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CHAPTER- II

REVIEW OF LITERATURE

A number of studies have been conducted from time to time to understand the

different aspects relating to primary market and merchant banking activities in India.

However, most of them have focused upon the primary market in India only. Research

in the area of merchant banking in India and its role in the primary market is very

limited and that too is descriptive in nature and deals with procedural aspects,

organization and management and marketing aspects of merchant bankers. A review

of important studies is presented below:

2.1 Literature Survey Verma (1990)1 conducted research on merchant banks in India with the purpose to

analyse their organization structure and management pattern and to assess their

suitability for medium and small size corporate and non corporate enterprises. The

suitability of merchant banking services in reducing investors’ risk and corporate

capital structure has also been examined. The information was collected from a

sample of 32 merchant bankers through questionnaire and the study covered the

period 1978 to 1984. The researcher found a number of weaknesses in the existing ‘divisional form’

organization and management pattern of merchant banks in India. This included deep

concentration of decision making power, lack of co-ordination, lack of appropriate

skill, inadequate training programme, strict dependence on the bureaucratic

framework, blocked communication channels and misdirected accountability.

The study revealed that 90 percent of the resources of all merchant banks were

devoted only to the management of public issues. A negligible performance of

merchant banks was found in other areas of services including loan syndication,

merger and amalgamation, inter corporate investments and corporate counselling.

Further, merchant banking activities were found to have remained concentrated with

only a few top merchant bankers, while stock brokers managed very small sized

issues covering just 15% of the total amount of public issues.

A good public response was found to the issues managed by category I

merchant bankers including merchant bankers of public sector banks, whereas the

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category II merchant bankers which included private firms had the public response of

second order.

The researcher highlighted the merchant banks’ contribution in causing risk

reduction both to investors (through portfolio management) as well as the industry

(through project counseling and corporate counseling). Empirical results also

highlighted that corporate enterprises which sought merchant bankers’ assistance were

financially sounder and less prone to sickness as compared to those not assisted by the

merchant banks.

Murthy (1993)2 in his paper examined the cost of raising capital from the public

issues floated during 1992-93. During 1992-93, an amount of Rs. 4677.74 crore was

raised through 514 public issues. The estimated expenses on these issues were Rs.

473 crore. Analysis of 506 public issues showed that issue expenditure as percentage

of net public offer was 10.10% and the proportion of issue expenses declined with the

increase in offer size. The study found that smaller projects tend to spend a higher

proportion as issue expenditure compared to the larger ones. The researcher also

compared the cost of raising capital of issues through the OTC (over the counter)

route and regular stock exchange option and found that the cost of raising capital

through OTC route was lower than the issues that opted for regular stock exchange

route.

The study pointed out that no uniform format existed for reporting the issue

expenditure in the prospectus. The researcher has suggested that the total issue

expenditure as percentage to the total issue amount be reported prominently in the

prospectus and abridged prospectus cum application form.

Shah (1995)3 conducted an empirical study on the data set of 2056 Indian IPOs listed

on the BSE from January 1991 to May 1995 with the objective to examine the under

pricing of IPOs and to establish the empirical regularities about India’s IPO market.

He examined six factors underlying under pricing, namely asymmetric information

between firms and investors, fixing the offer price too early, the interest rate float, loss

of liquidity on the amount paid at issue date (liquidity premium), building loyal

shareholders and merchant bankers rewarding favoured clients as an incentive to

under price.

Empirical study found that the average price on first listing day was 105.6%

above the offer size, average delay between issue dates and listing day was 11 weeks

36

and weekly excess return on market index (BSE Sensex) was 3.8%. The study further

found that correlation between the volume of IPOs under pricing and the return on

BSE Sensex was positive, under pricing among the smaller issues was high, average

long run trading frequency of IPO was lower than ‘A’ group companies and return on

IPOs during the first 200 trading days was more than market return.

Srivastava (1995)4 in his paper highlighted the need for efficient marketing of public

issues because of the transformation of new issue market from sellers’ market to buyer

dominated market as the geographical and demographical range of investors has

widened. According to him, the process of public issue marketing starts with the

selection of the issue by the merchant banker. Then the merchant banker plays the role

of a guide for the appointment of underwriters, brokers and an expert advertising

agency. The researcher has listed the current practices in public issue marketing which

include the application of data base marketing research, direct approach to investors (

like insurance, UTI ), seeking services of marketing experts as issue specialists,

branding the issues like mutual funds, and effective advertising through extensive and

intensive use of media. The author concluded that the future dimensions of public

issue marketing will include the after sale service to investors and giving instant

services of selling.

Aggarwal (1995)5 traced the origin, growth and history of merchant banking in India

and abroad. The objectives of the study included the analysis of organizational

structure, management pattern and performance evaluation of SEBI registered

category I merchant bankers during the period 1989- 90 to 1993-94.

The study found that merchant banking institutions lack skill development

programmes for training the staff, up to date information and more concentration of

decision making power. Despite this, the study highlighted the important role of

merchant bankers in the growth of capital market and mobilization of resources from

public through issue management activities. The author recommended for stopping

the turnover of personnel in merchant banking divisions of nationalized banks due to

transfers, who have up to date market information and adopt professional attitude for

providing services as merchant bankers.

Narta (1996)6 conducted a research study to find out the growth of new issue market

and underwriting of capital issues in India, and to analyse the cost of raising capital

during the period 1970-71 to 1988-89. The study was based on the secondary data.

37

The researcher found that after independence, a large number of public

financial institutions, investment institutions, merchant banking divisions of

commercial banks and investment consultancy agencies were engaged in the

underwriting operations of capital issues in India.

The researcher found that public financial institutions accounted for a larger

proportion in underwriting activities though their share declined from 63% in 1970-

71 to 22.64 % in 1986-87. The commercial banks showed an increase in underwriting

activities on account of opening of merchant banking divisions. Development banks

and GIC were found to prefer participation in the underwriting of large issues. Stock

brokers were more active in underwriting during boom conditions while commercial

banks were more selective to underwrite the issues of their valued customers. The

average cost of public issues during the period of study was found to be ranging from

8% to 10% of the amount offered to public. However, the cost of issues of existing

companies was higher as compared to IPOs because of aggressive campaign for over

subscription.

The suggestions by the researcher included opening of more merchant banking

divisions by commercial banks, joint underwriting, single window agency in new

issue market and priority to the underwriting of small issues by public financial

institutions.

Kailani (1998)7 in her research work examined the marketing strategies and

performance of merchant bankers during the period 1990-91 to 1997-98. The study

was based upon 77 merchant bankers.

The researcher evaluated the performance of merchant bankers by taking into

account of both qualitative and quantitative dimensions. While qualitative factors

included skill in issue management and quality of personnel and services to the

clients, the quantitative factors included number and amount of public issue handled

and the activity profile of merchant bankers (fund based or non fund based). The

variables taken for quantitative evaluation included projected and actual sales, profit

before interest, depreciation and taxes, profit after tax and earnings per share.

The study found that the role of merchant bankers had become more diverse

after the setting up of SEBI. Post liberalization era up to 1995 saw a number of small

financial companies entering into merchant banking business because of low entry

barriers. Consequently, bad quality issues were sold in large numbers. Further, high

38

concentration of merchant banking business was found among the top ten merchant

bankers and only six merchant bankers provided all the post issue services. The author

recommended for fixing the responsibility for fulfillment of promises made in the

prospectus, improving the quality of disclosures in IPOs, need for grading the

prospectus, mandatory participation of merchant bankers in the project and rating of

merchant bankers.

Qumar (1998)8 analyzed the non fund based financial services by the leading public

sector banks (PSBs) in the field of merchant banking for the period 1993-94 to 1997-

98. According to the author, the public sector banks entered in merchant banking

business on the recommendations of Banking Commission 1972 and dilution of

foreign equity of large number of foreign companies operating in India. He analyzed

the role played by public sector banks in handling the number and amount of issues as

lead manager, co manager, underwriter, adviser, banker to issue and the project

appraiser.

The author concluded that there should be reforms in the existing legal system

relating to financial services of PSBs, as frequent changes in guidelines had adversely

affected the financial services of PSBs. The author pointed out that limited range of

merchant banking activities, inferior quality of services and lack of trained and skilled

personnel were the reasons for declining trend in the merchant banking business with

public sector banks and suggested a close touch with the economy and developments

in capital market and more competitive and technical bank officers for improvement

in the merchant banking services by banks.

Mohiadeen (1999)9 conducted research on the topic ‘A study on New Issue

Management Services of Lead Merchant Bankers in India’. The objectives of the

study included identifying the functional activities of issue management and to assess

the functioning of the merchant bankers in the pre and post issue management phases.

The study covered the period from the year 1992-93 to 1996-97 and was based on

both primary and secondary data. The primary data was collected from a sample of 26

lead merchant bankers a questionnaire.

The study found that all private merchant bankers depended on the services of

the brokers, sub brokers and underwriters for the success of the issue but merchant

banks of private and public sector banks did not depend on them. The merchant banks

of nationalized banks and financial institutions had been rather concentrating only on

39

specific industries. Promoters’ track record, company fundamentals, industry type and

EPS were the important factors in pricing the public issues. The market support of

brokers was found to be inadequate. Collecting bankers to the issue were found to

have acquired the applications money even after closure of the issue. The performance

of the group lead merchant bankers who had handled the issues did not differ

significantly from those who had handled the issues individually. Lead merchant

bankers opined that actual public issue cost had been more than the cost mentioned in

the offer document. The correlation of issue price and market price in the case of

public sector merchant bankers was found to be highly positive, but negative in case

of public issues managed by private sector merchant bankers. The researcher

recommended that the merchant bankers should develop a large public investors’ base

for the development of equity culture in India and that there was a need for reduction

in the number of merchant bankers in the industry.

Guner (1999)10 in his paper analysed the relationship between underwriter (lead

manager)’s reputation and IPO under pricing in the Istanbul Stock Exchange (ISE) in

Turkey. The authors attempted to compare the findings of various studies on US

market that the IPOs managed by prestigious underwriters resulted in lower amount of

under pricing in short period, with that of emerging markets.

The sample for the analysis consisted of 180 IPOs that took place at ISE

during the period from 1993 to June 1999. The study used both traditional and

extended model for establishing the relationship based on the given characteristics of

the IPO.

The application of the traditional model on the IPOs in Turkey found no

relationship between initial day IPOs returns and the underwriter reputation regardless

of which reputation measure is used. However, a positive relation was found between

the initial day IPO returns and 15 day return on the market index before the first day

of trading. However, after controlling the factors that are important in determining the

price of an IPO in an emerging market, a complex relationship between underwriter

reputation measures and IPO returns was documented in the study.

In the extended model also, the study found a negative relationship between

the IPOs return and the underwriter reputation because these underwriters were well

known to the investors. The researcher further found a positive relationship between

the volume of IPOs handled by a particular underwriter and the initial day IPO return.

40

The variables having significant positive impact on the IPO under pricing in

Turkey were found to be the age of the issuing company and the relations of the IPO

firm and the underwriter. When underwriter was not related to the IPO firm, investors

had a greater confidence in the certification of the IPO price. The researcher

concluded that the underwriter reputation and the initial day return findings in USA

markets should not be extended to emerging markets without any modification.

Anand (2002)11 and others in their research paper studied the long term relationship

between business firms and investment banks with the premise that it leads to better

allocation of resources in the economy.

The objective of the paper was to study the conditions that must be met for

sustaining relationships between the investment banking and the security market. The

paper stated that the investment banking structure was determined by the technology

of relationships. The author developed a model of this relationship with the

assumption that investment bank must incur a sunk cost to establish this relationship.

The author also discussed the policy implications to develop this relationship as the

size-distribution of business firm depended heavily on the structural characteristics of

the economy. While policy can probably remove obstacles that increase the cost of

relationships, the size distribution of business firms determined whether an

investment banking industry was feasible: it will not emerge if large firms are few.

Joint Parliament Committee (2002)12 which was set up to look into the

manipulation and irregularities in the securities market, as a result of Ketan Parekh

scam, submitted its Action Taken Report (ATR) on December 19, 2002. The JPC has

made 276 observations/ conclusions/ recommendations. Each of the observation has

been listed in the report along with the response of the Government.

The Committee in its report held the stock exchange authorities, SEBI, RBI,

Department of company Affairs (DCA) and Finance Ministry responsible for the stock

market scam. The report criticized SEBI for its failure to monitor and regulate the

securities market, for its lack of action in case of mismatch between movements in the

primary and secondary market, the absence of regulatory framework for the private

placement to the detriment of the primary market and negligence in checking whether

bull operators obtained bank funds to finance their market operations. SEBI’s track

record of punishing wrong doers was found unsatisfactory by the JPC.

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The report also termed RBI’s supervision as weak and inefficient. RBI was

found to have failed in taking timely action in preventing diversion of funds from the

country and checking the irregularities in the functioning of certain banks for

providing undue advances for security market transactions. The Finance Ministry was

criticized for not keeping a watchful eye on the UTI that resulted into a crisis in its

famous scheme US-64.

With regard to primary market, the report further pointed out that pricing and

tracking the end use of funds was totally neglected by SEBI. The report pointed out

that pricing of securities in primary market was a difficult task and leaving this issue

entirely to the discretion of management, based on the recommendations of the

merchant bankers, did not serve the interests of small investors.

The Committee gave a number of recommendations like speeding up of the

process of demutualization and corporatization of stock exchanges to implement the

decision to separate ownership, management and operations of stock exchanges;

affecting legislative changes for investors’ protection and enhancing the effectiveness

of SEBI as a capital market regulator.

Kenourgios (2002)13 in his research paper analysed the initial performance of Greek

IPOs and studied the relationship of under pricing with the underwriter’s reputation

and oversubscription. The data for the study related to 169 IPOs listed on Athens

(Greek) stock exchange (ASE) over the period 1997-2002. The initial performance of

the IPOs was measured by raw returns and the excess or adjusted returns on the first,

fifth and 21st day respectively.

The study found a high average percentage of raw return as well as excess

return from IPOs. The average raw returns were found as 52.7%, 44.78% and 41.84%

on the first, fifth and 21st day respectively. Similarly the excess (adjusted) returns

during the period were 54.28%, 45.32% and 43.83% on the first, fifth and 21st day

respectively. The study further found a high positive correlation (0.799) between the

number of times of oversubscription and the first day adjusted returns of the IPOs. On

the other hand, initial excess returns of the IPOs was found as negatively correlated

with the underwriter’s reputation and hence supported the Beatly and Ritter’s

hypothesis of prestige underwriters. The downward trend in both raw and adjusted

returns over the time reported in the study was found to be consistent with the

findings of other studies on the Athens Stock Exchange. The researchers concluded

42

that the worldwide phenomenon of under pricing of IPOs of stock was a challenge to

the efficient market hypothesis.

Gupta (2002)14 in his paper examined the performance of merchant banks in India on

the basis of their different positions (lead manager, co manager, and adviser) and

different categories of ownership (Public, private and foreign). The researcher

selected 104 working merchant bankers out of 164 registered with SEBI and covered

the period from 1997-98 to 2001-02.

The researcher concluded that the private sector merchant bankers performed

well as compared to public sector and foreign merchant banks both as regards to

public issues managed and the amount of funds raised. Although, public sector and

foreign banks performed identically as regards total number of public issues managed

but the performance of foreign merchant bankers was better than that of the public

sector banks in terms of funds raised. The author pointed out that merchant banking

was mainly restricted to the activity of issue management and other activities such as

underwriting, loan syndication, investment counseling and portfolio management

were still not much emphasized. The researcher’s recommendations included the need

for providing quality services, functional cum expert oriented organization and a team

of specialists.

Findlay (2002)15 and others in their paper discussed some considerations involved in

implementing Customer Relation Management (CRM) in the field of investment

banking. They were of the view that increased competition and shrinking margin had

forced investment banks to rethink their fundamental approach to client management

and redesign their coverage strategies by use of information technology.

The author was of the view that investment banks must respond quickly to the

pressures from their clients to improve client management process and systems as the

clients regarded investment bankers as the ‘core providers of services’. Selecting and

managing the right client set, determining the products and services, reducing the cost

of coverage and co-ordination of multi product, multi country relations are the CRM

challenges before the investment bankers.

For the implementation of CRM system, the author recommended the global

understanding of each client’s situation, creation of new and sophisticated financial

instruments, sharing of qualitative and quantitative information with the clients and

the feedback from the clients.

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Hyderabad, R. (2002)16 in their paper attempted to study the overall performance of

merchant bankers in the area of public issue management from 1989 to 1998. The

criteria for evaluating the performance of merchant bankers included number of issues

handled, average amount handled, instrument wise performance (equity, preference

shares, debentures), the number of times the issue was oversubscribed and sector wise

analysis.

The study found bank subsidiaries as the market leader in respect of number

and amount of public issues handled. Competition and professionalism in public

issues management and the dominance of private merchant bankers was noticed. The

inadequate infrastructure, inexperienced staff, unhealthy competition, tight rules and

regulations by SEBI had been the major problems of merchant bankers in India.

The author suggested for changing yardsticks of performance in post issue

management services, widening the area of equity culture, establishment of

independent training institutes, and clear and consistent regulations for merchant

bankers by SEBI for improving efficiency of merchant banks.

Lakshmanna (2002)17 in their study aimed to analyze the functions of merchant

banking and their performance evaluation based upon a sample of merchant bankers

during the period 1994 to 1999. The authors observed that the sluggishness in the

primary market forced most of the category 1 merchant bankers to withdraw from

merchant banking activities and changes in rules and regulations had also significant

impact on their functioning and performance. The study also found that most of the

merchant bankers concentrated on floating the public issues function while

underwriting was secondary. The study did not find a direct correlation between

number of issues in each activity to the size and value of the issue. The authors

recommended professional approach in their working and adoption of best practices

of corporate governance for improving the performance of merchant banks.

Mallik (2002)18 in his article stated the conflicting interests in the investment banking

profession. In the primary financial service market, the investment banks’ operations

included raising money for companies and corporations by issuing and brokering

securities and providing advice to companies. The raising capital for companies,

advising investors and trading stocks for their proprietary trading activity often

resulted in direct conflict and the merchant bankers had to balance between all these.

Sometimes the inner information acquired by an investment bank from advisory

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services rendered to a company was used to help its competitors in a hostile takeover.

The author concluded that against the backdrop of inherent conflict of interests,

implementation of ethical practices was the only savior and hence the ethical

guidelines (code of conduct) issued by the regulatory authorities assumed importance.

Srinivasan (2002)19 conducted an empirical study on the marketing problems of

certain market players in financial sector including merchant bankers. According to

him, the marketing problems as revealed by merchant bank respondents were

fluctuations in security market, frequent changes in interest rates and policy,

competition for funds from other institutions (mutual funds, insurance, foreign banks),

lack of systematic efforts at ‘image making’ by merchant bankers, lack of proper

branding among merchant banking products, lack of effective media exposure, lack of

overall marketing coordination and segmentation. The author presented a bright future

for merchant banking in India since infrastructure projects, power projects and Euro

issues were getting big thrust under the liberalization policies of the government.

Madan (2003)20 in his research paper studied the under pricing of initial public

offerings during the period 1992-95 and found a very high initial excess return on

IPOs in the Indian primary capital market as compared to the experience of capital

markets of other countries. The study covered a set of 1,597 companies with IPOs

during 1989-1995 listed at the BSE. The study found that out of the 1,597 IPOs, 72

issues were fairly priced (Zero return on listing), 157 were overpriced (negative return

on listing) and 1368 issues were underpriced (positive return on listing). Initial return

on IPOs was found to be quite high (94%). Year wise performance in terms of return

on listing was found to be as high as 287% for the year 1991 and as low as 26.6% for

the year 1995. Also issues at par were seen to perform better than issues at premium.

A negative relationship was found between return on listing and the issue price and

the size of the issue (lower the issue price and size, higher is the return

accrued).However, a positive relationship was established between return on listing

and the foreign equity holding in the company as also the issue rating.

The paper concluded that the return was high on IPOs in the short period, but

it declined with the passage of time. There has been a drastic fall in the return on IPOs

in the long run and returns were found to be negative from the second to fifth year of

listing. The paper also highlighted the emergence of private placement market in India

as it was both cost and time effective method of raising funds. However, it was highly

45

informal market. So author suggested for guidelines by SEBI for private placement

market.

Dhawan (2004)21 in his article identified the decline in revenue of investment banks

in the year 2000 due to the meltdown of equity issues, and merger and acquisition

deals. The bidding war between various investment banks had pushed the fees on

privatization deals to less than 1% of the deal size (one of the biggest $ 2 billion

ONGC deal was won by Kotak at 0. 075% and GAIL bid went to HSBC at 0.14%)

The fees for private sector deals too were lower at 2.5%. During boom period, Silver

Line Technologies and Rediff.com had paid 7% to their investment banks for raising

capital and getting itself listed. Even the Govt. paid higher fee in those days (1.24%

for VSNL GDR and 2.25% for GAIL GDR).

The author pointed out that commercial banks like ICICI banks, Citigroup and

HSBC Securities improved their ranking in the M&A advisory business at the cost of

traditional players like DSP Merrill Lynch & JM Morgan Stanley.

The paper foresaw the major component of investment banking revenue from

raising equity capital than other activities. The author recommended that Indian

merchant bankers should tie up with global firms to tap the growing market of cross-

border acquisitions.

Ghosh (2004)22 in his paper empirically investigated the boom and slump phases in

the Indian primary capital market. The paper attempted to analyse the factors that

influenced the volume, under pricing and timing of IPOs in the hot and cold phases in

Indian IPO market. The study covered the period from 1993-2004 which was further

divided into two phases: boom phase (1993-96) when on average 50 companies got

listed on BSE on monthly basis and slump phase (1997-2001) when there was a

considerable decline in the number and total amount of new issues.

The study found that during the boom period, a company’s decision to go

public depended more on past IPOs volume as compared to slump period. Empirical

evidence found no significant relation between IPO volume and initial returns during

hot and cold period. The main reason for this was the long time taken by Indian

companies to get listed on the stock exchange after the decision to go public.

The researcher also studied the effect of other parameters (industry type, age

of company, size of new issues) on the volume of IPOs in hot and cold market and

46

found no significant influence of industry affiliation on the IPOs during the hot

market.

The paper concluded that the established companies raised large amount from

the primary market and under pricing considerably was more during the cold phase

whereas the small and young companies timed their public issues during the boom

phase in the primary market.

Gupta (2004)23 in his article stated that the integration of Indian economy and its

dynamic status calls for a number of challenges for investment banks in India.

According to the author, the problems faced by Indian investment banks included

increasing competition, tough operating environment and decreasing margin. Some

critical areas which pose a challenge to investment banks are broadening the customer

base, ensuring due diligence, appropriate valuation process, strong relation

management with customers, trusted and strategic advice, compliance to ethical and

regulatory code of conduct and accurate and greater disclosures.

The author recommended for the integration of Indian merchant banking with

global financial markets so as to have a major focus on investment in intellectual

capital, placement and marketing capabilities, size and scope of services, relationship

management, transparency in disclosure practices, corporate governance and use of

technology for cost effectiveness.

Khan (2005)24 in his article highlighted the excellent performance of the primary

capital market in 2004-05. The major reasons for this boom were found to be low

interest rates, recovery of investors’ confidence, high growth of GDP, FII inflows,

efficient exchange rate management and good liquidity in the economy. Average size

of the issue has gone up to Rs. 470 crore in 2004-05 as compared to Rs. 11.7 crore in

1995-96 due to the arrival of mega issues and the exist of small companies. The small

companies raised relatively small amount from the market due to high transaction

costs, high listing fee and strict disclosure norms set by SEBI to protect investors.

The author expressed concern that funds raised by Govt. companies, financial

institutions and banks might not result in capital formation and hence might not lead

to higher production, economic growth and employment generation. He pointed out

that 99.8% of equity shares were raised at premium during 2004-05 as compared to

76.6% in 2000-01. This showed the high expectations among investors for safe, fair

and honest capital market. But academicians had reservations about this as they felt

47

that qualified institutional investors, FIIs and high net worth investors in collusion

with the issuers were able to manipulate the share prices due to the asymmetry of

information in the stock market.

The recommendations by the author included improvement in the information

efficiency in the market and implementation of corporate governance not only by

listed companies, but by market intermediaries also.

Sharma (2005)25 in her research paper studied the marketing effectiveness in

merchant banking services in India. According to the researcher, the liberalization

process in India has led to major developments in the industrial sector to make India a

truly formidable and globally competitive industrial power and consequently, the

merchant banks have emerged as an important intermediary in the financial market.

The study aimed to analyse the relevance of marketing mix in the merchant

banking services and to make a comparative analysis of its effectiveness of public as

well as the private sector merchant banks.

The researcher found that the ‘people’ was the most important component of

marketing mix followed by product, price, promotion and place respectively. The

results also showed that private sector merchant banking had more effective and

efficient marketing mix as compared to public sector merchant banks. Unbalanced

service mix with the dominance of issue management, inadequate quality of services,

inadequate distribution network and inadequate promotional measures were found to

be the major deficiencies which hindered the marketing performance of merchant

banks in India.

Swedberg (2005)26 in his article analysed the corporate scandals in the US during

2001-02, which involved the relationship of business analysts and the investment

bankers. The business analysts, who were supposed to give unbiased advice to

investors about which shares to buy and sell, connived with the investment bankers

and helped them to attract business through overly optimistic analysis resulting into

worse long run performance of IPOs. The brokers, instead of becoming trustworthy to

their clients (small investors) were also committed to the investment bankers.

Dolvin (2006)27 in his research work evaluated the commonly believed assumption

that underwriters had perfect foresight of the market and they made subjective

adjustments to estimated values in order to select a final offer price of the issue. The

48

underwriter’s ability to fix an appropriate offer price that reduced the under pricing to

zero would create maximum value to the issuer.

The researcher studied the offer price selected by underwriters relative to offer

price estimates using three valuation based approaches. The primary services rendered

by underwriters have been classified as legal and administrative, certification and

market building and the pricing of the issue.

The researcher, due to lack of a single method to value the equity security, has

discussed three methods for determining the offer price, that is, a full information

price that uses current and past information available at the time the offer price is

selected, the residual income mode, which is an accounting derivation of the standard

dividend discount model, and a standard price ratio forecast using all firms in the

same industry.

The study is based on a sample of 3,092 IPOs covering the period of 1990-

1998 in the United States. The average IPO offer price was found to be $ 38.89

million and the average initial return was 15.85%.

The researcher also examined the pricing ability of underwriters and found

that medium and high quality underwriters captured more value for issuers than the

lower quality underwriters. The researcher concluded that underwriters did create

value for the issuers and that the value captured increased with the quality of the

underwriter.

Mayur (2006)28 in his research paper examined the determinants of public issue

decision by the Indian companies. The study classified these determinants into two

categories. Company factors included age, size, risk, profitability, leverage and

growth of the company. Macro economic variables included interest rates, stock

market returns, stock market indices and liquidity.

The IPO sample, which was categorised into two groups (IPO sample and

Private sample) included all IPOs completed in Indian primary market from 1999 to

2005. Private sample included all those companies that were eligible to do an IPO but

remained private during the study period. The sample for the analysis consisted of 150

IPOs and 2000 private companies during the period under review.

The study found that company size, profitability, age and leverage were the

significant determinants regarding decision to go public. The study found strong

evidence that Indian IPOs had not been motivated by financial needs. The larger and

49

profitable companies were found more likely to go public. Leverage and age of the

company were found negatively related to the probability of IPO by the company. The

study further found that the cost of credit, cost of disclosure, owners’ diversification

desire, listing cost, liquidity and market timing were the factors influencing IPO

decision.

Pandey (2006)29 conducted a study to examine whether the IPOs at NSE were

underpriced and whether the degree of under pricing was influenced by the demand

for the IPO, delay in listing and the money spent on the marketing of the issue.

The period covered for the study was 26th March 2004 to 31st October 2006,

during which 121 companies came out for the public issue but only 55 IPOs were

selected for the study. The degree of under pricing was measured as the ratio of the

difference in closing price on the day of listing and offer price to the issue. The degree

of under pricing for the sample companies were found to be varying from -33.04% to

82.50% with a mean value of 22.62%, While fifteen IPOs were found to be

overpriced and 40 IPOs were underpriced on the day of listing. The researcher found

the reduction in the degree of under pricing in the Indian stock markets over the years

which is good for the firms as under pricing is an indirect cost to the firm. Demand

generated for the issue and the listing delay were found to be the major reasons for

under pricing while the effect of money spent on the marketing of the issue was

insignificant. The IPO average performance after one month of listing was found to

be negative as compared to the average return of one month of listing

Patil (2006)30 in his article analysed the IPO benami demat scam and exposed the

dubious means adopted by the scamsters in the IPOs of Yes Bank and IDFC Ltd. The

scamsters led by Roopalben Panchal opened thousands of fictitious/benami demat

accounts with Karvy Depository Participant (DP) and Pratik Stock Vision DP. These

benami demat accounts were used to corner the Yes Bank and IDFC Ltd. shares from

the retail category. Similarly the banks which opened fictitious accounts for scamsters

included Bharat Overseas Bank, HDFC Bank, Indian Overseas Bank, ING Vyasa

Bank and Vijay Bank.

The study found that Roopalben and Sugandh cornered a total of 11.44 lakh

shares (6.54% of the total) of Yes Bank IPO from 7630 benami demat accounts.

Similarly, Roopalben and three other persons received a total of 1.70 crore shares

from 43,982 fictitious demat accounts from the IPO of IDFC Ltd. These shares

50

accounted for 8.28% of total shares issued by IDFC. The off-market transfers were

done by the scamsters in the favour of other persons including financiers immediately

after allotment and before the shares were listed. SEBI and Depositories (NSDL and

CDSL) blamed each other for the failure to detect the fraud.

The author was of the view that such a scam could not have occurred without

the active connivance and collusion of some of the bank officials as well as the

depository participants. Even the role of the merchant bankers and registrar to the

issue had also come under the SEBI scanner for their failure to identify and weed out

benami applications. The author felt the need for stern and quick action by the SEBI

and RBI against the scamsters as it is a question of the confidence of the retail

investors and the health of the primary market.

Haldea (2006)31 in his article stated that booming of primary market was due to the

strong secondary market conditions. The author appreciated the major reforms in

primary market especially banning of discretionary allotment to Qualified

Institutional Buyers (QIBs), imposition of margin money for QIBs and the

introduction of ECS (instant credit of refunds to the bank account).

To further accelerate the primary market, the author stated eight measures for

the IPO reforms. These included the greater reservation in IPOs for small investors,

larger public offer as a percentage of company’s equity capital, simplification of IPO

process (simple application form), a coordinated effort between the Companies Act

and the DIP Guidelines of SEBI to arrive at the new disclosure standards and format

for small investors, monitoring the utilization of issue proceeds and compensation to

investors in case of IPO fraud.

The author suggested that PSU divestment should be resumed to increase the

investors’ base in the market and it should be reserved only for retail investors. The

author further stated that 50% portion of an IPO reserved for QIBs should be

auctioned and the balance portion of IPO should then be sold through fixed price

route to the retail investors. The fixed price could be the lowest of the QIB allotment

price or the average of the bottom five QIB allotment prices.

Sravana ( 2006)32 in his paper studied the SEBI plan to introduce voluntary grading

of IPOs on a five point scale in the wake of YES Bank and IDFC IPOs scams. IPO

grading is a service carried by SEBI registered credit rating agency aimed at

facilitating the assessment of equity issues offered to public. It is not a

51

recommendation for investment, but only one of the inputs for the investors to

consider the shares in their decision making process. It will enable the merchant

bankers to market a high rated IPO issues. The author while feeling the need for IPO

grading also raised the concern about the complex process of grading as also its

biasness and it being optional. The author recommended the regulator (SEBI) to

safeguard investors from the nexus between credit rating agencies and the merchant

bankers.

Saha (2006)33 in his paper reviewed the different aspects of book building process of

public issues and merchant banking activities relating to such process in the Indian

primary capital market. The author was of the view that though the merchant bankers

remained almost stagnant and stereotyped till the 1990s, they witnessed a remarkable

growth after the process of economic reforms and deregulation of the Indian economy

due to structural modifications, introduction of new mechanism and instruments and

adoption of a number of steps to safeguard the interest of investors through more

disclosures and transparency.

It was observed in the paper that in most of the public issues under book

building methods during 2003 to 2006, only a few merchant bankers performed their

activities as BRLMs. The issuing companies usually approached those merchant

bankers who had the reputation and a very good track record in the market. The paper

concluded that the reforming and restructuring of the economy had opened up several

opportunities as well as challenges for financial services industry including merchant

banking. Dynamic, strategic and vigorous merchant bankers are required to meet the

challenges with a view to improve the corporate finance and to establish a healthy

corporate environment.

Kumar (2007)34 in his research paper examined the efficiency of book building

pricing mechanism in Indian IPOs by considering both direct costs (issue

management expenses) and indirect costs (under pricing of IPOs).

The study covered the period from 2003 to 2007 and a sample of 208 IPOs

floated in Indian primary market (157 book building Issues and 51 fixed price issues)

was taken for the purpose of the study. To compare the cost of fixed price issues and

cost of book building issues, the variables used included the age of the firm, BRLM’s

reputation, concentration of share holding, market sentiment, size of the issue and the

volatility of the market.

52

The study found that fixed price method had been used by the companies with

smaller issue size and book building route had been preferred by issuer companies

with large issue size. The study further found that smaller sized fixed price issues

experienced more under pricing than the large sized issues. No difference in the

under pricing level was found between larger and smaller sized book building issues.

The average cost of fixed price offers and book building offers was found at

25% and 23.67% respectively. Overall total cost of small size fixed price offers had

been more than of large size issues. However, no difference was found in the total cost

of small and large sized book building issues. Analysis showed that the issue expenses

for smaller issues were lower than those for large issuers for fixed price offers,

whereas the smaller issues were more costly than large issues for book building

issues.

The regression results showed that the issues managed by syndicate with US

based lead managers did not fare better than those managed by Indian merchant

bankers on both counts, that is, total cost and under pricing level. Further, size of the

issue, listing delay and the reputation of the book runner lead manager were found to

be the important determinants for choosing the IPO issuing mechanism.

Barua (2008)35 in his paper stated the happenings in the secondary market, subprime

crisis and the slowdown of the US economy as the major reasons for withdrawal of a

number of IPOs in India. The author blamed the lead managers to the issue (Merchant

Bankers) for their poor professional judgment in pricing and advice to the issuer. The

author did not see any structural problem with the Indian primary market, however,

huge over subscription of issues, high premium in the grey market and the collapse of

the premium on the listing were described as the causes for manipulation in the

primary market by vested interests. Putting a band on the day of listing (as proposed

by SEBI) was not favoured by the author as it would lead to breakdown of the market.

The author recommended some measures to improve the functioning of the

primary market which included the removal of facility of part payment for the issue,

removal of funding applications, disallowing a company to enter the primary market

for one year if it had withdrawn the issue and putting on record in the public domain

of lead managers in terms of under and over pricing of issues.

Gopalswamy (2008)36 conducted research on IPO market in India with the purpose to

investigate empirically the difference in long period post issue performance of IPOs

53

that entered the primary issue market through fixed price and book building offers. A

sample of 50 IPOs listed at NSE out of 183 IPOs floated during the period 1999-2004

was taken for the purpose of study.

The researcher found that the fixed price offerings as compared to book

building gave high initial median and average returns during the second and third

years of listing. Average percentage returns of IPOs through fixed price route were

found at 39%, 39%, and 30% at the end of 1st, 2nd and 3rd year respectively. On the

other hand, average percentage return from Book Building IPOs was 48%, 30% and

24% respectively at the end of first, second and third year. Sector wise analysis

showed that boom phase sectors like IT and Pharmaceuticals yielded higher returns

than other sectors in the long run. The study further stated that during the initial years,

the returns were quite comparable irrespective of the method used for the issue of

shares. But the long run performance differed, to a great extent, depending upon the

method of pricing of the IPO. The study found that there was a tendency for the fixed

price issues that yielded initial positive returns to underperform in the later periods. In

the case of book built issues, the positive returns persisted during the later years also.

The researcher concluded that irrespective of the issue method followed, the

average short run returns did not differ significantly and a significant difference was

found in the long run performance of IPOs.

Krishnamurti (2008)37 in his paper examined the functioning of the grey market in

the Indian IPOs with the purpose to investigate the investors’ sentiments and after

market performance of IPOs. Grey market trading include trading (buying and selling)

applications for a fee and trading allocated shares through an IPO issue before they

list on stock exchange.

The data taken for analysis included 75 IPOs floated from May 1, 2007 to

December 31, 2008. The last grey market price to the listing day was taken for

analysis. Grey market premium (GMP) was measured as the ratio of grey market price

to offer price. The issues were classified as low GMP if the GMP on the day before

listing was below or equal to the median for the sample and other issues were termed

as issues with high GMP.

The researcher found that large size firms with more profits and asset value

per share enjoyed higher grey market premium. Grey market premium has also been

found to be directly proportionate to the issue size and reputation of the lead manager

54

to the issue. The paper further found that aftermarket returns started correcting sharply

from the listing day onwards when grey market prices were used as a base. The study

concluded that grey market prices were highly predictable and were related to the

subscription level of investors and initial listing returns were positively and

significantly related to grey market premium.

Khurshed (2008)38 examined the association between subscription pattern, offer

prices and the under pricing of book built IPOs in Indian capital market. The

researcher studied the subscription pattern of three different groups of investors viz,

qualified institutional buyers (QIB), non institutional investors and retail investors.

The under pricing of IPOs was examined by dividing it into two components, one

relating to pre listing which was set by the underwriter (Lead manager) and the other

from the post listing period determined by the market. The pre listing period has

further been split into two parts: the pre book building period immediately following

the road show at which time the price band was determined, and the mandatory book

building period where the pattern and timing of various investor groups were visible.

Subscription pattern of different groups of investors was studied on the day-to-day

basis for the period the issue remained open.

The sample for the study was the 239 IPOs floated by corporate bodies in

India through book building process during the period from March 1999 to March

2008. The study found that the subscription level of non institutional investors and

retail investors was significantly influenced by the subscription pattern of QIBs. Also,

higher the offer price within the band, the greater was the level of aftermarket under

pricing. The study further found that the non institutional buyers followed the lead of

QIBs in the pre listing period and not in the post listing period. In the post listing

period, the under pricing of IPOs was driven primarily by the unmet demand of the

non institutional buyers and retail buyers. QIBs were not found active to participate in

the aftermarket period. A high correlation was found between the after listing under

pricing and the demand from non institutional investors and retail investors and to a

lesser extent by the subscription level of QIBs. The researcher has concluded that the

transparency of the book building process in Indian IPO market helped in reducing or

removing the winners’ curse for the retail investors.

Shah (2008)39 in his article studied the effectiveness of price band based book

building method in pricing of IPOs. The author was of the view that getting IPOs

55

withdrawn by the issuers was part and parcel of any market due to the price mismatch

between buyers and sellers. The author has raised the issue of pricing process, pricing

range and lengthy IPO process to make the IPO process user friendly and efficient for

retail investors. For determining the fair valuation of the issue, the merchant bankers

have to play the role of trusted advisor and it should be based on ‘what the market

should bear’ instead of ‘what the market can bear.’

According to the author, this price lied between the price determined as per

CCI formula and through book building process. The author further suggested

increasing range for price band from 20% to 40% due to more market volatility and

minimizing the time gap between closure of subscription for issue and listing to just

over a week.

Gopalan (2009)40 in his paper studied the importance of public equity market in the

firm’s investments and growth in emerging economy of India. The sample period of

study was taken from 1992-2002. First half of the sample period ( 1992-96 ) was

specified as ‘hot market’ for equity market in India, when 1094 firms went public for

first time and more than 200 firms completed secondary equity offering (SEO). In

1997, both the IPO and SEO markets collapsed and remained relatively inactive till

2002. Only 81 firms in the sample floated IPOs during 1997-2002 compared to 1094

from the period 1992-96. Similarly, only 22 SEOs were completed after 1996 as

compared to 209 from 1992-96.

The study found that the public equity market in India expanded to finance

small and young firms. Firms that went public prior to the collapse were smaller (in

terms of total sales) and younger (as measured by age since incorporation) relative to

the average private firms in the sample. The decline in equity issues in India was

found due to collapse in investor’s confidence, decline in foreign capital inflows and

Asian financial crisis in 1997.

Post IPO performance of companies showed a significant growth in sales one

year after the IPO and continued to grow at the faster rate until about three years after

IPO. After the collapse of the equity issue market in 1997, only well established firms

with high investment were able to to go public, and the IPO market’s role as a source

of finance for small, young firms was diminished.

The study concluded that both public and private firms in India were adversely

affected by the collapse of the equity market, but small and young firms appeared

56

particularly sensitive in the absence of a strong IPO and SEO market. The study

further concluded that newly established public firms, non group firms, young firms,

firms with few intangible assets and with greater needs for external finance exhibited

more decline in growth, investment and profitability following the equity market’s

collapse.

Singh (2009)41 conducted a study on equity issues and investors protection in India by

studying the disclosure practices in the offer documents of issuing companies and

evaluating the role of merchant bankers in pricing the equity issues on the basis of

rate of return obtained by investors at different points of time. Based on a sample of

322 equity issues floated by corporate bodies during the period from 1992-93 to 2003-

04, the study found that IPOs issued at par performed better than IPOs issued at

premium at all points of time covered by the study. The study revealed that book

building was a better method in equity share pricing than the conventional fixed price

method as investors obtained positive return from more percentage of equity issues

than fixed price issues during the period under review.

The performance of merchant bankers was evaluated in the study by dividing

all merchant bankers into six groups on the basis of their involvement in the equity

issues. On the basis of percentage of equity issue handled by each group of merchant

bankers, the study found that non-bank private merchant bankers performed better

than other groups of merchant bankers as their services were availed by as many as

26% of issuers under study. Further, the study highlighted that the best performance,

on the basis of first day return, was provided by the public issues of equity shares

jointly managed by private sector banks and non bank private sector merchant

bankers. The study further revealed that the best performance was provided by issues

managed jointly by the financial Institutions and public sector banks, where positive

return to the investors was provided by 65% issues under study.

The study concluded that no group of merchant bankers could completely

check the problem of negative return during the period under study. It pointed out that

though there were numerous other factors which influenced the market performance

of equity shares on stock exchange, the role played by the merchant bankers left

behind many unanswered questions when negative return was linked to overpricing of

the issues.

57

2.2 Need for the Present Study Primary market in India is dynamic as it has a close relation with secondary

market fluctuations. Merchant banking, as an intermediary, plays a crucial role in the

development of primary market by exploring the ways and means for the mobilization

of funds. Merchant bankers ensure the success of an ‘issue’ by lending their expert

guidance and advice regarding the type of the issue, preparation of prospectus, timing

of issue, pricing of issue and allotment of shares etc.

The SEBI (Merchant Banking) Regulations as amended from time to time

introduced a number of reforms for more transparency in disclosure requirements in

offer documents, abolished different categories of merchant bankers by making it

compulsory to register only category 1 merchant banker and limited the area of

merchant banking to non fund activities only. The amendment in the Act also

introduced a good surveillance system and professionalism in merchant banking

resulting in non professional and fraudulent merchant bankers out of scene.

Introduction of free pricing of issues, institutionalization of investors (Mutual

Fund, FIIs etc.), requirements of high standards of integrity, fairness, transparency and

accountability have changed the role of merchant banking in India. Despite several

amendments and modifications in the SEBI regulations from time to time, it has been

found that several IPOs scams such as Yes Bank, IDFC etc. took place during the

period 1997 to 2006. These scams showed failures of the regulatory mechanism

system evolved so far.

Literature on capital market in India reveals that the share of capital market

securities in resource mobilisation has declined over the period and only a very small

proportion of population has been participating in the capital market. RBI statistics

showed that the share of financial savings of the household sector in securities has

gone down from 22.9% in 1991-92 to 2.9% in 1997-98, 1.7% in 2002-03 and 1.1% of

GDP in 2003-04 and 2004-05, though it showed a little bit improvement in the latter

years. The disenchantment of household sector with securities is also confirmed by

the SEBI-NCAER survey which found that only 2.8% investment of all households

were in securities during 1997-98, indicating low priority of investors for securities.

Another survey of SEBI-NCAER on Indian investors in June, 2002 reported that only

7.4% of Indian households invested in equity and debt issues either directly or

58

through mutual funds. The comparative figures for UK stood at 23%, for Canada

46%, Germany 18%, France 48%, Australia 50% and US market about 48%.

Similarly the participation of investors in the capital market, as judged from

the number of demat accounts, has been very small. The number of demat accounts

with the two depository services stood at only 99.00 lakhs as on December 31, 2006.

It further increased to 1.433 crore on December 31, 2008 and 1.45 crore as on March

31, 2009.This figure is just about one percent of the total population of the country.

This shows the lack of retail investors’ confidence in the primary capital market in

India and it is a big challenge to the merchant bankers in India.

It emerges from the review of literature that most of the studies in the field of

merchant banking are related prior to SEBI (Merchant Banking) Regulation

Amendment Act, 1997. Previous studies on the subject mostly concentrated on

evaluation of organization and management, and overall functioning of merchant

bankers, and rules and regulations relating thereto.

No research work has so far been conducted in India to study exclusively the

role of merchant bankers in the management of public issues. Merchant banking is a

statutory adviser to the issuer companies in all matters relating to the issue of capital.

So there is a need to analyze the growth, performance and role of merchant bankers in

the primary market in India as well as opportunities and challenges faced by them

especially in changing scenario of capital market after 1997. This has been an

unexplored area of research till date and hence the present study "Role of Merchant

Banking in Managing Public Issues-An Empirical Study with Special Reference to

Post 1997 Era" has been undertaken.

59

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