underpricing of initial public offerings on african stock ...the paper provides empirical analyses...

Underpricing of Initial Public Offerings on African Stock

Markets: Ghana and NigeriaBy

Kofi A. OseiUniversity of Ghana

Business School

Charles K.D. AdjasiUniversity of Ghana

Business School

and

Eme U. FiawoyifeUniversity of Ghana

Business School

AERC Research Paper 257African Economic Research Consortium, Nairobi

July 2012

THIS RESEARCH STUDY was supported by a grant from the African Economic

-vidual members or the AERC Secretariat.

Published by: The African Economic Research Consortium P.O. Box 62882 – City Square Nairobi 00200, Kenya

Printed by: Modern Lithographic (K) Ltd P.O. Box 52810 – City Square Nairobi 00200, Kenya

ISBN 978-9966-023-34-6

© 2012, African Economic Research Consortium.

ContentsList of tablesAbstractAcknowledgements

1. Introduction 1

2. Institutional features of new issue markets in Ghana and Nigeria 4

3. Problem and motivation for study 6

4. Objectives of study 8

5. Literature review 9

6. Methodology 11

7. Conclusion 26 Notes 27

References 28

Appendix 32

List of tables1. Initial public offerings on the GSE, 1990–2006 72. Initial abnormal returns of IPOs in Ghana (per cent) 133. Initial and immediate after-market average abnormal return 144. After-market cumulative abnormal returns (unadjusted CAR) 145. Initial abnormal returns of IPOs in Nigeria (per cent) 156. IAR by industry in Nigeria (per cent) 157. Initial and immediate after-market average abnormal return (AARs) 158: After-market cumulative abnormal returns (CAR) 169. Year-by-year underpricing of Nigerian IPOs (1990–2006) 1710. BHAR for Ghana and Nigeria 1811. Normality test for robustness 1912. Average initial return for 33 countries worldwide 2113. Summary statistics of regression variables 2414. Correlation table 2415. Regression explaining IAR in Nigeria 25

Appendix: Nigeria IPO issues used in the study 32

List of figures1. CAR for Ghana after 90 days 142. CAR in Nigeria 90 days after IPO 163. Underpricing of IPOs by year 164. Underpricing, year and number of IPOs 175. Underpricing of underwriters by age 186. BHAR over 36 months in Ghana 197. BHAR over 36 months in Nigeria 20

AbstractThe paper provides empirical analyses of the initial and after-market short-run and long-run IPO returns on the Ghanaian and Nigerian stock markets over the period 1990 to 2006. The results show that the Ghanaian IPOs, on average, are underpriced on the initial trading day by 6.7% (market unadjusted) and 6.2% (market adjusted). In the case of Nigeria, the average underpricing is much higher at 43.3% and 43.1% for market unadjusted and market adjusted abnormal returns, respectively. There is evidence of three-year long-run underperformance as shown in the low mean buy and hold average return (BHAR) of 1.5% for the IPOs in Ghana and 0.6% for IPOs in Nigeria. Results from our regression model explaining initial abnormal returns for the IPOs of Nigeria show that size of firm and audit quality are important variables affecting underpricing. The results also show the presence of a non-linear relationship between the offer price and underpricing.

Key words: underpricing, IPO, abnormal returns, stock market, uncertainty, Africa

AcknowledgementsWe are grateful to Lemma Senbet, Chris Adam, Victor Murinde, as well as Machiko Nissanke, Leonce Ndikumana, Ernest Aryeetey and all the members of AERC Research Thematic Group C for helpful comments and suggestions.

Underpricing of initial pUblic offerings on african stock Markets: ghana and nigeria 1

1. Introduction

Initial public offerings (IPOs) are a means for firms to go public. IPOs offer opportunities for firms to diversify ownership, use stock markets as an exit strategy for mature businesses and raise funds for investment (Mudambi and Treichel, 2005).

In the case of younger firms, IPOs also serve as an early-stage financing option (Riding, 1998). One of the interesting anomalies in finance is the fact that IPOs provide significant abnormal returns on the initial day of trading (Khurshed and Mudambi, 2002). The abnormal returns from IPOs are a result of underpricing of IPOs. Underpricing occurs when the offer price of an IPO is significantly lower than the end of the first day’s trading price as well as trading prices for subsequent days.

There is a considerable amount of literature on the subject of underpricing of IPOs, particularly on common stocks. Existing studies on the topic include Reilly and Hatfield (1969), Neuberger and Hammond (1974), Bear and Curley (1975), Ibbotson (1975), and Reilly (1977) on the US market; and Merrit, Howe and Newbould (1967), Davis and Yeomans (1976), and Buckland, Herbert and Yeomans (1981) for the UK market. In Asia, studies include those by Dawson (1987), Dawson and Hiraki (1985), McGuinness (1992), Cullinane and Gong (2002), and Sullivan and Unite (1999). Studies on the anomaly have been documented in over 30 countries, as indicated by Loughran, Ritter and Rydqvist (1994) and Ritter (1998), as well as many others.

It is also argued that, although initial returns are high and positive, in the long run IPOs yield significantly negative abnormal returns, as can be seen in, e.g., Ritter (1991), Levis (1993), Loughran and Ritter (1995), and Espenlaub and Tonks (1998). Therefore, a satisfactory study of IPO performance would explain why IPOs are underpriced at issue, by introducing opening market price hikes as well as the slow dissipation of the initial abnormal gains over subsequent years.1

There are a number of explanations why IPOs are underpriced, of which the most common and most observed is adverse selection, which is due to information asymmetry problems. Information asymmetry exists among different investors as well as between the issuer and investors, which creates uncertainty about a firm’s value and, consequently, its IPO offer. In an attempt to solve information problems, IPOs are underpriced by investment banks to encourage investors to provide more information, as indicated by, e.g., Allen and Faulhaber (1989), and Chemmanur (1993). Underpricing, therefore, is an additional cost for issuers and a transfer of wealth to investors who buy the shares. IPO underpricing is a recurring phenomenon and African stock markets have not escaped it. Indeed, in Africa inefficiencies and information gaps on the markets could accentuate information asymmetry problems attributed to underpricing of IPOs.

Stock market activity in Africa has been growing steadily in the past decade. Plausible

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reasons for the growing development in stock markets in Africa are the potential contributions that stock markets make to firm financing, and to economic growth in general. Empirical literature on African stock markets shows that stock markets are important in financing firm growth. Mutenheri and Green (2003) found interesting differences among the various components of long-term finance. Equity financing was the most important source of long-term finance, at 7.8%. Long-term bank loans and bonds were each a very small component of total external financing. In South Africa, liabilities accounted for 61% of total financing and retained earnings, while external equity financed 21% and 18%, respectively, of total assets growth (Yartey, 2006). Furthermore, Yartey and Adjasi (2007) show that stock markets contribute to the financing of corporate investments, especially long-term external finance and, consequently, the growth of listed firms in Africa. The growth of stock market activity is crucial to financial development and the overall economic activity of an economy. The need to drive stock market activity is therefore vital for economic growth.

Megginson and Netter (2001) find that share issue privatizations (SIPs) played an important role in the growth of stock markets. They find that privatized firms are the most valuable companies in Japan, Britain, Germany, France, Italy, Spain, Australia, Mexico, Singapore and China, among others. The situation has been different in Africa. African governments owned the majority equity in over 80% of the enterprises in the respective African economies. Largely due to poor performance, most state-owned enterprises were privatized. In the early 1990s, liquidations were the most commonly used form of privatization, followed by competitive sales of shares. By the mid-1990s almost a third of all privatizations in Africa involved the sale of shares by competitive tender (Makonnen, 1999).

In Ghana, as many as 250 state enterprises were identified for privatization in the late 1980s and early 1990s. The Divestiture Implementation Committee (DIC) was set up and authorized to sell these state-owned enterprises (SOEs). With the exception of Ghana Commercial Bank, which was sold by share issue followed by listing on the Ghana Stock Exchange (GSE), the DIC mostly sold state enterprises outright to private investors. The situation is slightly different in Nigeria. Jerome (2008) indicates that between 1988 and 1993, 35 of the 55 firms privatized by the Technical Committee on Privatization and Commercialization (TCPC) were privatized through public offers on the stock exchange. Comparing the privatization of Ghana and Nigeria, one can say that the privatization of state enterprises in Nigeria helped the development of the Nigerian stock market in terms of stock market capitalization more than in the case of Ghana, as a considerable number of the divested firms ended up listed on the Nigeria Stock Exchange (NSE).

Senbet and Otchere (2009) also discuss the importance of stock markets in Africa concerning the potential retention of domestic capital, which is important in the midst of capital flight problems and volatility of external capital flows in Africa. Their policy prescriptions on the development of incentives for listing on stock exchanges and the strengthening of financial systems as measures to deepen stock market activity echo the findings by Senbet and Otchere (2006) on weak and malfunctioning banking systems as a deterrent to the growth of African stock markets. Empirical findings by Yartey and Adjasi (2007) and Senbet and Otchere (2009) also suggest that stock market development is positively associated with economic growth in Africa.


Other studies examined the development of African stock markets (Kenny and Moss, 1998), the efficiency of African stock markets (Dickinson and Muragu, 1994; Olowe, 1999; and Appiah-Kusi and Menya, 2003). There is also evidence of a growing integration of African markets with global capital markets, as exemplified by Lamba and Otchere (2001). Yartey (2007) also finds institutional quality to be an important determinant of stock market development in Africa.

Unfortunately, there is little research on African stock market IPOs. Existing studies include that of Page and Reyneke (1997) and Alli, Subrahmanyam, and Gleason (2010) on IPOs on the Johannesburg Stock Exchange in South Africa, and that of Chahine and Tohme (2009) on relationships between IPOs underpricing, CEO duality, and strategic ownership in 12 Arab countries of the Middle East and North Africa (MENA) region. More so, there is no study on IPOs on the relatively small and frontier stock markets in Sub-Saharan Africa. This study therefore attempts to examine the factors underlying IPOs on African stock markets. Two stock exchanges are chosen for this study: the GSE, and the NSE. These markets are chosen based on the availability of data on IPOs. In addition, these markets are significant African frontier markets.

The GSE was established in November 1990 with 11 listed companies. The number of listed equities gradually increased to 36 companies at the end of December 2008. The GSE all share index shows the market has been enjoying some rallying performances since 2002, a trend that has been attributed to low interest rates and a relatively good macroeconomic performance over the period. The NSE was established in 1960 and has over 300 listed companies. The all share market index of the Nigerian market has been performing very well since 1999. In both countries, the subject of IPO has gained considerable interest among investors.

The rest of the paper is structured as follows: the next section discusses institutional features of new issues in Ghana and Nigeria. Sections 3 and 4 provide the motivation and objectives of the paper, respectively, while the literature review is provided in Section 5. The methodology and empirical results are discussed and presented in Section 6, conclusions are drawn in Section 7 and the way forward for future studies is provided in Section 8.


2. Institutional features of new issue markets in Ghana and Nigeria

As this paper is focused on IPOs, it is most appropriate at this point to describe the processes which take place before IPOs are finally issued and, subsequently, listed on the various exchanges. We discuss these procedures to identify

structures or trends which might influence either the issuer’s or underwriter’s objective function. These discussions would also give an insight into the segmentation of markets.

The procedure for enlisting on the NSE is outlined in the Securities and Exchange Act No. 45 of 1999, and the Companies and Allied Matters Act of 1990. The enlisting company appoints an issuing house to design the instrument and raise funds through the sale of shares at a given price. Additionally, the issuing firm appoints reporting accountants, underwriters, trustees and solicitors. The prospectus is prepared by all parties involved, while three to five meetings are held to review the work done. The Securities and Exchange Commission then receives the offer document from the issuing house for review and, if satisfied, issues a letter confirming the registration of the securities. Again, a final meeting of the board is convened for all parties to witness the signing and onward submission of the documents.

The SEC gives approval to open the issue with application forms distributed by all banks. For public offers, 21 working days is given as closing time, while 28 days are allocated for the rights issue. The basis of allotment of the issue is prepared by the registrars, the issuing company and the issuing house. The proposal is submitted within six weeks of closure of offer by the issuing house. Moreover, the issuer receives its proceeds within 24–28 hours. The total cost of the issue does not exceed 10% of proceeds. The issuing house has five working days to publish the basis of allotment in at least two national daily newspapers. Surplus funds are remitted to subscribers who paid more than what was allotted to them. In addition, the registrar dispatches share certificates while a Declaration of Compliance is signed. The security is then listed on the exchange and a status report is required. Finally, an inspection of the utilization of the issue proceeds is conducted.

Nigeria has a detailed procedure for listing on the exchange. This might appear beneficial for the market and investor protection, especially as price setting would be done in a very detailed and comprehensive manner. However, this procedure might also influence IPO pricing in another way. A comprehensive time schedule for pricing might open more room for information asymmetry between the parties involved. Indeed, this may influence analysts and underwriters as well as issuers where their objective is to underprice, and to end up offering lower prices thereby resulting in underpricing of IPOs.

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A firm that decides to go public on the GSE has to approach a licensed dealing member (LDM) of the GSE and arrange the terms of financing with the LDM. A lead firm forms an underwriting syndicate comprised of other securities firms to share the marketing and distribution tasks. The issuing firm is required to prepare a prospectus which is filed with the GSE and the Securities and Exchange Commission (SEC). This document spells out how the proceeds from the share issue will be utilized. When the issue is sold and the share certificates distributed, the GSE gives approval for the securities to start trading on the GSE. Trading is carried out on the floor of the exchange with LDMs represented on the floor of the exchange by their authorized dealing officers (ADOs). All transactions on the floor of the exchange are made through an auction process to meet all buying orders at the least cost price and to sell orders at the highest selling price.

The GSE has a set of rules and regulations to govern its members. These include membership regulations of 1991;Legislative Instrument LI 1510, the listing regulations of 1990; LI 1509, listing rules for external companies, trading and settlement regulations; and securities clearing and settlement house rules, among others. These rules and regulations seek to govern its members’ code of conduct, qualifications, and ethics, among other things. The regulations governing requirements for sponsoring applicants and the sponsor’s responsibility are dealt with. The rules governing settlement procedure include, among other things, rules governing authorized dealers, and trading in approved securities.

The GSE has relatively short listing procedures. This may influence prices offered for an IPO in different ways. The relatively short procedures may leave little room for proper valuation, hence increasing the probability of underpricing. This could result in developments which would segment the primary market from the secondary market and introduce information asymmetry and the probability of underpricing. However, it is also plausible, and indeed more so, that the procedure leaves no room for information segmentation and asymmetry, and hence might reduce the probability of underpricing.


3. Problem and motivation for study

The floatation and listing cost on any exchange include the application and listing fees, valuation fees, advertising costs, cost of printing the prospectus, the registrar’s fee and many other costs. There are, therefore, considerable costs

associated with company floatation of shares and listing on an exchange. For example, floatation costs for the listing of Super Paper Products Company (in 1992) and Mechanical Lloyd Company (in 1994) on the GSE were 8.95% and 11.62% of the capital raised, respectively (Osei, 1998).

Underpricing represents a direct cost to the issuers of IPOs (Cullinane and Gong, 2002). If underpricing is an additional direct cost of floating shares, it means it could discourage companies to seek public listing through IPOs. Ghana has seen 21 IPOs from 1991 to 2006 (see Table 1 below). For the same period, about 200 IPOs were issued on the Nigerian stock market. Evidence shows that there are considerable price movements during the initial days of trading on these markets, as also observed in other markets. But how big are the price changes compared with other African markets, as well as with other nations? To what extent does underpricing as an additional direct cost reduce the benefit of public listing? What factors cause underpricing of IPOs in these markets, if it exists?

The motivation for this study is to find answers to the above questions, which will considerably increase our current knowledge of African stock markets. The study will especially be useful to academics, investors and issuing companies. The fact that not much research work has been done on the important topic of IPOs on African stock markets is an additional motivation for the study. In carrying out this study, we also hypothesize that information asymmetry problems are likely to be significant determinants of underpricing on African markets.

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Table 1: Initial public offerings on the GSE, 1990–2006Company Date Amount raised Comments % target (¢2 million) raised

Super Paper Product Dec 1991– Feb 1992 630.00 Undersubscribed 52.50 Company

Mechanical Lloyd Dec 1993 – Feb 1994 468.16 Undersubscribed 85.09 Company

Ashanti Goldfields March – April 1994 59,840.00 Oversubscribed 114.29 (1st local offer)

Ashanti Goldfields May – June 1994 2,815.10 Undersubscribed 12.55 (2nd local offer)

Home Finance Jan 1995 1,312.45 Oversubscribed 115.44 Company

Pioneer Aluminium May – July 1995 762.70 Fully subscribed 100.00 Factory

SSB Bank Sept – Oct 1995 12,020.50 Undersubscribed 70.37Aluworks Sept – Nov 1996 3,307.50 Undersubscribed 49.00

Ghana Commercial Feb – March 1996 34,219.24 Oversubscribed 138.26 Bank

Camelot Ghana 9 Aug – 20 Aug 1998 700.00 Fully subscribed 100.00 Limited

Produce Buying Dec 1999 – March 2000 192,000.00 Fully subscribed 100.00 Company

Sam Woode Limited March – April 2002 2,000.00 Fully subscribed 100.00

Cocoa Processing Sept – Nov 2002 134,605.00 Fully subscribed 100.00 Company

Clydestone March – April 2004 8,330.00 Oversubscribed 57.00

Benso Oil Palm June – July 2004 69,600.00 Oversubscribed 173.49 Plantation

CAL Bank Sept – Oct 2004 63,000.00 Oversubscribed 438.70Starwin Products 29 Oct – 26 Nov 2004 15,000.00 Oversubscribed 50.00Golden Web 7 June – 8 August 2005 550,000 Undersubscribed 58.60Ecobank 15 May – 2 June 2006 91,108 Fully subscribed 100Aryton Drugs 7 June – 7 July 2006 38,880 Fully subscribed 100Transol 31 Oct – 30 Nov 2006 22,660 Oversubscribed 113.3


4. Objectives of study

The main objectives of this study are to:

1. Determine if underpricing exists on the Ghanaian and Nigerian stock markets and evaluate the extent of underpricing of IPOs on these markets;2. Analyze the determinants of underpricing of IPOs for the Nigerian stock market;

and3. Examine the long run performance of IPOs on the Ghanaian and Nigerian stock

markets.

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5. Literature review

A plethora of studies exist on underpricing the IPOs of common stock. The consensus among academics is that IPOs are generally underpriced. However, there is no agreement as to the reasons why IPOs are underpriced. In the literature,

a number of reasons are offered to explain the underpricing anomaly. The different theories focus on various aspects of the relationship between the issuers, investors, and the investment banks that handle the IPOs.

Studies by Baron (1982); Beatty and Ritter (1986); and Rock (1986) and Tinic (1988) consider underpricing to be based on the information asymmetry hypothesis. The information asymmetry is assumed to exist among different investors (e.g., Rock, 1986) or between issuer and investors (e.g., Allen and Faulhaber, 1989; Chemmanur, 1993). In the case of the latter, it is suggested that, as an issuer of an IPO is in the capital market for the first time, there is uneven distribution of information about the issuing firm’s value as well as the demand for its shares among the issuing firms, investors and the investment bank handling the issue. Observers argue that underpricing of IPOs ensure full subscription of the new issue, thus reducing possible losses arising from ex ante uncertainty concerning an issuing firm’s value. Thus, the information asymmetry hypothesis postulates a positive relationship between the degree of underpricing and the level of ex ante uncertainty resulting from information asymmetry.

Rock (1986) indicates that information asymmetries could be between outside investors – the informed versus uninformed theory. Investors that have information about a firm’s prospects only participate in IPOs that are underpriced. this leads to a situation where the uninformed investors receive a disproportionate allocation of overpriced issues. Thus, issues that are persistently underpriced ensure uninformed investors participate in the new issues market and them earning a normal rate of return.

Mauer and Senbet (1992) also propose theories that explain underpricing. They observe that underpricing is a result of IPOs being traded in two separate markets, where one primary market has incomplete spanning and where a perfect substitute for a new issue in the other, secondary, market is absent. Therefore, underpricing even occurs in the absence of information asymmetry between parties involved in the issues. The underpricing of an IPO is the difference between an IPO's secondary market value and initial offer value and is due to a primary market risk premium. The primary market risk premium itself is a function of incomplete spanning of the initial issue by secondary market assets and the degree of investor access to the primary market. However, underpricing reduces as IPOs enter the secondary market place, because the degree of

9


incomplete spanning diminishes for subsequent IPOs with related technologies. The task of pricing a stock with no previous trading history is difficult for underwriters.

Corwin and Schultz (2005) report that “one underwriter offered that pricing an IPO is ‘part art and part science’”. This phenomenon poses potential problems for pricing of IPOs. Nonetheless, reputable underwriters are associated with less uncertainty and should reduce the probability of underpricing. However, indications are that this may not be the case. Indeed, it is argued that in their desire to hire seasoned underwriters, issuers become less concerned with the use of underwriters noted for excessive underpricing. This tendency among issuing firms, dubbed the analyst lust hypothesis by Loughran and Ritter (2004), can result in severe underpricing of IPOs. This hypothesis is supported by Cliff and Denis (2004) who contend that issuers could deliberately choose an underwriter with a highly ranked analyst in anticipation of excess money being left.

There are other theories which also explain underpricing; the theories may be grouped into topics such as the signalling, insurance premium hypothesis, control, lawsuits, or divergence opinion model. Some of these are discussed below.

Allen and Faulhaber (1989) indicate in their signalling model that the reputation of the offering firm is enhanced by the initial underpricing. The signal also enables the firm to return to the market in the future to raise additional funds. Baron and Holmstrom (1980) use a similar signalling model to establish whether investment bankers underprice new stock offers to enhance their reputation. Tinic (1988) uses the insurance premium hypothesis to explain underpricing of IPOs. He indicates that underpricing serves as an insurance premium to prevent any future legal liability which may arise for misrepresenting the value of an issue.

Other authors, e.g., Brennan and Franks (1995); Booth and Chua (1996); Zingales (1995); and Pagano, Panetta and Zingales (1998), hypothesize that the underpricing of new issues is a means for the owners to retain control of the firm. They explain that underpricing is likely to attract a large array of investors so that the new issue is sold to a dispersed group, which is not likely to threaten the control of the original owners. Tinic (1988), and Hughes and Thakor (1992) consider underpricing in their models as a method of minimizing the direct and indirect cost associated with lawsuits. They indicate that the likelihood of a big judgement, should issuers or their underwriters be found negligent in any of the steps of going public, is minimized if the issue is sufficiently underpriced.

There is also evidence to show that governments can use privatization for rent-seeking purposes or to signal firm commitment for good future performance of privatized enterprises (Jones et al., 1999). A committed government is more likely to value the benefits of privatization over lost proceeds than a populist government would. Underpricing could, therefore, be low under a populist government because it knows the potentially offsetting economic benefits will never materialize due to a lack of commitment (Jones et al., 1999).

Finally, it is important to note that the use of either private placement or public offering for listing on exchanges differ based on firm characteristics. Goergen et al. (2006) suggest that a firm’s decision to use either an offer or placing a contract depends on firm characteristics, the quality of the underwriter, availability of venture capital financing and the extent of the free float. Goergen et al. (2006) also show that there is some evidence, albeit weak, that underwriters prefer placement to public offering and are likely to promote private placement for firms going public.


6. Methodology

Data

Data for the study consist mainly of secondary data on IPOs introduced on the stock exchanges in Ghana and Nigeria from 1990 to 2006. We obtained data for 21 IPOs

issued on the GSE within the period, and 125 IPOs on the Nigerian exchange. In the case of Nigeria, the sampled IPOs are further reduced to 80 due to data inconsistencies with regards to some firms as well as the delisting of other firms. For the regression analysis, the Nigerian data for IPOs was further streamlined by removing firms with incomplete information.

Data on IPOs and firm specific characteristics as well as share prices for the listed firms were obtained from the Ghana and Nigerian Stock Exchanges, and from the Ghana and Nigeria Securities and Exchange Commissions.

Underpricing

We test for IPO underpricing by calculating the initial day return on stock i as Ri:

Ri =P1 - P0

P0 (1)

where Ri = total return at the close of the first trading day; P1 = the price of the stock at the close of the first trading day; P0 = the offer price of the IPO. A positive return indicates underpricing.

We find the average first day return ( R ) for n IPOs as

n

i = 1

( R ) = ∑ Ri 1

n (2)

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We calculate the return on the market index as Rm

Rm1 =SE1 - SE

0

SE0

(3)

where Rm1 = return on a share index (Ghana and Nigeria) at the end of the first day of trading the IPO.

SE1 = share index value (GSE, NSE) at the end of the first day of trading SE0 = Index value (i.e. GSE, NSE) at the close of the day before the introduction of an IPO.

We define ARi as the abnormal market-adjusted first day return of stock i as

ARit = Rit - Rmt (4)

We define AR as the initial day abnormal (market-adjusted) return of a cross section of n IPOs on an exchange as

n

i = 1

AR = ∑ ARi 1

n (5)

We also define the cumulative abnormal returns CARi,s,e for IPO i from the day of issue s to the end date, e, as the average difference between the cumulative returns obtained by investors acquiring a particular IPO against the cumulative returns of the corresponding reference portfolio during the same period:

e

t = s

CARi,s,e = ∑ ARit (6)

In studying the long-run performance of IPOs no particular length of post-event window is suggested by theory. Existing research on long-term returns usually follows the IPOs for three or five years after issuance. In computing the long-run performance we use buy and hold returns (BHAR), following Lyon et al. (1999). BHARs are used to determine whether or not investors earn abnormal stock returns by holding stocks over a particular time horizon. The BHAR method calculates after-market performance over the long run (three-year period) for each individual IPO and its corresponding reference portfolio, without any portfolio rebalancing. Due to the absence of the pre-event window data it is difficult to measure systemic risk in the pre-event window. Therefore, in this study, we have not adjusted the monthly abnormal returns for systematic risk. The buy and hold return for firm i is:

BHARiT = >∏(1 + ARit) - 1HT

t = 1 (7)


where t is the date of the first post-issue closing price; T is the end of the three-year window.

The mean abnormal return buy and hold return is computed as:

Mean 1

nBHART = ∑ BHARiT

n

i = 1

(8)

where n is the number of issuing firms

MeanBHAR

σ(BHARiT ) / √ nt = (9)

where σ(BHARiT ) / √ n = standard error of MeanBHART

Empirical results

Initial and after-market performance of IPOs on the Ghana Stock Exchange

The initial unadjusted and adjusted market abnormal returns and the IPO statistics are reported in Table 2 below. Also, the immediate after-market abnormal returns and the cumulative abnormal returns from two to 90 days are computed and reported in Tables 3 and 4. The results show an average initial abnormal return (market unadjusted and market adjusted) of IPOs in Ghana as 6.75% and 6.21%, respectively. The median, maximum and minimum IPO return, both unadjusted and adjusted, are also shown in Table 2. The highest IPO underpricing of 25% experienced by CAL Bank can be explained by the high oversubscription of 438.7% (see Table 1). This means investors who were under-allotted during the floatation of shares had to satisfy themselves with additional demand when the stock started trading on the exchange, thus pushing the price drastically up on the initial days following stock trading on the GSE.

Table 2: Initial abnormal returns of IPOs in Ghana (per cent)Statistics IAR (market unadjusted) IAR (market adjusted)

Mean 6.746 6.206Median 5 4.989Maximum 25. 25.19Minimum 0.00 -0.37Standard deviation 5.96 5.91


Table 3 shows the IPO returns after the first day of trading. These are aftermath daily returns (non-market adjusted) for the first eight days after the stock starts trading. The analysis shows that there is a drastic fall in returns in the days following the first day of IPO trading. By the end of the second day, about 85% of the initial abnormal profit is eroded. At the end of one week of trading, about 97% of the abnormal returns associated with listing are completely wiped out.

Table 3: Initial and immediate after-market average abnormal return IAR MIAR Day 1 Day 2 Day 3 Day 4 Day 5 Day 6 Day 7 Day 8

6.746 6.206 1.065 1.417 1.120 1.697 1.665 0.441 0.194 0.292

Note: MIAR is the market-adjusted IAR

The cumulative abnormal average returns (CAR) analysis in Table 4 is from the second day to the 90th day. The analysis is depicted in Figure 1. The figure shows increasing returns up to one week or so, after which the increases in the abnormal returns increase at a decreasing rate until about the end of the first month. Thereafter, the CAR flattens and starts dropping downwards by the end of the second month after listing on the GSE.

Table 4: After-market cumulative abnormal returns (unadjusted CAR) (2- (3- (4- (5- (6- (7- (2 (21- (30- (60- (90-day) day) day) day) day) day) weeks) day) day) day) day)

7.811 9.227 10.099 11.574 12.695 14.392 18.263 18.633 20.13 21.983 20.511

Figure 1: CAR for Ghana after 90 days

0

0.05

0.1

0.15

0.2

0.25

IPO

Day

Day

4D

ay8

Day

12D

ay16

Day

20D

ay24

Day

28D

ay32

Day

36D

ay40

Day

44D

ay48

Day

52D

ay56

Day

60D

ay64

Day

68D

ay72

Day

76D

ay80

Day

84D

ay88

CAR

CAR


Initial and after-market performance of IPOs on the Nigeria Stock Exchange

The IPO analysis for Nigeria is carried out using 80 companies which issued unseasoned IPOs during the period 1990 to 2006. These companies are further broken down into four industries, namely oil and mining, banking, finance houses, and other sectors.3 Table 5 shows that the mean underpricing on the Nigerian stock market is about 43.28%, with the median value being 4.99%. Clearly, the wide deviations from the mean are indicative of severe outliers in underpricing across the sample. Industry trends of IAR (Table 6) show that the highest average abnormal returns are recorded with issues in the oil-mining sector, at 69.4%. On the whole, the maximum initial large one-day return of 691.67% is attributable to the abnormal return from the IPO offer of the Law Union and Rock Insurance. Indeed, the maximum initial one-day return for the other industries in Nigeria (522%, 532% and 309%, respectively) are equally high compared to figures in Ghana. Median abnormal returns show 13.21% underpricing in the oil-mining industry, while underpricing in the other sectors record median underpricing of less than 10%.

Table 5: Initial abnormal returns of IPOs in Nigeria (per cent)Statistics IAR (unadjusted) IAR (market adjusted)

Mean underpricing 43.28 43.12Median 5.00 4.99Maximum 691.67 691.41Minimum -99.00 -99.02Standard deviation 125.26 125.23

Table 6: IAR by industry in Nigeria (per cent) Observations Mean Median Std. dev Min Max

Oil mining 8 69.4 13.21 184.6 -42.5 522Banks 28 44.1 5 107 -37 532Finance houses 23 59.6 5 156 -65 692Other 21 14.4 3.3 79 -99 309

Similar to Ghana, there is a sharp drop in abnormal returns in the days immediately following the first day of trading. In the first day following the introduction of the IPO, there is a drastic fall in return of about 98%, and by the end of the first week almost all the underpricing is removed, as shown in Table 7. The CAR analysis is shown in Table 8 and Figure 2. The figure shows that after the initial high IPO returns, cumulative market returns continue to increase but at a drastically decreasing rate. By the 37th day the average growth of cumulative return is almost zero.

Table 7: Initial and immediate after-market average abnormal return (AARs) MIAR Day 1 Day 2 Day 3 Day 4 Day 5 Day 6 Day 7 Day 8

Mean 43.12 1.121 0.893 0.008 3.076 0.562 0.609 -0.215 1.480Median 4.99 2.50 2.49 2.47 2.47 2.44 2.46 2.33 2.43


Table 8: After-market cumulative abnormal returns (CAR)(2- (3- (4- (5- (6- (7- (2 (21- (30- (60- (90-day) day) day) day) day) day) week) day) day) day) day)

44.401 45.294 43.302 48.379 48.942 49.551 53.304 55.136 57.84 58.6363 59.648

Figure 2: CAR in Nigeria 90 days after IPO

A sub-period analysis (Figure 3 and Table 9) of the IAR from IPOs issued on the NSE in the indicated periods could help to reveal interesting patterns.

Figure 3: Underpricing of IPOs by year

-100%

-50%

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19

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91

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IAR

(%) MedianMIAR

MeanMIAR

010203040506070

IPO

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ay8

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ay16

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ay24

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ay56

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ay64

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ay72

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ay80

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84D

ay88

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CAR


Table 9: Year-by-year underpricing of Nigerian IPOs (1990–2006)Year Median MIAR Mean MIAR Standard deviation No of IPOS

1990 38% 104% 2.073 171991 8% 4% 0.469 71992 -54% 11993 6% 59% 1.029 101994 6% 9% 0.083 31995 0% -10% 0.526 51996 19% 43% 0.555 31997 11% 11% 0.744 21998 0% 7% 0.130 51999 0% 14% 0.674 52002 0% 0% 0.007 32003 3% 3% 0.027 42004 0% -1% 0.060 52005 59% 164% 2.489 42006 75% 68% 0.611 3

The highest mean abnormal returns, at 164%, occurred in 2005. However, the highest median underpricing occurs in 2006 (75%). It is clear that in the period from 2005 onwards the highest underpricing was recorded on the NSE. The underpricing was largely concentrated in firms in the financial sector. During that period, seven IPOs made up of four banks, two investment houses and one oil-related firm were issued. The initial year, 1990, also recorded some high and appreciable underpricing at a mean of 104% and a median of 38%. Incidentally, that period also recorded the highest number of IPOs issued (Figure 4). Although there were fewer IPOs for the period 2005–2006, this period also recorded the highest median underpricing.

Figure 4: Underpricing, year and number of IPOs

-10.0000.00010.00020.00030.00040.00050.00060.00070.00080.000

02468

1012141618

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R (%

)

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of IP

Os

no IPOS MedianMIAR


The possibility of the analyst lust hypothesis, or money-on-the-table phenomenon, is examined in Figure 5. A casual inspection of the figure appears to reveal no trend in the relationship between reputation measured by age of underwriters and the level of underwriting. Indeed, it appears that underwriting is high among younger underwriting firms as well as older ones. However, upon a closer inspection one can discern a trend, median underpricing, which tends to increase in firms that have been established for 16 years or more. This trend is indicative of issuers either preferring to opt for more reputable underwriters known for helping issuers gain large proceeds, or underwriters leaving money on the table for obvious reasons.

Figure 5: Underpricing of underwriters by age

Long-run performance of IPOs issued on Ghana and Nigeria stock markets

The long-run performance of IPOs, as computed by the BHAR over three years, is presented in Table 10. In line with the theory and empirical hypothesis there is evidence of long-run underperformance as shown in the low mean BHAR. The BHAR for Nigeria is 0.6%, as well as for the IPOs in Nigeria, and 1.5% for the IPOs in Ghana. Therefore, it is evident that after entering the secondary market the information asymmetries arising from signalling theories and market segmentation dissipate and the abnormal initial returns reduce significantly. The mean BHAR for Nigeria is not statistically different from zero as shown by the test values and probability of significance level of both the parametric t test and the non parametric z test (Wilcoxon).

-200%

-100%

0%

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700%

800%

1 5 6 7 9 10 10 11 12 13 14 14 15 16 18 19 20 20 21 23 25 32 34 4069

.57

MIAR


Table 10: BHAR for Ghana and NigeriaVariable Mean T test Std. Error Wilcoxon

BHAR Nigeria 0.0065 1.99(0.2386) 0.00549 1.0 (0.2714)BHAR Ghana 0.0154 2.247(0.0312) 0.00686 1.848(0.0646)

The t test is a test of mean BHAR=0, figures in parenthesis represent probability of t-value

However, given that the returns could be non–normal, a normality test is run on BHAR for Nigeria and Ghana to check for robustness. The results of the normality test displayed in Table 11 indicate that BHAR for Nigeria is normally distributed, while that for Ghana is not. We therefore adjust the sample for Ghana by omitting outliers and testing for normality again. Results then indicate a normally distributed BHAR with a mean of 0.0033 for Ghana. When a new mean test for BHAR is run for Ghana, a t-value of 0.1078 is obtained, indicating that BHAR for Ghana is not statistically significant from zero.

Table 11: Normality test for robustnessVariable Pr(Skewness) Pr(Kurtosis) adj chi2(2) Prob>chi2

BHAR Nigeria 0.942 0.310 1.09 0.5793BHAR Ghana 0.000 0.001 21.64 0.0000BHAR Ghana – adjusted sample 0.694 0.267 1.50 0.4733

Figure 6 shows the trend in the long-run performance of IPOs issued on the GSE. The figure shows that, over a long period, the abnormal initial returns gradually dissipate. Figure 7 shows the trend in the long-run performance of IPOs issued on the NSE. The trend is similar to that of Ghana’s BHAR. Most importantly, all huge abnormal gains made in the initial IPO aftermath periods are reduced substantially.

Figure 6: BHAR over 36 months in Ghana


We also examine whether IPO performance differs according to the age of the firm, as noted by Jenkinson and Ljungqvist (2001). We therefore categorize the firms as either old (firms older than or equal to the median age) or new (firms below the median sample age). In Ghana, the mean BHAR for older firms is higher (4.2%) than for younger firms (2%), while in Nigeria the mean BHAR for older firms is lower (0.5%) than for younger firms (0.7%).

Figure 7: BHAR over 36 months in Nigeria

One can, therefore, not identify a discerning pattern in terms of age, however, it appears that more established firms in Ghana outperform their younger counterparts in the long run after the IPO issue. We must also add a caveat: the test4 between the two groups (old and young) for each country were insignificant in terms of the mean BHAR differences.

Comparison of IPO results of Ghana and Nigeria

Interesting trends emanate from the analysis so far. While median underpricing is almost similar in Nigeria and Ghana (4.99% and 4.98%, respectively), mean underpricing is

extremely high in Nigeria when compared to Ghana. When juxtaposed with the pricing of IPOs in both countries, the theoretical constructs reviewed earlier could explain the large difference between underpricing in Ghana and Nigeria. Specifically, segmented markets and incomplete spanning, uncertainty and information asymmetry, and an underwriters’ effect could explain the difference in underpricing in both countries. It can be said that uncertainty surrounding issuing firms and the segmented hypothesis would hold for underpricing in both markets. The procedure for listing in Nigeria could also create more room for speculation and uncertainty surrounding the valuation of stocks, and further build-up of an underwriting tendency.

In addition, an informal conversation by one of the researchers in this study with a senior analyst in an investment house revealed an interesting phenomenon. According


to the analyst, they are sometimes under immense pressure from some issuers to ensure that the IPO is successful –for large volumes that are largely oversubscribed. Analysts are therefore tempted to leave money on the table to satisfy issuers and for future purposes. Furthermore, some analysts believe that some investors obtain information on issuing firms privately and participate aggressively only in underpriced stocks.

However, the long listing requirements in Nigeria appear to create the opportunity to leave money on the table. Hence, there may be room for further adjustment of prices from the perspective of the underwriter, and this may be higher the more experienced the underwriter. Indeed, it appears that underpricing rises with the age reputation of underwriters in Nigeria. Although a few high underpricings with younger underwriting firms were recorded, it appears that most of the highest underpricing events occurred with the older underwriting firms.

Comparison of IPO results with other studies of the world

Table 12 shows the results of similar studies from around the world compiled by Ritter. It may be inferred that Ghana is among countries with very low IPO underpricing.

Indeed, most IPO abnormal returns from countries in Europe, Asia and Latin America have initial IPO returns far exceeding the 6.2% of the GSE.

Table 12: Average initial return for 33 countries worldwideCountry Author(s) of article(s) Sample size Time period Average initial return (%)

Australia Lee, Taylor & Walter 266 1976–89 11.9Austria Aussenegg 67 1964–96 6.5Belgium Roggiers et al. 28 1984–90 10.1Brazil Aggarwal et al. 62 1979–90 78.5Canada Jog et al. 258 1971–92 5.4Chile Aggarwal et al. 19 1982–90 16.3China Datar and Mao 226 1990–96 388Denmark Bisgard 32 1989–97 7.7Finland Keloharju 85 1984–92 9.6France Husson et al. 187 1983–92 4.2Germany Ljungqvist 170 1978–92 10.9Greece Kazantzis and Levis 79 1987–91 48.5Hong Kong McGuinness et al. 334 1980–96 15.9India Krishnamurti and Kumar 98 1992–93 35.3Israel Kandel et al. 28 1993–94 4.5Italy Cherubini and Ratti 75 1985–91 27.1Japan Fakuda et al. 975 1970–96 24.0Korea Dhatt, Kim and Lim 347 1980–90 78.1Malaysia Isa 132 1980–91 80.3Mexico Aggarwal et al. 37 1987–90 33.0Netherlands Wessels et al. 72 1982–91 7.2New Zealand Vos & Cheung 149 1979–91 28.8Norway Emilsen et al. 68 1984–96 12.5Portugal Alpalhao 62 1986–87 54.4Singapore Lee et al. 128 1973–92 31.4Spain Rahnema et al. 71 1985–90 35.0


Sweden Rydqvist 251 1980–94 34.1Switzerland Kunz and Aggarwal 42 1983–89 35.8Taiwan Chen 168 1971–90 45.0Thailand Wethyavivorn & Koo-Smith 32 1988–89 58.1Turkey Kiymaz 138 1990–95 13.6UK Dimson, Levis 2,133 1959–90 12.0USA Ibbotson, Sindelar & Ritter 13,308 1960–96 15.8

Ritter et al., 1998

The Nigerian figure of 43% is relatively higher and comparable with figures from around the world. It is important to caution that the results of these studies are from periods much earlier than those of Ghana and Nigeria, hence making the comparison somewhat difficult. In the next section we find empirical factors that determine underpricing on the Nigerian stock market.

Determinants of underpricing

In the empirical literature, the variables employed in regressions to explain underpricing of IPOs include: underwriter prestige, firm age, gross proceeds of the offer, use for

the proceeds, the number of risk factors listed in the prospectus, and the prestige of the auditors of the issue. Other variables include the percentage of ownership retained by the original owners, whether the prospectus indicates an earnings forecast, the standard deviation of returns in the aftermarket, and whether the underwriting of the issue is made on a firm commitment or based on best efforts. In most regression analyses, the explanatory variables may be further categorized into measures of ex ante uncertainty, measures of advising agent quality (prestige), measures of intrinsic firm value, incidence of secondary market issues, and market state variables.

Following the standard empirics in explaining initial abnormal returns in IPOs, for the Nigerian sample we estimate a regression model of the form:

IARj = α1 + α2Offpj + α2Ofpj2 + α3Agej + α4Size + α5PVolj +

α6Audj + α7Pv + α8U.writej + ηj (10)

where IARj underpricing of issue j; Offp = log of IPO offer price; Age = operating history of the issuing firm computed as log (1 + age); P.Vol = price volatility is the conditional standard deviation computed from a GARCH (1,1)5 estimation of daily returns for each issuing firm measured over the 60 trading days subsequent to the first day of trading; Size log of total assets; proxy measure of the firm’s reputation and is a dummy variable constructed to reflect whether the auditor of the firm has international or local accreditation. Aud = An audit firm with international accreditation is coded as 1 while firms without international accreditation are coded as 0. An underwriter’s reputation U.write is measured as log (1 + age of underwriting firm). This proxy is used in the absence of a ranking of underwriters in most African countries. Pv is a dummy variable


to capture privatization and is coded as 1 if the firm’s IPO was based on a privatization deal, and 0 if not.

In identifying the explanatory variables for the regression, we consider the theoretical underpinnings of underpricing of an IPO within the context of an African stock market. In this regard, the main reason for underpricing in African markets would be the information asymmetry problems stemming from uncertainties surrounding firms in Africa and the possibility of underwriters’ effect. Therefore, minimizing the level of uncertainty would lead to a minimization of the level of underpricing. Therefore, the selected variables capture the ex ante uncertainty measures which result in information asymmetry and underpricing, which are discussed in turn.

Offer price Studies suggest that offer price is a proxy for uncertainty about value and the total information costs incurred to achieve secondary-market liquidity (Booth and Chua, 1996 and Benveniste and Spindt, 1989). Therefore, as the offer price increases, it signals less uncertainty and the expected level of underpricing should decrease. Costs tend to be high for issues with a low offer price, and hence, increase the expected level of underpricing. Jain and Kini (1999) also argue that a low offer price may indicate little demand, little value, or both, and are associated with lower short-term performance. More importantly, a non-linear relationship between underpricing and the offer price has also been observed (Fernando, Krishnamurthy, and Spindt, 2004 and Wang and Ligou 2009). Therefore, we include both the offer price and its squared term to capture these effects.

Age This measures the operating history of the firm prior to going public and is a proxy for ex ante uncertainty. Older firms should exhibit lower ex ante uncertainty compared to younger firms. Therefore, we expect a negative relationship between age and underpricing.

Size This measures the possibility that underpricing may be higher in smaller firms than in large firms.

Price volatility Another explanation for the underpricing of IPOs is that issuers anticipate investors’ “ex ante uncertainty” regarding the future performance of IPOs (Ritter, 1984 and Beatty and Ritter, 1986). Furthermore, in an attempt to minimize the probability of unsuccessful IPOs, issuers lower prices when they perceive future price volatility to be high. Thus, underpricing might be required to convince uninformed investors to buy. The greater the ex ante uncertainty, the greater the underpricing needed to attract buyers. Underpricing is expected to have a positive relationship with volatility.

Auditors A firm using an internationally accredited auditing firm would have a good reputation and, therefore, reduce underpricing as compared to a firm using a relatively unknown audit firm.


Privatization This follows the works of Jones et al. (1999) and captures the effect of privatization on underpricing. Rent-seeking behaviours by political authorities are stronger in privatizations and may influence the extent of underpricing.

Underwriter This captures the fact that reputable underwriters with top analysts may be tempted to underprice to leave money on the table as per the analyst lust hypothesis of Loughran and Ritter (2004).

Empirical results from regression

Summary statistics of the variables and a correlation table of the variables are displayed in Tables 13 and 14, respectively. The data are first cleaned to omit severe outliers.

Furthermore , firms with missing data for variables other than for the regression analysis were also omitted, reducing the final sample to 55.

Table 13: Summary statistics of regression variables Mean Std. dev Min Max

Cond. std. dev daily returns 0.0867 0.0994 0 0.4968Assets (Naira) 3.10e+07 1.25e+08 242.48 8.18e+08Offer price 3.69 16.662 0.25 150.00IAR 0.4327 1.249 -0.99 6.92Age of issuing firm 17.75 11.55 1.00 69.57Age of underwriting firm 15.405 11.493 0.4 58

Table 14: Correlation table Offer price Age Size Price Age of volatility underwriter

Offer price 1.00 Age 0.1582 1.00 Size 0.0793 -0.0717 1.00 Price volatility 0.0946 -0.0775 0.2415 1.00 Age of underwriter -0.2365 0.1056 -0.0677 0.0567 1.00

Results for the IAR regression are displayed in column 1 of Table 15. In line with theory and empirics, the offer price is negatively and significantly related to underpricing. A higher offer price sends signals of low uncertainty surrounding the firm and lower information cost for the firm to attain secondary market liquidity. Hence, an increase in the offer price consequently decreases the level of underpricing. Again, in line with recent theoretical postulations by Fernando, Krishnamurthy, and Spindt (2004), and Wang and Ligou (2009), the empirical evidence shows a nonlinear relationship between underpricing and the offer price.

Interestingly underpricing is positively correlated to firm size. Our results also reveal that underpricing tends to be high with the use of auditing firms with international accreditation. Thus, acquiring international accreditation may not necessarily reflect good quality auditing that should reduce underpricing. However, it is likely to be the


case that good quality auditors may also be working mostly with larger firms.6 In this case, underpricing may reduce with quality auditing in larger firms. Therefore, we explore the interactive relation between the quality of auditing firms and firm size. Our results confirm that underpricing is reduced significantly when the quality of auditing is interacted with size. In this case, underpricing is also reduced among larger firms as they use quality auditors.

Table 15: Regression explaining IAR in NigeriaVariable (1) (2)

Offer price -0.382 (-4.53)***

Offer price squared 0.160 (2.86)***

Age 0.015 0.022 (0.22) (0.25)

Size 0.079 0.072 (3.24)*** (2.25)**

Price volatility -0.941 -1.496 (-0.74) (-0.89

Underwriter -0.030 0.017 (-0.68) (0.31)

Privatization 0.029 -0.046 (0.26) (-0.31)

Audit 0.717 0.758 (3.00)*** (2.42)**

Audit *size -0.047 -0.053 (-2.78)*** (-2.37)**

Constant -0.398 -0.471 (-1.62) (-1.43)

Adj R-squared (%) 53.02 3.47F(.) 4.094 1.84Prob > F 0.000 0.96Root MSE 0.6003 0.4711Observations 55 55

**, *** indicate 5% and 1% level of significance, respectively

Finally we acknowledge that, although useful, the inclusion of the offer price might introduce some bias in the regression as there is already information on the offer price in the dependant variable (IAR). Hence, we re-estimate the regression without inclusion of the offer price and its squared term for robustness. The results of this regression are shown in column 2 of Table 15. The results do not change much. Size and audit quality continue to be the most significant predictors of underpricing. However, we notice the poor quality of this regression as shown by the insignificance of the overall F test and the reduction in the adjusted R-squared from 53.02% to 3.47%.


7. Conclusion

This study discussed theoretical issues on IPO underpricing in industrial and emerging markets and, subsequently, examined the empirics of underpricing in two frontier African stock markets, Ghana and Nigeria. The results show that, in

line with other studies, underpricing is larger on the initial day after the IPO is issued and then declines gradually, as seen in the CAR for subsequent periods. The results show an average initial return and market-adjusted abnormal returns of IPOs in Ghana as 6.75% and 6.21%, respectively. The mean initial abnormal return for Nigeria (43%) is much higher than that of Ghana. This shows that some investors made huge abnormal gains from IPOs in Nigeria.

We also examine the long-run performance of issued IPOs to discover if, as theory suggests, there is significant underperformance of IPOs in the long run. In line with theoretical and empirical postulations, there is evidence of long-run underperformance as shown in the low mean BHAR. The BHAR is 0.6% for the IPOs in Nigeria, and 1.5% for IPOs in Ghana. It is evident that after entering the secondary market the information asymmetries arising from signalling theories and market segmentation dissipate, and the abnormal initial returns reduce significantly.

An empirical model to explain the determinants of underpricing is estimated for Nigeria. Information asymmetry and its associated uncertainty plus the signalling theory are the underlying causes of IPO underpricing in the Nigerian market. Our results for IPOs on the Nigerian Stock Exchange largely follow that of other studies on emerging markets as well as industrial markets. Consistent with theory and empirical studies, there is a non-linear relationship between the offer price and underpricing. Finally, our results reveal that it is important that auditing firms improve their auditing and local accounting standards for quality auditing. This helps to reduce the uncertainties surrounding the firm and, consequently, reduces the underpricing factor.

Minimizing information asymmetry and reducing uncertainty can help reduce the abnormalities associated with IPO pricing. However, as suggested by Mauer and Senbet (1992), IPO underpricing may still exist due to a primary market risk premium stemming from incomplete spanning of the initial issue by secondary market assets, as well as the level of investor access to the primary market. Furthermore, this underpricing exists because the primary market is dominated by firms with higher ex ante uncertainty due to a short operating history. Indeed, the evidence of long-run underperformance of IPOs suggests that IPO abnormal initial returns dissipate with a reduction in ex ante uncertainties and the primary market risk premium. Underpricing is reduced with complete spanning and perfect substitutability of the technological uncertainty of issues that are now in the secondary market. With this knowledge investors, asset managers, and analysts in Africa can take steps to properly value issuing firms.

26


Notes 1. We are grateful to Lemma Senbet for helpful and extensive insight into this.

2. ¢represents the local currency in Ghana.

3. Comprising food and beverage, construction, textiles, and agriculture.

4. Kolmogorov-Smirnov Test results: Ghana prob (0.945), Nigeria prob (0.136).

5. We are grateful to Chris Adam of AERC Group C for this suggestion.

6. We are grateful to an anonymous reviewer for the suggestion.

27


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Appendix Nigeria IPO issues used in the studyAboseldehyde Laboratory International BreweryAbplast Products Investment and Trust CompanyAcademy Press* Japaul Oil Maritime Services*Access Bank Krabo NigAcen Insurance Co Lasaco assuranceADC Airlines Law union and Rock InsuranceAfrican Paints Nig Linkage AssuranceAfrik Bank* Lion BankAfroil Liz-Olofin and CompanyAsaba Textile Mills Longman NigAvon Crowncaps and Containers nig Manny BankBenue Cement May and Baker NigBri-American Insurance Mutual benefits AssuranceC and I Leasing NAL BankCapital Oil* NEM InsuranceConfidence Insurance NFI Insurance CoCornerstone Insurance Niger InsuranceCooperative Bank Nigerian Lamps IndustriesCooperative Dev Bank Oceanic BankCrusader Insurance Onwuka Hi-Tek IndustriesDiamond Bank* Premier PaintsEcobank Nigeria* PrescoEIB International Bank Prestige AssuranceEllah lakes Regent BankEpic dynamics Rietzcot Nig PlcEterna Oil and Gas Royal exchange Assurance*Fidelity Bank* Sun Insurance Nig*First Assurance The Okomu OilFirst Atlantic Tourist Company of Nigfirst City Monument Bank Trans Nationwide Express*Guarantee Trust Bank* Tripple Gee and CompanyGuardian Express Bank Tropical PetroleumGuinea Insurance Unic Nigeria Insurance*Gulf Bank Nig Union Dicon Salt*Hallmark Bank* UNION HOMES SAVINGS AND LOANSHallmark Paper Product Universal Trust BankIBTC Chartered Bank Wapic InsuranceIMB International Bank* Wema BankInland Bank Nig West African Pro InsuranceIntercontinental Bank Zenith Bank

*These firms were outliers in the sample of firms with underpricing and, hence, were dropped from the regression

32


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