Editorial
It is my pleasure to bring you the final issue of 2017, with its enhanced content of articles and features. From this issue onwards, we plan to include a fifth full length article, along with our usual contents.
In a globalised scenario, financial crisis occurring in one country tends to affect the financial markets of other countries, and this suggests the existence of contagion in stock markets. Classifying Indian stocks into reachable (accessible to and frequently traded by foreigners) and remote (accessible only to local investors) stocks, in their paper “Cascading effect of contagion in Indian stock market: Evidence from reachable stocks”, Ms Sruthi Rajan and Professor Shijin Santhakumar examine the existence of contagion in the Indian stock market with special reference to reachable Indian stocks, testing for contagion separately for the global financial crisis of 2008 and the recent 2013 rupee downfall period in India. The United States has been taken as the crisis country, with contagion being classified into fundamental contagion (connected with trade and financial links across countries) and investor influenced contagion (connected with the behaviour of investors). The study observes the contagion effect in the Indian market for three consecutive time periods: (ii) stable period (January 1998 to December 2006); (ii) global financial crisis period (January 2007 to December 2010); and (iii) rupee downfall crisis period (January 2011 to November 2013).
The study creates two indices namely the Indian index representing the total market and the Investible index representing shares that are reachable to foreigners. The study selects NSE listed CNX 500 companies to represent the Indian economy and as per the selection criteria, 201 companies have been selected as the reachable index representing reachable stocks of the Indian economy. The data sources for the study are the Bloomberg database for the U.S. stock returns, and the Prowess database for NSE-listed CNX500 companies for creating the reachable index. The study methodology uses paired sample t-test, and a two-step embedded model estimated two-way as Full Information Maximum Likelihood (FIML) estimation and Limited Information Maximum Likelihood (LIML) estimation.
The correlation results prove that reachable returns have a significant correlation with U.S. return during the crisis period in comparison to the stable period. The cross-correlation results show the propagation of crisis from reachable stocks to remote stocks. The study further finds evidence for investor induced contagion as against fundamental contagion. The results are confirmed by the subsequent robustness test using Murphy-Tepel estimates.
In the realm of corporate financial management, while capital structure is increasingly being studied by researchers, extant research suggests that the capital structure issues prevailing in emerging markets are different from those in developed markets. In their paper “Firm characteristics, corporate governance and capital structure adjustments: A comparative study of listed firms in Sri Lanka and India”, Professors S.Buvanendra, P.Sridharan, and S.Thiyagarajan study the determinants of speed of adjustment towards optimum capital structure decision in the context of two Asian countries – India and Sri Lanka.
Ten independent variables comprising five firm specific factors (profitability, size, growth, tangibility, and non-debt tax shield), and five corporate governance factors (board size, percentage of non-executive directors, CEO--Chairman duality, family ownership, and percent of directors’ compensation), have been tested using dynamic adjustment model. In order to calculate capital structure of a firm, or leverage, researchers adopted the ratio of total debt to total assets in book values. As a first step, the optimum leverage in this study is calculated by estimating fixed effect regressions of the actual debt ratio on the firm specific factors. The dynamic capital structure model is extended to study the factors influencing the speed of adjustment, which depends on the aforestated five firm-specific factors and five corporate governance variables. In the second step, the popular Difference and System Generalised Method of Moments (GMM) estimation techniques are applied. The data have been drawn from Colombo Stock Exchange website for Sri Lanka and from Prowess database maintained by Centre for Monitoring Indian Economy (CMIE) for India. The time period for the study is 2003/04 to 2012/13 that includes the period of global financial markets meltdown and the resulting increased focus on governance failures around the world, including emerging markets.
The study reveals that major determinants of firms’ target leverage are profitability, size, tangibility, and non-debt tax shield, for Indian firms, whereas profitability, size, and non-debt tax shield influence Sri Lankan firms. The speed of adjustment of leverage ratios varies with the size of the firm’s leverage gap, its operating cash flow, its governance mechanism, its access to capital markets, and some elements of market conditions. Firms’ adjustment behaviours are country-dependent with Sri Lankan firms experiencing faster capital structure adjustment towards optimum debt equity ratio than Indian firms. The results are consistent with the dynamic trade-off theory of capital structure: firms have target debt ratio, and wish to return to those targets when costs make it optimal to do so. Further, for India, firm specific factors such as size, growth and tax shields have significant effects on speed of adjustment. But in the case of Sri Lanka, only profitability and tax shields contribute to capital structure adjustment. Among the governance factors, CEO--Chairman duality is significant for Sri Lankan firms, with family ownership significantly influencing Indian firms to reach the target quickly. One implication of these significant international differences in capital structure is that the internal governance mechanisms and business environments faced by firms in Sri Lanka and India are mostly different from each other. Finally, optimum capital structure decisions must be taken jointly with other firm level characteristics to guarantee an all-inclusive corporate response to the mix of debt and financing sources of firms that maximise shareholders’ wealth.
Book building is the dominant price discovery and allocation mechanism for initial public offerings (IPOs) issued in India, the central idea behind which is to reduce underpricing. Despite the increased use of book building, IPOs issued in India have witnessed high rate of underpricing relative to developed markets. The concept of anchor investors (a group of institutional investors who invest just one day before the issue opens to the public) was introduced by the market regulator, Securities Exchange Board of India (SEBI), in 2009 to bring transparency in the book building mechanism and to improve investment opportunity for retail investors through credible attestation of quality of the issue. “Do anchor investors create value for initial public offerings? An empirical investigation”, by Professor Seshadev Sahoo addresses the research questions whether (i) anchor investment reduces underpricing, (ii) participation by anchor investors stimulates other investors to bid for IPOs, (iii) anchor investment reduces the aftermarket risk for IPO stocks, and (iv) whether anchor-backed IPOs are more liquid than the non-anchor backed issues. The study also includes robustness checks to investigate how characteristics of anchor-backed IPOs are different from non-anchor backed IPOs.
The database consists of 135 IPOs issued in the Indian market through book building mechanism during 2009--2014 (53 IPOs backed by anchor investors and the remaining 82 IPOs exhibiting non-anchor participation). Besides anchor investment, the study also includes the following explanatory/ independent variables: offer size, age of the IPO firm, post issue promoter group holding, subscription rate, debt-equity ratio, group affiliation, number of anchor investors, total assets, earnings per share, book value per share, and market condition; the dependent variables are underpricing, listing day liquidity, and aftermarket price risk (volatility). The study uses econometric models of regression.
The study finds that anchor investment in IPOs reduces underpricing; anchor backed IPOs exhibit better pricing efficiency than non-anchor IPOs, elicit more response from potential investors, and are subscribed to at a better rate. Anchor participation reduces the cost of the firm going public and provides sufficient indication to the investors regarding fair valuation and quality of the issue, thus boosting investor confidence. Both qualified institutional investors and retail individual investors subscribe more to anchor invested IPOs than non-anchor issues. Further, anchor investment in IPOs reduces short term volatility and increases aftermarket liquidity. The authors aver that this study provides a new direction to the certification hypothesis, confirms the role of the anchor investor in soliciting better response from investors, and helps in partially resolving the information asymmetry that prevails in the IPO market.
Development projects, unlike other infrastructure projects, are essentially community-driven in nature and aim to bring facilities and services closer to people in order to alleviate poverty, create employment, and raise people’s standard of living. Hence the traditional performance criteria of time, cost, and quality would capture the economic aspects of development projects and not account for relevant social and environmental dimensions. In their paper, “Critical success factors influencing the performance of development projects: An empirical study of Constituency Development Fund projects in Kenya”, Professors Debadyuti Das and Christopher Ngacho attempt to identify the critical success factors (CSFs) that are enabling factors of the key performance indicators (KPIs) for development projects. The authors demonstrate the applicability of their approach with the help of data collected from the development projects financed through the Constituency Development Fund (CDF) in Western Province, Kenya, in the period between 2003 and 2011. The survey instrument secured the perceptions on 30 success variables of 175 respondents comprising clients, consultants and contractors involved in the implementation of CDF projects. The responses on all 30 variables relating to CSFs provided by the respondents were initially subjected to exploratory factor analysis (EFA), which resulted in an instrument consisting of six factors and 26 items. This instrument was subsequently subjected to confirmatory factor analysis which finally resulted in a six factor 18 item instrument. The robustness of the scale was proven with relevant statistical tests.
The process enabled the development and validation of a measurement scale for evaluating success of development projects. The study demonstrates that the success factors of a development project can be described in terms of project related, client related, external environment related, supply chain related, consultant related and contractor related factors and the corresponding variables of project success. Out of the six CSFs, client related, consultant related and contractor related factors are stakeholder based whereas project related factor is based on the characteristic features of a project. Supply chain related factor is based on sourcing and delivery of construction resources and external environment related factor addresses all environmental issues that affect project success. The application of the scale would enable practitioners to make optimal and judicious allocation of resources, make holistic decisions pertaining to the success of a project after considering the diverse goals and motivation of stakeholders, and address the unique requirements of a specific project, i.e. educational, healthcare, industrial estate and agricultural market project, in the context of the geography and status of development of that region.
Crude oil is an important commodity that significantly contributes to the industrial production in the modern economy. High oil price volatility may result in economic instability and hence generating more accurate forecasts of crude oil volatility and managing risk associated with it is crucial for the government, policymakers, oil exporters and importers, industrial consumers and other market participants. In the paper, “Forecasting energy futures volatility based on the unbiased extreme value volatility estimator”, Professor Dilip Kumar provides a framework for modelling and forecasting volatility of the energy futures based on the Add RS estimator. The data used in this study consists of daily opening, high, low, and closing prices of the near month futures contracts of the futures series NYMEX light sweet crude oil (WTI), ICE Brent crude oil, New York Harbor RBOB gasoline, New York Harbor No. 2 heating oil and NYMEX natural gas. The data from the Bloomberg database has been taken for the period 1 January, 1996 to 4 December, 2013, and data from 7 November, 2012 to 4 December, 2013, taken for the out-of-sample forecast evaluation exercises.
The study based on the statistical and the distributional properties of the logarithm of the Log(Add RS) estimator of the energy futures, proposes a specification based on the linear Gaussian model which incorporates the impact of long memory properties of the data series, and the model of volatility is referred to as the ARFIMA-Add RS model based on the Schwarz information criterion (SIC). The study evaluates the forecasting performance of the ARFIMA-Add RS model using the loss functions, the regression approach and the superior predictive ability (SPA) approach and compares the corresponding results with the alternative models from the GARCH family. The results of the out-of-sample forecast analysis indicate that the ARFIMA-Add RS model (i) generates unbiased forecasts for the futures series NYMEX WTI, RBOB gasoline, and NYMEX natural gas; and (ii) performs much better than the alternative models in forecasting realised volatility of energy futures. The study has important implications for governments, policy makers, oils importers and oil traders.
The Indian banking sector has fostered different types of institutions that cater to the divergent banking needs of various sectors of the economy. To meet the banking requirements of small customers, especially those located in rural and semi-urban areas, the Reserve Bank of India (RBI) encouraged urban cooperative banks (UCBs), regional rural banks (RRBs) and local area banks (LABs), and architected a regulatory framework for microfinance companies. The RBI has further decided to license differentiated banks and has released guidelines on licensing of small finance banks (SFBs) and payments banks in November 2014 to serve the needs of small business units and industries, small and marginal farmers and other unorganised sector entities, through high-technology-low cost operations.
In the Round Table on “Small finance banks: Challenges”, Professor Jayadev M and former IIMB PGP students Himanshu Singh and Pawan Kumar first analyse the functioning of the existing Indian banking institutions in the domain of banking for small customers and then consider the newly introduced institution of small finance banks, licensed by the RBI. They reflect on the justification provided in the academic literature for the competitive advantage of small finance banks in serving SMEs and small customers. The second part of the paper consists of a discussion with the CXOs of three new small finance banks on the challenges faced by these banks including the spirit of differentiation of these banks, devising the required technology driven business models, building a liability portfolio, regulatory issues, and the competition that they face. The three panellists are Mr. Sarvjit Samra, CEO, Capital Local Area Bank, Jalandhar; Mr. Rajat Singh, Head of Strategy and Planning, Ujjivan Financial Services; and Mr. HKN Raghavan, CEO, Equitas Microfinance.
The book review section carries a review by Nabendu Paul, doctoral student at IIM Bangalore, of “The Essential Book of Corporate Governance”, by G.N.Bajpai, Sage Publications, New Delhi.
With best wishes to all readers for a happy and prosperous new year 2018,
Nagasimha Balakrishna Kanagal
Editor-in-Chief
IIMB Management Review
India
Email address: eic@iimb.ac.in