Group Affiliation and the Performance of Initial Public Offerings in the Indian Stock Market

We document the effects of group affiliation on the initial performance of the 2,702 IPOs made in India during three different regulatory regimes in the period 1990-2004. There are two competing hypotheses regarding the effect of group affiliation on a firm's initial performance in the stock market: the certification hypothesis according to which group membership is a positive signal of firm quality, and the quot;tunnelingquot; hypothesis, under which group membership affords more opportunities for the controlling shareholders to misappropriate the firm's resources, and is thus a negative signal of firm quality. Our results show that the average underpricing of group companies is higher than that of standalone companies. In particular, the underpricing is very high for firms affiliated to foreign and domestic groups. The lowest underpricing is found for firms affiliated to the government. However, when we test the ex post performance of all IPOs, we find that group-affiliated firms tend to perform better than their standalone counterparts. Thus, it is difficult to conclude that higher underpricing is a negative signal of firm quality. We conclude that higher underpricing could be either due to investor overreaction to group-affiliated firms' IPOs, which is then reversed over time, or due to strategic behavior on the part of the groups to eliminate competition from lower quality issues