In its March Market Pulse, the NSE referenced a widely cited research paper by Supriya Katti, Edward R. Lawrence, and Mehul Raithatha, highlighting that factors such as IPO grading, pre-auction subscription rates, stock market analyst recommendations, grey market premium (GMP), and group affiliations can offer insights into a company’s potential. However, these indicators alone are not foolproof. The study pointed out that risk disclosures in IPO advertisements could serve as a strong indicator of a company’s quality. It also noted the differing risk perceptions of institutional and retail investors when investing in IPOs.
According to the NSE Economic Policy and Research team, which summarized the study, voluntary disclosure of information enhances investors’ perception of a company, thereby improving expectations about its future performance. Companies that provide more risk-related disclosures are often viewed as more credible by investors.
The study concluded that risk disclosures in IPO advertisements serve as a key signal of company quality. The findings suggest that firms making such disclosures tend to experience greater IPO underpricing, attract more institutional investors, and perform better after listing.
The research analyzed data from 155 Indian IPOs out of 278 issued between January 1, 2010, and January 31, 2021. It found that the average IPO underpricing in the sample was 11%, with an average issue size of ₹75 crore. Among the IPOs examined, 42% included risk disclosures in their advertisements. Companies that disclosed risks saw an average underpricing of 18.7%, compared to only 4.7% for those that did not.
Regression analysis revealed that firms disclosing risks experienced approximately 15% higher underpricing than those that did not. Additionally, institutional investors subscribed to shares 35.5 times the allocation for firms that disclosed risks, compared to 15.21 times for firms that did not. However, retail investors showed no significant difference in response, suggesting they may not view risk disclosures as a quality signal.
The NSE noted that high-quality firms confident in their future performance often signal their strength by underpricing their IPOs. The study hypothesized that greater IPO underpricing is likely when companies provide more risk disclosures, as these firms are better positioned to recover from initial losses once their performance becomes evident.
Post-listing performance, assessed using Return on Assets (ROA), Return on Equity (ROE), and Tobin’s Q, indicated that companies disclosing risks outperformed those that did not. This supports the argument that high-quality firms use risk disclosures as a credible indicator of their strength, which is later reflected in their market performance.
