As cited by Dimovski and Brooks, underpricing refers to transfer of wealth from the issuing firm to the investors in the IPO. (Brooks, 2010) The issue of IPO being launched at a price substantially less than their market value on the first day of listing, is a global phenomenon now. The issue is now widely documented as academic researchers are performing a plethora of research work to evaluate the IPO underpricing. Even though the issue of IPO under pricing is internationally pervasive, however, in the recent years, researchers are getting more inclined in evaluating the IPO pricing in emerging markets, and once such market is Australia, which in the recent time has seen a huge explosion in the IPO market. Aligning with the global trend in the IPO market, the IPO market continues to outperform ASX 200,with some stocks generating astounding returns.(Ritter,1991) For instance, stocks like Eclipx and Pepper Group had surged by 34.8% and 29.2% on the issue date, respectively. (Australian Stock Exchange, 2014). Even a report released by Deloitte also confirms relatively underpricing of IPO in the Australian market.(Deloitte, 2015) On the whole, of the total 48 listing in 2015, an average IPO gained 7.2% on the issue date. Therefore, the researcher community is showing an increased interest in validating the issue of IPO underpricing and also determining the factors that contribute to short-term performance of such IPO’s. (Pererra, 2014)
One such research paper, ’ Evaluation of Market Performance of Initial Public Offerings (IPOs) and Its Determinants: Evidence from Australian IPOs’’, reiterates the issue of IPO underpricing but use a different methodology as part of which it tests the IPO underpricing in primary, secondary and total market using various return measures. Additionally, the researcher also uses three different econometric models, binary regression, multiple regression and probability analysis to find out the main determinants that contribute towards IPO underpricing and short-term performance in the Australian IPO market. Important to note, even though IPO’s found their place years ago, but the phenomenon of IPO underpricing was first documented by by Stoll and Curley (1970), Logue (1973) and Ibbotson (1975). The vintage researchers, in order to evaluate the underpricing issue, used the first-day average return , which they calculated on the basis of closing price performance, and found that the issue of underpricing was predominantly prevalent in the IPO market. However, the academic fraternity cited major limitations in the methodology of using first-day return to study the underpricing issue on the following basis:
Investors face information asymmetry and do not know much about the newly issued IPO and issuer company
Capital market needs a reasonable time to look for the equilibrium in the short-run
First-day return does not provide any information about who is the real beneficiary of the short-run under pricing
(Pererra, 2014)
In the research paper selected, the researcher, in order to determine underpricing of IPO in the Australian market and to evaluate the determinants, investigated the short-run and long-run stock market performance of 254 IPO listed at the Australian Stock Exchange from 2006 to 2011. In order to determine the short-term performance, first day listing returns were divided into the primary market returns, secondary market returns and the total market returns by analyzing the difference between the first day closing price and opening price/issue price. The researcher then extended the time period by including post-day listings and analyzed the return for nine trading trading days after the issue of IPO. Marginal probability was also calculated to ascertain the associated probability of each independent variable in determining the short-term performance of the IPO issue. (Pererra, 2014)
Performing the research work using multiple quantitative techniques, the researcher found that during the period of the stud, Australian IPO’s were underpriced by 25.47% and 23.11%, both in primary market and total market, on the basis of market-adjusted abnormal return. However, the analysis of the secondary market returns indicated that the Australian IPO’s were overpriced by 1.55% on the market-adjusted abnormal return (MAR), thus indicating that over the time, the wealth created because underpricing gets diluted. Comprehensive discussion of the research findings is discussed here:
Analysis of short-run market performance showed that IPO’s issued on ASX were underpriced during the short-run, thus confirming the underpricing phenomenon in IPO in the Australian market. However, the results were contradictory for secondary market analysis, which indicated that Australian IPO’s were overpriced using MAR and RR return measures. However, on a cumulative basis and testing the IPO underpricing using MAR and RR return measures, IPO’s were found to be underpriced in both primary and total markets, although the post-issue day MR analysis confirmed that the level of underpricing slowly decreased after the listing, thus diluting the issue day analysis(Pererra, 2014)
As far as determinants of the IPO underpricing are concerned, following the binary regression , multiple regression model and marginal probability analysis, the researcher found the following outcome for each of the analysis model stated above:
Multiple regression model revealed that LISD, PRICE, time to listing (TOTP), market return (RETU), MV (MVt-10) and attached free share option availability (ATOA), are the main determinants of the IPO underpricing in Australia
The binary regression models indicated that IPOP, TOTP, LISD, TNPR and MV (MVt-60) are the main determinants of the short-run performance of the IPO’s issued in Australian Stock Exchange(ASX)
Marginal probability analysis confirmed that the main determinants of IPO underpricing in the Australian market were MV (MVt-60) and TNPR.
(Pererra, 2014)
Important to note, the reason for difference in model outcome relating to determinants of IPO underpricing was attributed to difference in analysis model and also by market where these shares were traded, i.e. primary or secondary.
On the whole, the researcher, using multiple and empirically accepted statistical techniques, confirmed that just like the global arena, the issue of IPO underpricing is relatively present in the Australian Stock Exchange(ASX), and investors can earn high returns on the very first day by dealing with IPO’s in the primary market. However, the investors should understand and should be cautious that their benefit of high returns get diluted as soon as the stock trades on the secondary market post the first day of trading because his research reveals that IPO are overpriced in the secondary market, and thus, the study has confirmed that even though underpricing is duly present in IPO’s issued on the Australian Stock Exchange(ASX), however, the wealth or the profit earned during the issue date decreases in the first-day secondary market and the post-day market. On the other hand, the researcher used two different econometric models, binary regression and multiple regression, and marginal probability analysis to determine the determinants of the IPO underpricing and short-run market performance. Using these models, the researcher found different determinants, with variation attributed to model inputs and market of analysis, however, the researcher postulated that the investors can use any of these determinants as the same will help them in formulating their short-run investment strategies in the IPO market. (Pererra, 2014)
List of abbreviations used in the paper:
RR: Raw Return
TOTP: Total Listing Period
ATOA: Attached free share option availability
LISD: Listing Delay
MV: Market Volatility
TNPR: Total net proceeds ratio
References
Australian Stock Exchange, (2016). IPO: the road to growth and opportunity. Sydney: Australian Stock Exchange, pp.1-16.
Business Statistics Wileyplus Blackboard Card. (2012). John Wiley & Sons Inc.
Dimovoski, W. and Brooks, R. (2010). Underwriter reputation and underpricing: evidence from the Australian IPO market. Springer Science Business Media, pp.2-3.
Ritter, JR 1991, ‘The long-run performance of initial public offerings’, The Journal of Finance, vol. 46, no. 1, pp. 3–27.
Turner, I. and Verma, T. (2016). Deloitte 2015 IPO report | Deloitte Australia | Financial advisory, Corporate finance, IPOs, M&A. [online] Deloitte Australia. Available at: http://www2.deloitte.com/au/en/pages/finance/articles/deloitte-2015-ipo-report.html?utm_source=social&utm_medium=social&utm_campaign=sl_fas_2015_ipo_report_15_03_10 [Accessed 28 Apr. 2016].
Wasantha Perera, K. (2016). Evaluation of Market Performance of Initial Public Offerings (IPOs) and Its Determinants: Evidence from Australian IPOs. Melbourne: Victoria University, pp.1-345.
