The Performance of IPOs in an Emerging Market

Evidence from Tehran Stock Exchange

Abstract

The outstanding initial public offering (IPO) literature, especially in the equity market without price limits such as the US stock market, applies the first day closing price to measure underpricing. This approach assumes that the fair market price of an IPO is immediately reflected after the stock becomes available for trading in the public market. This assumption holds true when investors can freely drive the stock price up or down without any predetermined limit. In this method, the initial return is calculated by taking the difference between the offering price and the closing price on the first trading day. However, the accuracy of the first day approach becomes problematic when daily stock price fluctuations are limited. As the daily price fluctuation is restricted, the closing price on the first trading day is much less likely to reflect the fair price perceived by the market compared to a market without limits. Therefore, researchers have proposed a non-hit day approach to measure underpricing in these markets. According to the non-hit day approach, an IPO stock will continue to hit the upper or lower limit of daily price fluctuation if the market believes that the fair price of this stock is higher or lower than the limit price. When the stock finally closes below the upper price limit for the first time after being publicly traded, the closing price on this non-hit day is considered the fair price of the stock. The underpricing of an IPO is therefore measured as the difference between the closing price on the non-hit day and the offering price.

This study empirically analyzes the initial and aftermarket returns for Iranian IPOs using the non-hit day approach to provide evidence on the performance of IPOs in an emerging market. The sample consists of 187 companies listed and traded on the Tehran Stock Exchange from 1996 to 2009. The results show that initial offerings reach equilibrium price, on average, after 3 days, and the average return of initial offerings in TSE, based on the non-hit day approach, is 10.8%, which is lower than the return in other developing markets. Our findings also confirm evidence from other stock markets around the world, which indicates long-run underperformance following initial equity issues. The investigation of factors influencing the initial performance of IPOs shows that ex-ante uncertainty and the operating history of firms prior to going public have a significant impact on the level of IPO underpricing in TSE.

Ali SANGENIAN

UNIVERSITE NICE SOPHIA ANTIPOLIS