Initial public offerings and price discovery mechanisms in the Indian capital markets

Abstract

The decision to go public is one of the toughest and most important decisions that a young company has to make. The sharp increase in the number of companies going public in the last couple of years is due to the huge benefits it has been observed to bring to companies that have taken the plunge and gone public. These include access to public equity capital, and may thus lower the cost of funding the company’s operations. The enhanced liquidity that is a consequence of going public means that companies no longer have to compensate investors for the lack of liquidity associated with a privately held company. The attention that any company that is about to go public receives may also bring with it advantages in the form of attracting a different caliber of manager. However the act of going public also brings with it certain costs. The company now becomes obliged to comply with greater transparency and disclosure requirements. Its ownership is also in the hands of a greater number of individuals, who will sell their shares at the hint of any problem, instead of helping the decision- makers of the company the way a venture capitalist might. The costs associated with the actual process of going public are also large, in the form of legal, auditing and underwriting fees, along with management time and effort in conducting and facilitating the process. Initial public offerings (IPOs) of shares are the most common method by which companies go public. An initial public offering (IPO) occurs when a security is sold to the general public for the first time, with the expectation that a liquid market will develop. The price discovery mechanism of IPOs has been the subject of much debate and academic research over the last three decades. In particular, the issue of IPO underpricing has generated much controversy.