Ijm 07 03_016

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International Journal of Management (IJM)
Volume 7, Issue 3, March-April 2016, pp. 172–184, Article ID: IJM_07_03_016
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INVESTOR EXPECTATIONS ON ‘RETURN’
AND ‘TRUST’ ON IPO GRADING: AN
EMPIRICAL ANALYSIS
Biju Thomas Muttath
Head–Finance (Star Group),
Research Scholar, R&D Centre,
Bharathiar University, Coimbatore–46, T.N, India
Dr. Assissi Menachery
Professor, Loyola Institute of Technology & Science,
K.K Dist, T.N, India
ABSTRACT
Oversubscription during IPO is the result of demand over supply due to
investors’ keen interest and expectation to subscribe new shares. Grading
agencies play a major role in attracting investors to subscribe shares during
IPO. This is due to the ‘trust’ that investors have on the grading agency,
regarding its capability to perform research on the key fundamental
indicators. Informed and knowledgeable investors act vigorously to get
maximum shares during the initial public offer. Book building pricing method
plays vital role in attracting the investors who anticipate efficient price
discovery. The study attempts to provide insights to investors on how
significantly efficient the listing prices of oversubscribed shares between 1 to
5 grades by approved rating agencies are; as well as the profitability in
investing oversubscribed IPOs with respect to the 1) Close price of the listing
day 2) Short term and 3) Long term returns in both manufacturing and service
sector.
Key words: Book building, Grading, Hot Issue Market, IPO, Under-pricing)
Cite this Article: Biju Thomas Muttath and Dr. Assissi Menachery, Investor
Expectations on ‘Return’ and ‘Trust’ on IPO Grading: An Empirical Analysis.
International Journal of Management, 7(3), 2016, pp. 172–184.
http://www.iaeme.com/IJM/issues.asp?JType=IJM&VType=7&IType=3
1. INTRODUCTION
Companies opt for Initial Public Offerings (IPOs) and approach potential investors for
capital, to raise funds for their various strategic plans. However, for an investor it is
questionable as to whether it makes sense to subscribe to the deluge offerings or not.

Investor Expectations on ‘Return’ and ‘Trust’ on IPO Grading: An Empirical
Analysis
Investors do not pursue value strategies because they may not be aware of the data, or
that much of evidence is refuted by the conclusions offered by the consultants [1].
Attracting and persuading the investor is the tactic of the investment banker and other
intermediaries. Investors are less informed about the fate of the issuers but glitters the
charms of the shares where insanity works among the investors [2]. In Indian IPO
market, book building mechanism was introduced in 1999 and since then gained
popularity particularly in respect of large IPOs. In this paper, researchers attempts to
study on how significantly efficient the listing prices of oversubscribed graded and
non-graded IPO’s with respect to 1) Close price of the first day 2) Short term return
and 3) Long term returns among manufacturing and service sectors.
Oversubscription of the IPO shares is the combined outcome of various
perceptions of the investors. Bull markets and irrational behavior of the investors
create a hot issue market where demand for new issues became very high [3]. In bull
market, when investors are greedy for buying stocks such IPOs, they find their way to
the hot issue market [4]. During this time, investors become irrational and their greed
to make money become prominent by investing in anything [5]. But such things
cannot happen in market especially in bull market, as the intention of issuers is to
raise maximum resources [6]. The expectations of the investors define whether the
shares are under priced or not [7]. Under-pricing of IPOs brought to the market by
reputable underwriters is lower than those brought by non reputable underwriters [8,
9]. While an IPO enhances a firm’s legitimacy, significant uncertainties remain about
its capabilities [10]. This study reveals the reality of oversubscribed IPO shares during
the period, 2006 to 2010, based on the investors’ perception on hot issue and under–
pricing phenomenon.
IPO grading is a service that provides an assessment of fundamentals regarding
quality of equity shares offered to aid comparative assessment which would be a
useful information and investment tool to investors [11]. This way, the investor, by
trusting on the IPO grading can decide whether the particular offer has potential to
bring returns or not. IPO grading methodology examines the key variables such as: i)
Business and Competitive position, ii) New projects- risks and Prospects, iii)
Financial position and Prospects, iv) Management Quality, v) Corporate governance
practices and vi) Compliance and litigation history.
ICRA and CARE have the following 5 point scale grading IPO fundamentals.
Grade 5 – Strong Fundamentals, Grade 4 – Above average Fundamentals, Grade 3
– Average Fundamentals, Grade 2 – Below average Fundamentals, Grade 1 – Poor
Fundamentals. During 1990 – 2000 many IPOs in India have vanished looting
millions of public funds. The regulator of Indian Stock Market, The Security
Exchange Board of India (SEBI) made grading of IPOs by all companies mandatory
from May 1, 2007 to help investors make informed decision and grading to be done
by the SEBI- registered crediting rating agencies. The rationale for such move, as per
SEBI, is to protect the retail investors from fly-by- night entrepreneurs. After six
years, SEBI scraped the mandatory policy of grading on December 24, 2013 making
the grading norms as voluntary.
Grading is resulting in an analysis of fundamentals and the grades should be
conveyed the same information to the uninformed investors, what the costly research
would be conveying to the institutional investors [12]. Investors incur a lower cost of
information accumulation if an IPO has some backing that signals better quality [13].
IPO grading decreases underpricing and positively influences the demand of retail
investors. In emerging markets, regulators role to signal the quality of an IPO

Biju Thomas Muttath and Dr. Assissi Menachery
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2-Jan-06 2-Jan-07 2-Jan-08 2-Jan-09 2-Jan-10
contributes towards the market welfare [11]. Studies also reveal that IPO grading has
limited influence on the IPO demand. It is not evident in Indian IPO market that IPO
pricing improves due to the introduction of IPO grading [14]. Shares which do not
have grading have higher short term return than graded [15]. Study on IPO grading on
under-pricing [16], reveals no significant influence between IPO grades and
subsequent market performance. Thus these analyses reveal the contrary results
between IPO grading and their performance. This research aims to examine the
similarities or differences among IPO grading and non-grading with respect to its
returns in manufacturing and service sectors during different investment durations.
Even though various studies on IPOs performance have been carried out in
different periods, the researchers intend to analyse the bull and bear phases of market,
IPO offerings in terms of total numbers of IPOs and influence of grading in
performance of the shares. This is because, values and IPOs are the reflections of bear
and bull markets respectively. Hence, researchers have taken up the time period that
integrate both bull and bear run to ensure homogeneity. 2006-2010 is the period both
bull and bear phases are apparent (Fig.1). Hence IPOs’ performance of these periods
had been taken into consideration to get a complete picture.
Figure 1
(NSE INDEX- NIFTY) Bull and Bear Rally during 2006 – 2010
Bear Rally-1
Bull Rally-1 Bull Rally-2
Moreover, special focus on manufacturing and service sectors with respect to IPO
performance in these periods has given preference in the present study. Other studies
with comparative analysis on manufacturing and service sector found to be scarce.
Hence, comparative analysis of the manufacturing and service sectors on the:
1. Listing day(first day) return
2. Short term return, and
3. Long term return would give insight to the investors regarding the right time for
investment in hot issue shares.
2. OBJECTIVES OF THE STUDY
1. To analyze and study the returns obtained while investing in graded IPOs on various
time periods such as a) First day of trade b) Short term basis and c) Long term basis
2. To analyze and study the returns obtained while investing in graded IPOs belonging
to manufacturing sector on various time periods such as a) First day of trade b) Short
term basis and c) Long term basis

Analysis
3. To analyze and study the returns obtained while investing in graded IPOs belonging
to service sector on various time periods such as a) First day of trade b) Short term
basis and c) Long term basis.
4. To analyze and study the returns obtained while investing in hot issue shares
(oversubscribed IPOs) on various time periods such as a) First day of trade b) Short
term basis and c) Long term basis.
(oversubscribed IPOs) belonging to manufacturing sector on various time periods
such as a) First day of trade, b) Short term basis and c) Long term basis.
(oversubscribed IPOs) belonging to service sector on various time periods such as a)
First day of trade b) Short term basis and c) Long term basis.
2.1. Hypotheses
1. There is no significant relationship between the average rates of returns obtained
while investing in hot issue shares (oversubscribed IPOs) and the time periods such as
a) First day of trade b) Short term and c) Long term.
while investing in hot issue shares (oversubscribed IPOs) in manufacturing sector and
the time periods such as a) First day of trade b) Short term and c) Long term.
while investing in hot issue shares (oversubscribed IPOs) in service sector and the
time periods such as a) First day of trade b) Short term and c) Long term.
while investing in hot issue shares (oversubscribed IPOs) and the time periods such as
a) First day of trade b) Short term and c) Long term.
while investing in hot issue shares (over subscribed) in manufacturing sector and the
time periods such as a) First day of trade b) Short term and c) Long term.
while investing in hot issue shares (over subscribed) in service sector and the time
periods such as a) First day of trade, b) Short term and c) Long term.
2.2. Methodology
2.2.1. Sample
Sample containing 220 from 321 companies came out with IPO, during the period
2006- 2010 have been considered in the study (Table 1). Out of 220 companies 94
were graded by registered agencies (Table 2). The information is drawn from the
SEBI, NSE and ICRA.
Table 1
Year wise IPOs & Sampling Frame
Year 2006 2007 2008 2009 2010 Total
Number
of IPO’s
Population 91 107 38 21 64 321
Sample 70 69 18 14 49 220

Table 2
Grading – Sector Wise
Sector
Grades
TotalHigh (4 and 5) Medium (3) Low (1 and 2)
Service 18 28 14 60
Manufacturing 7 13 14 34
Total 25 41 28 94
2.2.2. Sampling frame and Characteristics
It has been observed that all shares were oversubscribed by investors. The sample
consists of 220 companies are drawn on the criteria of availability of information on
IPO regarding book building price, issue date, issue price, listing date, listing day,
close price, short term price and long term price.
‘Book building price’, ‘Return on first day’, ‘Short term return’ and ‘Long term
return’ have been considered for the analysis.
 Return on first day is the return on the closing hours of the listing day.
 Short term return is considered as the return after the first year of listing and
 Long term return is considered as return on 30th
October 2015. Long term is
considered as more than five years.
These returns are again classified as positive and negative returns. The shares
have categorized into two sectors such as manufacturing and service. The graded
shares are grouped into three categories such as ‘High’, ‘Medium’ and ‘Low’. Shares
with 4 and 5 grades are categorized as high grade, shares with ‘3’ grade are
categorized as medium grade and shares with 1 and 2 grades are categorized as low
grade.
2.2.3. Technique
Cross sectional analysis is carried out to explore the significance or difference with
respect to returns generated in various time periods. Data collected were analyzed
using various statistical tools and the results are presented. Null hypotheses
formulated for the purpose of present investigation are put together using inferential
statistical tools. Chi-Square test is used to find out the significant association between
sectors, grading and returns. During discussion, attention has to been given in arriving
at a conclusive perspective on the analysis, hypotheses testing and interpretation of
data related to the variables. The results are discussed in detail.
2.3. Analysis Results and Discussion
2.3.1. Analysis: Grading and Listing day return
It is clear from the Table 3 that out of the total 94 shares that have been graded, 37
(39.4%) shares have given negative return and 57 (60.6%) shares have given positive
return. While considering the shares that have graded high, out of 25 shares, 4 (16%)
shares have given negative return and 21 (84%) shares have given positive returns.
Among the shares that have been graded as medium, out of 41 shares, 19 (46.3%)
shares have given negative return and 22 (53.7%) shares gave positive returns. When
low graded shares are considered, out of 28 shares 14 (50%) shares gave negative
return and 14 (50%) shares have given positive returns on first day of listing.

Analysis
Table 3
Grading and Listing day return
Classification of
Grading
Return
TotalNegative Positive
High 4 (16%) 21 (84%) 25(100%)
Medium 19 (46.3%) 22 (53.7%) 41(100%)
Low 14 (50%) 14 (50%) 28(100%)
Total 37 (39.4%) 57 (60.6%) 94(100%)
From Table 4 it is observed that the grading influences listing day returns whether
positive or negative. Further, the results of Chi-square provide the first indication that
the hypotheses is not supported, grading has an influence on listing day returns
whether positive or negative. Hence we reject the null hypotheses that there is
significant relationship between grading and listing day returns (positive or negative).
It is inferred from table 4 that there is relationship between grading and listing day
returns.
Table 4
Chi Square – Listing day return
Value df Asymp. Sig. (2-sided)
Pearson Chi-Square 7.881 2 .019
Likelihood Ratio 8.606 2 .014
Linear-by-Linear As 6.094 1 .014
N of Valid Cases 94
**Significant at 0.05 significance level
It is found that 60.6% of the graded IPOs have provided positive return on the
listing day. Among this, while considering higher grades 84% has provided positive
return on the listing day, whereas in medium grade 53.7% have got positive return and
in low grade 50% have got positive return. From this it can be concluded that
investing in higher graded IPO’s are advisable, provided the shares are sold on the
first day of the listing. Another possibility is that to short sell such shares on the
listing day. The study supports the findings of previous studies [2,17,18,19] where
they establish the presence of underpricing during the initial book building process
and creating artificial demand for retail investors during the initial hike of share price
on the first day. This is reported to be the advantage of information edge, which
financial institutions have over retail investors.
2.3.2. Analysis and Discussion: Grading and Short term return
It is clear from Table 5 that among the total 94 shares that have been graded, 74
return. While considering the shares that have graded high, among the 25 shares, 18
(72%) shares have given negative return and 7 (28%) shares gave positive returns. In
the category of medium graded shares, among the 41 shares, 30 (73.2%) shares have
given negative return and 11(26.8%) shares gave positive returns. Where as in low
graded shares out of 28 shares 26 (92.9%) shares have given negative return and 2
(7.1%) shares gave positive returns in short term.

Table 5
Grading and Short term return
Classification of
Grading
Return
High 18 (72%) 7 (28%) 25 (100%)
Medium 30 (73.2%) 11(23.8%) 41 (100%)
Low 26 (92.9%) 2 (7.1%) 28 (100%)
Total 74 (78.7%) 20(21.3%) 94 (100%)
From Table 6 it is observed that grading does not influence short term returns
whether positive or negative. Further the results of Chi-square provide the first
indication that the hypotheses should support grading of IPO’s does not have any
relationship at 0.05 confidence level on short term returns whether positive or
negative. However it shows statistically significant at 0.01 confidence level. Hence
we accept the null hypotheses that there is no significant relationship between grading
and short term returns (positive or negative) at 0.05 confidence level. It is inferred
from the above table that there is no relationship between grading and short term
returns (positive or negative).
Table 6 Chi Square – Short term return
Value Df Asymp. Sig. (2-sided)
N of Valid Cases 94
*Not Significant at 0.05 and 0.01 significance level
It is clear from the Table 7 that out of the total 94 shares that have been graded, 70
return. While considering the shares that have graded high, out of 25 shares 16 (64%)
shares have given negative return and 9 (36%) shares have given positive returns. In
medium grade category, out of 41 shares 31 (75.6%) shares have given negative
return and 10 (24.4%) shares have given positive returns. Where as in low graded
shares out of 28 shares 23 (82.1%) shares have given negative return and 5(17.9%)
shares have given positive returns in long term.
Table 7
Grading and Long term return
Classification of
Grading
Return
High 16(64%) 9 (36%) 25(100%)
Medium 31(75.6%) 10(24.4%) 41(100%)
Low 23(82.1%) 5(17.9%) 28(100%)
Total 70(74.5%) 24(25.5%) 94(100%)

Analysis
From the Table 8 (Appendix) it is observed that the grading does not influence
long return whether positive or negative. Further the results of Chi-square provide the
first indication that our hypotheses should support that grading of IPOs does not have
any relationship on long term returns whether positive or negative. Hence we accept
the null hypotheses that there is no relationship between grading and long term
returns.
Table 8
Chi Square – Long term return
Value Df
Asymp.
Sig. (2-sided)
No of Valid Cases 94
2.3.3. Analysis and Discussion: Manufacturing and Service Sector
It is clear from the Table 9 that among the total sample of 220 shares, 77 (35%) shares
have given negative return and 143 (65 %) shares gave positive return. While
considering the shares belong to service sector, among the 133 shares, 46 (34.6%)
shares have given negative return and 87 (65.4%) shares have given positive returns.
In manufacturing sector, among the 87 shares, 31 (35.6%) shares have given negative
return and 56 (64.4%) shares have given positive returns on the listing day. It can be
inferred that on listing day most of the shares generate positive return.
Table 9
Sectors and Listing day Return
Sectors
Return
Service 46 (34.6%) 87(65.4%) 133(100%)
Manufacturing 31 (35.6%) 56 (64.4%) 87 (100%)
Total 77 (35%) 143 (65 %) 220 (100%)
It is clear from Table 10 that the sectors do not influence listing day returns
indication that our hypotheses should be supported that sectors does not have an
influence on listing day returns whether positive or negative. Hence we accept the null
hypotheses that, there is no significant relationship between manufacturing and
service sectors and the listing day return (positive or negative).

Table 10
Chi Square – Listing day
Value Df
Asymp.Sig.
(2-sided)
Exact Sig
(2 sided)
Exact Sig (1
sided)
PearsonChi-Square .025 1 .874
Continuity correction .000 1 .988
Likelihood Ratio .025 1 .874
Fisher’s Exact Test .886 .493
Linear-by-Linear As .025 1 .874
N of Valid Cases 220
It is also clear from the study that among the total 220 oversubscribed IPO’s
belonging to service and manufacturing sectors, 65% of the total shares generated
positive return on listing day. Among this, while considering the service sector, 65.4%
has provided positive return and 64.4% of manufacturing sector provided positive
return on the listing day. It can be inferred from the analysis that both service and
manufacturing sectors are indifferent in providing return on listing day in between 64
to 66%. The study supports the findings of various studies [11,16,18,20,21] on the
underperformance of IPOs in Indian and foreign stock markets and substantiate the
prevalent under pricing phenomena.
It is clear from the Table 11 that among the total sample of 220 shares,
151(68.6%) shares have given negative return and 69 (31.4%) shares have given
positive return. While considering the shares belonging to service sector, among the
133 shares 94 (70.7%) shares have given negative return and 39 (29.3%) shares have
given positive returns. In manufacturing sector, among the 87 shares, 57 (65.5%)
shares have given negative return and 30 (34.5%) shares gave positive returns in short
term.
Table 11
Sectors and Short Term Return
Sectors
Return
Total
Negative Positive
Service 94 (70.7%) 39 (29.3%) 133(100%)
Manufacturing 57 (65.5%) 30 (34.5%) 87 (100%)
Total 151(68.6%) 69 (31.4%) 220 (100%)
It is clear from Table 12 that the sectors does not influence short term returns
indication that our hypotheses should support that sectors do not have any influence
on short term whether positive or negative. Hence we accept the null hypotheses that
there is no significant relationship between manufacturing and service sectors and
short term returns (positive or negative).

Analysis
Table 12
Chi Square – Short term return
Value Df
Asymp. Sig.
(2-sided)
Exact Sig
(2 sided)
Exact Sig (1
sided)
Pearson Chi-Square .650 1 .420
It is clear from the Table 13 that among the total sample of 220 shares, 162
(73.6%) shares have given negative return and 58 (26.4 %) shares have given positive
return. While considering the shares which belong to service sector, out of 133 shares,
99 (74.4%) shares have given negative return and 34 (25.6%) shares have given
positive returns. In manufacturing sector, among the 87 shares, 63 (72.4%) shares
have given negative return and 24 (27.6%) shares gave positive returns in the long
term.
Table 13
Sectors and Long Term Return
Sectors
Return Total
Negative Positive
Service 99 (74.4%) 34 (25.6%) 133(100%)
Manufacturing 63 (72.4%) 24 (27.6%) 87 (100%)
Total 162 (73.6%) 58 (26.4 %) 220 (100%)
From Table 14 (Appendix), it is observed that the sectors do not influence long
term returns whether positive or negative. Further the results of Chi-square provide
the first indication that our hypotheses should support that sectors do not have any
influence on long term whether positive or negative. Hence we accept the null
hypotheses that there is no significant relationship between manufacturing and service
sectors and long term returns (positive or negative).
Table 14
Chi Square – Long term return
Value df
Asymp.
Sig.(2-sided)
Exact Sig
(2 sided)
Exact Sig
(1 sided)
Pearson Chi-Square .111 1 .739

2.4. Discussion
The study intends to find out the relevance of IPO grading on the day of listing, as
well as on short term and long term returns. Moreover, the study also brings out the
relevance of investing in oversubscribed IPO’s on listing day, short term and long
term time periods.
From the study it is revealed that grading is not an indicator to get profits on short
term and long term basis. Only 20.3% and 25.5% of graded shares generated positive
return in short term and long term respectively. It is also clear from the study that total
of 220 overs subscribed IPO’s belong to service and manufacturing sectors has not
performing as expected by the investors in short term and long term periods. The
study also reveals that shares of medium grade is generating more profit in all three
periods, this supports the previous study [22]. The study recommends the investors to
invest in service sectors with high grade in order to generate positive return on listing
day of the IPOs. In spite of the information asymmetry prevailing in the stock market,
retail investors are consciously burning their fingers. Credit rating and grading are the
supportive indicators that can be considered for investing but not for a trusted value
investing. Probably, focusing on these persistent hot issues and underpricing
phenomena, the regulator took lenient step on the mandatory grading.
In order to generate return from investment, individuals ought to look into two
important qualitative aspects viz, quality of the management and sustainability of the
business in the present and future economic scenario. Risk analysis is another
important tool by which companies ensure sustainability in future so that investors
will be in a position to gain return from the investment. Negative returns in short term
and long term periods are evident in the stock market which emphasizes under
valuation of shares in the book building process. Moreover it becomes a relevant
question that whether companies are conducting adequate risk analysis that involves,
risk identification, assessment and mitigation. It is an alarming situation to note that
among the total 321 oversubscribed IPOs, only 20.3% and 25.5% of graded shares
generated positive return in short term and long term respectively. This calls for
immediate action from the SEBI, RBI and relevant statutory and regulatory authorities
to take appropriate corrective actions to bring out the governance of Indian companies
back into action.
Summary
1. There is a significant relationship between grading and listing day returns (positive or
negative) at 0.05 significant level.
2. There is no significant relationship between grading and short term returns (positive
or negative).
3. There is no significant relationship between grading and long term returns (positive
or negative).
4. There is no significant relationship between Manufacturing and Service sectors and
listing day returns (positive or negative).
5. There is no significant relationship between manufacturing and service sectors and
short term returns (positive or negative).
6. There is no significant relationship between manufacturing and service sectors and
long term returns (positive or negative)

Analysis
3. FUTURE RESEARCH DIRECTIONS
Initial Public Offerings are characterized by phenomena such as hot issue market,
under pricing and long term under performance. Researchers considered grading,
oversubscribed IPO’s and sectors as the variables to explore its influence on return of
IPO shares on listing day, shot term and long term returns. Investor heuristic,
economic indicators, political, national and international scenarios are few of the
other factors which determining the bull and bear rally in the stock market. Influence
of these factors on IPO prices, grading and its return at different time periods can also
be considered for detailed analysis to explore the philosophy of IPO returns.
4. CONCLUSION & RECOMMENDATIONS
The main reason behind companies’ decision to go public is to raise money and
spread the risk of ownership among a large group of shareholders. Reducing debt
component in the source fund is another major motive behind IPOs. While going for
investing in IPO, informed investors are rich with the information on fundamental
aspects of the issuing company. In order to reduce the impact of information
asymmetric, SEBI introduced grading mechanism. The Cross tabulation, Chi square
and Correlation study reveals that grading is not an indicator to get profits on short
term and long term basis. Only 20.3% and 25.5% of graded shares generated positive
return in short term and long term respectively. However it is found that 60.6% of the
graded IPOs have provided positive return on the listing day. Among this, while
considering higher grades 84% has provided positive return on the listing day,
whereas in medium grade 53.7% has got positive return and in low grade 50% has got
positive return. From this it can be concluded that investing in higher graded IPO is
advisable, provided the shares are sold on the first day of the listing. Further the study
emphasis the pervasiveness of under-pricing phenomena in book building process of
Indian IPO market. We strongly advocate that an investor goes for an IPO offer will
be in a position to generate a positive return, if he/ she off load the shares on the first
day of listing. The role of grading agencies in awarding various grades is also
questionable as the strips graded 3, 4 and 5 failed to meet the expectations of the
investors. Trust on grading agencies in awarding 4 and 5 graded shares are also
skeptical. We conclude that IPO is a speculation opportunity to make expected return
on listing day and grading is not the only parameter investors should rely upon.
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