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RESEARCH includes research articles that focus on the analysis and resolution of managerial and academic issues based on analytical and empirical or case research Executive Summary Determinants of Going-Public Decision in an Emerging Market: Evidence from India Manas Mayur and Manoj Kumar During the past two decades, numerous Indian firms have gone public by undertaking Initial Public Offerings (IPOs) of their equity shares. Yet, many other Indian firms have intentionally chosen to remain private even though they fulfill the eligibility criteria of going public. This raises the question as to what are the determinants of firms’ going-public decision. While researchers have propounded several theories to explain the firms’ going-public decision, yet the empirical studies conducted to test the proposed theories are still scarce, mainly due to lack of data on privately held firms necessary for a direct investigation of the choice between going public and remaining private. None of the existing studies have assessed the determinants of Indian firms’ going-public decision. Besides, no consistent stylized facts have so far emerged. Rather contradictory findings have been reported in some of the existing studies. Further these individual studies have not been comprehensive as each of them has focused only on a limited number of determinants. This study investigates the determinants of going-public decision of the Indian firms, juxtaposing the following two related research issues: • What ex-ante (pre-IPO) characteristics of going-public Indian firms differentiate them from those Indian firms that continue to remain private even though they fulfill the eligibility criteria of going public? • What ex-post consequences of IPOs on firm characteristics influence their goingpublic decision? KEY WORDS Initial Public Offerings Going-Public Decision Emerging Market India The preceding research issues are examined using two independent analyses. First, a panel probit regression analysis is done to identify the ex-ante characteristics of going-public Indian firms that differentiate them from those Indian firms that continue to remain private even though they fulfill the eligibility criteria of going public. This analysis reveals that going-public Indian firms tend to be younger, riskier, transparent, more profitable, experiencing higher sales growth, and larger-sized than firms that decide to remain private. Also if a firm belongs to retail trade sectors, it increases its probability to go public. In the second analysis, ex-post consequences of IPOs on firm characteristics are examined by comparing pre-IPO characteristics of IPO firms with their post-IPO characteristics using Wilcoxon two-sample signed rank test. This analysis suggests that Indian firms go public to: • • • • finance their growth and investments diversify owners’ risk rebalance their capital structure bring down their borrowing rates. VIKALPA • VOLUME 38 • NO 1 • JANUARY - MARCH 2013 65 T he last decade had witnessed significant changes in the Indian capital market. During this period, it graduated into a mature market, to be at par with or even better than the developed capital markets on certain parameters. India has the second largest number of listed companies after the USA. According to Standard and Poor’s Fact Book 2009, India is ranked 7th in terms of market capitalization and 15th in terms of turnover ratio. During the past two decades, numerous Indian firms have gone public by undertaking Initial Public Offerings (IPOs)1 of their equity shares (Table 1)2. Yet many other Indian firms have intentionally chosen to remain private even though they fulfill the eligibility criteria of going public. This raises the question as to what factors influence the firms’ going-public decision. Traditionally, most corporate finance textbooks suggest that firms go public primarily to raise equity capital required for financing their growth. While researchers have propounded several alternate theories to explain the firms’ going-public decision, yet the empirical studies conducted to test the proposed theories are still scarce, mainly due to the lack of data on privately held firms necessary for a direct investigation of the choice between going public and remaining private (Albornoz & Pope, 2004; Chemmanur, He & Nandy, 2005). The authors, in their literature review, came across only six empirical studies on this topic (Table 2)3. None of the existing studies have assessed the determinants of Indian firms’ going-public decision. While these studies have unfolded a wide variety of factors influencing the firms’ going-public decision, no consistent stylized facts have emerged. Rather contradictory findings have been reported in some of the existing studies. Further, these individual studies have not been comprehensive as each of them has focused only on a limited number of determinants. Therefore, the existing empirical literature cannot provide clear insights into the determinants of the Indian firms’ going-public decision. This study investigates the determinants of going-public decision of the Indian firms. The above investigation jux- 1 We take the meaning of IPO and going public as the same. 2 All the Tables are given in Appendix. 3 The research design of these studies has mostly been probit analysis. This study uses a similar research design. There is another set of research studies which has used survey research design (Brau & Fawcett, 2006; Brau, Ryan & DeGraw, 2005, etc). This study does not follow survey research design. 66 taposes the following two related research issues: What ex-ante (pre-IPO) characteristics of going-public Indian firms differentiate them from those Indian firms that continue to remain private even though they fulfill the eligibility criteria of going public? What ex-post consequences of IPOs on firm characteristics influence their going-public decision? In the extant literature, the above two research issues have always been studied together. Pagano, Panetta and Zingales (1998) argue that if the relevant decision makers have rational expectations, the answers to the above stated research questions should be consistent: the motives to go public uncovered on the basis of ‘ex ante evidence’ should square with the actual post-IPO consequences on the firm characteristics. But in practice, rather than being redundant, ex-post information is likely to complement the evidence based on the ex-ante characteristics of the companies that go public, for two reasons. First, the importance of some variables can be assessed only by looking at ex-post data; for example, the controlling shareholders’ intention to divest after going public can hardly be assessed from the ex-ante analysis. Second, in some cases, the effects of going public may not be fully anticipated, so that only ex-post information can uncover them. Thus, in this study and the existing studies of this type, researchers have attacked the issue of why companies go public by using both ex-ante and expost information on their characteristics. LITERATURE REVIEW Finance literature documents two major approaches to find out the determinants of going-public decision. The first approach is to examine managerial perceptions of determinants of going-public decision by conducting surveys of companies’ managers. The second approach is to statistically analyse the fundamental financial data of companies and macro-economic variables to know the determinants of their going-public decision. The results of survey-based studies are discussed first, followed by the discussion on the results of studies based on fundamental financial data of companies and macro-economic variables. Survey-Based Studies Brau and Fawcett (2006) conducted a managerial survey of 336 CFOs of the US firms which hitherto either (a) had successfully completed their IPO; or (b) had initiated their IPO process but later on chose to call off their IPO; or (c) DETERMINANTS OF GOING-PUBLIC DECISION IN AN EMERGING MARKET... were eligible to do an IPO but decided to remain private. Their survey sample of 336 CFOs was the result of a response rate of 18.1 percent. The survey revealed that: the acquisition purpose was a major factor that motivated the US companies to do IPO; issuers timed their IPOs to take advantage of prevailing market conditions; and preservation of decision-making control and ownership were the main reasons for remaining private. The major strength of their study was their large survey sample of 336 CFOs. However, the sample was derived from within a narrow time span of only two years, i.e., from 2000 to 2002. Due to the narrow time span used for deriving the sample, their study did not allow for variations in managerial perceptions resulting from changes in market conditions and mechanisms over a larger time frame. Burton, Helliar and Power (2006) conducted a survey on managers and intermediaries associated with the goingpublic decision of the UK firms. They conducted their study in three steps. First, personal interviews through a semi-structured questionnaire were undertaken with various parties involved in the IPO process. The interviews were conducted with ten organizations that had been involved in IPOs. Second, postal questionnaires were sent to the UK companies that had an IPO in the last two years. Out of a total of 450 companies, 102 companies responded back, representing a response rate of 23 percent. Third, information about the amount that each company had raised and their market capitalization was obtained through secondary sources. The survey revealed that: the benefit in terms of increased visibility and reputation associated with IPO had major influence on the going-public decision; the need for growth was the most important determinant of timing of the issues and the biggest difficulty encountered by the managers was to manage both, the IPO process and the company operations together. Brau, Ryan and DeGraw (2005) carried out a survey of CFOs of 438 US firms (with a response rate of 44.5%). The sample was divided into pre-Internet bubble (1996-1998) and post-Internet bubble (2000-2002) IPOs. Due to the anomalous nature of the IPO market during Internet bubble, the study did not survey firms that went public during the height of the Internet bubble between 1998 and 2000. They found that: financing of growth and increase in liquidity were the two major motivations behind the going-public decision; CFOs’ sentiment remained the same in bull and bear periods and underwriting fees VIKALPA • VOLUME 38 • NO 1 • JANUARY - MARCH 2013 and indirect costs related to going public were major concerns for CFOs in IPO. Marchisio and Ravasi (2001) conducted a survey on family-owned companies of Italy. The result of the study was based on the responses of 54 family-owned firms (with 73% response rate) who went public during 1996-2001. The research question of the study was, “Why do familyowned firms do IPO?” Specifically, authors investigated strategic motives behind going-public decision. The survey revealed that beside the usual financial motives, family-owned firms go public to increase the visibility and to expand and strengthen the network of relationships that can sustain entrepreneurial activity. Block (2004) carried out a survey on the US firms that went private between January 2001 and July 2003. Out of a total of 236 firms that went private, 110 firms participated in the survey (response rate 46.65%). The study investigated the reasons behind ‘going private’ decision of the firms and found that the following factors can motivate a company to become private again: (a) the costs associated with being a public company in terms of pressure and time constraint on top management, (b) absence of liquidity, and (c) threat of delisting by the stock exchange. Park (1990) carried out a survey on Korean companies. The study showed that while the most important benefits of going public were easy access to a source of funding and gaining market credibility, fear of loss of control was considered as one of the critical obstacles for Korean companies. Though the research question was not exactly the same with the present study, there are a few surveys done on issues related to IPOs. For example, Eije, Witte and Zwaan (2000) conducted a survey of Dutch companies which went public between 1987 and 1997 and found that IPO could cause changes within a company like effectiveness, planning and control, capital budgeting, internal communication, etc., and that the changes could contribute positively to the long-term performance of a company. Studies Based on Fundamental Financial Data of Companies & Macro-economic Variables A number of studies have searched for empirical relationship between the companies’ characteristics and going-public decision. Numerous regression models 67 incorporating a wide variety of explanatory variables have been specified to reveal the determinants of goingpublic decision. The theoretical costs and benefits associated with going public have formed the basis for the models specified. While most of these studies have arrived at some common determinants for companies’ going-public decision, there are some contradictory findings. Further, the proxies used to capture the same theoretical costs/benefits, at times, have varied across different research studies. Table 2 provides a summary of a few such studies, showing the type of statistical analysis conducted, the explanatory variables adopted, and the empirical results. Pagano, Panetta and Zingales (1998) investigated the determinants of going-public decisions of Italian companies through a probit model. They compared 69 Italian public companies, which completed their IPOs between 1982 and 1992, with 12,391 Italian private companies, which were eligible to do their IPOs but preferred to remain private during the above period. The study analysed both, the ex-ante characteristics of the companies and expost consequences of IPO on the companies that had an IPO. They found that the probability of going public increased with the increase in stock market valuation of other firms within the same industry and company’s size; financing of subsequent investment and growth were not amongst the major motivations behind going public; IPOs helped companies in borrowing cheaply from the banks; and incumbent’s wealth increased in the post-IPO period. Chun, Lynch and Smith (2002) adopted the approach of Pagano et al. (1998) and investigated the factors influencing the going-public decision for Korean firms. Their sample consisted of (a) 304 Korean firms which completed their IPOs between 1986 and 1995; and (b) 1,722 Korean firms which remained private during the above period. They also carried out analysis on sub-samples of: (a) Chaebol or large conglomerate subsidiaries vs. Independent firms; and (b) financially healthy firms and marginal firms. They found that the: IPOs are timed to take the advantage of windows of opportunity; financially marginal firms are more likely to go public to take advantage of windows of opportunity; a high (low) industry market-to-book value (MTB) increases (decreases) IPO probability; firms do not go public to fund investment in fixed assets; returns on assets decreased in the post-IPO period; Chaebol subsidiaries use IPOs to fund takeovers 68 or other equity investments; Chaebol subsidiaries experienced a fall in interest rates after the IPO which was consistent with IPO motive of lowering the cost of capital to fund takeovers. Boehmer and Ljungqvist (2004) examined 330 German firms that went public between 1984 and 1995. The result of the study was based on a hazard analysis of factors influencing the timing of IPOs. Authors argued that the probit and logit models, used by most of the studies, do not analyse the time factor associated with the variables, which according to them can be incorporated using a hazard model. The firms were observed from the date of IPO announcement to the date of their IPO. Following factors were found to be positively affecting the likelihood of IPO: sales, profit margins (relative to other firms in its industry) and stock market returns of the firms in the same industry, and uncertainty about the future profitability. To preserve the private benefits of control was found to be a major motivation behind staying private. Albornoz and Pope (2004) analysed 830 public firms that were listed on London Stock Exchange. The research design of the study was similar to Pagano et al (1998). They found that going public decision of companies was related: (a) positively to their size, stock market valuation of other companies within the same industry; and (b) negatively to their leverage levels and profitability. Based on the analysis of post-IPO evidences, the study suggested that ‘financing needs’ and ‘reduction of leverage’ were not the major factors influencing IPO decisions in the UK. Rosen, Smart and Zutter (2005) conducted a sector-specific study wherein they investigated 240 US banks which completed their IPOs between 1981 and 2002. The advantage of doing a study on banking sector was the easy accessibility of required data, even of the private banks. Unlike the other sectors, both public as well as private banks are required to disclose their annual financial data to the regulators. Authors found that: the riskier banks were more likely to go public; the chance of getting acquired increased the probability of going public; the chance of becoming an acquirer also increased the probability of going public, and the banks went public to take the advantage of prevailing market condition. Chemmanur, He and Nandy (2005) investigated the relationship between product market characteristics and probability of going public for a large sample of US firms. The DETERMINANTS OF GOING-PUBLIC DECISION IN AN EMERGING MARKET... investigation was based on two types of firms: (a) all those firms that had an IPO between 1972 and 2000 and (b) all those firms that stayed private during the period. A probit model was used to examine the relationship between the product market characteristics of firms immediately before going public and its likelihood of going public. The following characteristics were found to be positively affecting the likelihood of going public: firms with larger size, sales growth, total factor productivity (TFP), market share, and capital intensity; firms operating in less competitive and more capital-intensive industries; firms in industries characterized by riskier cash flows; firms with projects that are cheaper for outsiders to evaluate; firms operating in industries characterized by less information asymmetry; and firms with greater average liquidity of already listed equity. Kim and Sung (2005) carried out their study on groupaffiliated Korean firms. Their sample size consisted of 35 group-affiliated firms that had an IPO between 1997 and 2002 and private firms that were eligible for IPO but remained private during the period. The study hypothesized that the following factors increase the probability of going public: (a) direct share ownership by group-controlling shareholder, (b) each firm’s contribution to group control, and (c) internal capital market. A probit model and a multivariate regression model were used to analyse the pre-IPO firms’ characteristics and consequences of IPO on the performance of firms respectively. The analysis showed that the probability of going public increased for the firms: (a) where group-controlling shareholder held high direct share ownership in the firm; (b) where its contribution to group control was low; and (c) when it could not benefit from the internal capital market. Kim and Weisbach (2005) explored the underlying motivations behind going public decision using a large sample of 16,958 IPOs from 38 countries. Their sample consisted of three types of offerings: (a) IPOs where new primary shares were issued, (b) IPOs where exclusively secondary shares held by insiders were issued and (c) IPOs with a combination of the above two. Authors concluded that capital raising was an important motive for going public. Their result was based on their following observations. First, maximum proportion of IPOs around the world involved issuance of primary shares. Second, IPOs with primary share offerings were associated with a higher demand for capitals than IPOs with secondary share offerings. VIKALPA • VOLUME 38 • NO 1 • JANUARY - MARCH 2013 Pin and Wei (2006) studied 383 IPOs of Taiwan, for the sample period of 1989 to 2000. The probit model used to analyse the determinants of IPOs in the study concluded that: Taiwan IPOs were not motivated by financing needs or constraints and larger and profitable firms were more likely to go public. Breinlinger and Glogova (2002) examined the influence of macro-economic factors on going-public decision. Their sample consisted of firms from six European countries (Austria, Belgium, Denmark, Finland, France, and the Netherlands) that went public between 1980 and 1997. They explored the determinants of IPO volumes through a panel data analysis of the following macro-economic factors: stock index returns, changes in savings deposits, GDP growth, interest rates, and exchange rates. The authors found that the overall IPO volume was dependent on stock market returns but the dependence was not significant for all the stock price levels. Also, except Finland and Austria, the relationship was not significant for other countries. Other factors like changes in savings, GDP growth, interest rates, and exchange rates exhibited nonsignificant influence on IPO volumes. THEORETICAL FRAMEWORK AND HYPOTHESES DEVELOPMENT Researchers have propounded several alternate theoretical models to explain the firms’ going-public decision4. These models view the firms’ going-public decision as a trade-off between the benefits and costs of going public, as are summarized in Table 3. First, the hypotheses based on the discussion of benefits-based theories are developed. Next, the hypotheses based on the discussion of costs-based theories are developed. Table 5 summarizes all the hypotheses developed in this section. Table 4 provides detailed definitions of all variables used for testing of the hypotheses developed in Table 5. Benefits-Based Hypotheses Raising capital for growth and expansion: Most theoretical models assert that firms go public to raise additional capital required for financing their growth and expansion. The opportunity to tap public markets for equity capital is appealing for high growth firms with large cur4 Pagano et. al (1998) in their seminal work observed that factors influencing firms’ decision to become public are far more complex to be captured in any single model. 69 rent and future investments that may have limited access to other financing alternatives due to high leverage and high growth (Pagano et al., 1998; Huyghebaert & Hulle, 2005). Therefore, it is conjectured that firms which go public tend to have higher leverage levels and should be experiencing higher sales growth than firms which remain private. Further, firms after going public tend to enhance their capital expenditure and investments. Risk diversification: Some studies have explained the companies’ going-public decision as risk sharing and diversification vehicle for the initial owners. Huyghebaert and Hulle (2005) asserted that companies with major investments on current projects for the future growth tend to be risky. The initial owners of such high growth companies, therefore, dislike investing more of their own personal wealth into their companies. Hence they rely on external finance for funding of their major investments. The time lag between investments and cash generation makes debt financing unsuitable for the risky projects. The high premium charged by venture capitalists discourages such risky companies from raising money through them. Hence for risky firms, raising equity capital through IPOs is the most suitable form of financing. Therefore, it can be conjectured that firms which go public tend to be riskier than firms which decide to remain private. A related motive behind going-public decision of firms is the initial owners’ desire to divest or diversify their wealth (Pagano, 1993; Zingales, 1995; Stoughton & Zechner, 1998; Chemmanur & Fulghieri, 1999). The owners of a closelyheld firm tend to have a large investment in their company and hence are overexposed to the business risk of the company (Albornoz & Pope, 2004). An IPO creates a public market for the company’s shares, which in turn enables the company’s initial shareholders to convert their shares into cash at any point of time (Zingales, 1995; Mello & Parsons, 1998). Black and Gilson (1998) added that the IPOs provided venture capitalists an attractive opportunity to harvest their investments into the risky businesses. Therefore, it is conjectured that the level of promoter’s ownership should come down after IPO. Capital structure rebalancing: Pagano et al (1998) found that companies undertook IPO to rebalance their capital structure. As per this argument, companies having higher amount of debt in their capital structure tend to go public to bring down the ratio of debt in their capital structure. 70 Therefore, it can be conjectured that firms which go public tend to have higher financial leverage than the firms which decide to remain private. It is further assumed that a firm’s debt-equity ratio should come down after it becomes public. Lowering cost of capital: The tax shield advantage of debt helps the firms to reduce their overall cost of capital. But a company cannot continuously minimize its overall cost of capital by employing debt. A point or range is reached beyond which debt becomes more expensive because of increased risk of excessive debt to creditors as well as to shareholders. When the degree of leverage increases, the risk of creditors increases, and they demand a higher interest rate and may not grant loan to the company at all, once its debt has reached a particular level. Further, the excessive amount of debt makes the shareholder’s position very risky. This has the effect on increasing cost of capital. Thus, up to a point, the overall cost of capital decreases with debt, but beyond that point, the cost of capital would start increasing. According to Scott (1976) and Modigliani and Miller (1963), companies conduct a public offering when external equity minimizes their cost of capital. Diamond (1991) and Holmstrom and Tirole (1993) added that raising public equity offered the opportunity to obtain low-cost direct financing without the intervention of financial intermediaries such as banks or venture capitalists. Trading on major stock exchanges increases the visibility of the companies. Also a sufficiently large number of quoted shares help in attracting more number of investors (e.g. institutional investors). The visibility and popularity amongst the large number of investors also helps in reducing the cost of capital (Booth & Chua, 1996; Maug, 1998). Therefore, it is conjectured that firms: (a) which go public have higher cost of capital than firms which decide to remain private; (b) face lower cost of capital after becoming public. Liquidity: Listing on major stock exchange provides liquidity in the stock and makes share trading cheaper (Amihud & Mendelson, 1986; Booth & Chua, 1996; Bolton & Thadden, 1998). Shares of private companies can be traded only by informal searching for a counterpart, at a considerable cost for the initiating party (Pagano et al., 1998). Therefore, companies may go public to facilitate the trading of their shares by listing them on formal stock exchanges aftermath of their IPOs. DETERMINANTS OF GOING-PUBLIC DECISION IN AN EMERGING MARKET... The ease of share trading is particularly necessary when firms want to raise capital from the dispersed small investors to avoid close monitoring by the bigger block investors. As a result, if the initial owners raise money from dispersed investors, they factor in the liquidity benefit provided by being listed on an exchange. As highlighted by Pagano, Panetta and Zingales (1998), many microstructure models document that the liquidity of a firm’s shares increases with the trading volume which is, in turn, related to firm size. Therefore, it is conjectured that firms which go public are likely to be larger than firms which decide to remain private as the former firms are better positioned to reap the benefit of improved liquidity after becoming public. Monitoring: In a private company, addition to the existing shareholders can be very costly as each new shareholder expends time and effort to check that the company is a sound investment. Pagano and Roell (1998) emphasized that private companies owned by large shareholders experienced excessive monitoring. A large shareholder, such as a venture capitalist, more closely monitors the company than a large group of small investors. Therefore, companies intentionally try to limit the stake of large shareholders and raise the expansionary capital by dispersing the stake across small and dispersed shareholders. If the scale of a planned expansion is very large, and thus needs to be financed by many investors, the cost of avoiding over-monitoring at the hands of large shareholders becomes so large that it is preferable to go public. In a public company, expanding the shareholders’ base is comparatively inexpensive. Therefore, it is conjectured that firms tend to do higher capital expenditure and investments after becoming public as the very reason for going public is the subsequent planned large scale expansion. Windows of opportunity: The firms’ managers are opportunistic and approve a public offering only when they perceive their firm to be overvalued (Myers & Majluf, 1984; Dharan & Ikenberry, 1995). The above argument was based on the following assumptions: (a) managers act solely for the welfare of existing shareholders; and (b) managers have superior insider information. Viewed in the above background, companies apply for listing in a prestigious exchange at a time when their performance is at the peak, and hence firms have a greater chance of making a successful listing. Moreover, compaVIKALPA • VOLUME 38 • NO 1 • JANUARY - MARCH 2013 nies do their IPOs during the periods when the companies in the same industry are overvalued. More the overvaluation, more is the possibility that a company will go public (Ritter, 1991). Therefore, it is conjectured that firms are likely to do their IPOs when peer firms in their industry are overvalued. Moreover, the industry peers of firms which have recently gone public should suffer significant erosion in their valuations. Also, firms tend to underperform after becoming public. Publicity: The high visibility of severely discounted IPOs serves as a marketing vehicle for issuers. Recent theoretical works on IPOs emphasize the benefits of publicity to both customers and issuers. When companies go in for IPOs, they get publicity that helps them to reduce the information asymmetry between insiders and outsiders. The stock prices of publicly listed firms are visible to all and hence customers can easily assess the value of such firms (Subramanyam & Titman, 1999). Stoughton, Wong and Zechner (2001) argued that the decision of a company to go public could serve as a signal of its high quality to the product market. They proposed a model where high-quality firms distinguished themselves, and thereby built product market share, by incurring the indirect cost of underpricing and subjecting themselves to the scrutiny of secondary market investors engaged in costly information production. In their model, consumers related the quality of a company’s products to the market prices of its listed stocks. Consumers perceived a company’s products to be better if its stock prices were high and hence, were ready to pay more for its products. Therefore, a good company could charge higher product prices in high market conditions. They showed that firms with higher first-day returns gained larger market share in the product market. Helwege and Packer (2001) argued that these benefits should be higher for companies with a large customer base. Therefore, it is conjectured that companies belonging to retail trade sectors should have higher propensity to become public. Currency for Mergers and Acquisitions (M&As): Some researchers have highlighted the role of IPOs in facilitating corporate M&A activities. Zingales (1995) argued that an IPO could serve as a first step in acquiring a company at an attractive price. Brau, Francis and Kohers (2003) supported Zingales (1995) that IPOs could create public shares for a company which might be used as a “currency” in either acquiring other companies or in being 71 acquired in a stock deal. This theory is not tested in this paper for want of required data. Cost-Based Hypotheses Information asymmetry and adverse selection costs: The economics of information is based on the premise that different parties of a transaction often have different levels of information about the transaction. Information asymmetry refers to a situation in which sellers often have superior information than buyers about some aspect of product quality. Akerlof (1970) pointed out that information asymmetry prevailed in all markets. He identified the fact that if the good quality sellers had no means to signal high quality, all products in the markets would be sold at a single price reflecting the average quality level of the market. This would lead to a situation where the high quality sellers will have no other choice than to withdraw from the market because high quality sellers in an information asymmetrical market have to sell products at lower prices than actual worth of their products. Ultimately only “lemons” (bad quality products) are sold in the market, which is how buyers also view the products being sold in the market place. This leads to a market failure situation referred to as “adverse selection”. Leland and Pyle (1977) noted that the information asymmetry was particularly high in the primary markets. In IPO situations, investors are generally less informed than the issuers about the true value and quality of the company doing an IPO. Thus, prevailing information asymmetries about the quality of issuers in IPO market results in adverse selection and should be a factor influencing the firms’ going-public decision (Pagano et al., 1998; Albornoz & Pope, 2004). They insisted that information asymmetry adversely affected the average quality of the companies seeking a new listing and thus affected the price at which their shares could be sold. Chemmanur and Fulghieri (1999) predicted that information asymmetry could result in an IPO price lower than that raised by selling private equity to a small group of venture capitalists. They, therefore, argued that adverse selection can work as an obstacle for the young and small companies which have little track record and low visibility. Chemmanur and Fulghieri (1995), Rock (1986), and Welch (1989) empirically confirmed a positive relationship between age and probability of going public. Diamond (1991), however, asserted that the adverse selection problems could be avoided if a company had visible prof- 72 itability. A visible profitability can send positive signals to the investors about the company’s quality, and hence a young company can also think of accessing public capital market through IPO. Therefore, it is conjectured that firms which go public tend to be bigger, established, and visible than firms which decide to remain private. Loss of confidentiality and higher taxes: In most countries, the securities market regulator(s) have more stringent disclosure requirements for the public companies than the private companies. Some of the mandatory disclosures to be made by public companies may be internally sensitive and whose secrecy may be crucial for their competitive advantage5. This may deter the companies from going public (Campbell, 1979; Yosha, 1995; Maksimovic & Pichler, 2001). Pagano et al. (1998) argued that tax outgo of companies as a fraction of their operating income should experience a permanent increase in the post-IPO period. They attributed this increase to the close scrutiny of public companies from tax authorities, reducing their scope for tax elusion and evasion relative to private companies. Hence, companies which are relatively less transparent (paying low taxes) and hence probably fear large confidentiality loss on becoming public may not like to go public. Therefore, it is conjectured that firms which go public tend to pay higher taxes as compared to firms which decide to remain private. Initial and subsequent expenses: The initial and subsequent expenses associated with IPO can discourage companies from going public (Bhattacharya & Ritter, 1983; Ritter, 1987). Some of the major initial costs include: the lead underwriter’s commission; out of pocket expenses for legal services; accounting services; printing costs; personal marketing “road show” by managers; ongoing legal, accounting, filing, and mailing expenses; and other unforeseen expenses. Ritter (1987) observed that approximately 18 percent of the total proceeds were paid as initial expenses by the US companies. All public companies also have to keep incurring several recurring expenses on an ongoing basis. Such expenses 5 Public companies are required to release all operating and financial details to the public, at the time of filing and on the annual basis after IPO. These details include sensitive information about their markets, profit margins, Research & Development (R&D) projects, and present and future strategy. DETERMINANTS OF GOING-PUBLIC DECISION IN AN EMERGING MARKET... ( may include: listing fee to be paid to stock exchange(s), relatively high annual auditing fees compared to being a private company, high printing charges of annual reports, high costs of arranging shareholders’ meetings and maintaining investors’ relations, etc. The existence of initial and recurring costs of going public suggests that the likelihood of an IPO should be positively correlated with company size. π (IPOit = 1) = f β1Sizei,t-1 + β2Agei,t-1 + β3IAi,t-1 + Increased possibility of litigations: Possibility of getting entangled into litigations increases significantly for the public companies. Because litigations are costly, companies have incentives to avoid them. Hence companies may decide against going public to minimize the possibility of legal suits (Tinic, 1988). This theory is not tested in this paper for want of required data. β8Leveragei,t-1 + β9 B METHODOLOGY In the extant literature, the determinants of going-public decision are viewed from two complementary perspectives. The ex-ante firm characteristics of going public firms are studied along with the ex-post consequences of going public decision of the firms. This study follows the same design by carrying out two related but independent analyses. First, a panel probit regression analysis is done to identify the ex-ante characteristics of going–public Indian firms that differentiate them from those Indian firms that continue to remain private even though they fulfill the eligibility criteria of going public. In the second analysis, ex-post consequences of IPOs for firms are examined by comparing pre-IPO characteristics of IPO firms with their post-IPO characteristics. The methodologies for both the analyses are described below. Panel Probit Regression Analysis Based on the hypotheses in Table 5 regarding the ex-ante determinants of going-public decision of firms, initially, the following probit regression model specification (1) is estimated π (IPOit=1) = f(β1Sizei,t-1 + β2Agei,t-1 + β3IAi,t-1 + β4Betai,t + β5SGi,t + β6PBDITi,t-1 + β7Disci,t-1 + M β8Leveragei,t-1 + β9 B i,t-1 + β10Retaili,t) (1) Further, specification (2) and specification (3) are estimated by one way random effect probit regression. Specification (2) is estimated to control industry effects and specification (3) is estimated to control year effects. VIKALPA • VOLUME 38 • NO 1 • JANUARY - MARCH 2013 β4Betai,t + β5SGi,t + β6PBDITi,t-1 + M β7Disci,t-1 + β8Leveragei,t-1 + β9 B i,t-1 + ) β10Industry (2) ( π (IPOit = 1) = f β1Sizei,t-1 + β2Agei,t-1 + β3IAi,t-1 + β4Betai,t + β5SGi,t + β6PBDITi,t-1 + β7Disci,t-1 + M i,t-1 + β10Retaili,t + β Time) 11 (3) There has been considerable interest in random effects models for longitudinal and hierarchical, clustered or multilevel data in corporate finance. But there has been very less focus on random-effects models for discrete data. Our study uniquely applies the random effect probit model to analyse the determinants of going-public decision. The model variables are explained below. Dependent Variable The nomenclature of dependent variable is ‘IPO,’ a dummy variable, which equals 1 if the company is publicly held and 0 if the company is a private in a particular year. Individual companies are indexed i: for each year t, in the sample. At any time t, the sample includes all companies which are private at that point in time, and the companies which go public (had an IPO) in that year. After a company goes public, that company is dropped from the private sample. Independent Variables Table 4 provides detailed definitions and calculations of all the independent variables used in the above model. The selection of the independent variables in the model is based on hypotheses included in the Table 5. The brief justifications for inclusion of each of the independent variables in the model are as follows: Size is included in the model as review of literature indicates that bigger firms (a) tend to attain more liquidity benefits than the smaller firms; (b) tend to face lower information asymmetry and adverse selection costs than the smaller firms; and (c) have relative ease in bearing the initial and subsequent expenses owing to the firm becoming public. Based on the above discussion, a positive 73 relationship between size and probability of going public is anticipated. Age is included in the model as the review of literature indicates that younger firms are perceived to be riskier than the older firms. Therefore, a negative relationship between age and probability of going public is anticipated. IA (Intangible assets to Total assets ratio) is included in the model as review of literature indicates that firms with higher IA are perceived to be riskier than the firms with lower IA6. Therefore, a positive relationship between IA and probability of going public is anticipated. Beta is included in the model as a measure of the systematic risk of the particular firm. Firms with higher beta are riskier and have higher cost of capital than firms with lower beta. The review of literature indicates that firms go public to facilitate the risk diversification by the initial owners and to bring down their cost of capital. Therefore, a positive relationship between the firm’s beta and probability of going public is anticipated. To the best of the authors’ knowledge, this is the first ever study to gauge the influence of firm’s beta on its going public decision. SG (Growth in sales) is included in the model to examine whether firms go public to raise the capital required for their planned growth and expansion. Firms experiencing higher sales growth require more capital than firms experiencing lower sales growth. Therefore, a positive relationship between SG and probability of going public is anticipated. PBDIT (PBDIT/Total assets) is included in the model as review of literature indicates that more profitable firms tend to face lower information asymmetry and adverse selection costs than the less profitable firms. Therefore, a positive relationship between PBDIT and probability of going public is anticipated. Disc (Corporate current taxes to Sales ratio) is included in the model as a measure of the firm’s level of transparency. Firms with higher ‘Disc’ are more transparent than firms with lower ‘Disc’. The review of literature indicates that firms which are already more transparent should experience lesser loss of confidentiality than those which 6 Firm with high proportion of intangible assets have less assets available as collateral and therefore finds difficulty in raising capital through banks. IPOs appear to be the only feasible option for such firms (Brealey & Myers, 2000). 74 are relatively less transparent. Therefore, a positive relationship between ‘Disc’ and probability of going public is anticipated. Leverage (Debt to Equity ratio) is included in the model to measure financial leverage of the firms. The literature review indicates that firms do IPO to rebalance their capital structure. Therefore, a positive relationship between Leverage and probability of going public is anticipated. M/B (Industry market to Book ratio) is included in the model to access whether firms take advantage of windows of opportunity or not. The literature review indicates that firms belonging to overvalued industry are more likely to go public. Therefore, a positive relationship between M/B and probability of going public is expected. Retail is included in the model as the review of literature indicates that firms belonging to the retail sectors tend to drive more benefits from the higher publicity arising from the public listing. Therefore, it is anticipated that firms belonging to retail trade sector are more likely to go public. Hence we have also included a dummy variable Retail in the model, which takes the value 1 if a firm belongs to the retail trade sector. Post-IPO Analysis In addition to the methodology discussed in the previous section, the likely consequences of IPO decision on variables like promoter’s ownership, leverage, capital expenditure and investments and cost of credit are examined by analysing the post-IPO changes in these variables. The rationale behind analysing post-IPO consequences was to see what actually had happened after IPO and was it related to the factors that can motivate a company to do IPO. The possible motivations are already discussed in the theoretical framework section. The post-IPO consequences of Indian firms are analysed by comparing the post-IPO values of variables with pre-IPO values using a three-step procedure (Table 8). First, the firm-wise percentage changes in the variables for the following three time windows are calculated: (i) one year before IPO (Y-1) to IPO year (Y+0), (ii) one year before IPO (Y-1) to one year after IPO (Y+1), and (iii) one year before IPO (Y-1) to two years after IPO (Y+2). It is to be noted that the percentage changes in variables are calculated separately for every firm in our sample. Second, the median values of the firmwise percentage changes in the variables are separately calculated and reported for each of the three time win- DETERMINANTS OF GOING-PUBLIC DECISION IN AN EMERGING MARKET... dows considered above. Finally, the ‘Wilcoxon two sample signed-rank test’ is used to assess whether the median value of the variable in post-IPO period is significantly different from its value in the pre-IPO period. Following variables are used for the post-IPO analysis. Promoter’s ownership is used to examine whether risk diversification was the motivation to do IPO or not. The review of literature indicates that promoters do IPO to dilute their stake in their company. Therefore, a significant decrease in promoter’s ownership is anticipated in post-IPO period. LEVERAGE (Debt to Equity ratio) is used to examine whether companies do IPO to rebalance their debt-equity structure in post-IPO period or not? Therefore, a significant decrease in LEVERAGE is anticipated in post-IPO period. Capital expenditure and investments are examined in postIPO period as the literature review indicates that higher capital expenditure and investments signifies (a) the requirement of capital for growth and expansion; and (b) that firm went public to raise capital from dispersed shareholders to reduce the excessive over-monitoring by large shareholders. Therefore, a significant increase in both, capital expenditure and investments, is anticipated in the post-IPO period. Cost of credit is used to measure the cost of credit of the firms. The literature review indicates that IPOs help firms in bargaining for a lower cost of credit from the banks. Therefore, a significant decrease in ‘Cost of credit’ is anticipated in the post-IPO period. Beta (accounting beta) is used to examine the cost of capital of firms in the post-IPO period. The literature review indicates that firms go public to reduce their cost of capital. Therefore, a significant decrease in ‘Beta’ is anticipated in the post-IPO period. Data Sources and Sample The pre-IPO determining factors were analysed by applying probit regression model where the data for both private and public firms were required. For public firms, the sample was derived from 521 public firms that went public between 1997 and 2007. For private firms, the sample was derived from a total of 18,000 unlisted firms whose information was recorded in CMIE Prowess. The sample for private firms included only those unlisted firms VIKALPA • VOLUME 38 • NO 1 • JANUARY - MARCH 2013 which were eligible7 to do IPO in the experiment year. The study did not include pre-1997 IPOs because of two main reasons: (1) Many researchers have documented the instances of “fly-by-night” entrepreneurs who eroded investor wealth during 1992-1996; (2) During this period, the Securities and Exchange Board of India (SEBI) introduced more stringent regulations8 While collecting the data, it was found that for some firms, the values were missing for some of the variables. These firms were dropped from the sample. For some firms, the values were not available for all the time windows. These firms were also dropped from the sample. The methodology required data from one year before IPO to two years after the IPO. Therefore, firms that went public after 2007 were also dropped from the sample as for them the data for the next two years would not be available. The final sample of this study consisted of 306 public firms. The sample selection process eliminated 215 public firms that went public between 1997 and 2006. The sample for probit analysis can be categorized into two groups: (a) IPOs sample; and (b) Private sample. IPOs sample included all IPOs completed between 1997 and 2007, and the sample for private firms included all those firms that were eligible to do an IPO but remained private during the experiment years. RESULTS AND DISCUSSION Summary Statistics The annual trend in the number of IPOs and capital raised by Indian firms through IPOs are shown in Table 1. The spurt in the IPO activity between 1991 and 1996 is attributable to the structural changes in the political economy of India, primarily through the economic liberalization initiatives of the Indian Government from 1991 onwards. The later part of period between 1991 and 1996, however, witnessed several instances of fake IPOs and fly-by-night entrepreneurs, which eroded the investors’ wealth and 7 The firms in private sample were selected on the basis of general eligibility criteria to do an IPO like net tangible assets of at least ` 5 crore in each of the preceding three years, distributable profit for the last three years and net worth of at least ` 1 crore in each of the preceding three years. 8 During this period, SEBI enforced restrictions on promoters, such as the lock-in period for their holdings. In 1995, SEBI appointed Malegam Committee to recommend appropriate regulations for closer scrutiny of proposed offerings. See Marisetty and Subhrahmanyam (2008), Shah & Thomas (2001) and Rao (2002) for more details. 75 confidence into the Indian capital market in the following period. In particular, the retail investors distanced themselves from the Indian IPO market. During 1996-97, SEBI, the Indian securities market regulator, introduced fresh regulations related to the IPO pricing and enforced other restrictions on the promoters and the management board of the companies that compelled them to be more responsible towards the shareholder wealth. This restricted the number of companies tapping the IPO market and created a slump in the Indian IPO market (Aggarwal, 2000; Marisetty & Subrahmanyam, 2008). It can be seen from Table 1 that between 1996 and 1999, the number of IPOs and amount raised through these IPOs declined drastically. This lean period was followed by peaking up of the dot-com boom during 1999-20019. The excessive optimism about the dot-com companies encouraged several of them to raise money through their IPOs during 200001. It can be seen from the Table that the number of companies going for IPOs increased to 124 during 2000. The peaking up of the dot-com boom was followed up by the dot-com burst during 2001-02 wherein all major stock markets suffered huge losses10. This drastically reduced the number of IPOs by the Indian companies between 2001 and 2002. The increased interest of international investors in the emerging markets from 2003 onwards gradually revived the IPO activity and there was a huge surge in amount of funds being raised through their IPOs by the Indian companies till 2007. than private firms. The average sales grew by 41.80 percent for IPO firms in the last three years before the IPO. The average profitability, measured as operating return on total assets, was the same for both the samples. The level of disclosure was measured by the ratio of Tax to Sales. Statistics show that private sample firms were paying more tax than the IPO sample firms, as the average tax was found to be more for private sample. The operating risk measured as the ratio of intangible assets and total assets was three times more for IPO firms. While the average operating risk was 0.01 for private sample, the average operating risk was 0.03 for the IPO sample. The debt-equity ratio was less for IPO firms. While the debtequity ratio was 0.86 for the IPO sample, it was 1.55 for private sample. The cost of credit was found to be higher for the private sample. The industry market-to-book ratio was more for the IPO sample indicating that the IPO sample consisted of firms belonging to the overvalued industry. The average beta of 1.17 for the IPO sample firms was higher than the average beta of -0.01 for the private sample firms. The negative figure of average beta for the private sample firms meant that many private firms in our sample had negative beta. A negative beta indicates that the accounting returns of any such firm moves in the opposite direction to the returns on the market. This appeared counter-intuitive and authors do not have any particular explanation for the same. Probit Analysis The sample of the study was classified into 27 sectors. Maximum number of IPOs – 70 – was from the computer software sector followed by 28 IPOs from the banking services sector, 17 IPOs from drugs and pharmaceuticals sector, 9 from infrastructural construction, and 8 from readymade garments. The summary statistics (see Table 6) shows that the average size of a company in an IPO sample is almost four times bigger than the private sample. While the average size for the private sample was 1,247.17 crores, the average size for the IPO sample was 4,945.54 crores. Statistics shows that the average age at which companies do IPO is around 17 years which is lower than the average age of private sample which is around 29 years. It was found that the percentage growth in sales was more for IPO firms 9 The BSE Sensex, the most popular stock index in India, touched its highest value (till that point of time) of 6, 151 on February 14, 2000. 10 The BSE Sensex touched a low of 2, 595 on September 21, 2001. 76 The results of maximum likelihood estimate of probit model are presented in Table 7. Model 1 is a simple probit estimation of probability of going public. Model 2 controls for inter-industry effect using random industry effects. Model 3 controls for year effect using random year effects. The results in Table 7 indicate that ‘Size’ and probability of going public is positively related. A standard deviation increase in size increases the probability of going public by more than three times of sample average probability of going public. This result is consistent with our hypotheses related to variable ‘Size’. ‘Age’ is found to be negatively related to the probability of going public. A standard deviation increase in Age reduces the probability of going public by more than two times of sample average probability. A negative relationship between Age and probability of going public is as per our hypothesis. DETERMINANTS OF GOING-PUBLIC DECISION IN AN EMERGING MARKET... The positive relationship between IA and probability of going public indicates that risky companies are more likely to go public. An increase of one standard deviation in IA corresponds to three times increase in the sample average probability. However, insignificant relationship between IA and probability of going public for the yearcontrolled model indicates that the positive relationship between IA and probability of going public is year-specific. A positive and significant relationship between ‘Beta’ and probability of going public confirms our hypothesis that riskier firms are more likely to go public. A positive and significant relationship between SG and probability of going public confirms our hypothesis that firms do IPO to raise the capital required for their planned growth and expansion. One standard deviation increase in SG increases the probability of going public by around four times of sample average probability of going public. Positive relationship between PBDIT and probability of going public shows that firms with high profitability are more likely to go public. The result confirms our hypothesis that Indian firms reduced adverse selection cost by signaling their financial position through high profitability. An increase in one standard deviation corresponds to three times increase in sample average probability. However, insignificant relationship between PBDIT and probability of going public for the industry-controlled model indicates that the positive relationship between PBDIT and probability of going public is industry-specific. A significant positive relationship was found between Disc and probability of going public indicating that firms with high level of disclosure/transparency are more likely to go public and firms with low level of disclosure/transparency are less likely to go public. However, the likelihood depends on the industry because there is no significant relationship for the industry-controlled model. A positive and significant relationship between Retail and probability of going public indicates that firms belonging to the retail trade sector are more likely to go public. The relationship is significant even when the year effect is controlled in Model 3. LEVERAGE and M/B were found to have insignificant influence on firms’ going-public decision. We expected highly levered firms to be more likely to go public but a VIKALPA • VOLUME 38 • NO 1 • JANUARY - MARCH 2013 negative and insignificant value in Table 7 shows that Indian firms may not have gone public to reduce the pressure of debt. The insignificant relationship between leverage and probability of going public is similar to Pagano et. al. (1998), Helwege and Packer (2003), and Kim and Sung (2005). Unlike Pagano et. al. (1998), industry market-to-book value does not appear to have a significant effect on probability of going public. Our result supports the view given by Pastor and Veronesi (2003) that it is the change in valuations, measured by recent returns, which should determine the factor for IPO decision rather than valuation levels of the industry, measured by industry market-tobook ratio. Therefore, it is expected that firms are more likely to go public after recent improvements in market conditions regardless of the level of valuations in the current market. Post-IPO Analysis Table 8 shows results of the three-step procedure (already explained in the methodology section) followed to calculate the median changes (percentage) in the firm-specific variables of Indian firms around their IPOs for each of the following three time windows: (i) one year before IPO (Y1) to IPO year (Y+0), (ii) one year before IPO (Y-1) to one year after IPO (Y+1), and (iii) one year before IPO (Y-1) to two years after IPO (Y+2). The promoter’s ownership of IPO firms decreased by: (a) 0.01 percent at the time of IPO; (b) 3.14 percent in one year after IPO; and (c) 4.24 percent in two years after IPO (all significant at 0.01 level). The decrease in promoter’s ownership indicates that insiders offload their shares at the time of IPO and during the following two years to diversify their risk. The debt-equity ratio of IPO firms decreased by: (a) 19.35 percent at the time of IPO; (b) 51 percent in one year after IPO; and (c) 36.40 percent in two years after IPO (all significant at 0.01 level). The drastic reduction in debt-toequity ratio indicates that firms do their IPOs to rebalance their capital structure. The level of capital expenditure increased by: (a) 58 percent at the time of IPO; (b) 139 percent in one year after IPO; and (c) 138 percent in two years after IPO (all significant at 0.01 level. The level of investment increased by: (a) 18 percent at the time of IPO; (b) 285 percent in one year 77 after IPO; and (c) 347 percent in two years after IPO (all significant at 0.01 level). The significant increase in capital expenditure and investments indicates that firms do their IPOs to: (a) finance their future investment and growth; and (b) reduce the excessive over monitoring by the large shareholders. The cost of credit decreased by: (a) 9.76 percent at the time of IPO (significant at 0.1 level); (b) 31 percent in one year after IPO (significant at 0.1 level); and (c) 65 percent in two years after IPO (significant at 0.01 level). The significant decrease in cost of credit shows that IPOs enabled firms to bargain for lower cost of credit. Using Beta to assess the impact of IPO on the cost of capital provides similar results. Beta decreased by: (a) 0.62 percent at the time of IPO; (b) 6.55 percent in one year after IPO; and (c) 12.61 percent in two years after IPO. Wilcoxon test, however, is significant for only the last time window. CONCLUSIONS The study provides an analysis of the factors determining going-public decision of Indian firms. The determinants were investigated by examining both ex-ante characteristics of the IPO firms and ex-post IPO consequences of the IPOs. Two independent analyses were carried out. First, a panel probit regression specification is estimated to identify the ex-ante characteristics of goingpublic Indian firms that differentiate them from those Indian firms that continue to remain private even though they fulfill the eligibility criteria of going public. Second, ex-post consequences of IPOs for firms are examined by comparing pre-IPO characteristics of IPO firms with their post-IPO characteristics. The probit analysis reveals that going–public Indian firms tend to be younger, riskier, transparent, more profitable, experiencing higher sales growth and large-sized than firms that decide to remain private. Also, if a firm belongs to the retail trade sector, it increases its probability to go public. The ex-post analysis reveals that firms go public to: finance their growth and investments, diversify owners’ risk, rebalance their capital structure, and bring down their borrowing rates. Put together, the revelations of the above two indepen- 78 dent analysis implies that Indian firms go public to: (a) raise capital for their growth and expansion; (b) diversify the risk of initial owners and capital structure rebalancing; (c) bring down their cost of capital; (d) increase the liquidity of their shares; (e) avoid excessive monitoring of large/block shareholders; and (f) seek publicity. These Indian firms face following costs/deterrents in becoming public: (a) Information asymmetry and adverse selection costs; (b) Experience loss of confidentiality; and (c) Bear initial and subsequent expenses. Overall, this study provides useful insights for corporate managers, investors, market intermediaries, stock exchange authorities, as well as for academic and business researchers. An understanding of the motivation and costs associated with the going-public decision of Indian firms can enable the corporate managers of private Indian firms to take an informed decision whether to become public or remain private. An insight into the characteristics of IPO firms can facilitate investors to take informed investment decision— whether or not to invest in IPO firms, and whether to have a short or a long investment horizon. The market intermediaries and stock exchanges can make use of the findings of this study to educate the eligible Indian private firms regarding the pros and cons of going public. The results of this study may also be applicable to the firms from the other emerging economies, since in many ways, India resembles economies like Brazil, Russia, Malaysia, etc. However, the findings may be subjected to several limitations. Though the study used proxy for the need of financing and growth and cost of credit, the accurate proxy for such factor is debatable. In future, the analysis can be done by using other variables. The time windows analysed in the study is a matter of debate. One can argue that two years may be a short period to judge the effect of IPO on firm-specific variables. We expect the availability of the information not to be a restricting factor to decide for time windows for future studies. In fact, in contrast to other studies on a similar issue, where the time windows were mainly from one year before IPO to three years after IPO, the variables can be compared for as long as two years before IPO to ten years after IPO. The scope of the study could be increased further by adding those factors which are post-IPO and can motivate a company to do an IPO like the merger and acquisition activities, cash out of venture capitalists, etc., which can only be captured through a survey. DETERMINANTS OF GOING-PUBLIC DECISION IN AN EMERGING MARKET... APPENDIX Table 1: Number of IPOs and Amount raised by Indian Companies from 1989 to 2008 Year 1989-90 Amount (in crores of `) 2,793 No. of Issues 187 1990-91 141 1,704 1991-92 196 1,898 1992-93 528 6,252 1993-94 770 13,443 1994-95 1,343 13,312 1995-96 1,428 11,822 1996-97 753 11,687 1997-98 62 3,061 1998-99 32 7,911 1999-00 65 7,673 2000-01 124 6,618 2001-02 19 6,423 2002-03 14 5,732 2003-04 35 22,145 2004-05 34 25,526 2005-06 102 23,676 2006-07 85 24,993 2007-08 91 53,219 2008-09 22 3534 Source: Prime Database Note: The Table presents the IPO activities in India from 1989 to 2008. The sample in the present study is taken from this total population of IPOs. The table shows the annual number of public issues and amount raised by Indian companies in the given time period. Table 2: Summary of Results of Similar Studies Research Study Pagano, Panetta & Zingales (1998) Boehmer & Ljungqvist (2004)a Albornoz & Pope (2004) Chemannur, Chorruk & He & Worthington Nandy (2010) (2005)b Sample firms (IPOs/ Private) 69/12391 330 IPO firms 830/9968 1315/2578 Country Country Category 110/5118 Chun, Lynch & Smith (2002) Overall 304/1722 Italy Germany UK US Thailand Korea Developed Developed Developed Developed Developing Developing Multiv. (Probit) Multiv. (Probit) Multiv. (Probit) +* +* +* +* –* +* – Ex-ante results Statistical Technique Multiv. (Probit) Multiv. (Cox) Multiv. (Logistic) Explanatory variables Size +* Age Profitability +* + +* +* Asset Risk M+/– –* +* Cost of Credit + Leverage – Bank Rate – Market-Book Ratio +* Growth –* A+ M+/– A+ N –* –* –* – +* +* + VIKALPA • VOLUME 38 • NO 1 • JANUARY - MARCH 2013 +* – + M– – M– + M+ +* M+ 79 Table 2 (contd.) Research Study Pagano, Panetta & Zingales (1998) Capital Expenditure Boehmer & Ljungqvist (2004)a Albornoz & Pope (2004) + Chemannur, Chorruk & He & Worthington Nandy (2010) (2005)b + +* Investments Overall M+ – Index Volatility Chun, Lynch & Smith (2002) –* M– +* A+ + N Publicity/Coverage +* Total Factor Productivity +* A+ Ex-Post results Statistical Analysis Univariate Sales + – + A +/– Profitability – Capital Expenditure – – – Leverage – – – A– Investments 0 0 – N Payout 0 TAX 0 Growth 0 Interest Rate – Ownership – + A +/– A +/– N N + – + – M +/– + – A +/– A– Size – Covergae A– – Total Factor Productivity – A– A– Notes: * Significance at 1-10%, + Positive relationship, – Negative relationship, 0 - No relationship A Always significant, M Mixed results, N Always not significant a Boehmer & Ljungqvista also used product market charateristics b Chemannur, He & Nandy also included industry-specific and macro-economic factors Note: This Table summarizes the results of studies which have adopted similar approach that we have followed (for discussion on studies on different approaches, see literature review section). Ex-ante determinants are discussed first, followed by Ex-post determinants. For Ex-post determinants, only those studies are considered that focused on post IPO determinants (a few studies adopted similar approach to examine the impact of IPO on performance and other variables; see Mayur and Kumar (2009) for summary of such studies). Other characteristics of studies like sample size, year, study area, country category, and statistical technique used are also presented in the table. Table 3: A Summary of Theoretical Framework for Going-Public Decisions Theories Research Studies A. Benefit-related Theories 1. Raising capital for growth and expansion Loughran et al, 1994; Pagano et al, 1998; Subrahmanyam &Titman, 1999 and Huyghebaert & Hulle, 2005. 2. Risk diversification Pagano, 1993; Zingales, 1995; Stoughton & Zechner, 1998; Chemmanur & Fulghieri, 1999; Mello & Parsons, 1998; Black & Gilson, 1998. 3. Capital structure rebalancing Pagano et al. (1998) 4. Lowering of cost of capital Scott, 1976; Modigliani & Miller, 1963, Diamond, 1991; Holmstrom & Tirole, 1993; Booth & Chua, 1996; Maug, 1998. 5. Liquidity Booth & Chua, 1996; Bolton & Thadden, 1998; Pagano et al, 1998.. 6. Monitoring Pagano & Roell,1998 7. Windows of opportunity Myers & Majluf, 1984; Dharan & Ikenberry, 1995; Ritter,1991. 8. Getting publicity Subrahmanyam & Titman, 1999; Stoughton, Wong & Zechner, 2001. 9. Currency for Mergers and Acquisitions Zingales (1995) 80 DETERMINANTS OF GOING-PUBLIC DECISION IN AN EMERGING MARKET... Table 3 (contd.) Theories Research Studies 1. Information asymmetry and adverse selection costs Akerlof, 1970; Leland & Pyle, 1977; Rock (1986); Welch (1989); Chemmanur & Fulghieri (1999) 2. Loss of confidentiality and higher taxes Campbell, 1979; Tinic, 1988; Yosha, 1995; Maksimovic & Pichler, 2001 B. Cost-related Theories 3. Initial and subsequent expenses Bhattacharya & Ritter, 1983; Ritter, 1987 4. Increased possibility of litigations Tinic, 1988 Table 4: Definitions of Firm-specific Financial Variables used in this Study Variables Definition and calculation Size Size is measured by value of total assets. Total assets include value of fixed assets, investments, and current assets. Age Age of companies at time ‘i’ from date of their incorporation. IA Ratio of intangible assets to total assets. Beta* Accounting beta was calculated by regressing historical accounting earnings for each IPO against the accounting earnings for the market. The model used is as follows: Rit =α+βiRmt + ui. The coefficient of the above regression, βi is the accounting beta for the ith IPO. Rit is the accounting return of the firm under observation, whereas Rmt is the accounting return of market. BSE Sensex firms are included as market. Accounting return is proxied by ratio of profit before depreciation, interest and tax (PBDIT) and total assets. SG Average of growth in sales in last three years. PBDIT Ratio of Profit before depreciation, interest and tax (PBDIT) and Total assets. Disc Disclosure is measured by ratio of corporate tax and total sales of a company. Corporate tax includes portion of corporate income tax provided by the enterprise during a particular accounting period. Sales is income generated from main business activities like sale of goods and services, fiscal benefits, trading income. It also includes internal transfers. LEVERAGE Debt-Equity ratio is used as a measure of financial leverage of a company. This ratio is calculated by dividing total borrowings of a firm by net worth. M/B The median market-to-book ratio of the industry that a firm belongs to. Retail Dummy variable which takes value 1 if a firm belongs to retail, telecom or utility industry; otherwise, its value is 0. Promoter’s ownership A promoter is a person(s) who is in control of the company, or a relative of the promoter. Promoter’s ownership is calculated as shares held by promoters (in percentage) including foreign promoters and persons acting in concert as a percent of the total outstanding shares of the firm. Capital expenditure Lagged value of capital employed over total assets. Investments Investments in shares/debentures of companies, PSU bonds, mutual fund schemes of UTI and other mutual funds, etc. It includes both quoted investments as well as unquoted investments. Cost of credit is measured as ratio of firm’s annual interest expense and total borrowings from bank. CoC *Note: Since it was not possible to calculate market beta for private firms, accounting beta was taken as a proxy of the market beta. Accounting beta was computed in a way that is similar to the computation of market beta. Historical earnings for each company were regressed against the accounting earnings for the market. VIKALPA • VOLUME 38 • NO 1 • JANUARY - MARCH 2013 81 Table 5: Summary of Research Hypotheses Benefits Raising capital for growth & expansion Risk diversification Ex-ante Hypotheses Ex-post Hypotheses Statement Relationship Statement Relationship Firms which go public experience higher sales growth than firms which remain private. (SG)pub> (SG)pri Firms tend to do higher capital expenditure and investments after becoming public (Capexp)preIPO < (Capexp)postIPO Firms which go public have higher financial leverage than firms which remain private. (Leverage)pub > (Leverage)pri Firms which go public face more risk than firms which decide to remain private. (Beta)pub > (Beta)pri (Invest)preIPO < (Age)pub < (Age)pri (Invest)postIPO The level of promoter’s ownership in firms should significantly come down after they become public (Promoter’s ownership)preIPO > (Promoter’s ownership)postIPO (IA)pub > (IA)pri Capital structure rebalancing Firms which go public tend to have higher financial leverage than the firms which decide to remain private. (Leverage)pub > (Leverage)pri Debt Equity ratio should significantly come down after firms become public (Leverage)pre IPO>(Leverage)postIPO Lowering of cost of capital Firms which go public have higher cost of capital than firms which decide to remain private. (Beta)pub > (Beta)pri Firms face lower cost of capital after becoming public (Beta)preIPO > (Beta)postIPO Firms which go public are likely to be larger than firms which decide to remain private. (Size)pub > (Size)pri Liquidity (CoC)preIPO > (CoC)postIPO Monitoring Firms tend to do higher capital expenditure and investments after becoming public (Capexp)preIPO < (Capexp)postIPO (Invest)preIPO < (Invest)postIPO Windows of opportunity Firms are likely to do their IPOs when their industry peers are overvalued. (M/B)pub > (M/B)pri Getting publicity Firms belonging to retail trade sectors should have higher propensity to become public β(Retail) > 0 82 DETERMINANTS OF GOING-PUBLIC DECISION IN AN EMERGING MARKET... Table 6: Summary Statistics Variable Mean Std. Dev. Min Max Obs 112,220.90 149.00 0.83 3.27 793.84 0.90 1.00 1.00 121.05 102.35 4,059.00 4,059.00 4,059.00 3,845.00 4,059.00 4,059.00 3,947.00 3,226.00 4,059.00 3,216.00 252,058.7 140.00 0.79 790.52 267.94 0.88 0.60 0.47 109.47 25.08 310 310 310 263 310 310 310 310 310 247 Sample Eligible to Go Public Size Age IA Beta SG PBDIT Disc CoC LEVERAGE M/B 1,247.17 28.59 0.01 -0.01 21.98 0.14 0.04 0.09 1.55 1.93 4,608.17 23.34 0.04 0.13 62.90 0.09 0.14 0.22 4.64 5.38 20.48 3.00 0.00 -5.57 -100.00 0.00 0.00 0.00 0.00 -42.27 The IPO Sample Size Age IA Beta SG PBDIT Disc CoC LEVERAGE M/B 4,945.54 17.44 0.03 1.17 41.80 0.14 0.02 0.33 0.86 4.122 20,956.4 21.25 0.10 16.11 85.31 0.11 0.05 0.05 10.40 3.93 0.23 3.00 0.00 -0.11 -225.00 0.00 0.00 0.00 0.00 0.52 Note: This Table provides the summary statistics of private and public samples. Private sample consists of companies that were eligible to do IPO but remained private throughout the study period. IPO sample contains total companies that went public during study period (1997–2006). Definitions of variables are discussed in Table 4. Size is expressed in crores, age is expressed in years and growth in sales is expressed in percentage. The remaining variables are expressed in ratios. The summary statistics describe the mean, standard deviation, minimum, maximum and number of observation of the variables. Table 7: Probit Model: Determinants of Going Public Decision Variable Model 1 Model 2 Model 3 Size 0.0001*** (0.0000) 0.0001*** (0.0000) 0.0001*** (0.0000) Age -0.0113*** (0.0105) -0.0279* (0.0043) -0.0087* (0.0071) IA 1.4848** (0.75019) 1.6488** (0.8700) 0.7095 (1.6785) Beta 0.0001* (0.0000) 0. 0001* (0.0000) 0.0001* (0.0000) SG 0.0283*** (0.00548) 0.0030* (0.0006) 0.0004*** (0.0001) PBDIT 0.5801* (0.5281) 0.5136 (0.6868) 2.5030* (1.7087) Disc 0.0009* (0.0016) 0.0015 (0.0043) 0.0002* (0.0040) LEVERAGE -0.0259 (0.0713) -0.0308 (0.0307) -0.0155 (0.06294) M/B 0.0001 (0.0040) 0.0002 (0.0014) 0.0003 (0.0038) VIKALPA • VOLUME 38 • NO 1 • JANUARY - MARCH 2013 83 Table 7 (cont.) Variable Model 1 Retail 0.6969** (0.3741) Constant -2.9866*** (0.4369) Obs Log likelihood χ2 Model 2 Model 3 0.5834** (0.3885) -1.0056*** (0.2093) -3.4623*** (0.6439) 1712 1712 1712 -32.2580 39.51*** -269.5918 39.15*** -32.2580 39.51*** The sign ***, ** and * indicate significant at 1%, 5% and 10% respectively. Note: This Table presents the results of maximum likelihood estimate of probit model used to investigate the determinants of going-public decision of firms in the period 1999 to 2006. Model 1 is a simple probit estimation of probability of going public. Model 2 controls for inter-industry effect and Model 3 controls for year effect. In order to control for industry effect and year effect, one way random effect model was used where the differences in industry group and year group was assumed to be because of random effect. The nomenclature of dependent variable is ‘IPO’, a dummy variable, which equals 1 if the company is publicly held and 0 if the company is a private in a particular year. The explanatory variables are: the size, age, sales growth, profitability, level of disclosures, asset risk, leverage, industry market to book value and market risk of the included companies. Detailed definitions of all variables are given in Table 4. The number represents the coefficient in the probit regression model. Standard errors are reported in the parentheses. Number of observations, log likelihood and χ2 for the model are also reported in the Table. Table 8: Analysis of Post IPO Factors Variables Median Change (%) from IPO-1 to IPO Median Change (%) from IPO-1 to IPO+1 Median Change (%) from IPO-1 to IPO+2 Promoter’s ownership -0.01*** (-5.822) -3.14*** (-7.378) -4.24*** (-8.092) Debt to equity -19.35*** (-4.543) -51.95*** (-7.992) -36.40*** (-4.473) Capital expenditure 57.993*** (-4.72) 138.844*** (-5.81) 138.191*** (-5.92) Investments 17.70*** (-7.40) 284.75*** ( -10.62) 346.47*** ( -11.58) Cost of credit -9.76* (-0.68) -31.34* (-1.21) -65.19*** (-3.28) Beta -0.62 (-.55) -6.55 (-.13) -12.61*** (-2.87) The sign ***, ** and * indicate significant at 1%, 5% and 10% respectively. Note: The above Table presents the median changes (percentage) in variables of Indian firms around their IPOs. 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He has published research papers in journals of national and international repute like, Journal of Financial Services Marketing, Vikalpa, Management Review, Journal of Modern Accounting and Auditing, Bombay Stock Exchange Review, Indian Management, and ICFAI Journal of Applied Finance. He has contributed research papers in several edited volumes. He has also presented papers and chaired sessions at several international and national level professional conferences. His area of specialization is Accounting and Finance. e-mail: [email protected]. 86 DETERMINANTS OF GOING-PUBLIC DECISION IN AN EMERGING MARKET...