trueman (1986) developed a framework showing that reputable auditors associate
themselves with low-risk firms as their association with risky firms may entangle them in lawsuits.
This framework was further empirically supported by Simunic and Stein (1987), Beatty (1989) and
Feltham et al. (1991). In contrast, Datar et al. (1991) not only reported positive relationship between
audit quality and IPO risk but also positive relation between firm’s valuation and audit quality. Several
studies such as Ammer and Zaluki (2016), Velamuri and Liu (2017), Sundarasen et al. (2018), Alvarez-
Otero and Lopez-Iturriaga (2018) have also documented positive relationship between auditor reputation
and IPO valuation. The results explain that firms with reputable auditors intentionally underprice their
issues in order to signal good quality to investors and to ensure the subsequent sale of seasoned equity
offerings (Alvarez-Otero & Lopez-Iturriaga, 2018; Datar et al., 1991). In addition, Sundarasen et al.
(2018) argued that since reputable auditors reduce ex ante uncertainty and information asymmetry
regarding IPO, investors are induced to buy shares thereby increasing their demand even in secondary
market. This increased demand tends to increase closing price leading to higher underpricing. In fact,
various studies such as Balvers et al. (1988), Jacobs (1983) and Sutton and Benedetto (1988) reported
that reputable underwriters encourage their clients to appoint reputable auditors because of their belief
that reputed auditors would accurately report the discrepancies in firm and thus prevent them eroding
their reputational capital. Even few findings, such as Vong and Zhao (2008), Badru and Ahmad-Zaluki
(2018), reported insignificant relationship. Based on literature review, positive relation between auditor
reputation and underpricing has been hypothesized in present study.
Arora and Singh 5

Underwriter Reputation
IPO is usually one of the make or break moments in the life of a firm and every company going public
needs a specialized staff in helping it go public. Moreover, since newly issued companies may not have
their own reputation, they need the reputation of professional advisors to sell shares efficiently (Logue,
Rogalski, Seward, & Foster-Johnson, 2002). Besides the marketing skills of underwriters, their financial
and technical expertise also comes in handy for issuing firms. Their expertise is a guarantee to the inves-
tors that company is sound for making investments. Underwriter is usually financial specialist who
ensures that firms meet all regulatory requirements and shares are fully subscribed. Therefore, under-
writer reputation has been used in present study. Carter and Manaster (1990) measured underwriters’
reputation based on rankings in tombstone announcement. Later on, Megginson and Weiss (1991) used
a relative market share of underwriter—a modified form of Carter and Manaster’s method as a proxy for
underwriter reputation. The firms going public suffer from the liability of market newness and this liabil-
ity can be reduced through the information disclosures in prospectus. One of such disclosures is reputa-
tion of third party specialist in prospectus. Prestigious underwriters are expert in estimating true value of
firm to investors, thereby reducing uncertainty regarding the firm and consequently ‘adverse selection
problem’ (Carter & Manaster, 1990). Also, reputable underwriters associate themselves with low-risk
firms because the value of low-risk firm can be precisely estimated and this precise estimation builds
investor confidence in firm thereby reducing underpricing. This also helps in maintaining reputational
capital (Carter, Dark, & Singh, 1998; Carter & Manaster, 1990; Megginson & Weiss, 1991).
Several studies have reported negative relationship between underwriter reputation and underpricing.
Dhamija and Arora (2017) used a sample of 399 IPOs from April 2005 to March 2015 to reveal that under-
writer reputation negatively influences IPO underpricing. Similar findings were reported by Sundarasen
et al. (2018), Beatty and Ritter (1986), Johnson and Miller (1988), Reutzel and Belsito (2015).
The positive relationship between underpricing and underwriter reputation has been documented in
studies such as Beatty and Welch (1996), Mitchell Van der Zahn, Singh, and Singh (2008), Chahine and
Tohmé (2009), Liu and Ritter (2011), Gao et al. (2015), Thorsell and Issakson (2014). The explanation
for positive relation is that reputed underwriters help in reducing the information asymmetry and uncer-
tainty regarding the IPO. This further enhances the firm’s quality and consequently demand for IPO
shares is increased on the first day of trading leading to higher closing price and consequently higher
underpricing (Sundarasen et al., 2018). Alvarez-Otero and Lopez-Iturriaga (2018) using a sample of
72 IPOs in Spain argued that underwriters intentionally underprice their shares to signal good quality to
investors and to prevent the shares from being unsubscribed. Beatty and Welch (1996), Liu and Ritter
(2011) empirically tested that underwriters are used as a marketing tool to create publicity in the market.
Also, underwriters and firms set their prices of their shares below market value in order to protect them-
selves from various litigation cases and risk of insolvency if IPOs are not fully subscribed.
In contrast to Beatty and Ritter (1986), Johnson and Miller (1988), Reutzel and Belsito (2015),
Dhamiza and Arora (2017), Sundarasen et al. (2018) which reported negative relationship and Beatty
and Welch (1996), Mitchell Van der Zahn, Singh, and Singh (2008), Chahine and Tohmé (2009), Liu and
Ritter (2011), Thorsell and Issakson (2014),Gao et al. (2015), Alvarez-Otero and Lopez-Iturriaga (2018)
which reported positive relationship between underwriter reputation and underpricing, various other
studies such as Shin (2010), Tian (2012), Anderson, Chi, and Wang (2015), Velamuri and Liu (2017),
Bhattacharya (2017), Badru and Ahmad-Zaluki (2018) reported insignificant relation between the two.
In the context of our study in Indian setting in case of SMEs, the positive relation between underwriter
reputation and underpricing has been hypothesized in present study.
6 Management and Labour Studies

Research Gap
Most of the studies focusing on signalling role of prestigious professional advisors, that is, underwriters
and auditors have been undertaken in developed countries with stronger investor protection and legal
enforcement. India, being an emerging economy is of interest in the study to check if the established
relationships between underwriter/auditor reputation and underpricing holds true in a country with dif-
ferent institutional background. Moreover, very few studies to the best of knowledge have been under-
taken exploring the interaction effect of underwriter and auditor reputation on IPO initial returns. Hence,
present research attempts to fill the gap by focusing on signalling role of auditors and underwriters in
emerging markets like India.

Research Methodology

Data Collection
The study examines the IPOs listed on BSE SME platform and NSE EMERGE issued during February
2012–January 2018. Data related to variables under the study have been taken from prospectuses and
official websites of BSE and NSE. The sample comprises of 328 IPOs that were further reduced to 286
IPOs due to non-availability of information on certain variables and presence of extreme observations.

Statistical Analysis and Variable Measurement

The present research attempts to identify the signalling role of prestigious underwriters and auditors and
their impact on underpricing of SME IPOs. Multiple regression has been used to study the signalling
effect on IPO initial returns in India. The regression model was checked for the assumptions of hetero-
scedasticity and multicollinearity. The problem of heteroscedasticity was discovered using Harvey test
and it was contained using White test. Variance inflation factors for all variables were found to be below
10, hence the problem of multicollinearity was not discovered.

Underpricing = α + β1issue price + β2listing delay + β3firm age + β4issue size + β5total assets +
β6total oversubscription + β7underwriter reputation + β8auditor reputation + εi

For measuring IPO performance in terms of underpricing, market-adjusted excess return (MAER,
dependent variable), regarded as underpricing has been used. MAER has been calculated by subtracting
market return from initial raw return. The purpose to compute MAER is to adjust market movements
between issue close date and listing date. As proposed by Carter et al.(1998) and Certo, Daily, & Dalton
(2001), level of underpricing is calculated as the percentage increase from offering price to closing price
on the first day of trading.

MAER = ((P1–P0) / P0 – (M1 – M0) / M0) × 100

MAER = Market-adjusted excess return
P1 = Closing price of the securities on the first day of trading
P0 = Offer price of security
M1 = BSE SME IPO index on the first day of trading
M0 = BSE SME IPO index on offer closing date of IPO
Arora and Singh 7

Relative market share of underwriters is computed to measure underwriter reputation using Megginson
and Weiss’ (1991) methodology:
Underwriter reputation = (IPO proceeds underwritten by underwriter / total IPO proceeds in the
sample) × 100
As far as auditor reputation is concerned, the study adopts the methodology used by Velamuri and Liu
(2017) to compute auditor market share.
Auditor reputation = (IPO proceeds of the firms (in the sample) of the auditor / total IPO proceeds in
the sample) × 100
After computing auditor market share, auditor dummy variable is constructed which takes the value
1 for auditors who have above median market shares and 0 otherwise. Since the control variables have
been shown to be the good predictors of dependent variable in the previous researches, they have been
included in the present study to ensure that the impact of auditor reputation and underwriter reputation
on underpricing is unbiasedly captured. Issue price reflecting the stronger fundamentals of the company
is expected to show a positive relationship with underpricing (Su & Fleisher, 1999). The negative
relation of firm age (referring to number of years firm has been incorporated) with underpricing suggest
that younger firms are expected to have higher underpricing due to higher information asymmetry sur-
rounding the IPO (Certo et al., 2001., Darmadi & Gunawan, 2013). Isobe, Ito, and Kairys (1998) reported
that larger issue size signals firm’s good quality to investors thereby generating higher initial returns.
Firms with larger asset base are reported to not only have better long-run performance but also higher
initial returns (Certo et al., 2001; Hearn, 2011). Longer time lag is expected to increase various risks
faced by investors thereby leading to higher underpricing (Chahine & Tohmé, 2009; Chowdhry &
Sherman, 1996; Mok & Hui, 1998). Higher oversubscription reflecting higher demand signals higher
returns on the first day of trading (Koh & Walter, 1989). The details of variables under study and control
variables are shown in Table 1.

Table 1.  List of Variables Under Study and Returns

Variables Description
Underpricing on listing day Market-adjusted excess return – Raw return – Market return as measured
by the BSE Sensitive Index
Independent variables
Underwriter reputation (IPO proceeds underwritten by underwriter / Total IPO proceeds in sample)
× 100
Auditor reputation Dummy variable is constructed with 1 for above median market shares and
0 otherwise.
Control variables
Oversubscription No. of times issue has been oversubscribed
Issue size Natural logarithm transformation of proceeds received from issuing new
shares
Listing delay No of days between close of issue and listing on BSE/NSE
Issue price Inverse of price at which shares are issued through IPO
Firm age Natural logarithm transformation of number of years between date of
incorporation and IPO issue date
Total assets Natural logarithm transformation of book value of total assets as expressed
in lakhs
Source: The authors.
8 Management and Labour Studies

Data Analysis and Interpretation

Variations in MAER of SME companies across independent variables included in our present study have
been shown in Tables 2 and 3.The results show that average MAER is as high as 7.067 per cent when
reputed auditor is hired (auditor dummy = 1) as compared to auditor when reputed auditor is not hired
(auditor dummy = 0). Also, average returns are highest when underwriter market share increases beyond
9.18 per cent. This is only rough sketch of relationship that has been probed further through regression.
Table 4 highlights the descriptive statistics of all variables used in present study. It shows mean,
median, minimum, maximum, standard deviation, skewness and kurtosis of IPOs listed in BSE SME
platform and NSE EMERGE.
As documented in Table 3, most IPO firms are underpriced with average underpricing stood around
at 6.206814 (mean), minimum initial return at –22.76989, maximum initial return at 115.75 and standard
deviation at 16.21987. Underwriter reputation has mean value of 7.136588 meaning that average market
share of underwriters is 7 per cent. The minimum share is 0.04254 per cent while the maximum share is

Table 2.  Table Analysing Changes in MAER on the Basis of Auditor Reputation

Auditor Dummy No. of Observations MAER (%)

0 154 6.494038
1 157 7.066173
Source: The authors.

Table 3.  Table Analysing Changes in MAER on the Basis of Underwriter Reputation

Underwriter Market Share No. of Observations MAER (%)

UMS %0.990 77 9.014672
0.990 < UMS % 4.935 62 1.873113
4.935 < UMS % 9.180 80 4.687085
Above 9.180 87 9.611062
Source: The authors.

Table 4.  Descriptive Statistics of Variables

Variables Mean Median Maximum Minimum Std Dev. Skewness Kurtosis Observations
MAER 6.206814 2.255238 115.75 –22.76989 16.21987 2.600187 16.19297 300
1_Issue price 0.038367 0.028571 0.1 0.001087 0.028067 1.037763 2.954589 306
Ln(Firm age) 2.251593 2.310492 4.760721 –0.729413 0.80508 –0.709055 4.045753 306
Ln(Issue value) 6.651163 6.506681 9.134927 4.442651 0.842091 0.192701 2.553045 305
Ln(Total assets) 7.800423 7.80366 10.82226 0.21188 1.17083 –0.811077 7.671659 305
Listing delay days 11.6634 10 240 0 14.67599 13.00172 195.5951 306
Total 10.63115 1.6 255.958 0.7366 29.4368 4.996107 32.26934 293
oversubscription
Auditor dummy 0.488746 0 1 0 0.500679 0.045027 1.002027 311
Underwriter 7.136588 5.569192 19.05203 0.04254 6.423283 0.6777 2.339141 306
market share
Source: The authors.
Arora and Singh 9

19.05203 per cent. Auditors’ reputation has highest value of 1 and lowest value of 0 as dummy variable
is used to capture auditor reputation. Skewness and Kurtosis tests the deviations from normality.
Skewness of majority variables is low indicating normality of variables. Moreover, deviations from nor-
mality is not a cause of serious concern in our data due to larger sample size. In nutshell, descriptive
statistics of variables shows that IPO firms do have variation in variables tested.

Correlation Analysis
Table 5 shows the correlation between MAERs, independent variables and control variables. Since none
of the correlation estimates in the table is above the threshold limit of 0.90, there is no problem of mul-
ticollinearity.
Relationship Between Auditors’/Underwriters’ Reputation and Initial Return
In order to explore the impact of prestigious auditors and underwriters on underpricing of SME IPOs, the
following multivariate regression equation has been used:

MAER = α + β1issue price + β2listing delay + β3firm age + β4issue size + β5total assets + β6total
oversubscription + β7underwriter reputation + β8auditor reputation + εi

The study uses MAER as dependent variable to examine the impact of auditor reputation and under-
writer reputation on initial adjusted raw return. Table 6 reports the regression outcome.
The empirical results indicate that among control variables, inverse of issue price, firm age, listing
delay and total oversubscription are positive and significant at 5 and 1 per cent levels, respectively. Issue
price reflecting the stronger fundamentals of the issue leads to better pricing performance (Su & Fleisher,
1999). Listing delay positively influences underpricing meaning that investors do not perceive longer
time lag to be a signal of good quality, thereby leading to high underpricing (Chahine & Tohmé, 2009;
Chowdhry & Sherman, 1996; Mok & Hui, 1998). Oversubscription is also highly significant at 1 per cent
level and positively influences underpricing. The positive relationship indicates that issues with higher
demand fetch higher price, thereby leading to higher underpricing (Koh & Walter, 1989). The negative
coefficient of firm age in line with Certo et al. (2001), Darmadi and Gunawan (2013), Thorsell and
Issakson (2014) indicates that older firms have good disclosure of longer track record thereby mitigating
information asymmetry and reducing underpricing.
Among independent variables, underwriter market share is positive and significant at 1 per cent level.
The results reveal that underwriter reputation positively influence IPO returns. The justification behind
positive relation is that since reputed underwriters are concerned about their reputation they associate
themselves with low-risk firms so that they can easily and correctly estimate true value of firm. Estimation
of true value of firm thus helps in reducing uncertainty and information asymmetry among issuers and
potential investors. This low uncertainty signals firm’s good quality to investors thereby inducing the
investors demand in the secondary market, consequently pushing the closing price upwards and hence
higher initial returns. These findings are in line with Beatty and Welch (1996), Mitchell et al. (2008),
Chahine and Tohmé (2009), Liu and Ritter (2011), Gao et al. (2015). As far as auditor reputation is con-
cerned, results indicate that though the coefficient of auditor reputation is negative, it is insignificant.
Although insignificant, negative relationship implies that firm’s association with reputed analysts
increases the investors’ confidence in firm, thus enabling the firm to fetch higher issue price. Moreover,
Table 5.  Correlation Data Matrix

Ln Issue Ln Total Listing Total Auditor Underwriter

MAER 1_IssuePrice Ln Firm Age Value Assets Delay Days Oversubscription Dummy Market Share
MAER 1 – – – – – – – –
1_Issue Price 0.104633242* 1 – – – – – – –
Ln(Firm age) –0.109211713** –0.182160868*** 1 – – – – – –
Ln(Issue value) –0.047543137 –0.639768487*** 0.229764716*** 1 – – – – –
Ln(Total assets) 0.06824951 –0.283306385*** 0.289812412*** 0.57609233*** 1 – – – –
Listing delay days 0.335138983*** 0.125164519** –0.057822615 –0.120886446** 0.011625354 1 – – –
Total 0.230867857*** –0.15302271*** 0.107931669* 0.137679446*** 0.10936759* –0.050914319 1 – –
oversubscription
Auditor dummy –0.068452679 –0.452016347*** 0.16263*** 0.7452590*** 0.4743333*** –0.078366924 0.068872652 1 –
Underwriter 0.222883075*** –0.077173749 0.066943149 0.019557974 0.206693635*** 0.039257377 0.036773918 0.045709021 1
Market share
Source: The authors.
Note: ***, ** and * indicate significance at 1, 5 and 10%, respectively.
Arora and Singh 11

Table 6. Relation Between Signalling Variables (Underwriter and Auditor Reputation) and IPO Initial Return

Independent Variables Coefficient P-Values

Constant –14.69975 0.1261
1_Issue price 64.51655** 0.0442
Ln(Firm age) –2.155105** 0.0165
Ln(Issue size) 1.720698 0.2645
Ln(Total assets) 0.558567 0.4652
Listing delay 0.276121*** 0.0000
Total oversubscription 0.113915*** 0.0000
Auditor dummy –2.419061 0.2366
Underwriter market share 0.426127*** 0.0001
R2 0.248514 –
Adjusted R2 0.226810
No. of observations 286
F-statistic 11.45037***
Source: The authors.
Note: ** and *** indicates significance at 5% and 1% level respectively.

auditors’ reputation is an attestation to the fact that information provided is true, accurate and duly
certified. The findings of insignificant relation are corroborated by Vong and Zhao (2008), Badru and
Ahmad-Zaluki (2018), Sundarasen et al. (2018).

Relationship Between Interacted Independent Variables (Underwriter Reputation

and Auditor Reputation) and Initial Return
Independent variables are interacted in the regression model in order to know the combined effect of
auditor and underwriter reputation on underpricing. Therefore, the main effects (underwriter reputation
and auditor reputation) are controlled for in this regression model. Table 7 reports the result of interac-
tion effect of professional advisors on IPO initial returns. The equation is specified below:

MAER = α + β1issue price + β2listing delay +β3firm age +β4issue size +β5total assets + β6total
oversubscription + β7underwriter reputation  +β8auditor reputation + β8underwriter
reputation × auditor reputation + εi

The variables representing interaction effect of auditor reputation and underwriter reputation are
regressed against MAER. As documented in table, empirical results show the outcome of interacted
independent variables on initial returns. Underwriter reputation variable is interacted with variable used
for measuring auditor reputation. The explanation for interaction effect is that reputed underwriters have
tendency to recommend reputed auditors to the firms because of their huge reputational capital involved.
The results indicate that coefficient of interaction of underwriter reputation and auditor reputation is
negative and significant at 5 per cent level. The findings in line with Sundarasen et al. (2018) suggest that
combined effect of both professional advisors’ reputation depresses initial returns. The justification for
the aforementioned result is that since reputed underwriters have huge reputational capital at stake, they
12 Management and Labour Studies

Table 7.  Relationship Between Interacted Independent Variables and IPO Initial Returns

Independent Variables Coefficient P-values

Constant –17.64476 0.0602
1_Issue price 70.42693* 0.0601
Ln(Firm age) –2.153251** 0.0433
Ln(Issue size) 1.971838 0.2126
Ln(Total assets) 0.527216 0.5046
Listing delay 0.274828*** 0.0000
Total oversubscription 0.111410*** 0.0000
Auditor dummy 0.490653 0.8515
Underwriter market share 0.627148*** 0.0001
Underwriter market share # auditor dummy –0.419603** 0.0394
R2 0.259216
Adjusted R2 0.235060
No. of observations 286
F-statistic 10.73091***
Source: The authors.
Note: *, ** and *** indicate significance at 1, 5 and 10%, respectively.

entice the company to appoint prestigious auditors. This may build the confidence among investing
fraternity regarding underwriters’ capability in pricing the issue fairly. Underwriters association with
reputed auditors may positively impact the investors’ perception that accounting standards are properly
adhered to and financial statements reflect true and fair view of firm performance, thereby reducing
uncertainty surrounding the IPO and consequently underpricing.

Conclusion
The present study sheds some light on the signalling roles of underwriters and auditors in case of SME
IPOs in emerging market like India. Owing to the distinctive capital market regulations, the study in
Indian settings holds much more importance. Moreover, being relatively young and due to lack of track
record of operating profits, SMEs tend to suffer from the problem of information asymmetry. Hence,
they need to overcome the ‘liability of market newness’ (Certo, 2003). The way to reduce this liability is
by effectively communicating the firm value to investors through the use of various signals in IPO
process. Auditor’s reputation and underwriter’s reputation are such signals that entrepreneur use to
portray firm quality to investors. Since, auditors attest the accuracy of financial statements, the firms
association with reputed third party specialists would send a strong signal of firm quality to investors,
thereby reducing the information asymmetry among issuers and potential investors. However, the results
report lack of statistical relationship. For the underwriter reputation, positive relationship is documented.
The positive relationship suggest the increase in investors’ demand of issues on the first day of trading
due to portrayal of good firm quality to investors. Underwriter’s reputation plays a significant role among
SME firms in emerging market like India due to presence of information asymmetry among investors
regarding new issues. Negative relationship of interacted variables with initial returns further strengthen
the fact. The relationship indicates that good-quality underwriters induce the firm to appoint good-quality
auditors because they are overly cautious about their reputational capital and therefore avoid being
Arora and Singh 13

associated with poor quality auditors. This association leaves the good impression in investors’ mind
thereby leading the company to command higher issue price, reducing the initial returns.

Implications
The present study is valuable for issuers, investors and regulators. The findings have implications for
various stakeholders. First, the newly issued firm should keep in mind the reputation of underwriters
while appointing them if they want their IPOs to be highly demanded in secondary market. As against,
if issuers have no qualms in leaving more money on the table, they may work with non-reputable under-
writers as their fees is much lower than reputed underwriters. Second, the findings implicate that if the
issuers want to leave less money on the table, then they should hire reputed underwriters as it would
signal the investors that firm is confident about its financial performance. This would also help them to
maximize the shareholders’ wealth. Third, since the good-quality underwriters associate themselves with
reputed auditors, this would assure the investors that financial statements reflect true and fair view of
firm position. Thus, these findings act as a guiding tool to both issuers and investors in raising capital
and taking investment decisions in SME IPOs in India. Fourth, the regulators like SEBI can use these
results in including the regulations pertaining to auditors and underwriters in IPO process in India.

Declaration of Conflicting Interests

The authors declared no potential conflicts of interest with respect to the research, authorship and/or publication of
this article.

Funding
The authors received no financial support for the research, authorship and/or publication of this article.

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