Evaluation of the Factors Affecting Initial Public Offering Underpricing by Newly-Accepted Companies Into Tehran Stock Exchange

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Evaluation of the Factors Affecting Initial Public offering Underpricing by Newly-accepted Companies into Tehran Stock Exchange

Mashaallah Randideh

Department of Accounting, Kermanshah Branch, Islamic Azad University, Kermanshah, Iran.

Corresponding Author: Mashaallah Randideh

ABSTRACT: Previous studies have reported three unusual features for initial public offering: underpricing (short-term return), variability of initial offerings from year to year, and negative long- term performance. The aim of the resent study was to examine the factors influencing the underpricing by newly-accepted companies into Tehran stock exchange. New resources are provided for the development of the company on arrival at the stock exchange, that’s why companies like to be traded in stock exchange. In this study, the relationship between the independent variables (age of company, type of industry, and type of ownership) and underpricing were analyzed to evaluate the factors affecting the underpricing of new shares. The statistical society included newly- accepted companies into Tehran stock exchange from 2004 to 2008. The findings indicated no significant relationship between the variables of the study and underpricing during the study period. This indicates that the activity of Tehran stock exchange is similar to that of other countries. Keywords: initial offering, underpricing, age of company, type of industry, type of ownership

INTRODUCTION

In recent decades, initial public offering has undergone a remarkable growth all over the world. In the late 1990s in the United States, the significant yield of initial public offerings in the technology-based companies at the first day, the formation of internet companies’ bubbles during 1999-2000 and then the bubble’s bursting during 2000-2001 have caused intense fluctuations in initial public offerings. This has attracted the attention of researchers and experimental studies and consequently the theoretical literature has expanded in this field. Using methods and techniques of public offering of stocks is one of the most efficient methods of privatization in most of the countries. Implementing the provisions of the policies of Article 44 of the constitution in transferring the state-owned companies to decrease the government incumbency and to increase optimum supervision on resources, providing the requirements for equity shares and implementing the separation of primary and secondary markets as well as their mechanisms have caused experience be considered important in other capital markets and the process of offering shares be carried out with more accuracy by estimating the possibility of their application in the economical conditions of Iran in terms of content and structure. Initial public offering is a condition in which an enterprise that has not been active in the stock exchange so far, sells its shares to the public. Three similar models of initial public offering that have been observed in the world include: Short-term underpricing of the share Cycles affecting the underpricing of initial shares Poor long-term performance and less than the market performance (Rittre, 1998) These three phenomena have been discussed in the literature. The focus of the present study was on the evaluation of the factors influencing the underpricing in the initial public offering. Hundreds of companies in the world enter the stock exchange daily through initial public offering. They try to provide the required investment to continue and expand their activities. So, it is important for these companies that the determined price for their shares indicate the real value of their properties, development and growth opportunities in the future. This is while the studies conducted on initial offering of shares by many researchers around the world show that the determined price for shares and securities of companies in the initial offering is not favorable and make investors increase their short-term interest to purchase the shares of these companies and gain unusual revenue. Initial public offering means the first selling of a company's shares to the stockholders in the stock exchange. The companies that are offered in the stock exchange for the first time are not newly-established.

Intl. Res. J. Appl. Basic. Sci. Vol., 8 (7), 873-880, 2014

The word “initial” here means the company’s shares are offered to the external stockholders in the stock exchange for the first time. The most important and interesting event about initial public offering is underpricing. Underpricing refers to a condition in which the firm offering the shares determines the initial price of share surprisingly lower than the market price. The amount of underpricing or short-term revenue is obtained from the difference between the closing price in the first day of exchange and price of the shares divided by the stock price. Thus, as investors get the shares with lower prices in the initial public offering and sell them with higher prices in the first day of initial offering, they can gain a large benefit. This process is known as underpricing in the initial public offering market. Initial offering in Iran during the recent years has had a remarkable growth so that the number of initial offerings in 2003 and 2004 were 48 and 39, respectively. This was virtually equal to all initial offerings from 1997 to 2994 (89 initial offerings). Enactment of securities act in 2005 by the parliament and enactment of the instructions of registration and public offering of securities in 2006 by the supreme council of stock exchange indicate coherence and systematization in the initial public offering market. This study made an attempt to investigate the factors affecting underpricing in the initial public offering by the newly accepted companies into Tehran stock exchange. The research questions were formulated as follows: What is the relationship between the age of company and underpricing of the shares? What is the relationship between the type of industry in which there is initial public offering and underpricing? What is the relationship between the type of ownership (public and private) when being accepted into stock exchange and underpricing? The general and specific objectives of this study are presented as follows: Identification of the factors affecting underpricing in the initial public offering by the new companies accepted into Tehran stock exchange in order to direct the stock exchange toward determining the primary price and prospective market according to the market conditions as well as other factors. The theories and hypotheses are analyzed with regard to Tehran stock exchange to predict an appropriate model when trading new shares in order to help investors in Tehran stock exchange. Some of the studies conducted in and out of Iran are presented as follows: In the study carried out by Dr. Abdeh Tabrizi & Demouri (2003) in Tehran stock exchange on the shares of the newly-arrived companies in the market from 1990 to 1995, the factors influencing long-term return were the amount of annual trade of shares, size of the company, and short-term return gained from trading the shares of the newly-arrived companies in the stock exchange. The results of this study indicated that higher short-term return and lower long-term return of the newly-accepted companies into stock exchange were comparable to the market (index) return. Thus, the pricing performance of the newly-accepted companies into Iran’s stock exchange could be considered similar to other capital markets in other countries. In his M.A. thesis titled “the measurement of short-term and long-term returns of initial public pricing” conducted in Ahwaz University of Shahid Chamran, Mehdi Alikhani Bowani (2008) investigated 122 companies in Tehran stock exchange from 1998 to 2006. The findings showed that in Iran like other companies, the unusual short-term return of initial public offerings was positive and equaled 13.78%, but there was no evidence on the negative performance regarding long-term return. Also, only the market return affected the 3-year long- term return of initial public offerings among factors such as market return, age of the company, and short-term return. Ritter & Welch (2003) analyzed the initial public offerings in the United States and investigated why companies present initial public offerings. They suggested various reasons the most important of which are presented below: Access to more funds: while the company has initial public offering and its shares are traded in stock exchange, owing to the requirements of special disclosing of stock exchange, financial institutions and banks give larger loans to companies. Joining the stock exchange will expose the company, which has probably been unknown for some time, to millions of investors. This causes an increase in the company's shares and more precise evaluation of the company. Carrying the name of "public limited company" can bring indirect benefits for the enterprise as well, one of which can be hiring competent managers. Gounopoulos (2003) studied the performance of initial public offerings in Athens' stock exchange. By referring to the studies conducted in the capital markets in the United States, England, Germany, Canada, China, Switzerland and Australia, he considered initial underpricing of the new shares as a general and common phenomenon in the capital market. Many studies have been conducted on the performance of the new shares in the Athens' Stock exchange. That's why the researcher made an attempt to analyze the short-term performance of the new companies in Athens's stock exchange from 1990 to 2001. He presented many hypotheses (16 hypotheses) for his study, some of which are presented below: There is a negative relationship between the size of the company and underpricing.

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There is a negative relationship between the credibility of the new sharebrokers and underpricing. There is a negative relationship between the new shares and underpricing. There is a negative relationship between the market conditions and underpricing. There is a negative relationship between the age of the company and underpricing. There is a negative relationship between the risk of the industry the new shares belong to and underpricing. To carry out his study, Gounopoulos considered the underpricing of the new shares in the percentage of the changes between the price of offering shares and the price of the new shares at the end of the first day and used regression test to determine the relationship between the variables.

THE RESULTS OF HIS STUDY INCLUDE THE FOLLOWING

The analysis of the primary performance of the new companies in the Athens' capital market indicated that the initial offering of the new companies in this market was around 62.52% underpricing which was relatively higher than the findings of previous studies carried out in Athens (new underpricing, 57%, the result of the study by Kazantzis and Thonas, 1996). The results of the multivariate analysis showed that the market condition (boom or bust) is the most influential factor in underpricing. There was no significant relationship regarding other variables. As it was mentioned, the factors influencing underpricing in the initial public offering by the newly-accepted companies into Tehran stock exchange were investigated in this study, so the hypotheses were formulated as follows: Hypothesis 1. There is significant relationship between the age of the company and underpricing. Hypothesis 2. There is significant relationship between the type of the industry holding the new shares and underpricing. Hypothesis 3. There is significant relationship between the type of ownership on arrival at stock exchange and new underpricing.

METHODOLOGY

This study was descriptive correlational and the statistical tests applied were correlation and Chi- square tests. Also, the data were collected in two stages; in the first stage, the theoretical basics of the study were collected using library method and in the second stage, the data from 2003 to 2008 were collected through Tehran stock exchange site. Further, Rahavard Novin software and the site of research center for Islamic studies were used to collect data. SPSS software was used to analyze data and perform statistical tests and part of the analyses was carried out by Excel. The statistical methods used in this study are presented below: The correlation analysis tool was used to determine the type and degree of the relationship between a quantitative variable and another quantitative variable. Correlation coefficient is one of the criteria used to determine the correlation between two variables. Correlation coefficient indicates the degree and type of relationship (direct or reverse). This coefficient is from 1 to -1 and it is zero in case there is no relationship between two variables. Pearson and Spearman Correlation Coefficients: Pearson Correlation Coefficient (r) is calculated via the following formula: (1) n (xi  x)(yi  y) r  i1 n n 2 2 ((xi  x) ((yi  y) ) i1 i1 In this formula and are n paired observations. ( xn , yn) (1 وx1y) This correlation coefficient is a parametric method used for the data with normal distribution or large number of data. If the number of the data is low and the normality assumption is not logical, another correlation coefficient is used which is not based on the main sums and is calculated based on the rank of the data. The correlation coefficient, that is calculated according to the ranks of the data, was proposed by spearman ( r s ) and is calculated through formula 2: 2 6(di ) (2) r  1 s n(n 2 1)

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In this formula, n represents the number of data and 2 indicates the sum of squared differences between (di ) the ranks of two variables. The value r is the similar sample of p, the correlation coefficient of the statistical society. The correlation coefficient of the society is defined in formula 3: Cov(x, y) (3) ) p  Corr(x, y)    y Thus, the sample correlation coefficient r can be considered as the estimator of the correlation coefficient of the society, p. By squaring the correlation coefficient (r), the coefficient of determination ( r 2 ) is obtained. The coefficient of determination indicates what percentage of changes in the dependant variable is explained by the independent variable. This coefficient is widely used in regression. The direction of relationship in correlation is two-sided and the researcher does not know which variable affects another variable. If the researcher knows the direction of the relationship, the regression analysis will be used. If one variable is quantitative and another one is qualitative, the quantitative variable should first be changed into qualitative variable and then the relationship between them be determined by  2 test. The aim of the independence test is analyzing the presence of independence between two non-quantitative variables. Chi-square ( ) test is applied to examine the independence hypothesis of two variables one of which is qualitative and another one is either qualitative or quantitative with limited levels (the quantitative variable changed into qualitative variable).

In general, an r×c table has r rows representing different states of xr ,..., x2 , x1 for a variable and 3 columns indicating different states of yn ,..., y2 , y1 for another variable. The statistical hypotheses are formulated as follows:

H 0 : Two random variables are independent.

H1 : Two random variables are not independent. The independence test is calculated via formula 4: r c 2 (oij eij ) (4)  2   i1 j1 eij

In the above formula, oij is the observed frequency (experimental frequency) and eij is the expected frequency (theoretical frequency) for the point where ith row meets jth column. For every box in the table, the expected frequency eij is determined via formula 5. sumisumj (5) e  ij sumtotal Sum i: total of row i Sum j: total of row j Sum total: total In a table with row r and column c, the degree of freedom is computed according to formula 6: (6) df= (r-1) (c-1) The independence test with tables include critical right-handed areas because small values of confirm the independence claim of the two variables. On the other hand, if observed and expected frequencies are close, is small. Large amounts of are right-handed in the chi-square table and reflect a significant difference between observed and expected frequencies. 2 The null hypothesis is rejected when the numerical value of test statistics is larger than  a,(r1)(c1) . If the analysis of the , multiple test indicates correlation between two variables, the power of this correlation can be computed through the formula 7, in which is calculated according to the formula and n is the total number of observations.  2 (7) c   2  n

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The statistical methods used are different according to the measurement scale. To analyze the relationship between all independent variables and dependant variable, underpricing of new shares, the following statistical methods are used: Independent variable dependant variable statistical methods Age of company underpricing the new shares correlation Type of industry underpricing the new shares independence test Type of ownership underpricing the new shares independence test It should be pointed out that, in order to analyze the independent variable, type of ownership, it is divided into two public and private classes for which independence test is used. Also, to perform statistical methods, the normality of the data should be analyzed by Kolmogrov-Smirnov test.

RESULTS

With regard to the significance of the normality assumption, the results of Kolmogrov-Smirnov test indicated the normality of the primary data. In fact, the following hypotheses were tested:

H 0 : Data are normal.

H1 : Data are not normal. Asymp. significant level (two-sided test) was 289% which was larger than α=0.05 (95% confidence level) and the null hypothesis was confirmed. Thus, the primary data were normally distributed based on Table 1.

Table 1. The results of normality of data obtained via Kolmogrov-Smirnov test Description Value-Result Number of companies tested in the research 83 Normal distribution parameter (Mean) 186.70 Normal distribution parameter (Standard deviation) 132.509 Maximum absolute deviation 0.108 Maximum positive deviation 0.108 Maximum negative deviation -0.091 Z value 0.983 Two-sided test 0.289

The results of the research hypotheses are presented separately as follows:

Testing the first hypothesis The first hypothesis suggested that there is significant relationship between the age of the company and underpricing of the new shares. Since the aim of analyzing the relationship between the variables is quantitative, Pearson and Spearman correlation coefficients were used. The simplest and most efficient method of analysis is scatter plot because this graph shows the general idea about the relationship between two variables. As indicated in Graph 1, the scatter plot of the age of company (independent variable) against underpricing of new shares (dependant variable) did not reveal any specific model.

0.0600000

0.0400000 u.pricing

0.0200000

0.0000000

0 200 400 600 age

Figure1. Scatter plot of the first hypothesis

Further, Pearson and Spearman correlation coefficient tests were used to test the research hypotheses.

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H 0 : There is no significant relationship between the age of the company and underpricing of new shares.

H1 : There is a significant relationship between the age of the company and underpricing of new shares. On the other hand: 0 ρ =: 0 ρ ≠ : Table 2 demonstrates the results of Pearson correlation coefficient, two-sided test and number of the companies. According to the findings presented in this table, as the result of the two-sided test was 0.773 and higher than 0.05, the null hypothesis was confirmed. Therefore, there is no significant relationship between the age of the company and underpricing of new shares.

Table 2. Results of Pearson correlation coefficient for the first hypothesis Variables Explanation Underpricing Age of the Variables company Underpricing Pearson correlation coefficient 1 -0.032 Two-sided test 83 0.773 Number of companies 83 Age of the company Pearson correlation coefficient 1 Number of companies

Testing the second hypothesis The second hypothesis stated there is a significant relationship between the type of company and underpricing of new shares. As argued previously, when testing the relationship between a quantitative and a qualitative variable, independence test can be used. The independence test was used to determine the relationship between the independent variable, type of industry (qualitative variable) and dependant variable, underpricing (quantitative with limited levels). So, the null hypothesis and its counterpart are defined as follows: : There is no significant relationship between the type of company and underpricing of new shares. : There is a significant relationship between the type of company and underpricing of new shares. Table 3 illustrates the value, degree of freedom, two-sided test, and Pearson Chi-square test. As it is indicated, the result of two-sided Pearson Chi-square test was 0.123 (p0.05), which shows the null hypothesis was not rejected. Thus, there was no significant relationship between the type of company and underpricing of new shares.

Table 3. Results of Pearson Chi-square test for the second hypothesis Description Value df Two-sided test Number of companies 83 Invalid data 0 Valid data 83 Pearson Chi-square 82.805 69 0.123

In Graph 2, some descriptive statistics about underpricing and the type of company are illustrated separately, which indicates that the type of company has no effect on underpricing.

6 Count

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 industry.t

Figure 2. Scatter plot of the second hypothesis

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Testing the third hypothesis The third hypothesis stated that there is a significant relationship between the type of ownership on arrival at stock exchange and underpricing of new shares. As previous test, independence test was used to determine the relationship between independent variable, type of ownership (qualitative variable), and dependant variable, underpricing (quantitative variable with limited levels). The null hypothesis and its counterpart were defined as follows:

H 0 : There is no significant relationship between the type of ownership on arrival at stock exchange and underpricing of new shares.

H1 : There is a significant relationship between the type of ownership on arrival at stock exchange and underpricing of new shares. Table 5 demonstrates the value, degree of freedom, two-sided test and Pearson Chi-square statistics. As it is indicated, the result of two-sided Pearson Chi-square test was 0.809 (p0.05), which shows the null hypothesis was not rejected. Thus, there was no significant relationship between the type of ownership on arrival at stock exchange and underpricing of new shares.

Table 5. Results of Pearson Chi-square for the third hypothesis Description Value df Two-sided test Number of companies 83 Invalid data 0 Valid data 83 Pearson Chi-square 0.967 3 0.809

DISCUSSION AND CONCLUSION

The finding obtained from the first hypothesis indicated no significant relationship between the age of the company and underpricing of new shares. In previous studies the age of company had been considered as the recognition benchmark of the firm for investors. Perhaps in the stock exchange, investors do not care for the recognition of the firm and this can not affect their long-term return. On the other hand, it is possible that the age of company is not a good criterion for being known and other criteria may interfere with underpricing. The results of the second and third hypotheses revealed no significant relationship between the type of the company, in which the newly-accepted companies were active, the type of ownership (governmental or non-governmental) on arrival at stock exchange and underpricing as dependant variable. As explained in the literature review, Gounopoulos (2003) investigated the performance of the initial offerings in Athens stock exchange. By referring to the studies conducted in the capital markets of United States, England, Germany, Canada, china, Switzerland and Australia, he considered initial underpricing of new shares a general and common phenomenon. Many studies have been done over the performance of the new shares in Athens stock exchange. That is why the researcher tried to analyze the short-term performance of the new companies in Athens stock exchange by selecting a sample consisting of 225 companies in a time period of 1990-2001. He proposed 16 hypotheses for his study, three of which were about the relationship between the age of company, type of industry, type of ownership of newly-accepted companies into stock exchange and underpricing of new shares. The results of multivariate test indicated that the market conditions (boom or bust) were the most influential factors in underpricing of new shares. Regarding other variables such as age of the company, type of industry and type of ownership, the results of regression did not show significant relationship, which indicate that the results of the present study are similar to those of other countries. As indicated in the previous section, the independent variables (age of the company, type of industry and type of ownership) were used along with the dependant variable, underpricing of new shares. Future studies are recommended to investigate the following domains: The relationship between the size of the company and financial leverage, and underpricing of new shares. Whether underpricing, as a kind of advertising, is more cost-effective than other forms of advertisement. Whether the time delay from listing the company in the exchange board to initial public offering affects underpricing of new shares. Whether initial offering methods (American, auction or fixed price) affects underpricing of new shares. Comparison of underpricing between different types of industry, calculation of underpricing for every industry and using the results.

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Measurement of underpricing in every type of ownership (public, private, governmental, non-governmental and banks) on arrival at stock exchange separately and comparing the results to better analyze underpricing.

REFERENCES

Abdeh Tabrizi H, Damouri D.2003. Identification of the factors affecting the long-term return of the newly-accepted shares into Tehran stock exchange, Economy journals, financial research, 15. Alikhani Bowani M.2008. Measurement of the short-term and long-term returns of initial offerings. MA. thesis of accounting, Ahwaz university of Shahid Chamran, faculty of post-graduate studies. Dastgir M, Alikhani Bowani M. Initial public offering: underpricing and its related assumptions, Stock monthly, 58, p: 30. Gounopoulo D, Both B. 2003. " The initial performance of IPO: evidence from Athens Stock Exchange ", in European Financial management Association conference Helsinki, Finland. Javaherizadeh N.2007. A guide to research proposal preparation. Tehran: Farhang Zaban. Momeni M, faal Ghayoumi A.2007. Statistical analysis of data by SPSS software. Tehran, Ketab e no. Rahimi Boroujerdi A. 2006. Privatization, Tehran, Tehran university publications. Mehranfar M.2008. Basics of Tehran stock exchange. Tehran Chalesh publications. Ritter J, Welch I.2003. A Review of IPO Activity, Pricing and Allocations, Journal of Finance, 57(4): 1795 – 1828. Ritter J.1998. The cost of going public. Journal of Financial Economics 19, 269-281.

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