Factors driving IPO variability: evidence from Pakistan stock exchange.

AutorMehmood, Waqas
  1. Introduction

    In the context of the Pakistani market, 272 initial public offerings (IPOs) were offered between 1992 and 1997 but only one IPO exercise was held in 1998 and none in 1999 as a result of the country's nuclear attempt, which saw the USA imposing various sanctions that hampered Pakistan's development (Mehmood et al., 2021). This downward trend in IPO issuances persisted from 2000 to 2018, with only 93 firms going public during the period. This dismal number could be attributed to numerous macroeconomic factors, including terrorism activities, political instability, social security threats, low employment, low gross domestic product (GDP), as well as excessive inflation and interest rates.

    Several studies have examined the macroeconomic factors that influence IPO issuances in both developed and emerging economies (see Ameer, 2012; Angelini and Foglia, 2018; Tran and Jeon, 2011), but none has focussed on the Pakistani market. Hence, the current study aims to fill the gap by examining Pakistan's economic conditions and uniqueness to relate the identified macroeconomic factors to IPO variability. Unfavourable macroeconomic factors can affect IPO issuance decisions in several ways. Firstly, the decision to go public can be done at any conceivable time, but it is irrevocable once decided. A delay in an IPO issuance reflects a worsening of the waiting firm's unfavourable macroeconomic conditions. Firms go public when it is possible to raise the maximum capital that reflects their worth. However, uncertainties occur in raising the projected capital amounts from IPOs owing to poor macroeconomic performances, causing firms to delay their IPO exercises until the uncertainties dissolve. As explained by Lowry (2003), uncertainties that arise from dismal economic growth cause firms to remain doubtful of their capital demand. The entire business landscape may weaken during severe periods of uncertainty along with unfavourable macroeconomic factors, leading to lower consumption and output rates (Christiano et al., 2014).

    Unfavourable macroeconomic factors have been regarded as the causes and drivers of fluctuations in IPO issuances; yet, there is insufficient evidence to support this contention. Hence, there is a need to study the effects of macroeconomic factors on IPO issuances. Thus, the present study examines the effects of macroeconomic determinants, namely the stock market index, treasury bill rate (TBR), inflation rate (INF), GDP growth rate and foreign direct investment (FDI) on IPO variability.

  2. Literature review

    2.1 Stock market index and IPO variability

    The Pakistani Stock Exchange index began trading in November 1991 at a 2,000-base point. The KSE-100 Index fell one-third from the all-time high recorded in April 2008 as Pakistan's coalition government continued to receive mounting pressure to address the issue of Taliban militants, which worsened the apprehensions concerning the country's economic condition. In January 2017, the stock market hit an all-time high of 49,969 points and later 49,876 points on 13 February of the same year. Consequent to Britain's departure from the European Union (EU) on 24 June 2017, the KSE declined by 1,100 points (3.1 per cent) with stock markets undergoing turmoil as investors began investing in safer alternatives in gold and government bonds. The downward trend persisted in 2018 and 2019. Remarkably, IPO variability has continued to decrease since 1992. Hence, the notion that stock markets are affected by pessimistic and optimistic outlooks is consistent with investor sentiment and market timing theories. Given that investors' inclination to invest determines the stock market index, the frequency of IPO variability varies accordingly.

    Companies are more likely to go public if the stock market provides high returns that ensure profits for both the company and the investors. As a result, equity investors prefer to earn a higher initial return on newly listed stocks to maximize compensation while facing higher risk due to low country-level institutional quality (Wei et al, 2021). As a result, higher returns from newly listed stocks are regarded as the most powerful signals for displaying valuable information. Stock index levels and returns are found to pose a significant and positive effect on IPO variability (Ljungqvist, 1995; Loughran et al, 1994; Rydqvist and Hogholm, 1995). Ultimately, Brzeszczynski (2014) concluded that "the IPO variability in emerging markets and the profitability of the public offers are related to macroeconomic conditions, business cycles and stock market activity. In most emerging market countries, there is a time lag between movements of the stock market index and decisions to launch new IPOs". Given the above discussion, this study proposes the following hypothesis:

    H1. Stock market index has a positive effect on IPO variability.

    2.2 Treasury bill rate and IPO variability

    Mehmood et al. (2020b) asserted that a firm's engagement in a stock market is driven by several macroeconomic variables such as interest rates that provide valuable stock information. The present study uses the TBR to measure the effects of interest rate on IPO variability since it provides a comprehensive picture of market conditions. In the context of developed countries, the USA offers a TBR of 1.56% of 2019; meanwhile, developing countries have been demonstrating an upward trend, with Pakistan reporting an annual TBR of 13.10% in 2019. According to Ameer (2012), IPO variability decreases by 10% for every 1 % hike in interest rate. The author adds that the interest rate is a vital monetary policy instrument that drives the capital market and proliferates the IPO cycle. Interest rate is negatively correlated to the frequency of IPO exercises, as companies are discouraged from issuing IPOs during high-interest rate periods. Additionally, Brau et al. (2003) suggest that a high interest rate influences a firm's decision to go public. An increase in the interest rate will cause an increase in capital cost. Pakistan has been showing an increasing trend in its annual TBR for the past five years, reaching 13.10% in the year 2019, which has caused an increase in the capital cost. The few studies that have been conducted found that interest rate affects IPOs variability and the total amount derived from equity issuances (see Ameer, 2007; Brau et al, 2003; Chang, 2009; Neumeyer and Perri, 2005; Uribe and Yue, 2006). Based on the argument put forth by Brau etal. (2003), interest rate influences the IPO choice for a new company takeover whereby lower interest rates enable the acquiring company to utilize more debt for acquisition purposes, thus lowering the IPO and boosting the takeover variability. Based on all the above, this study proposes the following hypothesis:

    H2. The TBR has a negative effect on IPO variability.

    2.3 Inflation and IPO variability

    In Pakistan's context, the State Bank of Pakistan is the sole body practising mandatory monetary policies, which influence all asset prices bubbles and private capital inflows and outflows. Pakistan recorded an INF of between 10 and 13% from 1991 to 1999 that persisted well into 2019, albeit with a minor decrease to 9.41% in 2019 (Iqbal and Naveed, 2016; Shahzad, 2019). The INFs recorded by Pakistan are significantly higher than any developed nation; hence, there are high capital costs for equity offerings that must be borne by newly listed securities, thus discouraging firms from going public (Omran and Pointon, 2001).

    High rates of return are anticipated during periods of high inflation. Likewise, a high-risk premium tends to complicate the generation of new future investments due to the additional strict requirements of funds (Ameer, 2012). Tran and Jeon (2011) found a positive link between inflation and IPO variability. Whilst, this current study suggests that the INF is a proxy for inflation consistent with the findings of other past works (Omran and Pointon, 2001; Tiwari et al., 2015). The USA recorded a 1.6% INF in FY2018. As indicated by Omran and Pointon (2001), high rates of inflation discourage investors from going public due to demands for higher returns, which in turn elevates the capital cost for the firms.

    H3. INF has a negative effect on IPO variability.

    2.4 GDP growth rate and IPO variability

    The GDP is popular among all previous studies because it reveals market conditions; therefore, it is the major capital structure determinant of country-level performance (Shabbir et al., 2020; Pradhan et al., 2020; Dey and Tareque, 2020; Camara, 2012). In the Asian region, high annual GDP growth rates are recorded in 2019, India (7.1%), Malaysia (5.9%) and China (6.9%). Meanwhile, Pakistan's GDP growth rate fell from 5.8% in 2018 to 3.3% in 2019 due to increased uncertainty. According to Mehmood et al. (2020b), low economic growth reduces investment opportunities for businesses, causing the economy to deteriorate. Since GDP growth rates are determined by consumption demand as well as monetary and fiscal policies, positive performance of macroeconomic factors can lead to economic balance and improvement in the instability outcomes. According to the neoclassical economic theory, GDP growth rates provide strong signals to entrepreneurs to invest in the market. Likewise, Ameer (2012) asserted that the GDP growth rate shows the country's economic snapshot, which has a direct influence on IPO activities. Thus, an increase in GDP will lead to an increase in IPO variability. Numerous studies have shown that GDP growth has a significant positive effect on IPO variability (see Ameer, 2012; La Porta et al., 1997; Tran and Jeon, 2011).

    H4. GDP growth rate has a positive effect on IPO variability.

    2.5 Foreign direct investment (FDI) and IPO variability

    According to the recent report of World Investment (2020) [1], FDI inflow into Pakistan increased from US$1.7bn to US$2.2bn in 2019. The total amount of FDI inflow reached...

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