Collateral Regulation and IPO‐Specific Liberalisation: the Case of Price Limits in the Athens Stock Exchange

• Published date: 01 March 2016
• Date: 01 March 2016
• DOI: http://doi.org/10.1111/eufm.12051

Collateral Regulation and IPO‐Specific

Liberalisation: the Case of Price Limits

in the Athens Stock Exchange

Stavros Thomadakis

University of Athens, School of Economics, Athens, Greece

E-mail: thomadakis@econ.uoa.gr

Dimitrios Gounopoulos

School of Business Management and Economics, University of Sussex, Falmer, Brighton, UK

E-mail: d.gounopoulos@sussex.ac.uk

Christos Nounis

University of Athens, School of Economics, Athens, Greece

E-mail: cnounis@econ.uoa.gr

Andreas Merikas

University of Piraeus, Department of Maritime Studies, Piraeus, Athens, Greece

E-mail: merikas@otenet.gr

Abstract

This paper uses a uniquetesting ground on the effect of price limits uponIPO pricing

and initial returns. The Athens Stock Exchange offers the opportunity for this new

experiment, as three substantialchanges in limit regulations were implemented in a

short period of eight years. The results indicate significant differences in initial

returns. Effective price limits reduce underpricing in all market segments, without

visible diminution of IPO activity. The introduction of mandatory book‐building

after price limits were phased out in Athens also led to reduced underpricingin the

main market segment. Nevertheless, the existence of an independent effect of price

limits explains why some regulators continue to use them to the present day.

We gratefully acknowledge Cecile Carpenter, Thomas Chemmanur, Elroy Dimson, John

Doukas (The Editor), Tim Jenkinson, Conul Golak, Antonis Kallias, Kostadinos Kallias,

Mario Levis, Jay Ritter, Silvio Vismara, two anonymous referees and seminar participants at

the Vrije University of Amsterdam, the University of Athens and the University of Sussex

for useful comments and suggestions. We would like to thank participants of the European

Finance Association, European Financial Management Association and the Financial

Management Association for helpful comments on earlier versions of this paper.

Correspondence: Dimitrios Gounopoulos

European Financial Management, Vol. 22, No. 2, 2016, 276–312

doi: 10.1111/eufm.12051

© 2014 John Wiley & Sons Ltd

Keywords: price limits, IPO underpricing, IPO regulation, government intervention,

hot/cold market conditions

JEL classification: G14, G32, G24

1. Introduction

The regulation of IPOs has a long history around the world and is linked to intrinsic

informational asymmetries that surround new listings (Chan et al., 2004; Chambers and

Dimson, 2009; Carpentier et al., 2012; Ekkayokkaya and Pegniti, 2012; Burhop

et al., 2014). Regulatory objectives regarding IPOs have sought the twin goals of financial

regulation: efficient pricing and investor protection (IOSCO 2010). These goals have been

pursued with a variety of instruments. Disclosure requirements, audit regulation,

contractual obligations of issuers and underwriters, arrangements (including constraints)

for IPO pricing, price guarantees, overallotment options and trading restrictions for the

after‐market represent the wide range of regulatory interventions across developed and

emerging markets.

As we would expect, the sophistication and timing of regulatory tools appear to vary

with the degree of market development, the sophistication of market agents and market

conditions. Regulatory techniques first introduced in developed markets, (viz. disclosure

requirements, audit regulation or book‐building), have been emulated in emerging

markets in the process of their development. Regulatory interventions have been

subjected to empirical tests which seek to clarify their effectiveness. These tests are based

on diverse theoretical views about the desirability of regulation and the power of markets

to self‐regulate, to which we return below.

In this paper we focus on price limits. These have been a controversial subject and their

empirical evaluation has been tested on the question of whether they affect price volatility.

Here we pose a different and simple question: do price limits in the after‐market have any

effect on the well‐established market inefficiency that is IPO underpricing? This simple

question has not been asked before. But it is a reasonable question. In both theory and

practice, early aftermarket conditions are important to those who make IPO pricing

decisions. The answer to this question may inform regulatory decisions beyond what

existing empirical evidence has already provided.

The occasion for asking this simple question is an enticing empirical opportunity

presented by changes in Greek regulatory arrangements in the 1990s, a time when the

Greek market experienced considerable development. General daily limits on price

variation were imposed for the first time in 1992 and lasted until the end of the decade.

Although directed to market stability in general, price limits had collateral consequences

for the early IPO aftermarket. Recognising this, regulators later decided that policy

towards IPOs should change and price limits were relaxed specifically for early trading of

IPO stocks in late 1996. This policy change allows us to test an area that has not been

much examined in other empirical literature on IPO regulation: the impact of price limits

on underpricing in conditions closely resembling a controlled experiment.

As we explain in the body of the paper, the impact of price limits on early trading of IPO

stocks and the implications of the removal of these limits show, based on the Greek

experiment, the occurrence of two synchronous effects: on one hand, the imposition of

© 2014 John Wiley & Sons Ltd

Collateral Regulation and IPO‐Specific Liberalisation 277

limits appears to reduce overall underpricing but, on the other hand, it also delays and

complicates early price adjustment. We argue that these effects correspond to received

theoretical reasoning and correlated empirical findings from various markets and times. In

a broad sense, the explanation of variation in IPO underpricing across markets and times

cannot be oblivious to regulatory interventions, as several authors have argued (Loughran

et al., 1994). Furthermore, regulatory intervention itself must be evaluated in search for

policy implications, as regulators continue to seek effective tools whenever they perceive

market malfunction or failure.

Looking more specifically at after‐market arrangements for newly listed stocks, we

note that non‐discretionary trading limitations such as price limits, trading halts or circuit‐

breakers continue to be used in many markets, especially emerging ones. For example, as

recently as January 2012, SEBI, the Indian market regulator, imposed restrictive daily

price limits for first‐day trading of IPO shares, attempting to ‘prevent IPO manipulation’,

in one of the largest emerging markets. Is this persistence of price limits warranted?

Price limits on stock market variation are a controversial subject both among

practitioners and scholars. The central issue is the speed and efficiency of price discovery.

Different lines of argument have been formulated about the impact of price limits on the

quality of price adjustment. One side argues that limits are inefficient because they

suppress rapid price discovery after an information shock (Fama and French, 1989). A

contrary line suggests that limits offer opportunities for ‘cooling down’of investor

sentiment in an environment of information asymmetry, and thus allow for smoother price

adjustment (Hanley, 1993; Chowdhry and Nanda, 1998; Loughran and Ritter, 2002;

Thomadakis et al., 2012). Both these views, which we can summarise as the competing

‘information’and ‘overreaction’hypotheses, are concerned with price shocks due to

varying intensities and degrees of asymmetry of information. A considerable amount of

empirical works has attempted to distinguish between these competing hypotheses. The

impact of limits on volatility, serial correlation and price reversals has been studied with

mixed results. The two competing views –the ‘information’and the ‘overreaction’

hypotheses ‐lead to opposing regulatory implications about the desirability of limits.

An interesting variant of thinking relates to price change that is rooted not in pure

information shocks but in a different source of disturbance: market manipulation.

According to this view, the basic regulatory rationale for imposing price limits is to

constrain the potential for manipulation by market participants who have the means to

conduct manipulative schemes, (Kim and Park, 2010). This rationale seems to us to be

very pertinent to newly issued shares where asymmetries of information are more intense

and the potential for manipulation is larger, especially in emerging markets where weaker

competition and lack of contractual and investor sophistication weaken market‐based

deterrence to manipulation.

In the extensive literature on underpricing of IPOs, the effect of regulatory

interventions has been examined, although not price limits, specifically. An example

of this approach is the ‘regulatory overreach hypothesis’relating to the effects of the

Sarbanes‐Oxley act on US IPO activity (Gao et al., 2013). Arguing that Sarbanes‐Oxley

improves transparency of primary offerings, Johnston and Madura (2009) present

evidence that IPO underpricing in the US has declined after implementation of the act.

The Greek market in the 1990s, on which we focus, was classified as an ‘emerging

market’, despite its participation in the European Union and its alignment to European

legal arrangements. We have therefore paid special attention to tests of regulatory effects

in emerging markets. Based on evidence from the Pacific Region, Loughran et al. (1994)

© 2014 John Wiley & Sons Ltd

278 Stavros Thomadakis et al.