Friday, October 3, 2008

Under Pricing of IPO’s

When we were taught pricing of IPO’s in class of Management of Financial Institutions I found it very interesting. The concept was that the primary aim of the merchant banker should be to get the full subscription of the shares and leave enough gravy on the table so that even in case of strong bear sentiments in market the investors to the IPO don’t lose money. 

Our professor told us that there is phenomenon of overpricing of the IPO’s by the Indian merchant bankers. They overprice in order to get merchant banking contract from the company going for listing as there is lot of competition among the merchant bankers. The banks which can get the shares fully subscribed at the highest price are the preferred one in the industry. It clearly brings more funds for the company; hence companies want to overprice. This phenomenon causes lot of loss to the IPO investors in case the listing price of IPO is less than the IPO book building cutoff price. The overpricing of IPO’s happened throughout 2008 in Indian stock markets including the likes of Reliance Capital. Hence the IPO’s should be under priced. 

Today I came across a piece of statistics which confused me about the whole theory. The American merchant bankers in order to have full subscription repeatedly followed this principle of under pricing. IPOs were underpriced by 11 percent between 1990 and 1998, but that gap soared to almost 70 percent during 1999 and 2000. In 1999 and 2000 alone corporate America left more than $60 billion on the table money that could have been invested in the development of the newly listed companies. Now thinking that the promoters of the company are the major subscribers in any equity issue, it’s not the common man who is only benefiting out of these under priced issue. Infact it can be seen as a major issue of corporate governance. 

So what should be the correct strategy of the pricing of the IPO’s? By looking at the demerits of both under pricing and overpricing I think fair pricing of the IPO with regards to the risk and relative to industry peer might be a good way of pricing. But the question remains, deciding the fair value is very subjective and there is nothing like fair value of any company.So confusing !

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