IPO’s and the Grading Market

Last month SEBI bared DLF from tapping capital markets for three years in one of the watchdog’s toughest punishments toblog date.

The order was related to non-disclosures in its 2007 IPO documents. The order was passed against DLF’s six top executives for lapses in disclosures made at time of IPO in 2007.

In the same year on the 30th April 2007 SEBI decided to make grading of all IPOs mandatory. Grading makes additional information available for the investors, in the sense that it is supposedly an objective opinion of a credit rating agency arrived at after analyzing business and financial prospects, management quality and corporate governance practices etc of the issuer. Grades represent relative assessment of the fundamentals of the issue compared to other listed equity securities. Now that the IPO grading is about to complete 7 years, we seek to assess its impact on the primary market of equity shares.

DLF scored the rating/grading of 3.5 in 2007. I did not find any study done on the grading considering the data availability now it can be done with ease.

Intuitively, we feel that grading should have direct effect on subscription statistics. Issues with grading of 3 or below should attract less subscription and issues of grading 4 or 5 should attract more subscription. It means that by and large the variability in subscriptions of different issues (i.e. if an issue gets times subscribed, the variability in p) should rise after introduction of grading. If investors are risk avers, and if they trust grading, more monies should go to better graded issues.Introduction of grading will also have some indirect fall out. While we do not expect to see it immediately, we feel eventually grading will have impact on the quality of issues. Grading should reduce the number of issues.It will force the smaller issuers with inadequate processes – that get reflected in their fundamentals – to reconsider entering the markets. Will it affect entrepreneurship? It is a vital question and begs for rigorous research.

Another related issue is how poorly graded issues have fared after listing. (And how have those fared that were graded 5 or 4.) Unfortunately here the observation time is too short – just about a year of data. A final issue is who, if any, are heeding the grading. We have three investor types – QIB’s, Retail and HNI. It is assumed that QIBs are qualified to make their own assessment of IPOs. Are their assessments, as should be evident from their willingness to subscribe, in line with grades i.e. the assessments of CRAs? We have no view on the matter but we feel this enquiry can throw some interesting findings.


In view of the above we propose to direct our enquiries towards:

  1. Variability in subscription before and after introduction of IPO Grading
  2. IPOs as percent of total capital formation of the economy, before and after introduction of grading
  3. Abnormal returns given by shares of different grades of IPOs over next nine months
  4. Inter-se subscriptions details among the three investor types for issues of different grades

For first objective:

P   Collection of subscription data of about 50 in-graded issues (IPOs) before introduction of compulsory grading and of all issues after introduction

P   Estimation of variance in subscription data in the two sets

For second objective:

P   Estimation of percent capital formation through IPOs over two years before introduction of IPO grading and over the one year after introduction

For the third objective:

P   Estimation of bottom up beta of the issuers that have become public after IPO grading

P   Estimation of abnormal returns given by the various shares of such IPOs from the date of listing till 15th May 2008

For the fourth objective:

P   Analysis of distribution of subscription among the investor types for different grades of IPOs

Estimation time for the whole could be 16 weeks .

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