Transparency in IPO Mechanism: Retail investors’ participation, IPO pricing and Returns

Abstract

Using data from Indian IPOs issued in a mechanism which is far more transparent than the bookbuilding in the US and in most other markets, the paper examines retail investors’ participation, their influence on IPO pricing and the returns they make on IPO investment. The transparency in the mechanism, which allows investors to observe prior investors’ demand, leads to demand which is concentrated at either one or two points of the offer price range. Examination of the evolution of investors’ demand over time shows that the participation of retail investors is significantly influenced by the extent of institutional investors’ participation. Our analysis of IPO pricing shows that favourable demand by retail investors is positively associated with a high IPO price even after controlling for demand by institutional investors. Further, we find that due to aggressive bidding by overconfident investors, retail investors are, on average, unlikely to make positive allocation weighted initial returns even in a setting where they do not have to compete with institutional investors. Retail investors, however, can earn significant positive allocation weighted initial returns if they limit their participation in IPOs with above average institutional investors’ demand.

Keywords: IPOs, Indian IPOs, Regulation, Emerging Markets, Auction, Bookbuilding, Demand Curves, Information Production, Pricing, Underwriter reputation, Investor Welfare