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The Strategic Role of Issue Composition and Market Sentiment in

Determining Initial Public Offer (IPO) Underpricing and Valuation

in India

Viswan M G

Department of Commerce,SSV College, Valayanchirangara, Perumbavoor

DOI:

https://doi.org/10.51583/IJLTEMAS.2026.150400021

Received: 26 March 2026; 31 March 2026; Published: 02 May 2026

ABSTRACT

This study investigates the strategic interplay between Issue Composition (Proportion of Fresh Capital vs. Offer

for Sale (OFS)), Market Sentiment ("hot" vs. "cold" markets), and the resulting Underpricing and Valuation of

236 Initial Public Offerings (IPOs) in the Indian capital market during 2009-2020. The analysis confirms a

negative relationship between the proportion of fresh capital and underpricing, with full OFS issues (0% fresh)

recording the highest average underpricing (20.61%) and 100% fresh issues recording the lowest (8.04%).

Critically, a mean comparison shows that issuers opportunistically float a significantly lower proportion of fresh

shares during hot market periods (51.62%) compared to cold periods (63.51%), suggesting the exploitation of

market waves for existing shareholder exit. Furthermore, Ordinary Least Squares (OLS) regression analysis

reveals that a lesser proportion of fresh issue is significantly associated with a higher Price-to-Book (P/B) Ratio,

indicating more aggressive valuation when existing shareholders dominate the offering. The findings support

the notion that issue structure acts as a signal to investors and that issuers strategically utilize market conditions

to maximize proceeds for both the company and selling shareholders, reinforcing the relevance of prospect

theory in the Indian IPO context.

Keywords: Underpricing, IPO, Offer for Sale, Price-to-Book (P/B) Ratio

INTRODUCTION AND REVIEW OF LITERATURE

The Underpricing Puzzle and Offer Size Components

The initial underpricing of IPOs remains one of the most studied anomalies in financial economics (Chhabra et

al., 2017, p. 202322; Habib & Ljungqvist, 2001; Ljungqvist, 2007; Mumtaz & Smith, 2021; Rock, 1986).

Underpricing is the phenomenon where the offer price is significantly lower than the price at which the stock

begins trading on the exchange, resulting in immediate gains for investors who receive allotment. While

numerous theories—including information asymmetry, signalling, and prospect theory—have attempted to

explain this return, empirical focus on the composition of the offer size is crucial for understanding issuer intent.

An IPO’s total offer size is typically a composition of two types of shares: Fresh Issue (new shares, the proceeds

of which go to the company for investment) and Secondary Shares (Offer for Sale or OFS, the proceeds of which

go to the selling shareholders). The motivation for offering these two components differs: fresh capital is raised

primarily to finance investment and rebalance capital structure, while secondary shares are often offered to

increase liquidity and provide an exit route for existing owners(Brau et al., 2007).

Global and Indian Contextual Evidence

Signalling and Secondary Shares

A significant stream of literature, particularly in the U.S. market, has explored the signalling effect of secondary

shares(Allen & Faulhaber, 1989; Ljungqvist, 2007). The prevalent notion is that a larger portion of shares sold

by existing shareholders sends a negative signal to prospective investors, implying that the firm's true value may

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be lower, and insiders are opportunistically cashing out. Some studies suggest firms employ strategies to conceal

this negative signalling. Conversely, other findings suggest that selling is motivated by the existing owners'

desire for portfolio diversification rather than opportunistic timing. In the Japanese market, a study reported that

a lesser proportion of secondary shares was associated with greater underpricing, adding complexity to the

signalling hypothesis (Bannenberg, 2019).

Issue Composition and Underpricing

(Habib & Ljungqvist, 2001) proposed that if the secondary share portion is lower, existing owners are less

motivated to fix a high issue price, potentially leading to greater underpricing. Conversely, (Dhamija & Arora,

2017)conducted one of the few studies in India, finding a negative relationship between the proportion of OFS

and underpricing. Their result implied that when OFS is part of an IPO, the issue is more likely to be fairly priced

or overpriced, leading to lower underpricing, based on the assumption that selling owners are aware of the

intrinsic value and try to fix a higher price band. The Indian context, where secondary shares are defined as OFS,

therefore requires a dedicated investigation.

Market Timing and Research Objectives

The decision of when to go public is also influenced by market sentiment, known as the "hot" or "cold" market

phenomenon. Academic literature and newspaper reports indicate an increasing trend of OFS in Indian new

issues, often viewed as an exit route for founders and venture capitalists when market conditions are favourable.

This raises questions about the issuer's ability to maximize proceeds by leveraging market sentiments while

determining the issue structure.

Considering the existing literature and the specific dynamics of the Indian market, this study seeks to address

the following research questions:

1. Do issuers sell a lesser proportion of fresh shares (more secondary shares) during hot periods compared to

cold periods?

2. Does the impact of the proportion of fresh issue on underpricing differ during hot and cold markets in India?

3. Do issuers set maximum prices for the shares offered during hot markets, and does the proportion of fresh

issue affect this pricing strategy?

DATA AND RESEARCH METHODOLOGY

Sample and Data Collection

The study utilized a sample of 236 IPOs listed on the Indian stock exchanges over a specified study period. Data

were meticulously collected from the official websites of the National Stock Exchange (NSE) and the Securities

and Exchange Board of India (SEBI). Specifically, crucial data points like the final offer price, NAV (Book

Value), and details of the offer composition were collected from the Red Herring Prospectuses (RHP) filed with

SEBI.\

Measurement of Key Variables

 Underpricing (MAAR): Measured as the Mean Adjusted Abnormal Return (MAAR), the initial return

calculated on the listing day.

 Proportion of Fresh Issue (FRESH): The percentage of new shares in the total issue size. The sample was

categorized into three groups based on this variable: 100% Fresh Issue (n=86), 0% Fresh Issue or 100%

OFS (n=57), and Combination (n=93).

 Market Sentiment (HOT/COLD): Market conditions were classified into "Hot" (n=149) and "Cold" (n=87)

periods based on a pre-established methodology Following (Mumtaz & Smith, 2021) who identified the hot

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market by comparing the number of IPOs in a quarter with the highest number of IPOs in the previous five

years in the same quarter. In this study the average number of IPOs in the previous 5 years of the same

quarter is taken as a base for comparison. For instance, 2009 Q1 has been compared with the average number

of IPOs in the first quarter of years 2008, 2007, 2006, 2005, and 2004 and for 2009 Q2, the number of IPOs

in the second quarter (Q2) of the previous 5 years (2008-2004) has been taken and so on. There were 48

quarters out of which 17 quarters were identified as hot periods

 Pricing Strategy (P/B Ratio): The Price-to-Book Ratio (P/B) was used to indicate the issuer's ability to set

the offer price in multiples of the intrinsic value (Net Asset Value/Book Value).

P/B ratio = Offer Price/Net Asset Value per share

 Control Variables: Variables included in the OLS model to control for firm-specific and issue-specific

characteristics were Log of Assets (LNASSETS), Underwriter Reputation (UR)

Research Hypotheses and Analytical Techniques

The study employed both descriptive statistics (mean, standard deviation) and inferential statistics:

1. ANOVA F-test and Welch F-test: Used to test the null hypothesis of no significant difference in the mean

underpricing among the three categories of issue composition (100% Fresh, 0% Fresh, Combination).

2. t-tests: Used to test the equality of mean proportions of fresh issue between hot and cold markets.

3. Ordinary Least Squares (OLS) Regression: Used to test the relationship between the proportion of fresh issue

and the pricing strategy (P/B Ratio).

4. Diagnostic Tests: Multi-collinearity was checked using Variance Inflation Factors (VIF), and

heteroscedasticity using the Breusch-Pagan-Godfrey (BPG) Test.

Results

Underpricing and Proportion of Fresh Issue

The descriptive statistics provided the initial evidence of the inverse relationship between the proportion of fresh

issue and underpricing.

Table 1: Proportion of Fresh issue in IPOs and Underpricing

Variables

100% Fresh

Issue

0% Fresh Issue (Full

OFS)

Both Fresh and

OFS

Observations

(n)

Proportion of Fresh Issue (%)

(Mean)

100

48.56 (SD

24.85)

N.A.

Underpricing (MAAR) (Mean)

8.04 (SD

33.64)

20.61 (SD 34.82)

16.59 (SD

31.21)

236

Observations

ANOVA F-test (Prob.)

0.0622*

Welch F-test (Prob.)

0.0737*

(* indicates Significant at 10%)

The results clearly indicated that the average underpricing (MAAR) was the highest (20.61%) in the 0% fresh

issue (full OFS) category, followed by the combination category (16.59%). The lowest underpricing was found

in the 100% fresh issue category (8.04%). The ANOVA and Welch F-tests confirmed that the difference in

underpricing among the three categories was statistically significant at the 10% level, thus rejecting the null

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hypothesis of no difference. This primary result suggested a negative relationship between the proportion of

fresh issues and initial returns.

Market Timing and Issue Composition (Opportunistic Selling)

To address the first research question, the proportion of fresh issue was compared between the hot and cold

market periods.

Table 2: Test of Equality of Mean Fresh Issue Proportion

Variable

Cold Period

Hot Period

t-test Probability

Mean Proportion of Fresh Issue (%)

63.511 (SD 40.687)

51.616 (SD 41.58)

0.0336 (**)

Observations

149

(** indicates significant at 5%)

The results showed that the mean proportion of fresh issue was significantly lower in the hot period (51.62%)

than in the cold period (63.51), statistically different at the 5% level. This confirmed the first research question:

issuers tend to sell more secondary shares (fewer fresh shares) during the hot market, suggesting the use of

favourable market sentiment as a partial exit route for existing owners.

A further segregated analysis of underpricing among the three categories during hot and cold markets was

performed. The ANOVA F-test showed that the difference in mean underpricing was significant during the cold

period (0.0687 at 10% level) but not significant during the hot period (0.4605). Specifically, in the cold period,

the 100% fresh issue category had very low underpricing (3.52%), while the other two categories were above

20%. This suggested that the hot market does not offer excess returns to investors across different issue

compositions.

OLS Regression: Determinants of Pricing (P/B Ratio)

To test the third research question, the OLS regression model was applied to determine the factors influencing

the Price-to-Book (P/B) Ratio.

Table 3: Determinants of P/B Ratio

Dependent Variable: P/B

RATIO

Coefficient

Std. Error

t-Statistic

Prob.

VIF

30.245

7.689

3.933

0.000

FRESH

-0.049

0.03

-1.615

0.108*

1.2830

HOT

0.615

2.388

0.257

0.797

1.0668

LNASSETS

-2.675

0.866

-3.091

0.002***

1.9155

0.302

0.133

2.269

0.024**

1.6971

R-squared: 0.056

Adj. R-squared: 0.027

F-statistic

Prob: 0.068**

(*, **, *** represent significance at 10%, 5% and 1% respectively)

Key Findings:

1. Fresh Issue Proportion (FRESH): The coefficient for the FRESH variable was negative (-0.049) and

significant at the 10% level. This was a crucial finding, suggesting that as the proportion of fresh capital

in an IPO increases, the P/B ratio tends to be lower. Conversely, a higher OFS portion implies that issuers

price the shares at a much higher multiple of their Net Asset Value.

2. Market Sentiment (HOT): The HOT variable was not statistically significant (Prob. 0.797), failing to

prove the hypothesis of generally higher P/B ratios in hot markets.

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3. Control Variables: Underwriter Reputation (UR) had a significant positive influence on the P/B ratio,

supporting the Signalling theory that high-repute underwriters are used to indicate firm quality and justify

a higher issue price.

4. Log of Assets (LNASSETS) had a significant negative relation with P/B ratio, indicating that for

companies with a large asset base, the offer price may not be proportionally high, resulting in a lower

P/B ratio.

5. Model Fit: The overall model was significant at the 10% level (F-statistic Prob. 0.068). Diagnostic tests

confirmed the absence of multi-collinearity and heteroscedasticity.

DISCUSSION AND IMPLICATIONS

Signaling, Prospect Theory, and Opportunistic Exit

The collective evidence strongly suggests that the composition of the IPO issue is a strategic choice used by

issuers to interact with both market sentiment and investor perception.

The significant inverse relationship between the proportion of fresh issue and underpricing, coupled with the

high P/B ratios in high-OFS issues, aligns with the argument that existing shareholders, confident in their

valuation (P/B ratio), attempt to maximize the offer price when selling their holdings. This aggressive pricing

strategy, however, results in higher initial returns (underpricing) for investors, contradicting the idea that a high

OFS portion should deter investors.

The finding that issuers significantly increase the secondary share component during hot markets confirms the

use of IPOs as an opportunistic exit route. Even though underpricing was not statistically different across market

categories in hot markets, the low P/B ratio for high-fresh-issue IPOs compared to high-OFS IPOs during cold

markets suggests a strategic divergence in pricing depending on the issue’s intent. Signalling has been used by

the issuers to mitigate the information asymmetry between the issuers and prospective investors(Colombo, 2021;

Connelly et al., 2011). The present study reported that the firm uses underwriter reputation as a positive signal

of the quality of the issuing firm and thereby raise maximum amount from the investors by increased valuation

and pricing especially during positive market waves. This finding support the observations of (Neupane &

Poshakwale, 2012) on Indian IPOs.

This behaviour supports the Prospect Theory (Loughran & Ritter, 2002), which posits that issuers are not overly

concerned with leaving "money on the table" due to the overall wealth appreciation in their retained equity and

the benefit of successfully completing the offering. Issuers are primarily focused on the success of the offer and

the strategic benefits of going public, which include funding growth (fresh issue) and providing liquidity (OFS).

The use of Underwriter Reputation as a positive signal to mitigate information asymmetry and justify higher

valuation further underscores the sophistication of the Indian IPO process.

Practical and Policy Implications

This study offers critical insights for market participants:

 For Investors: Short-term investors seeking maximum listing-day returns are statistically better off by

prioritizing IPOs with a higher proportion of secondary shares (OFS), as these issues demonstrate the

highest average underpricing. Conversely, IPOs with a large proportion of fresh shares, intended for

growth financing, may offer lower immediate returns but potentially higher long-run returns for long-

term investors.

 For Regulators and Issuers: The study provides evidence that issue structure is a key signalling and

pricing mechanism. While issuers can use a lower fresh issue proportion to achieve higher valuations

(P/B ratio), this comes at the cost of higher initial returns for investors. Issuers must carefully consider

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the preferred investor base; a higher fresh issue may attract institutional and long-term investors, while a

higher OFS may be more attractive to retail investors looking for quick returns.

In conclusion, this research confirms that the underpricing of Indian IPOs is strongly and negatively influenced

by the proportion of fresh capital in the issue. The strategic use of the OFS component, particularly during

favourable market conditions, allows existing shareholders to realize a successful exit, thereby reinforcing the

importance of issue structure as a key financial signal in capital market research.

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