How we apply behavioral economics in the case of IPO pricing? a brief presentation by Sagnik Sanyal Bsc.economics from SISTER NIVEDITA UNIVERSITY

1. Behavioral Economics:
Application of Prospect Theory in
Indian Primary Market
Sagnik Sanyal
Student of Economics
Student ID: 1811112034005
Sister Nivedita University

2. Introduction
• The process of offering shares in a
private corporation to the public for the
first time is called an initial public
offering (IPO).
PURPOSE OF IPO:
There are mainly two purposes for IPO.
1. Establishing new business
2. Expanding existing business

3. Process of IPO

4. TENDENCY OF IPO PRICING:
• Underpricing is the percentage difference
between the first day market closing price and
the offer price.
• Historically, IPOs have always been ‘under-
priced’. Underpriced IPO helps to generate
additional interest in the stock when it first
becomes publicly traded.
• This might result in significant gains for investors
who have been allocated shares at the offering
price.

5. MONEY LEFT ON THE TABLE:
Money left on the table is defined as the first day
price gain multiplied by the numbers of shares
transacted.
SLNO. COMPANY'SNAMES OFFERPRICE 1STDAYMARKETCLOSINGPRICEUNDERPRICING NO.OFSHARESTRADEDMONEYLEFTONTHETABLE
1SALASARTECHNOEngineeringLTD. 108 272.1 151.9444444 3328964 546282992.4
2BHARATROADNETWORK 205 208.15 1.536585366 29300000 92295000
3CAPACITEInfraprojectsLTD. 250 342.4 36.96 16000000 1478400000
4ASTRONPAPER&BOARDMILLLTD. 50 119.7 139.4 14000000 975800000

6. Behavioural Economics
TRADITONAL
ECONOMICS
BEHAVIORAL
ECONOMICS
Tastes and
preferences are
given.
humans are emotional and
easily distracted beings.
People are
rational
people sometimes make
irrational decisions their
behaviour does not follow
the predictions of
economic models.
Behavioural Economics
is the study of
psychology as it relates
to the economic
decision-making
processes of
individuals and
institutions.

7. Prospect theory
• The theory was
created in 1979 and
developed in 1992 by
Daniel Kahneman and
Amos Tversky
• Daniel Kahneman
was awarded the 2002
Nobel Memorial Prize in
Economic Sciences
Introduction:
i. Prospect theory assumes that issuers
care about their change
in wealth rather than
the level of wealth.
ii. Prospect theory predicts that in most
situation occurring in the IPO market issuers
will sum the wealth loss from leaving
money on the table with the larger wealth
gain on the retained share from a price
jump producing net increase in wealth for pre-
issue shareholders.

8. The Value Function

9. Literature Review
We have get a number of notable scholars in this field who have explained
the behavior of underpricing of IPOs in terms of behavioural Economics,
more specifically in terms of prospect theory.
1.Ritter (2003)
2.Loughran and Ritter (2002)
3. Jay R. Ritter
Indian Context
1.Seth et al (2018)
2.Ray and Chattopadhyay (2016,19)

10. Research Gap
• In India, less attempts are taken to explain underpricing of IPOs in
terms of Behavioural Economics or Prospect Theory.
• There is further scope to examine the prospect theory in our context
to see whether issuers prefer money left on the table or not.

11. Objectives and Hypothesis
Objective
The basic objective is to examine whether issuers prefer money left on
the table or not.
Hypothesis of the Study
:. : Issuers prefer money left on the table.

12. • Data Source:
• Bombay Stock Exchange
• National Stock Exchange
• Draft Prospectus
• Money Control
Time Period- 2015-16

13. Methodology
• Each individual has a value function, which is
similar to a utility function
• The function being steeper for small losses
than for small gains (loss aversion)
• Due to the concavity of the value function for
gains, two gains will be segregated.
• The convexity of the value function for losses,
two related losses will be integrated.
• In Figure issues that are underpriced
following an upward revision in the offer
price will be in the lower right-hand
quadrant.

14. Apply Loughran&Ritter’s model in Indian
Market
[(shares retained by the ith shareholder
+ secondary shares sold by the i th
shareholder) × (Offer price - midpoint of
original file price range) + (shares
retained by i th shareholder) × (market
price - offer price)] > [(market price -
offer price) × (secondary shares sold by
the i th shareholder + primary shares
sold by issuing firm) × (shares retained
by the i th shareholder/ shares retained
by all shareholders together)]
• In the stated condition L.H.S.
represents revaluation of
promoters’ shareholdings
after issuing IPOs whereas
the R.H.S. of the inequality
indicates amount of money
left on the table
• Promoter’s shares holding/
money left on the table >1

15. Revised formula
To examine the actual behaviour of Indian issuers, however, we have revised the
inequality expression of the prospect theory as we do not have sufficient data for the
individual promoters; the revised formula used in our study is as follows:
[(shares retained by the i
th shareholder + secondary shares sold
by the i
th shareholder) × (Offer
price - midpoint of original file price
range) + (shares retained by i
th share
holder) × (market price - offer price)] >
[(market price - offer price) × (secondary
shares sold
by the i
th shareholder + primary shares sold by
issuing firm) × (shares retained by all
the
shareholders together)
 If they have strong disliking against
underpricing, they will set a higher offer
price, which leads to prevent underpricing
of IPOs.
Revision of offer price from the file price
range captures major portion of
underpricing of IPOs.
 revision of offer price from file price
range is an indicator of first day return of
IPOs.
 Indian issuers are less resistive against
underpricing of IPOs.

16. Application of Prospect Theory in Indian IPO Market
Year Average
Underpricing
CV Average
MLOT
CV
Number of IPOs Percentage Measure of
Underpricing
Monetary Measure of
Underpricing (MLOT)
Money Left on Table (INR
Million)
Average
Underpricing
CV Average
MLOT
CV
2014-15 5 20.83 145.34 793.89 138.08
2015-16
2016-17
19
4
0.81
82.46
1897.82
90.45
3.92
739.18
18010.69
76.64134

17. In both the years, the ratio is greater than one. This implies that
issuers wealth gain is higher.
YEAR Average
Revaluation of
Promoters'
Shareholding
(INR Million)
Average
Money Left
on Table
(INR Million)
Average of
Revaluation/ML
OT
2014-15 262.95 74.63 8.21
2015-16 13.49 -4.55 6.31
Application of Prospect Theory in Indian IPO Market

18. Summary and Conclusion
• Issuers are really concerned more about their revaluation of wealth than on
underpricing phenomenon.
• Revaluation of issuers wealth is significantly higher than the money value of
underpricing they might suitable the benefits of underpricing of IPOs in
India.
 Drawback of Study
1.Lack of statistical tools are used. We need to improve our statistical analysis.
2.We don't get sufficient data on promoters shareholding in 2017. So that we
have taken into consideration only two years—2014-15 and 2015-16.

19. Question-Answer

20. ACKNOWLEDGEMENT
I would like to express special thanks of gratitude to my teacher as
well as who gave me the golden opportunity to do this wonderful
project on the topic which also helped in doing a lot of Research and
I came to know about so many new things. I am really thankful .