IPO grading not successful tool to attract investment: IIM-A study

Last Updated: Fri, Jan 18, 2013 08:16 hrs

The move by securities market regulator, Securities and Exchange Board of India (SEBI) to introduce mandatory grading of all IPOs by credit rating agency has failed to serve its purpose, noted a recent research by the researchers at Indian Institute of Management - Ahmedabad (IIM-A).

The working paper named, Mandatory IPO Grading: Does It Help Pricing Efficiency? by IIM-A faculties Joshy Jacoby and Sobhesh Kumar Agarwalla showed that mandatory grading of IPOs by a credit rating agency has only a limited influence on the IPO demand of retail and institutional investors. "The low grade issues appear to have weaker demand from investors relative to the ungraded IPOs. But there is no evidence to support improvement in IPO pricing due to the introduction of IPO grading. This suggests the failure of grading as an IPO certification," the study report noted.

SEBI had made the grading of all IPOs by a credit rating agency mandatory from May 1, 2007. SEBI is the only regulator in the world to mandate the grading of IPOs.

The sample of the study comprised 352 IPOs issued over the six year period between October 2005 and September 2011. Of the sample size, 181 were graded issues.

"Only about one-fifth of the graded IPOs have been given the high grades (4 or 5) and about one-tenth are graded at the lowest level (1). The lowest grade IPOs accounted for a large share of the IPOs during the year 2007. Going by the issue amount, nearly 60 per cent of the graded IPOs are high grade and only 1 per cent is in the lowest grade," the study noted.

Also, the study found that the efficiency of IPO pricing appeared to be uninfluenced by the IPO grades.

The underpricing of the issues is unrelated to their grade. "Graded issues do not have a relatively lower underpricing compared to ungraded issues. Or high grade issues do not have lower underpricing compared to the low grade issues," it said.

According to SEBI, the grade represents an assessment of the fundamentals of that issue relative to the other listed equities in India.

And the grade was expected to provide incremental, readily interpretable and independent information about IPOs to investors. Therefore the grade claimed to help investors better assess the investment potential of IPOs.

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