Group Affiliation and the Performance of Initial Public Offerings in the Indian Stock Market

Abstract

We document the effects of group affiliation on the initial performance of the 2,713 Initial Public Offerings (IPOs) made in India under three different regulatory regimes during the period 1990-2004. We distinguish between two competing hypotheses regarding the effect of group affiliation on a firm’s initial performance in the stock market: the certification hypothesis according to which group membership is a positive signal of firm quality, and the “tunneling” hypothesis, under which group membership affords more opportunities for the controlling shareholders to misappropriate the firm’s resources, and is thus, a negative signal of firm quality. Our results show that the average underpricing of group companies is higher than that of stand-alone companies. In particular, the underpricing is high for companies affiliated to private foreign and private Indian groups. The evidence in support of the certification hypothesis is reinforced when we test the ex post performance of all IPOs: we find that, over time, group-affiliated companies have a higher probability of survival and success than their stand-alone counterparts. Groups appear to support their affiliates to maintain their reputation in the eyes of investors. However, the long-term stock market performance of firms in all categories is negative or insignificantly different from zero. Further, the long-term performance of group companies is somewhat worse than their stand-alone counterparts. We conclude that the higher underpricing of IPOs of group affiliated companies is due to investor overreaction, and may be the result of strategic behavior on the part of the groups to eliminate competition from lower quality issues.