IPO market: Tracking GMP alone? How to spot 'foolproof' high-quality companies

In its March Market Pulse, NSE mentioned a highly cited research paper by Supriya Katti, Edward R Lawrence and Mehul Raithatha to suggest that IPO grading, pre-auction subscription rates, stock market analyst recommendations, grey market premium (GMP), and group affiliations may help investors gauge a company's potential but are not foolproof. The study revealed that how risk disclosure in IPO advertisement could be a good indicator of a quality company. It also cited how institutional investors and retail investors perceive risks differently while investing in IPOs. 

NSE Economic Policy and Research team, which prepared the summary of the research note, said that voluntary information disclosure helps enhance investors’ perceptions of a firm, thereby increasing their expectations about the company’s future  prospects. In this context, companies that provide more warnings or risk-related information are seen as more credible by investors, it noted.

"In conclusion, the study underscores the importance of risk disclosures in IPO advertisements as a signal of company  quality. The findings suggest that firms that disclose risks experience higher IPO underpricing, attract more institutional investors, and perform better post listing," NSE cited the research paper as saying.

These results, NSE said, supports the notion that risk disclosures are an effective signaling tool for identifying high-quality companies in the IPO market.

The study used data from 155 Indian IPOs, drawn from a total of 278 IPOs issued between January 1, 2010, and January 31,  2021. Preliminary results showed that the average IPO underpricing in the sample was 11 per cent, with the average issue size being Rs 75 crore. Of the IPOs analysed, 42 per cent included risk-related disclosures in their advertisements. The underpricing for firms that disclosed risks averaged 18.7 per cent, while those that did not disclose risks saw underpricing of only 4.7 per cent.  

"Regression analysis indicates that companies that disclosed risks experienced approximately 15 per cent higher underpricing  than those that did not," NSE suggested the research paper suggested as saying.

The findings showed that institutional investors subscribed to 35.5 times the number of shares allocated to firms that disclosed risks, compared with 15.21 times for firms that did not disclose risks. However, no significant difference was found in the case of retail investors, suggesting that they may not recognise risk disclosures as a signal of quality.

NSE citing the paper, said high-quality firms, which are confident in their future performance, often signal their strength by underpricing their IPOs. Thus the research note suggests hypothesised that IPO underpricing will increase if companies provide more risk disclosures, as such firms are more likely to recover from initial losses once their performance materialises.

Also the post-listing performance for firms disclosing risk in their IPO advertisements -- using  Return on Assets (ROA), Return on Equity (ROE) and Tobin’s Q as performance metrics -- suggests that companies that  disclosed risks performed better than those that did not. 

"This suggests that high-quality firms use risk disclosures as  a credible signal of their quality, and their post-IPO performance reflects this.