Determinants of initial public offer underpricing: the moderating role of market conditions in African securities exchange association member stock markets

Abstract

Firms continually make financing decisions in the course of business operations. One of these is the issuing of equity to the public through an Initial Public Offer (IPO). Despite the extensive research on the subject of IPOs, little attention has been given on the possible interaction between market conditions and the determinants of IPO underpricing. The general objective was to establish the determinants of IPO underpricing and the moderating effects of market conditions in African Securities Exchange Association (ASEA) member countries securities market. The specific objectives were to determine: the effect of transaction volume, offer size, investor oversubscription and listing delay on IPO underpricing and to establish the moderating effect of market conditions on the relationship between transaction volume, offer size, investor oversubscription and listing delay on the level of underpricing of IPOs. The study was based on market timing theory and the theories associated with information asymmetry namely the winner’s curse theory, ex-ante uncertainty and signaling theory to explain what determines IPOs underpricing. The study used stratified random sampling to sample three countries, South Africa, Egypt and Kenya. The study used cross-sectional research design. Data was collected for all firms that issued IPOs in Nairobi Securities Exchange, Egyptian Exchange and Johannesburg Stock Exchange for a period of fifteen years (1996 to 2011). Data on IPOs offered per year per country was derived from the respective stock markets and financial information was collected from firm formation documents, prospectus and financial statements. The results showed that transaction volume, investor oversubscription and market condition had a positive and significant effect on IPO underpricing while listing delay had a negative and significant effect on IPO underpricing. Offer size was not significant. Furthermore, a hot market condition was found to have enhancing and significant interaction effects on transaction volume, offer size and investor oversubscription. There was no interaction on listing delay. This study contributes to theory by centering market condition on the empirical testing of market timing theory as well as the influence of share allotment on the reduction of the winners curse. The study recommends to issuers to take into consideration the market condition before issuing shares in an IPO as it enhances the impact of transaction volume, offer size and investor oversubscription on IPO underpricing. Further to this, the study recommends to policy more stringent scrutiny of offers made during a hot market to protect investors from possible impropriety occasioned by their enthusiasm as evidenced by investor oversubscription. The study suggests future research to investigate the allotment methods used in other developing markets in relation to the winners curse. The study further recommends inquiry on the impact of cold market condition on the determinants of IPO underpricing and an investigation on the events surrounding the transition from hot to cold markets to better understand and utilize the prediction capability of the noticeable indicators.