Corporate governance and underpricing of small and medium enterprises IPOs in India

• Pages: 503-525
• DOI: https://doi.org/10.1108/CG-08-2019-0259
• Date: 19 March 2020
• Published date: 19 March 2020
• Author: Nischay Arora,Balwinder Singh
• Subject Matter: Corporate governance,Strategy

Corporate governance and

underpricing of small and

medium enterprises IPOs in India

Nischay Arora and Balwinder Singh

Abstract

Purpose –The purposeof the paper is to examine the impact of corporategovernance mechanisms, i.e.

board structure and ownership structure on the underpricing of small and medium enterprises (SME)

IPOs in India.

Design/methodology/approach –Most of the extant empiricalresearch studies have either pivotedon

mainstreamIPOs or SMEs IPOs in developed economies, butthe present study examines 200 SME IPOs

issued during Feb 2012to April 2017. Multiple regressions have been used to examinethe impact of the

corporate governancemechanisms on raw return (RR). Furthermore,robustness of the results has been

verified through the employment of market-adjusted excess return (MAER) as an additional proxy of

underpricing.

Findings –The results highlight that board size, inverse of board committees, board independence,

board age, board directorships positively, and top ten shareholding negatively influence RR. Further,

direction of promoter ownership variable indicates curvilinear relationship with underpricing. Other

explanatory variables used in model lack statistical validity. Similar results have been obtained when

variables were regressed against MAER with related board members being additionally significant in

model.

Practical implications –The findings suggest that Indianinvestors do take cues from board structure

and ownership patterns for makinginvestment decisions in small- and medium-sized firms. Further,the

resultsare also helpful to top management in structuring their boards.

Originality/value –The presentresearch enriches SME IPOs underpricingliterature because theimpact

of corporate governance mechanisms on unadjusted returns is relatively under explored particularly

withinthe context of small- and medium-sized firms.

Keywords Corporate governance, Ownership structure, Board structure,

Market-adjusted excess return, SME IPOs

Paper type Research paper

1. Introduction

In the wake of various corporate collapses at international level, such as Enron, Worldcom,

corporate governance has intrigued the attention of researchers, academics and

legislatures across the globe. The numerous appalling corporate governance failures in

Indian scenario, such as Satyam scam,PNB scam have prompted the authorities to step up

their vigilance and keep erring entities on their toes. However, the attention has been

traditionally confined to large-scale organization with growing emphasis on smaller

companies that are preparing to go public (Filatotchev and Wright, 2005;Lowry et al.,

2017). Initial public offering, which entails the transition of private entity into public entity, is

a watershed event in the lifecycle of a firm (Certo, 2003;Lowry et al., 2017). Because, the

IPOs provide vital resources essential for future expansion and growth, they hold

paramount importance for small entrepreneurial firms which are predominantly resource

Nischay Arora and

Balwinder Singh are both

based at the Department of

Commerce, Faculty of Arts

and Social Sciences, Guru

Nanak Dev University,

Amritsar, India.

Received 18 August 2019

Revised 8 November 2019

5 February 2020

Accepted 13 February 2020

DOI 10.1108/CG-08-2019-0259 VOL. 20 NO. 3 2020, pp. 503-525, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 503

dependent (Filatotchev and Wright, 2005). These potential benefits that small and medium

enterprises (SMEs) gain through IPO necessitates the establishment of effective

governance mechanism that not only should protect the investors’ interest by aligning the

interest of managers with shareholders but also capacitate the companies to combat the

hindrances associated with the growth and expansion of SMEs (Baker and Gompers, 2003;

Abor and Adjasi, 2007;Huse and Zattoni, 2008). In this vein, board characteristics and

ownership structure constitute the important internal control mechanisms that attenuate the

uncertainity and information asymmetry engendering from their newness in the market

(Certo, 2003).

The present study is focused on the IPOs listed in SME platform of Bombay Stock

Exchange of India and attempts to examine the impact of corporate governance attributes

on underpricing of SME IPOs in India.Given the fact that the studies analyzing the impact of

corporate governance mechanism on underpricing of IPOs have substantially concentrated

on larger firms listed on main board, it is critical to examine it in the context of SME firms

listed on SME boards. Additionally, within the SME context, the limited studies have been

undertaken in developed countries (Eisenberg et al., 1998;Chahine, 2004;Thorsell and

Isaksson, 2014). Hence, it is imperative to appraise the impact of corporate governance on

underpricing of SME IPOs in developing economies, given the important role of SMEs in

these economies. India, being a developing economy, adds value to the study, due to its

compelling contribution in growth, employment and wealth distribution in the economy.

Furthermore, statistically, SME segment contributes to 45 per cent of the manufactured

output, 40 per cent of exports and is among the largest generator of employment in the

Indian economy Ayyagari and Beck (2015). Besides, crippled with the problems of lack of

availability of adequate and timely credit, huge cost of credit, collateral requirement and

limited access to equity capital, it has become vital for SMEs to resort to public equity

markets through SME exchange. Although, various initiatives in the past, such as

establishment of Over the Counter exchange of India (OTCEI), Inter Connected Stock

Exchange of India (ICSEI) and BSE Indo Next have been made to promote SME

exchanges, they failed to gain attention due to lack of effective governance mechanism.

Because, the performance of exchange depends on the performance of IPOs, the present

study undertakes to examine the performance of SME IPOs through corporate governance

attributes.

2. Institutional characteristics: Indian equity market for small and medium

enterprises

SME exchanges meant for listing of SME IPOs with paid up capital of 10 crore were

launched in 2012 to vitalize the innovation and entrepreneurship through the common

framework for both SMEs and investors. From the experience accumulated by its own

previously failed initiatives of OTCEI, ICSEI, BSE INDONEXT, separate trading platforms,

i.e. BSE SME platform and NSE EMERGE for the SME were set up with the recommendation

of Prime Minister Task Force.

SEBI has laid down regulations for SME IPOs which are different from main board IPOs to

ensure the governance of SME exchange and protect the investors’ interest. First, the

companies with the paid up capitalof 10 crore are eligible to list its securities on SME board

as compared to paid up capital of 25 crore for mainstream IPOs. However, the companies

with post issue paid up capital between 10 and 25 crore have an option to migrate to main

board subject to compliance of rules and regulations of main board. Also, the listing

regulations with regard to distributable profits, net worth, minimum tangible assets

compared to main board have been relaxed. Second, the minimum number of investors

participating in SME IPOs should be at least 50 as against 1,000 in main board. Third,

underwriters to the issue ensure that issue is 100 per cent underwritten out of which 15 per

cent is underwritten by merchant banker on his own account who is simultaneously

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