What Impacts IPO Underpricing ? Evidence from Dhaka Stock Exchange

Initial Public Offering (IPO) is an important and widely popular research topic among many researchers in finance discipline. This study is prepared to identify the connection among various empirical studies and theories regarding underpricing of IPO in the stock market of Bangladesh. We have chosen the time frame of June 2011 to June 2016 at DSE to conduct the research. In this study, ordinary least square (OLS) regression method is used to identify in what extent the dependent and the independent variables are related in the level of underpricing. The results of the study disclose that oversubscription rate, offer size have substantial influence in IPO underpricing at DSE. On the other hand, offer time and size of the firm do not have significant influence on the level of underpricing. These variables are very significant and play important roles with the level of underpricing at DSE and it shows relation to signaling theory, information asymmetry theory and agency cost theory.


Rational of the Study
Initial Public Offering (IPO) is an important and widely popular research topic among many researchers in finance discipline.There are various theories regarding this issue explaining it in different aspects.Researchers have documented several studies and empirical evidence regarding this topic which identifies IPOs can be underpriced both in developing and developed countries (Islam and Ali 2010).Ritter (1984) argued that underpricing occur when a firm decides to go public.IPOs are said to be underpriced, when the price of the IPO goes above the offer price of that IPO in its after-market where it can be traded immediately.There are several theories and models provided by significant number of authors.The core intention of this research study is to identify the price behavior of IPOs of the Dhaka Stock Exchange in the period of June 2011-June 2016.This paper will contribute to the current literature of IPOs in the emerging market and specifically that in Dhaka Stock Exchange with regard to the underpricing and the stock price behavior subsequent to IPOS.The general objective is to detect various theories which are related to the level of underpricing taken place in DSE.More specifically we have tried to find the variables that affect underperformance of IPO in the short time period.We have also tried to identify the trend of underperformance of IPO in Bangladesh Stock Market.
Over the last decade the capital market of Bangladesh has evolved and graduated from a very nascent stage to a developing stage with the implementation of new regulatory enforcements and infrastructural development.Dual listing is allowed for the initial public offerings in this market.It has been observed that 95% listed IPOs in Chittagong stock exchange are also listed at DSE.As a result, this study will be helpful to identify the extent of underpricing and reasons behind it in Bangladesh.

Review of the Literature
Initial Public Offerings (IPO) has been a significant topic for research among various renowned researchers.There are significant number of works and empirical evidence regarding this topic in the finance discipline.These research shows significant amount of evidence that underpricing IPOs have become an important concern among the investors.Stoll & Curly in (1970) identified a tendency that the IPOs are providing abnormal return to the investors who are purchasing it at the initial offerings.Miler and Really (1987) identified that, there are significant effort of modifications and extensions used in this issue to examine the abnormality of IPO underpricing among the investors.
There are documents that provides empirical evidence that the levels of underpricing in IPOs in Dhaka Stock Exchange (Islam and Ali 2010).It is found that there exist very substantial relationship between the offer size and company's size.Regression analysis clearly revealed this significant relationship between these two variables.The results from the regression reveals that, age of the firm and the offer timing do not have any significance in the level of underpricing.Bansal and Khanna in (2012) identified the presence of a substantial difference when they worked with the underpricing level.They mainly conducted their research on Bombay Stock Exchange.They had taken the time frame of April 1998 to December 2012.In this time frame they have found that the extent of underpricing can be explained by several factors.Among them firm's ownership structure, firm's age and the market capitalization are significant.In 2009, Sohail and Raheman investigated the connection between two important offerings which are known as pre and post initial public offerings.
They have conducted their research on Karachi Stock Exchange.Their results showed positive relation to the interest of the investors in the pre initial public offerings demand to the offer ratio.
There are various empirical evidence provided by Kumar & Tsetsekos in (1992), Titman and Trueman (1986) on this issue.They have identified the evidence that support the model that many renowned underwriters have linked to comparatively less risky IPOs.It their investigation it is found that, IPO which has a minimum level of market value has significant relation with the quality of the underwriter.So they have documented in their research that IPOs have little chance to become underpriced if the company choose quality investment banker.There are many research work conducted on signaling theory of underpricing (Allen & Faulhaber 1989).Other prominent research works were conducted by Griblatt & Hwang in (1989) and Ibbotson in (1975).They identified the harsh part of the underpricing the IPOs.They have documented that, IPOs are mainly underpriced for fraudulent purpose.It will provide a signal to the general investors about the good taste of the IPOs so that they can the same firm can sold their future underwritings at a very high price to the common investors.Various theories were also developed to increase the stock market efficiency.Major works were conducted by Benveniste and Spindt in (1989).They mainly established a theory regarding this market efficiency.This theory is considered as the pioneer of creating the book building method of IPO underwriting.This method has achieved popularity and is taken by many countries including developing economies around the world.Third world country like Bangladesh has taken the method but to a little extent.This model helps to identify the actual demand for the new issue and also the condition of the issuing firm at that time.Underwriters can use the help of this method so that they can reduce the underpricing level in the stock market.This will help to adjust the offer price with demand created in the market.Agency theory has also gained popularity in this aspect.This theory has many impact on this IPO issue.Research work on this issue were conducted by (Robinson and Peng 2004).They have conducted their research on US market which is considered as the largest stock market around the world.As a result they had to take a large sample.Their sample size was 3090 IPOs of US market.They had taken a ten years large time frame which was January 1987 to December 1999.They have identified that, US market usually have documents regarding IPO owners are high previously.This will signal the management of the issuing companies always expect higher future revenue which increased the agency cost associate with entrenchment.This signaling model was also identified by other researchers.Allen andFaulhaber in (1989), Welch (1989) were also worked on this signaling model.They have also identified the same factors that, IPOs are underpriced to deceive the common investors so that they can sell their future underwritings at a higher price.Another important theory regarding this issue is Agency Theory.Robinson and Peng in (2004) worked on this theory.They have identified that, underwriters and the investors have different mindset and they have different level of interests in the underwritings.Robinson and Peng have conducted a research with a sample size of 3080 IPOs of US stock market.Their time frame was similar which is from January 1988 to December 1999.Their results showed that, management of the underwriting or the issuer always expect higher revenue in future.This demand goes against the interest of the investors thus generates higher agency cost.Rock (1986) indicated adverse selection model.This model helped to find out the information asymmetry situation between various investors who may be both informed and uninformed.Through this situation lemon problem occurs as the uninformed investors know nothing but the general information about the IPO which we call mean value.So they end up with bad IPOs.Another important theory in IPO underpricing is information asymmetry.Allen and Fauhaber (1989), Booth & Smith (1989) developed this information asymmetry theory.In this theory they have documented that, the issuers and the underwriters have better information about the market and also about their company.Therefore the investors need to be compensated by the issuers on the ground of the information asymmetry.As the underwriters have inside information, they can easily manipulate the offerings at the cost of the common investors.

Methodological Framework
In this study we have used ordinary least square (OLS) method to predict or understand our dependent variable.This OLS method is used to predict the unknown variables of our linear regression models.The main purpose of using this method is to minimize the sum of the squared differences between the observed variables and the predicted value for the dependent variable.OLS regression model provides the optimum estimates from the possible parameters under the assumptions that we have used for processing our models.
In this study, we have used two regression models using the same dependent variable.Here, in model 1 we have used size of the firm along with offer time and over subscription rate as dependent variable.But in model 2, we have used offer size instead of size of the firm as dependent variable.In order to separate this two dependent variables, we have created two econometric model.The reason is that, if we use offer size and size of the firm in a same econometric model, it will lead to multicolinearity problem.Using this two variables in a same model will lead to misleading results to determine how well our independent variable can predict the dependent variables.It also provides less reliable probability values for market adjusted abnormal return (MAR).

Dependent Variable
Market adjusted return (MAR) is considered as the dependent variable.We have calculated MAR in the following way.It has relevance with proper methodology.We have calculated underpricing level on the basis of percentage change with respect to offer price and closing pricing.In the secondary market which have used previously.

First day underpricing (Traditional basis) = ((closing price-offer price)/ offer price)) * 100
In order to make the initial return of a share similar and comparable to another share it is necessary to quote the initial return in relation to the share's issue price.Then we have to multiply it with 100 to get a proportional return.In the following way we have calculated MAR that is market adjusted return: At first, we have calculated return on security i.We have used the following formula: where Ri= (P1-P0)/P0 in which, Ri= return on i security, P1= Price of i security on first listing day, P0= offer price of i security.

Ri= (P1-P0)/P0
(1) Secondly, we have calculated the index return on corresponding days.Where, Mi = (Ii-I0)/I0.In which Mi= market return on the ith day.Ii= closing index of DSE at the listing day.I0= closing index of DSE at offer day.

Mi= (Ii-I0)/ I0
(2) The raw return is also known as security return.It is used to determine the IPO return for each share on the level of market adjustment.Here is the formula:

Explanatory Variable
Size of the firm Kiyamaz (2000), Bhabra & Pettway (2003) identified an inverse relationship between size of the firm and the level of underpricing.If the size of the firm is larger, there will be lower uncertainty that the value of the firm will go down at listing time.

H1: Initial Underpricing and size of the firm are negatively related
Offer Size It is argued by Carter and Manaster (1990) that investors use the size of the offer to measure the performance of the IPOs.They have found a negative relationship between offer size and level of underpricing.

H2: Offer size has a negative relationship with the level of underpricing.
Offer Time It is identified by Balwinder Singh (2003) that offer timing is a very significant determine in underpricing IPOs.The more offer timing is the more road show can be arranged as a result underpricing will go high.

H3: Offer timing has positive elation with initial underpricing.
OSR It is identified by Dawson (1984) that, pre IPO investors require after market performance influences.In the very first day, an upward pressure exists as it is demanded by the investors.Over subscription mainly helps to identify the investor's demand.

H4: Over subscription rate has a positive link with the initial public offering
The variables are calculated as follows:

Sources of Data
Data is primarily collected from the website of DSE.The price compilation is collected from DSE news archive.Daily price is used to reflect most accurate changes in the market.

Sampling and the Inclusion Criteria
The IPOs taken are all within a 5 years' timeframe from June 2011 to June 2016.The IPOs include only shares of companies newly listed and offering that is "Initial" but not "Repeat".Mutual funds are left out because it may lead to double count the market, and also as mutual funds are actively manage funds, that will always tend to give a biased result towards upside.Banks and Financial Sector are also excluded.We have only taken IPOs from non-financial sector.

Research Model Development
The IPOs taken are all within a 5 years' timeframe from June 2011 to June 2016.We have only taken IPOs from non-financial sector.We have taken a sample of 50 IPOs listed in Dhaka Stock Exchange form June 2011 to June 2016.Simple linear regression model is used to analyze the data.Variables are selected in this paper is based on prior theories and empirical evidences.
The econometric model can be made functional in the following way: Here,

Review of IPO Underpricing in Dhaka Stock Exchange
Initial public offering underpricing means, price of the IPO goes very high when it is traded for the first time.It is called initial return or it can be termed as first day return of IPO.We can use the following method: Underpricing IPO = (First day closing price-Offer price) / Offer price* 100% This closing price on the first day indicates the willingness of the investors and their motivation to pay regarding the share of the firm.The IPO will be underpriced, if the offer price is less than IPO's closing price.IPOs are underpriced often because of uncertainty related to liquidity and the price level at which the stock will trade.If the IPOs are not that much liquid and not predictable to a certain level then it will be more underpriced, as it will have to compensate the people to invest there for the risk they have taken in the market.

Difference between Offer Price and Face Value
Offer price of IPO has substantial level of difference from its face value.During our time period, out of 50 companies in Dhaka Stock Exchange 32 IPO issued at premium with a mean of 22.0625%.anda standard deviation of 11.24202.Table 1 shows the identification of offer price and the value of the selected IPOs.

Raw Level of IPO Underpricing on Yearly Basis
Here we have arranged the raw level and market adjusted IPO underpricing.We have found the maximum number of underpricing in 2014 which is 237.5912%.The standard deviation of this underpricing level is 191.2931.It is very high as we have found that, 18 firms got listed in this particular year.We have recorded the second best underpricing level in year 2012 which was 168.3375% and its standard deviation was 165.047%.It happened as 10 companies have found listed in that year.The third maximum level is found in year 2015 which was 148.5643% and the standard deviation was 138.7208.We have found 8 firms that were listed with DSE that year.ijbm.ccsen

Yearly
The maxi was 181.4 standard IPOs which were issued under fixed price method were selected for this data set.Book building method is getting popular in recent days.Further research can be done on this field considering more explanatory variables and different data set can be used to explain the relationship among these variables in future.
The market that was selected for our analysis is Dhaka stock Exchange.It is the biggest stock exchange of Bangladesh having 90 times more trade value and 114 times more trade quantity than the other stock market of the country that is Chittagong Stock Exchange.Dhaka Stock Exchange also has approximately twice the number of listed stock than CSE.Most of the Investors of the country are related with DSE and information shows up quite fast in the price.Being in the center of the Capital of the country, it also gets the most amount of notice.So it is logical to select DSE as the market to take data from to perform research.

Table 1 .
Face value and the offer priceIn this section we have identified underpricing and overpricing level within our selected time frame in Dhaka Stock Exchange.In table 2, we can see the underpricing and overpricing level within the selected time frame.It indicates underpricing level at DSE within the time frame was 198.7918%.We have identified the standard deviation which is 163.8705.Among 50 IPOs, we have found 47 were underpriced.Rest of the 3 (6.4388%)wereoverpricedTable2shows the underpricing level among our IPOs.

Table 3 .
Yearly basis raw level IPO underpricing Source: This table is found inIslam, & Ahmed (2010).It is the updated version.