IPO and Empirical Regularity of IPO

in Bangladesh

By
Mahmood Osman Imam Ph.D., FCMA
Professor and Ex-Chairman
Department of Finance
and
Executive Director
Center for Corporate Governance and Finance
Studies
University of Dhaka

Mahmood Osman Imam 1

 IPO Issue Management , Pricing and Price Performance
Behavior in the Aftermarket

IPO Rationale:
mechanism for assisting the firms initial shareholders in
diversifying their holdings.
assist managers (often the firms founder[s]) in
procuring the necessary funding for undertaking new
projects.
The IPO enables these individuals to sell a portion of
their holdings in the firm and utilize the funds generated
from the sale of stock to diversify their investment risk
(Rock, 1986).
Both goals can be simultaneously achieved.
Arkebauer (1991) found that the need to generate funds
to pursue new projects dominated portfolio
diversification.
For many entrepreneurial ventures, an IPO enables firm
management to pursue growth opportunities that would
otherwise be impossible to fund.

2
 IPO in Primary Market New Issue Management

Why do companies go public (list)?

At some point in time, in the life cycle of a firm's external financing for
growth, privately-held firms generally find it desirable to "go
public" by selling stock to a large number of diversified
investors.
Possible incentives for going pubic:
First, it enables a firm to raise new equity funds for expansion and future
investment.

Second, it may enable the original owners of the firm to realize part of
their investment, and thus can serve as an important exit route for the
entrepreneur or venture capitalists.

Third, it provides a mechanism for assisting the firms initial shareholders

in diversifying their holdings.

Fourth, once the stock is traded, this enhanced liquidity allows the firm to
raise additional capital via secondary issues..

3
 IPO in Primary Market New Issue Management

Advantages of Listing or Going Public

The best way to raise fund for your company
Liquidity
Enhancement of efficiency
Outreach to investors for future finance need
Tax Benefit
Enhanced Reputation

Disadvantages of Listing or Going Public

There are costs associated with listing or going public, too. These are:
Ongoing costs of compliance associated with the need to supply information
on a regular basis to investors and regulators for publicly-traded firms.
Furthermore, there are substantial one-time costsnamely,
Direct costs that comprise costs of legal, auditing & underwriting fees etc.,
and
Indirect cost, if the shares are sold for less than investors would be willing
to pay (i.e. underpricing).
These direct and indirect costs affect the cost of capital for firms going
public.

4
 IPO in Primary Market New Issue Management

IPO Process:
Upon deciding to undertake an IPO, firm management must
first secure the services of a issue-manager (& lead
underwriter as well).
The issue-manager assist firms managers in preparing the
extensive paperwork involved in complying with SEC
guidelines, including the registration statement, of which the
prospectus is a part.
Prospectus/IM is these materials that serve as the primary
marketing tool for the firms securities.

5
 IPO in Primary Market New Issue Management

IPO Process:
The IPO marketing process is punctuated by what is called a
road show.

These presentations focus on the firms operations, products

and services, and management.

The road show is designed to gauge the anticipated demand

for the firms stock and serves as a key input in the merchant
bankers final determination of the price at which the firms
stock will initially trade.

6
 IPO Issue Management , Pricing and Price Performance
Behavior in the Aftermarket

IPO Process:
Upon completion of the road shows, and just prior to the actual first
day of trading, firm managers and the underwriters shepherding the
process will set the initial offering price.

This is a critical decision point for firm management because once

the price has been set, shares cannot be offered to the initial
investors at a higher price the first day of trading regardless of the
level of demand (Gordon & Jin, 1993).

It is this initial stock price that forms the basis for underpricing given
that underpricing represents the difference between the initial stock
price set by IPO firm managers and the underwriters and the price of
the stock at the close of the first day of trading.

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 IPO Issue Management , Pricing and Price Performance
Behavior in the Aftermarket
Book Building Method
Issuer shall invite for interest for indicative price offer from the eligible
institutional investors through proper disclosure, presentation, document,
seminar, road show, etc;
The issuer, in consultation with the issue manager, shall quote its own
indicative price in the draft prospectus based on the indicative prices so
obtained from the eligible institutional investors;
Provided that the issuer and the issue manager shall send the
Information Memorandum to eligible institutional investors (EIIs) without
mentioning the indicative price.
The Indicative Price should be disclosed by the Issuer and Issue Manager
after the quotation received from the EIIs.
The said indicative price should be supported by at least 20 EIIs including
at least 3 (three) quotations from each of the following category:
Merchant Bankers
Commercial Banks
Asset Management Companies
Non-Banking Financial Institutions (NBFIs)
Insurance Companies
Stock Dealers

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 IPO Issue Management , Pricing and Price Performance
Behavior in the Aftermarket

Book Building Method

The institutional bidders will be allotted security on pro-rata basis at the
weighted average price of the bids that would clear the total number of
securities being issued to them.

General investors, which include mutual funds and NRBs, shall buy at the
cut-off price.

The Company and The Issue Manger shall submit the status of bidding
and the Cut Off price along with the final draft prospectus, simultaneously
to the Commission and the stock exchanges within 5 working days from
the closing day of the bidding.

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 IPO Issue Management , Pricing and Price Performance
Behavior in the Aftermarket

Book Building Method

Prerequisites of an issuer for becoming eligible
An issuer may determine issue price of its security being offered following
book-building method (i.e. price discovery process) subject to compliance with
the following, namely:
The issuer-
must have at least Tk. 30 crore net-worth;
shall offer at least 10% shares of paid up capital (including intended offer)
or Tk. 30 crore at face value, whichever is higher;
shall be in commercial operation for at least immediate last three years;
shall have profit in two years out of the immediate last three completed
financial year;
shall have no accumulated loss at the time of application;
shall be regular in holding annual general meeting;
shall audit at least its latest financial statements by a firm of chartered
accountants from the panel of auditors of the Commission;
shall appoint separate person as issue manager and registrar to the issue
for managing the offer; and
shall comply with all requirements of these Rules in preparing prospectus.

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 IPO Issue Management , Pricing and Price Performance
Behavior in the Aftermarket

Book Building Method

The price discovery process through bidding
-- Modified English Auction
-Truthful revelation Process

Distribution mechanism for issuance of security

Issue Size in EII Quota MF Portion NRB Public

Face Value Portion Portion
30 50 cr. 40% 15% 10% 35% or
balance amt
Over 50 100 cr 50% 15% 10% 25% or
balance amt.
Over 100 cr. 60% 15% 10% 15% or
balance amt
Lock-in --- lock-in of 4 (four) months from the first trading day to EIIs

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 IPO Issue Management , Pricing and Price Performance
Behavior in the Aftermarket

Underwriting the IPO:

At least 50% of the IPO size need to be underwritten.

Firm Commitment Vs. Best Effort.

In firm commitment in US, IB/underwriter(s) buys the

securities less than the offering price and accepts the risk
of not being able to sell them. In other words, underwriter
advances money against underwriting shares and sale
proceeds of these to public are then adjusted with their
advances.
In firm commitment in Bangladesh, underwriters provide a
form of guarantee that if any share remains
undersubcribed, then unsold portion will be taken over by
them

14
 IPO Issue Management , Pricing and Price Performance
Behavior in the Aftermarket

Price Stabilization:
Price stabilization support is provided by the underwriters in
US in the one month aftermarket. If the price will tend to go
below the subscription price, underwriter support price
pegging at the issue price.

Merchant banks, being the underwriters, in Bangladesh could

not afford to provide this sort of support.

15
 IPO Issue Management , Pricing and Price Performance
Behavior in the Aftermarket

Book Building Methods Reform Agenda

Book Building Method is itself relying on prudency of
eligible institution investors and are misused recklessly
during bubbles.

The Book Building method is reformed in order to

prevent institutional imprudence.

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 IPO Issue Management , Pricing and Price Performance
Behavior in the Aftermarket

Fund Raising through Equity Market

Companies raise money from the primary market
through IPO and Right offer
In the last 9 years, on an average 15 new companies got
listed through IPO each year in Bangladesh market.
As of May 2015, in total 324 companies are listed
(including 41 mutual funds) in DSE
During last 9 years, average yearly capital raised through
IPO and Right Issue are BDT 14956.54 mn and
7825.31mn respectively.

17
 Fund Raising through Equity Market

Year No of new IPO IPO Issue Size (BDT Mn) Year Right offer (BDT Mn)
2006 7 3727 2006 1673.62
2007 14 10057 2007 598.79
2008 12 8270 2008 2112.32
2009 18 19047 2009 2439.87
2010 18 28653 2010 17601.14
2011 14 16899 2011 18589.51
2012 17 18175 2012 4979.09
2013 12 16640 2013 1803.04
2014 20 13141 2014 20630.45
Total 132 134608.86

Sources of the Chart : A presentation by Mohammed Nasir Uddin Chowdhury, MD &CEO, LankaBnagla
Finance

18
 Steady Progression of Foreign Portfolio
Participation in Bangladesh

Foregin Turnover Net buy/ (Sell) Foreign Turnover %

Year
( BDT Mn) (BDT Mn) of Total turnover
2006 1822.91 954.53 2.80
2007 19904.69 8890.61 6.16
2008 13655.13 -2644.15 2.04
2009 14383.89 2751.25 0.97
2010 28349.03 -6765.84 0.71
2011 23552.37 784.32 1.51
2012 19041.96 7925.92 1.90
2013 33621.16 19428.95 3.53
2014 66009.40 26197.84 5.55
Sources of the Chart : A presentation by Mohammed Nasir Uddin Chowdhury, MD &CEO, LankaBnagla
Finance

19
 Trends in Foreign Portfolio Investment

Particulars Unit 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14

Portfolio USD -259 -117 -28 198 368 825
Investment mn

20
 IPO Anomalies
Short-run Price Behavior Underpricing
the high initial returns investors earn between subscription
and the first trading day in the aftermarket known as the
"underpricing" phenomenon.

Hot Issue Wave

the temporal variations in the magnitude of initial
returns and in IPO volume known as the "hot
issue" market phenomenon.

Long-run Price Performance Poor aftermarket stock

price performance of IPOs in the long-run window

21
 IPO Anomalies
Short-run Price Behavior Underpricing
Initial Return:
Initial Return without or with market-adjusted
Raw return or Abnormal Return
First Day Return -- Return calculated from the offer price
to first-day aftermarket trading closing price
(debut day price).
Initial Return on equilibrium price day Return calculated
from the offer price to the equilibrium price
adjustment event day deducted by market
return for the period
Hot Issue Wave temporal variations of IPO return and
volume
Long-run Price Performance IPO Underperformance in the
long period of three to five year vis--vis market and matched
portfolio (by sized and industry)of seasoned firm
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 Even Study Methodology used documenting
Underpricing phenomenon associated with IPO

A traditional event study performance analysis was

conducted over the post IPO (also referred to as the
seasoning) period. The market- adjusted return method is
commonly employed to obtain the abnormal for each IPO
over s trading day, as follows:
ar=
it rit rmt
where is the abnormal return for issue i in day t , is the raw
return on issue i in the event day t, and is the corresponding
return on the market index during the same time period.
The next step is to compute daily average abnormal returns
over the i = 1....n on day s as follows :
n
ARs = 1/nARis
i=1

23
 Findings of Underpricing and Asymmetric Information
associated with IPO

Non-financial firms that go public during the period of 1991

to 2007 have been underpriced on an average of 92.54%
(first day initial return) and 84.29% on equilibrium day (Event
Day15).
Abnormal Holding period Return (Non-Financial)
94.00
92.00 92.54

90.00
Abnormal returns

88.00
86.00
84.00 84.29 84.46
82.83 83.03
82.00 81.90
80.00
78.00
76.00
1 15 (EQ Day) 16 17 18 19
Event Trading day

24
 Findings of Underpricing of IPO

The degree of underpricing on the initial day for non financial

sector was found to be 92.54% The equilibrium price
adjustment day was found to be 15th day in case of non
financial sector.

The degree of underpricing on equilibrium price adjustment

was 84.29%.

It was observed in our study that the average under pricing

was highest and the standard deviation was also highest in
1996 (218.21%), an outcome from the hot issue period.

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 Findings of determinants of underpricing

Controlling for industry effects and incorporating some well

known proxies for, reputation, information signaling, uncertainty,
size and excess demand aftermarket standard deviation,
oversubscription and free float were found to be the
significant factors explaining underpricing.

There is existence of initial overshooting behavior in our IPO

market.

Initial overshooting turned out to be around 9 percentages on

an average.

It is observed that both oversubscription and green field dummy

variables have significant impact on underpricing and as the
excess demand was found to be positive in our study we can
conclude that overshooting behavior exist in our market.

26
The use of

Methodology of documenting
Long-run Price Performance of IPO
The average abnormal return for month t following the IPO
is:
nt
arit
1
AR t =
nt i=1

where is the number of issues present in the cross section

in postIPO month t.

The average cumulative abnormal return metric [Dimson and

Marsh (1986)] from the month s to month T is the cross-
sectional average of the individual cumulative compounded
abnormal return
n T

(1 + arit ) 1]
1
CAR s, T =
n i =1 i=s

The use of CARs , T implicitly reweight our event portfolio

every month

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 Methodology of documenting
Long-run Price Performance of IPO
Since such a portfolio strategy is difficult to implement, we
also analyze buyand-hold returns alternatively. The buy-
and- hold return for firm is defined as:

(1 + rit ) 1
min( T ,delist )
RiT =
t =1

where is the earlier of its delisting date or the end of the five
year window. For firms that went public near the end of our
sample period, the delisting date is no later than April, 2011,
since the return interval is truncated on this date.

Following Ritter (1991) and Loughran and Ritter (1995), we

also compute wealth relative as a performance measure,
which can be defined as:
1 n
1 + averge 5-year buy- and-hold return of IPO 1+ RiT
WR = =
n i =1
1 + averge 5-year buy-and-hold return of market 1 n
1 + RMT
n M =1

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 Findings of Lon-run Underperformance of IPO

Non-financial firms that go public during the period of 1991 to

2007 have underperformed vis-a- vis market benchmark.

Market Adusted Returns, during the first five years trading

for the 99 IPOs in 1991-2007
40.0

30.0
% Average CAR or Excess HP return

20.0

10.0

0.0

-10.0

-20.0

-30.0

-40.0

-50.0

-60.0
0 10 20 30 40 50 60
Month of Seasoning

RawHP Return Cumulative Mkt Adjusted Return Mkt. Adjusted HP return

29
 Findings of Lon-run Underperformance of IPO

The sample of 99 IPOs underperformed the market benchmark

by 10.19% per year in five years of going public.

Focusing on the five-year returns, the overall five-year mean

wealth relative is 0.66. In other words, a strategy of investing in
IPOs on the fifteenth trading day and holding it for five years
would have left investors with only 66 taka relative to one
hundred taka from investing in a market portfolio.

While examining the systematic risk profile of IPOs in

secondary trading in our sample, we find that IPO firms, on
average, have a cross-sectional beta lower than one (0.91).

We do not find any beta-bias with respect to the market

portfolio, confirming the robustness of the long-run IPO
underperformance vis--vis to the market benchmark.

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 Findings of Lon-run Underperformance of IPO

Initial returns have no systematic relationship with long-run

performance implying that no long-run reversals have been
observed.

We also find that companies with highest initial return

quartile have done worst in the aftermarket.

This finding is consistent with Shillers fads hypothesis

which states that companies with highest initial return should
subsequently have lowest returns.

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Conjectures of causing Lon-run Underperformance of IPO

Can the phenomenon be attributed to:

a) The ability of the issuer to time their offerings and take

advantage windows of opportunity in the sense of Ritter
(1991).

b) Unanticipated post-IPO decline in operating performances

[Jain and Kini (1994) and [ Imam and Amin (2010)].

c) Earning management by IPOs prior to going public [ Imam

and Jaber (2010)], that leads to disappointment hypothesis
of making downward correction of IPO price in the long run

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 Inefficiencies in primary market

Initial Public Offerings (IPO) There have been several challenges in the
primary market and in the process of IPO. Some of them are listed below:

Absence of regulatory measures or incentives to bring new companies

in the market with strong fundamentals.

Discovery of price through Book Building Methods becomes very

difficult due to lack of experts/analysts or prudent EIIs.

Sometimes small companies face difficulties due to large pre-IPO

capital rules

Weak activities of merchant banks

Distribution in Bangladesh is uneven. Only retail investors can

participate in the IPO whereas, Institutional Investors and Foreign
Investors can participate in the IPO in fixed price method like general
investor.

33
IPO Price in the aftermarket fails to reflect values

Market finds it difficult to price a security reflecting its

fundamental value in both primary and secondary levels

Both Fixed Price and Book Building have resulted in

huge price anomaly. The fixed price method fails to
recognize the future earning potential while the book
building method alleged to be subject of rampant
manipulation.

Rumor, demand-supply influence the price of a security

in the secondary market more than the fundamental
value of a security. Most of the recent IPOs have noted
price jump on the 1st day of trading followed by quick fall
in prices after 20 or 30 trading days.

34
Initial Return and Short-run Price Performance of recent IPOs
Price return of IPO 2014
First day return on Return till year
Companies
offer price end
Hamid Fabrics Limited 60.3% -27.8%
Khan Brothers PP Woven Bag Industries Limited 666.0% -50.7%
Western Marine Shipyard Limited 79.1% -11.4%
Saif Powertec Limited 138.0% 10.8%
Ratanpur Steel Re-Rolling Mills Limited 93.3% -10.1%
Shurwid Industries Limited 382.0% -28.9%
Far East Knitting & Dyeing Industries Limited 68.1% -31.1%
Tung Hai Knitting & Dyeing Limited 178.0% -23.2%
Khulna Printing & Packaging Limited 271.0% 10.0%
Shahjibazar Power Co. Ltd. 46.0% 482.0%
FAR Chemical Industries Ltd. 426.0% -34.5%
The Peninsula Chittagong Limited 22.3% -27.2%
Hwa Well Textiles (BD) Limited 341.0% -14.3%
Matin Spinning Mills Limited 13.2% 0.0%
Emerald Oil Industries Limited 400.0% -20.2%
AFC Agro Biotech Limited 550.0% -17.1%
Mozaffar Hossain Spinning Mills Ltd 353.0% -22.7%

Sources of the table : A presentation by Mohammed Nasir Uddin Chowdhury, MD &CEO,

LankaBnagla Finance

35
 Use of Proceeds of recent IPOs

The observation that most of the IPOs that came in 2013 and
2014 are significantly and heavily using the proceeds of IPOs to
repay bank/NBFI debt is counter intuitive for raising funds for
further expansion and growth.

The BSEC has imposed new conditions to the issue of capital, right issue,
and the usage of money raised through initial public offering (IPO).
- No share money deposit before consent from BSEC for Raising Capital.
- Shares transferred by a sponsor/director to any person within preceding 12
months of submitting IPO application shall be locked for 3 years from the date of
issuance of IPO prospectus.
- An issuer of a listed security cannot issue rights shares within 2 years from the
date of publication of IPO prospectus and before full utilization of fund raised
through IPO or previous rights issue or repeat public offering (RPO).
- A listed company cannot utilize more than one-third (1/3) of the fund raised
through IPO for the purpose of loan repayment.

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Earnings Management of IPO firms

IPOs on average in US and in Bangladesh are boosting

up their earnings by managing their accruals prior to
going public.
Imam et al (2010) finds evidence, using Modified Jones
Model of discretionary accrual testing methodology, that
entrepreneurs of IPOs coming to the market during
1991-2000, behaved myopically in boosting earnings in
the year prior to going public.
Mean managed accruals of sample IPO firms accounted
for 6.0% of the total assets (it was around 2.6% of total
assets in developed countrys context) under the
Modified Jones Model.
It is also documented in that study that earnings
management had a positive impact on initial firms
value.

37
THANK YOU ALL

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