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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
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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. The changes are analysed
for the following three time windows: (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 year after IPO (Y+2). The test for differences between the two groups is performed
using the Wilcoxon two-sample signed rank test, which assumes that the observations are independent. Z statistics are shown in
parentheses.
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Manas Mayur is a member of the Faculty of Finance at the
Goa Institute of Management, Goa. He obtained his Masters
from the Forest Research Institute, Dehradun and a Ph.D. from
GGSIP University, Delhi. This paper is based on his doctoral
work. Besides publishing papers in the ICFAI Journal of Applied Finance, he has contributed research papers and cases in
several edited volumes. He has also presented papers at several international and national level conferences. His area of
specialization is Accounting and Finance.
e-mail: [email protected]
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public. Review of Economic Studies, 62(3), 425-448.
Manoj Kumar is a member of the Faculty of Finance & Accounting at the Indian Institute of Management, Rohtak. He
has taken a Ph.D in Finance from IIT Bombay. 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].
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DETERMINANTS OF GOING-PUBLIC DECISION IN AN EMERGING MARKET...