Theories of IPO Costs and Grading

Though the books on IPO costing is loaded in number, the degree of books related to grading of IPOs is very limited.

Winner's Curse Hypothesis: Rock's (1986) asymmetric information theory (also known as success curse hypothesis) is most high-ranking model that is developed to clarify the inconsistencies in the newly given IPOs. Rock's model is dependant on two key assumptions: two kinds of investors, those people who have the data about the true value of the firm and the ones who are completely unaware about the real value of the organization. Informed shareholders are cognizant into the future prospects and can only try to buy when the issue is under-priced whereas uninformed traders don't have any idea about under-pricing and over prices of issues, and therefore don't differentiate between issues. Uninformed shareholders due to insufficient knowledge usually get negative Primary Results. They get all the stocks they want of the indegent issues plus they get small percentage of good issues. For this reason adverse selection problem, the uninformed investors will exit the market unless IPOs are sufficiently under-priced on average to compensate them because of their informational handicap.

Information Gathering Theory: Benvenistc and Spindt (1989) created the "Information gathering theory" and explained that underpricing is a way to convince informed traders to disclose personal information about the demand for stocks in the pre-selling period. Inside the IPO market, business lead managers seek advice from clients before setting up offer price in prospectus. Lead professionals may intentionally underprice an IPO, to entice increasingly more clients. The Demand Information is accumulated through the pre-selling period, which forms the basis for pricing the problem. So the vendor bankers play game with a lot of their large clients.

Signal Theory: Allen and Faulhaber (1989) said that underpriced new issues leaves a good impression in Investor's Head. Firms have a tendency to communicate their quality to investors by offering their stocks at relatively lower principles and following adjusting for losing in their seasoned offering.

Kam C. Chan and Yung Ling Lo in their article credit ratings and long-term IPO performance discovered that there's a reduction in information asymmetry when there is a provision of credit ratings prior to IPO which assists with improving market efficiency. There is reduction in information risk and price discount rates by the increase in disclosure through credit scores. IPOs tend to be positively identified by outside Investors when they have a credit history as compared to those who don't have any credit ratings. The market reactions for ranked IPOs tend to be trustworthy and speedy while the long-term performance is insignificant because of reduction in the information asymmetry.

The findings of Heng (Hunter) An, and KamC. Chan in Credit scores and IPO prices of the evaluation of U. S. common show IPOs from 1986- 2004, suggests that scored IPOs underpriced less than the unrated IPOs. Credit rating levels employ a slight effect on IPO underpricing. IPO companies with high credit ratings are not always underpriced less than those with low ratings. Credit scores reduce the amount of price revision during the book building process. Credit scores also decrease the aftermarket volatility in the post-IPO period.

Mandatory IPO grading: Joshy Jacob and Sobesh Kumar Agarwalla discover that grades do influence both institutional and retail demand for IPOs. The demand from QIBs is weaker for the relatively low grade IPOs, compared to the high quality or ungraded IPOs. The demand from retail shareholders forungraded IPOs is apparently positive in accordance with both low and high quality IPOs. The weaker demand for the low grade IPOs, set alongside the ungraded IPOs, tentatively implies a information role for the IPO level in the case of the retail traders. Information content of IPO grading by Deb. S. S. and Marisetty V. B (2010) found that IPO grade influences both the retail as well as institutional investorёs membership levels.

Grading, transparent catalogs and initial general population offerings by Khurshed et al. (2011) build that IPO grading is not significant in the retail demand. It is found that QIBs demand is weaker for low-grade issues.

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