Foreign capital raising by Indian firms: An examination of domestic stock price response

Global Finance Journal 25 (2014) 181–202

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Global Finance Journal journal homepage: www.elsevier.com/locate/gfj

Foreign capital raising by Indian firms: An examination of domestic stock price response Alex Meisami a,⁎, Lalatendu Misra b, Jamshid Mehran a, Yilun Shi c a b c

Indiana University South Bend, South Bend, IN, United States University of Texas at San Antonio, San Antonio, TX, United States Elon University, Elon, NC, United States

a r t i c l e

i n f o

Available online 16 October 2014

JEL classification: F21 F34 F65 G14 G15 Keywords: Stock price response Capital raising Financial market Economic liberalization

a b s t r a c t We examine the domestic stock price response to foreign capital issuance by Indian firms. Firms have extensively used foreign equity and convertible foreign debt sources since 1994. The role of foreign investment bankers, size of the issue, firm's growth opportunities, and other factors are examined in the cross-sectional analysis of domestic stock price response. We find that firms experience positive stock price response to both equity and debt issues abroad, with greater response to issuance of American Depositary Receipts (ADRs), and financing high corporate growth. © 2014 Elsevier Inc. All rights reserved.

1. Introduction We examine the domestic stock price response when Indian public firms issued either equity or debt securities in international markets following the economic liberalization of India in the early 1990s. Previous studies in the literature have examined firm level response to particular types of issue across a number of countries with a focus on the domestic stock price response; American Depositary Receipts (ADRs) issues (Miller, 1999) and public debt issues (Miller & Puthenpurackal, 2002). These and similar studies focus on the cross-country determinants of stock price response and relate variations therein to the prevailing legal structures and protection from various financial claimants across the sample countries.

⁎ Corresponding author at: 1700 Mishawaka Avenue, P.O. Box 7111, South Bend, IN 46634-7111, United States. Tel.: +1 574 520 4355 fax: +1 574 520 4866. E-mail address: [email protected] (A. Meisami).

http://dx.doi.org/10.1016/j.gfj.2014.10.002 1044-0283/© 2014 Elsevier Inc. All rights reserved.

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We focus on three major issues in this paper, which differ from earlier cross-country capital issuance studies. First, we examine capital issues made by firms from only one country – India. A country-specific analysis allows for a focused examination of the determinants of the market response and enables us to identify firm-specific factors that influence the creation of value for the issuer. Second, our time period of analysis spans foreign capital issuances over 1993–2009: a period during which the regulatory and legal structures in India underwent modifications. Specifically, equity issues in the earlier period were subject to extensive government scrutiny and monitoring. In the latter period, a greater level of the monitoring activity was undertaken by external rating agencies and other private interests. We measure the differential impact of the monitoring/certification across these time periods and thereby attempt to isolate the value impact of regulatory changes. Third, we examine the response of “group” firms. Earlier Indian-based studies have shown that large group companies in India are positioned to create value in many corporate activities, because of their superior managerial ability, processes, and ability to exploit the regulatory structure (Khanna & Palepu, 2000). We examine whether such large group companies are able to create additional value in foreign capital-raising efforts by developing expertise in foreign markets similar to their purported abilities to exploit market, and structural inefficiencies domestically in India. At a broad level of analysis, we investigate issues of capital market segmentation and information asymmetries. At the beginning of the sample period, the Indian capital market is segmented from the world market. As the liberalization process unfolds, the barriers are removed and some firms are better equipped, or better able to exploit the removal of barriers and/or to mitigate the effects of informational asymmetry. We find significant positive domestic stock price response to the announcement of Indian firms issuing equity and debt securities abroad. We relate the abnormal returns to firm/issue specific variables including the following: issue size (positive), foreignness of the investment banker (IB) (+), high firm growth (+), relatively high foreign offer price (+), first time issuers (+), and ADR issuers (+). We find that the value consequence of external private monitoring is similar to that of monitoring by Indian regulators. Thus, monitoring by external entities is perceived to be as effective as that of the regulator. We find weak evidence that large group companies issuing foreign securities create additional value. This paper is organized as follows. We provide a discussion of some of the literature regarding issuance of foreign securities by firms in the following section. In Section 3, we provide a brief summary of the economic liberalizations undertaken in India subsequent to its balance of payments crisis in 1990, and present hypotheses that are examined in this paper. We describe the data in Section 4, and provide a discussion of the role of foreign capital and the role of the IB in the capital raising process. We discuss the authorization process, the measurement of the market response, and the cross-sectional regression analyses in Section 5, and present concluding remarks in Section 6.

2. Literature on foreign capital issuance There is an extensive body of literature that examines the potential costs and benefits of issuing capital in foreign markets. The cross-listing valuation benefits to going abroad arise primarily from two sources: (1) benefits arising from issuing securities in a foreign market (Karolyi, 2012), and (2) benefits arising from a reduction in informational asymmetries (Bris, Cantale, & Nishiotis, 2007). Managers indicate in surveys that a variety of benefits accrue to listing securities in foreign markets. These benefits include access to larger and deeper market for capital, reduced market segmentation, diversification of ownership base, and greater trading liquidity that benefits shareholders. With regard to the concerns of information asymmetry, global security issuance may attract more analyst coverage and market monitoring and thereby reduce asymmetric information problems (Hasan, Kobeissi, & Wang, 2011). The benefits arising from reduced informational asymmetries fall broadly into two broad categories: (2a) the benefits due to bonding hypothesis that arises from the commitment made by the firm to increase its disclosure and legal obligations to its investor base both domestic and foreign, and (2b) the signaling hypothesis suggesting that the firm, by the act of listing abroad, conveys its higher quality to market participants. Firms subject themselves to greater monitoring and scrutiny by listing abroad and thereby create value (Fernandes & Giannetti, 2014; Stulz, 1999).

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Additionally, by cross-listing the stock in a foreign market with high disclosure and regulatory standards, the firm potentially limits the private benefits of control to the managers. The present value of the savings due to sustained limitations of the future private benefits of control provides a source of value gain to the firm (Benos & Weisbach, 2004). Overall, the findings in the literature regarding issuances are in line with the broad predictions of international asset pricing models which suggest that the removal of market segmentation or liberalization of markets in previously fully segmented countries results in value creation for the shareholders of the companies in those markets and general reduction in the cost of capital in the economy of the issuing firms. The costs and benefits of security issuance in the foreign market can alternatively be viewed from the perspective of competition for resources in the foreign capital market. A firm's entry into a foreign capital market subjects it to a “liability of foreignness” (Bell, Filatotchev, & Rasheed, 2012). The foreign firm is at a disadvantage compared to the local firms as it faces the “home bias” of the local investors. As a consequence, its cost of capital and informational asymmetries are higher than that of comparable local firms; and analyst coverage and liquidity are lower. Managers of the entering firm must take steps and act in ways that can mitigate these liabilities and ensure that the entering firm gains relative to its no-foreign capital raising or status quo situation. U.S. firms that issue equity simultaneously in domestic and foreign markets face negative stock price reactions at the time of announcement; Chaplinsky and Ramchand (2000) report 3-day cumulative abnormal returns equal to − 2.2% for global equity offerings made by U.S. firms during the 1986–1995 period. In contrast, international asset pricing models predict a lower cost of equity (and positive stock price response) when companies from less developed markets issue securities in more advanced foreign markets following liberalization in their home market by diversifying their country specific risk. This is a consequence of integration of previously segmented capital markets. Literature on foreign security issuance mainly examines issues relating to ADRs issued by firms from different countries.1 Errunza and Miller (2000) investigate the impact of market liberalization on the cost of capital at the firm level by studying the cost of equity of firms from emerging markets that started to issue ADRs after their country underwent some form of economic liberalization. They examine the pattern in realized returns before and after liberalization. They find that in the pre-liberalization period, investors have significantly larger buy-and-hold returns relative to the post-liberalization period. Subsequently, there is a significant decline in the buy-and-hold returns. Positive domestic stock price response for firms issuing ADRs from a large number of countries is reported by Miller (1999), while Foerster and Karolyi (1999) report longer term returns of 19% to the foreign ADR firm in the year before listing, 1.2% during the listing week, and negative 14% in the year following the listing. Miller and Puthenpurackal (2002) study 260 public debt issues made by firms from different countries in the Yankee Bond market. They find that foreign investors demand significant premiums for issues from countries where investor rights are not well protected.

3. Economic liberalization in India 3.1. The environment Following a major balance of payment crisis in the 1989–1990 period, the Government of India (GOI) promulgated extensive policy liberalizations with substantial impact on trade, corporate, and financial sectors. Economic liberalization in India started in 1991 and for a period extending beyond the next decade, many important policy changes were undertaken. Summary performance of the Indian economy following economic liberalizations is presented in Table 1.

1 An extensive body of literature proposes that ADR listings improve the information environment of the issuing firm. Even for noncapital raising ADRs the information environment of the foreign firm is enriched. The market expectation of higher disclosure standards bonds the ADR issuance. See Bailey, Karolyi, and Salva (2006), Boubakri, Cosset, and Samet (2010), Doidge, Karolyi, and Stulz (2004), Fernandes and Ferreira (2008), Karolyi (2012), Lee and Valero (2010), and Stulz (1999) for discussions of various aspects of the information environment of the foreign firm in ADR issuance. In addition to the bonding benefits of ADR, Pinegar and Ravichandran (2010) note that ADR issues are larger and that they employ more reputable underwriters than do GDR issues.

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Table 1 Summary data regarding measures of performance of the Indian economy. This table provides some summary economy-wide aggregate data for the Indian economy. The data is collected from various Indian and IFS sources including Datastream and DataMonitor. Data item GNP growth GDP growth, current price GDP growth, constant price Inflation (CPI growth rate) Manufacturing volume BSE index growth Exchange rate ($/Rs) Exports as % of GDP Imports as % of GDP FX reserves as % of GDP Growth in FX reserves FDI inward total Portfolio investment (Intl)

Average

Growth rate 11.70% 13.04% 6.80%

5.78% 7.60% 11.65% −2.50% 13.97% 17.00% 12.13% $455.1 bn $448.4 bn

25.31% 28.10% 17.70%

Time period Jan 94–Dec 09 Jan 93–Dec 08 Jan 93–Dec 08 Jan 93–Dec 08 Jan 93–Dec 09 Jan 93–Dec 09 Jan 93–Dec 09 Jan 93–Dec 08 Jan 93–Dec 08 Jan 93–Dec 08 Jan 93–Dec 08 Jan 03–Dec 08 Jan 03–Dec 08

Indian firms could not seek external financing by issuing securities abroad prior to the economic liberalization. Pertinent to the present study, the liberalization process enabled Indian companies their first opportunity to explore foreign markets for new equity and debt capital.2 Issuance of foreign security by an Indian firm involved government vetting of the firm's need and the intended use of the capital. The GOI required the issuer's assurance regarding its future ability to repay, and required the issuer to file mandatory follow-up statements with the government. Thus, in the first phase of the liberalized climate, the regulatory vetting requirements were stricter than the certification process involved in S&P or Moody's rating filing. GOI monitoring of the ongoing financial health of the issuing firms was common knowledge to market participants and provided an implicit certification at the time of issue. The onerousness of the demands was relaxed by the end of the decade. 3.2. Test design Didier and Schmukler (2013) report that in India and in China firms that issue equity or bonds are typically larger than firms that are publicly listed but do not issue equity or debt. Additionally, they present evidence that issuing firms grew at two-times the rate of growth of firms that are publicly listed but do not issue securities. Issuer and non-issuer firms are different along this and other dimensions. Based on data, to be presented, we conclude the following facts. (a) Domestic issues for debt and equity are for relatively small amounts during the period. The average size of domestic equity issue was $7.6 million compared to the average size of public debt issue of $33.9 million (Table 3). (b) We find that the aggregated value of foreign issuance is comparable to domestic public issuance over the sample period (Fig. 1). (c) We show that the size of foreign debt issues averages $95 million, i.e., greater by a factor of 2.5 times the average size of domestic debt issues (Table 4). Foreign equity issues average at $102 million which is 14 times as large the average domestic equity issue. (d) The foreign issuing firms are very large entities compared to the average firm in India. The average asset base of the foreign issuers is $581 million (shown in Table 4), compared to the average asset base of $35.8 million for 5401 firms from the PROWESS database in 2001, which is the mid-point of our study; or an average asset base of $122 million for 7108 firms in 2008. Indian firms issuing foreign equity (GDR/ADR) or foreign debt are substantially larger than firms that issue equity or debt locally in India (Allen, Chakrabarti, De, Qian, & Qian, 2012). A test designed to include domestic issuing firms in this study is not likely to be useful due to the huge differences in firm size. The capital market reaction for the smaller and less widely followed domestic issuers would bias our tests. Thus, a control sample approach cannot be followed which subjects our study to the endogeneity criticism. Firms undertaking debt 2 Indian firms seeking external financing abroad used to face a vastly different regulatory environment compared to firms from other emerging economies such as; Indonesia, Malaysia, Singapore, Taiwan, and Korea, where public policy enabled firms to engage in foreign capital raising activity without being subject to extensive government supervision. Government control of the process was the hallmark of the Indian system during the first phase of liberalization pre-2000. Regulatory oversight was reduced in 2000 and beyond.

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Fig. 1. Domestic and foreign capital issuances by Indian companies. This figure shows the total amount of debt and equity issues (in US $ million) made by non-financial Indian firms between 1993 and 2009. The data is collected from SDC and the data for 2009 is partial. The starting and the ending dates are chosen to coincide with the sample of foreign capital issuance described subsequently.

or equity issuance presumably engage in capital structure and investment choice decisions prior to entering such transactions. The objective of our study is not to examine the determinants of the debt–equity decision of the firm, but to examine the aggregate consequences of the choices, presumed to be optimal, that are made by the issuing firms. 3.3. Hypotheses The topic of stock price reaction to security issuance in the Indian domestic market is not well examined in the literature. Marisetty, Marsden, and Veeraraghavan (2008) examine the price reaction to rights issues in the Indian market and report that there is a small positive, but statistically insignificant, price response in the domestic market. Firms with group affiliations display a significantly larger negative price reaction than do non-group firms. The price response to foreign issues is a novel aspect of our study. The lowering of capital market segmentation barriers leads to a lowering of the risk premium. The Indian firms that were allowed to raise foreign capital could do so at a lower cost due to the removal of such barriers. Steps taken by the GOI ensured that the highest quality firms were allowed to enter foreign capital markets. These strict requirements were relaxed during the latter part of the study. Additionally, periodic filings with the government ensured future monitoring of the quality/ability of the issuers. In short, the Indian foreign capital issues were not only made by high quality issuers at the time of issuance, but their subsequent performance was also implicitly guaranteed. According to the pecking order and information asymmetry theories of capital structure, investors penalize firms that issue stocks, because the level of information asymmetry between the firm's management and the investors is highest in equity issuance relative to internal financing and debt issuance. In the case of Indian firms, we expect the regulations to lead to a lower degree of information asymmetry and, consequently, to a lower cost of capital. The Indian firm can also experience an increase in the domestic stock price, and a lowering of capital cost, by placing the GDR/ADR either at a premium relative to the domestic stock, or at a smaller discount than what would be required if such an issue could be placed domestically as secondary stock issuance. H1. Indian firms that issue equity securities in global markets will experience positive abnormal returns around the announcement of the equity issuance. Stulz (1999) suggests six mechanisms by which managers can be monitored that would provide extra security for the investors and lead to a reduction in the cost of equity. The capital markets, and especially the IBs hired to play a certification role for firms selling securities to the markets, also provide an important monitoring function. Once again, companies from less developed markets

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seeking capital in global markets will rely on the certification of the most highly reputed investment banks to secure lowest cost access. We expect the certification effect of foreign IB discussed in H2 to be applicable for global debt issues; the use of foreign U.S./European IB in the debt placement process will result in positive domestic stock price response in view of ease of placement and the likelihood of a better price. Thus, IB quality (foreignness) will have a positive impact on both debt and equity issues. H2. Indian firms issuing securities by engaging foreign IBs will experience a higher level of positive price response compared to firms that do not do so. Global debt issues should also provide investors with a stronger signal. According to theories of capital structure, issuing debt, if possible, is preferable to issuing equity due to lower information asymmetry problems associated with debt issuance. Firms can also lower their cost of capital, and experience stock price increases, by being able to raise debt in the foreign market at a lower cost compared to the Indian market. By issuing debt firms can also signal the investors that their stock price is undervalued globally. Therefore, we expect higher announcement returns to global debt issues, which leads to our next hypothesis: H3. Indian firms that issue debt in global markets will experience positive abnormal return on their stocks around the announcement of the debt issuance. We view the certification process, in Indian security issues, to have three interlinked layers. The first layer derives from the GOI's attestation of the quality of the issuer, which is a product of the regulatory vetting and monitoring. Foreign IB involvement in the issuance is the second layer, as the IB provides quality certification backed by reputation. The presence of a foreign IB such as Goldman Sachs or UBS provides a higher level of implicit certification than that of an Indian IB such as the ICICI Bank from the perspective of foreign investors. The third layer of certification is due to the requirements of fuller disclosure of financials based on either International Accounting Standards for European issues, or FASB GAAP standards for U.S. issues. Thus, capital raising ADR issues would have a higher level and quality of disclosure than Regulation S, 144A, or GDR issues in Luxembourg. 3 Even when the security is ADR level 1 or 2, there is the benefit of an implicit or explicit certification. A firm can signal its investors more effectively when it is willing to go through all the hoops to get listed in a developed market. This strong signal can lead to a reduction in the cost of capital. Roosenboom and Van Dijk (2009) present evidence that the destination market matters: the abnormal returns with U.S. exchange listing are the highest among all types of foreign listings. Hail and Leuz (2009) show that cross-listing a firm in the U.S. decreases the firm's cost of capital between 70 and 120 basis points. They report smaller reductions associated with cross-listings in the over-the-counter markets. We expect to see positive abnormal returns around the announcement of equity issuance in the U.S. market. H4. Indian firms issuing ADRs will experience a higher level of market response relative to those issuing GDRs. Lins, Strickland, and Zenner (2005) examine the ability of firms to access capital and they hypothesize that the benefit of freer access to capital would be the greatest for firms that face relatively high barriers to capital. Access to large amounts of capital in the Indian markets was difficult for firms during the sample time period due to general paucity of funds relative to growth induced demand: H5. Larger-sized issues, relative to issuer size, are expected to result in greater value creation. Group firms are likely to exhibit weaker price response, but large group firms may show positive price response, consistent with a hypothesis by Khanna and Palepu (2000). There are additional hypotheses, as described below, that we will examine in the regressions stage. All of the hypotheses are summarized in Table 2. Capital issuance resulting in greater sales growth will be positively rewarded in the marketplace.

3 The choice of issuance across forms of depository receipts is not a matter of interest for our study. Interested readers are referred to Boubakri et al. (2010) who examine the determinants of this corporate choice.

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Table 2 A summary of hypotheses. This table provides a summary of the hypotheses being examined and the locations of the tables where the evidence is presented. We connect our hypotheses to the literature, and in some cases, the connection is made by extrapolating from the available theory or evidence. Hypotheses

Market response we find

Hypotheses related literature

Table location

Certification 1 Equity issuance 2 Debt issuance 3 ADR versus GDR

+ + ADR N GDR

Miller (1999) Miller and Puthenpurackal (2002) -. -

10; Panel A 10; Panel A 10; Panel B

Issue size 4 Size relative to assets

+

-. -

11–13; Model 1–6

Investment banker use 5 Use of foreign IB

+

Stulz (1999)

11–13; Model 1–6

Capital used for growth 6 Sales growth exceeds asset growth

+

Pilotte (1992)

12; Model 3, 4

Group company capital 7 First issue 8 Group issuer 9 Large group issuer

+ − +

Errunza and Miller (2003) Khanna and Palepu (2000) Khanna and Palepu (2000)

13; Model 5 12; Model 4 12; Model 4

High GDR offer premium 10 GDR premium

+

-. -

13; Model 6

4. Data description 4.1. Time and size distribution of domestic and foreign issues We provide summary information regarding the issuance of domestic securities in India by non-financial corporate issuers as a reference point to examine the size of foreign capital issues. We collected foreign and domestic capital issues from 1993 to mid-2009 from the Security Data Corp (SDC). Domestic corporate debt Table 3 Summary data regarding domestic capital issuance by Indian firms. This table provides a summary of the number of debt and equity issues made by non-financial Indian firms between 1993 and June 2009 and their total amount (in US $ million). The data is collected from SDC. The starting and the ending dates are chosen to coincide with the sample of foreign capital issuance described subsequently. Number of domestic issues Debt 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Total obs. Average size

47 48 33 16 3 3 3

155

$ Amount of domestic issues

Equity

Total

Debt

Equity

Total

576 972 1030 821 75 8 25 113 14 1 8 22 63 86 99 37 11 3961

623 1020 1063 837 78 11 28 113 15 2 8 22 63 86 99 37 11 4116

1758 865 1524 836 106 15 29 0 39 79 0 0 0 0 0 0 0 5251 33.88

1472 2693 3081 1363 146 20 309 678 44 189 42 1441 1800 5510 6182 3113 2122 30,205 7.63

3230 3558 4605 2199 252 35 338 678 83 268 42 1441 1800 5510 6182 3113 2122 35,456 8.61

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issues are few as shown in Table 3 and Fig. 1. The most prevalent types of debt issues in India are by the Government followed by high quality corporates. Lower quality firms raise debt in the form of bank loans and trade credits. In this regard, the role of the “groups” is important since the holding company or a higher quality group member can provide substitute access, via an internal capital market, for the weaker member firms of the group to the debt market. In contrast to the debt market, Indian equity markets are vibrant. Equity activity at issuance and secondary trading are many multiples of debt transactions. Significant amounts of initial capital are raised from the equity markets. The total dollar amount of debt issuance is $7.1 billion compared to $32.2 billion from equity issuance, giving a total of $39.3 billion over the sample period. The average size of debt issue is $26 million compared to $7 million for equity. Numerous issuers enter the equity markets and raise funds, whereas the number of debt issuers is limited. Smaller sized debt issues are likely to be uneconomic due to potential high cost of issuance. As large size firms issue debt, they make larger sized debt issues. Reliance industries made the first foreign issue – a debt issue – by an Indian firm abroad in May 1992. Subsequent issues were made in the GDR markets, mostly in Luxembourg, London, and Frankfurt, OTC, and as 144A and Regulation S issues for U.S. investors serving qualified institutional buyers. The first Indian issue listed in London (LSE) was East India Hotels in October 1994, whereas the earlier issues traded on other European locations or in OTC. The first Indian capital raising ADR issue in the U.S. market was by BPL Telecom in May, 1997. Early issues were subjected to substantial GOI scrutiny and some degree of investor skepticism. The GOI monitoring process partially allayed the concerns of the foreign investors and IBs. The monitoring of the regulatory process is likely to have helped ease of placement. In the more recent time frame, post-1999, firms are able to raise foreign capital through the “automatic route” if they satisfy specific criteria; otherwise, they can raise foreign capital based on the “approval route.” There was a policy emphasis on non-debt creating inflows at the beginning of the liberalized era, which was subsequently relaxed. Corporate debt issuance was strong in the latter part of the 1990s and during the 2005 to 2007 period, due to favorable levels of global liquidity, high sovereign credit rating for India, and lower risk premium for emerging market securities (Mohan, 2008). The unraveling of subprime debt market in the U.S. in mid-2007 led to a decline in the supply of global liquidity and low levels of debt issuance by emerging market issuers. In the recent period, both domestic equity and foreign equity (such as ADR and GDR issuance) provide likely sources of corporate funding (Saxena, 2009). Our initial sample is based on SDC data augmented by Prowess, Datastream, SKINDIA, and LexisNexis reports. We have not included issues for which news announcements were not available. SDC's dates and details of transaction data may be at variance from the LexisNexis news wire and from Indian publications. In the event of discrepancy, we have employed the news story dates. Issue details such as offer price, and exchange ratio are more reliable when they are cross-checked from multiple sources. We have excluded issues made by financial firms, and cases where the Indian firm undertakes external commercial borrowing (ECB) from lending institutions abroad. 4.2. Sample description Our sample is composed of a total of 291 firms making 407 foreign security issues; 214 of which were debt securities, primarily convertible debt with ten cases of non-convertible debt. There are 193 cases of equity type issues in the sample consisting of 166 GDRs, 17 issues of ADRs, and 10 cases where GDRs were issued simultaneously with convertible debt. These ten cases where both types of securities are issued are classified as equity issues. The total dollar value of the issues is almost evenly split between debt and equity with each accounting for approximately $20 billion. The time distribution of the issues is shown in Table 4. There were a total of 43 cases during 1994. Prior to 2004, there were a relatively modest number of debt issues, accounting for a total of 25 cases or 11% of the sample. In the pre-2004 period, GDR and ADR issuance were more common than debt issues, accounting for 43% of the total equity issuance. Subsequent to 2003, there was an explosion of foreign debt issues accounting for 180 cases or 84% of total. During this period there were 103 GDR issues accounting for 54% of the total sample. Statistics for the firms and issue size is summarized in Panel B of Table 4. The average size (total assets) of debt issuer is $696 million compared to $453 million for equity issuers, and the size of debt issue is $95 million

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Table 4 Summary of foreign capital issuance by Indian firms. This table provides summary of the number and types of foreign capital issues made by non-financial Indian firms between 1993 and June 2009 in Panel A. Capital raised by issuing convertible debt (204 cases) and non-convertible debt (10 cases) gives a total of 214 cases of debt issues. GDR (166 cases) and ADRs (17 cases) are equity issues. Simultaneous issuance of convertible debt and equity (10 cases) made by a firm is categorized as an equity issue giving a total of 193 equity issues and a grand total of 407 cases in the sample. We provide summary statistics of the relative size of issues and issue as a percent of the total assets of the firm in Panel B. The assets and sales are obtained for the prior year in Rupees (1 Crore = 107 Rupees) and converted to US $ (million) at the rupee–dollar exchange rate prevailing on the issue date. Relative size is the ratio of the issue amount to the total assets of the capital issuing firm. Panel A: Time distribution of the amount of foreign capital raised by Indian firms Debt issues ($ mn) Year 1993 1994 1995 1996 1997 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Total

Amount 275 434 150 677 852 27 – 90 120 150 2097 2930 5351 6726 480 13 20,371

Equity issues ($ mn)

All issues ($ mn)

Cases

Amount

Cases

Amount

Cases

3 5 1 7 4 1 0 1 1 2 18 45 56 61 8 1 214

219 2929 205 732 942 515 712 435 180 409 255 2769 3238 3310 279 2601 19,729

3 38 3 8 4 4 8 3 4 7 7 35 29 22 10 8 193

494 3362 355 1409 1794 541 712 525 300 559 2352 5699 8589 10,036 759 2614 40,101

6 43 4 15 8 5 8 4 5 9 25 80 85 83 18 9 407

Panel B: Summary statistics of size (in $ mn), and capital-raised by Indian firms Debt issue Mean Total assets Sales Issue size Relative size

697 440 95 68%

Equity issue Median 146 98 60 36%

Mean 453 307 102 309%

All issues Median 122 94 46 39%

Mean 581 377 99 184%

Median 138 94 55 37%

and for equity issue $102 million. The size of issue relative to the level of assets is 68% for debt (median 36%) compared to 311% for equity (median 39%). Most of the issues had overallotment or green shoe options attached to them. The typical size of a green shoe option is approximately 15% of the issue size. The option enables the underwriter to sell more shares than originally planned by the issuer. Overallotment options are utilized in the face of strong demand for the security and enable the IB to maintain price stability in the secondary market. In most of the issues the green shoe options were fully utilized. The issue size that we report here does not include the green shoe option allotment. 4.3. Importance of foreign capital to Indian firms Raising debt from foreign markets is a desirable choice for many Indian debt issuers as larger sized issues are possible in these markets.4 The aggregate amount of foreign debt issues is 4.5 times as large as the domestic debt issued during the period. The average size of foreign debt issue is 3.7 times larger, $95 million 4 Henderson, Jegadeesh, and Weisbach (2006) report that debt issuances abroad generally account for substantially more dollar amount of issuance compared to equity issuances abroad, 89% versus 9% in their sample consisting of international security issuance involving 15 countries/regions over the 1990–2001 period.

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compared to $28 million in domestic issues. The total amount of equity raised from abroad is about 60% of the total domestic amount. The average size of equity issued abroad, however, is $102 million compared to $7.1 million domestically. Foreign equity issues are less frequent but they raise, on average, 14 times as much capital as do domestic issues. Economic liberalization brought about fundamental changes in exchange structures and the process of security trading in India. During the early stages, trading in GDR securities in London and other foreign markets was high (Kadapakkam & Misra, 2003). Levine and Schumkler (2007) show that trading for the international firm migrates from the domestic to the international markets. By 2007, however, foreign investors had shifted some of their trading focus back to India, and the NSE and BSE exchanges had become the primary markets for Indian stock transactions. The rationale for opening the securities markets from both sides, i. e., enabling Indian firms to raise capital from abroad and allowing foreign investors access to India, rested on the need for new capital for the corporate sector to finance its growth. Product market relaxations increased aggregate domestic demand, and enhanced presence in specific sectors increased foreign demand of Indian firms. Foreign capital markets provided an important source of funding the growth induced capital needs of the Indian corporate sector, as rules allowed going abroad to meet the larger sized needs. One important motivation for foreign capital issuance is the perceived cost of capital benefits to raising capital abroad. The availability of large pools of capital abroad enabled the Indian firms to fund larger projects, investments, or acquisitions than what was feasible from solely domestic funding sources. With the opening of markets Indian firms started to compete and make acquisitions abroad requiring the availability of foreign capital since the acquisition of foreign currency at home was too costly (dual exchange rate) or infeasible due to regulatory constraints. Informational impact of the foreign issuances on the domestic securities of the issuers is, therefore, expected to be large. As indicated in Panel B of Table 4, the median relative size of the issues is 37% of the total size of the firms. The capital structure changing nature of the issue size provides a further rationale for the importance of studying the topic from the perspectives of Indian firms and Indian public policy. 4.4. Group and industry classifications Many large Indian firms are affiliated with business groups, which have diverse interests spanning many industries. Proscriptions against ownership and control changing transactions in certain industries add to the allure of the group structure. Khanna and Palepu (2000) examine the performance of diversified Indian business groups and report that firms within most of the diversified Indian business groups have lower Tobin's q relative to unaffiliated firms; however, firms affiliated with large, prominent business groups exhibit higher Tobin's q than unaffiliated firms. Larger business groups have superior management skills, internal processes, or political connections which enable them to create value – a hypothesis that we propose to examine in the capital raising context. The group company coding in the database often includes smaller firms, conducting business in one or two industries. Such firms may have one capital issuance transaction. Conversely, large group companies with presence in multiple industries have multiple capital issues. We distinguish between the large group companies with multiple capital issuance (191 cases, coded 0) versus the rest of the sample consisting of firms which are either coded Private or belong to smaller Group companies engaging in only one capital issuance abroad (216 cases, coded 1). One-time issuers include 149 unaffiliated firms and 67 group firms. The remaining groups did multiple transactions with 56 groups accounting for a total of 191 issues, or 3.4 issues on average per group. Some groups such as the Tata Group made 19 transactions and Mukesh Amabani's Reliance Group made ten transactions.5 The proportion of debt versus equity issuance is the same for the single time capital issuers compared to multiple capital issuers as shown in Table 5. The industry affiliation of firms, according to the New Industrial Classification (NIC) scheme of India, is also summarized in Table 5. Manufacturing firms (237 cases), account for more than half of the total number of transactions. Chemical and Petro-chemical firms account for 88 cases, or over 20% of the total number of 5 Firms that are coded as Private in the Prowess data base are smaller publicly traded firms. The private coding is not to be confused with a private entity – many public companies in India are registered as Pvt. Ltd. or Private Limited companies with their securities trading in Indian stock exchanges.

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Table 5 Issuing firms – industry distribution and other characteristics. This table shows the group affiliations of the firms in Panel A. There are a total of 291 firms in our sample. There are 123 groups represented in the sample and 149 firms which are private limited firms. There are 56 groups engaging in multiple issuances adding to 191 cases. The incidence of debt versus equity issuance across the group and nongroup firms are similar as shown on the right side of Panel A. The industry classification of the firms is shown in Panel B with the 2digit new industrial classification (NIC2) on the left panel and an alternative classification on the right side of the panel. Panel A: Group affiliations Group vs non-group Group firms 67 28 12 7 2 3 2 1 1 Group firms total Non-group firms 149 Sample total

Debt vs equity Cases 1 2 3 4 5 6 7 10 19

Total 67 56 36 28 10 18 14 10 19 258

1

149 407

Multiple-issuer groups Debt issuers Equity issuers Total

103 88 191

One-issue firms Debt issuers Equity issuers Total

113 103 216

Grand total

407

Cement Chemicals Construction Consumables Diversified Electricity Fabrics Hotels Infrastructure Manufacturing Media Metals Pharmaceuticals Services Software Telecommunication Vehicles Total

Cases 9 37 20 25 8 22 18 9 9 66 11 39 37 16 54 15 12 407

Panel B: Industry affiliations Mining and extraction Manufacturing: Food & textiles Manufacturing: Chemicals & petroManufacturing: Metal products Manufacturing: Machinery Manufacturing: Motor vehicles Electricity generation Construction & real estate Hotels, recreation Transport and communications Computer and related activity Miscellaneous (4 industries) Total

NIC2 10–14 15–19 21–25 26–28 29–33 34–36 40 45, 70 55, 92 61–64 72 –

Cases 8 37 88 50 31 31 14 28 21 26 55 18 407

cases. Computer and Related Activity group account for 55 cases. Many of the computer and related firms, such as Infosys, Satyam and Wipro, conducted most of their businesses abroad and had stronger investor recognition abroad at the time of the capital issuance. The smaller firms are more likely to have difficulty in accessing domestic capital markets or raising capital at a reasonable cost. Foreign capital may prove to be a cheaper source of funding for these firms and, thus, a source of value gain. Firms that belong to larger groups are likely to have easier access to domestic capital or have internal capital markets. Foreign capital-raising may not be motivated primarily by cheaper cost of capital concerns for large group firms, rather, access to large capital pools thus allowing significant corporate expansions or acquisitions may be the major motivation for foreign capital issuance of large firms. There is a significant amount of corporate learning that takes place in the capital raising activity, multiple capital issuances might lead to lowering the cost for the issuer compared to the cost for a one-time issuer. This would be particularly true for group companies since learning can be shared across firms belonging to the group or capital may be raised at the group level.

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4.5. Financial characteristics of the issuing firms We present summary data of the capital issuing firms in Table 6. The size of the capital issue is shown in Panel A as a percent of the total assets of the firm. The median size of the issue relative to the firms' total asset is 36% for debt and 39% for the equity case. The lower relative size for debt issue is likely due to the need to manage the issue size in view of the risk impact of leverage. The debt–equity ratio prior to the capital issuance averages 115% for the sample with a median value of 86% as shown in Panel B. There is little difference between the debt and equity issuers with respect to the pre-issue leverage ratios.6 We report the change in the debt–equity ratio of the issuers in the year following the issue. As expected, the debt–equity ratio for debt issuers increases on average by 21% with a median increase of 37%. Consistent with our priors, the debt–equity ratio of equity issuers declines approximately 40% (median of 21%). The aggregate level of debt and equity issuance was of a similar order of magnitude. For the sample as a whole, the change in the debt–equity ratio is moderate with average ΔD/E of − 6% (median of 3%). Issuers with higher levels of profitability and assets as collateral may be more likely to issue debt rather than equity. We report the relative level of capital intensity, computed as the ratio of Gross Fixed Assets to Total Assets, in Panel C of Table 6. The average capital intensity is 56% (median of 57%) for debt issuers compared to the average of 52% (median of 48%) for equity issuers. As in the case of domestic issuance of corporate debt, the foreign debt issuance is more likely to be successful for firms with higher levels of fixed assets. The median level of the operating profit margin is 19.6% for debt issuers compared to 18.6% for equity issuers. Again, the higher the level of operating profit, the more likely the issuers are to provide better debt servicing or assure the investors of such capabilities. Capital raised to support growth of sales is more likely to be positively rewarded by the market. Pilotte (1992) examines the price response to the issuance of securities in the U.S. and reports that stock price response is positively related to the measures of growth opportunity. We expect a higher stock price response to growth opportunities for the Indian firms issuing foreign securities. We present the asset and sales growth rates for the sample for a 3-year period preceding issuance and report it in Panel D of Table 6. A clear pattern does not appear to emerge from this data. We employ a look-ahead variable to capture the relationship between sales and asset growth, and obtain the growth rates between year +1 and −1 relative to the issue year. If the sales growth rate exceeds the asset growth rate, define a dummy variable that takes on a value of 1, otherwise zero. There are 47 cases of higher sales growth for debt issuers and 48 cases for equity issuers. We expect a positive relationship between the dummy variable and the market response in regressions. 4.6. Issue characteristics There are a number of features of the issues that are discernible from the news reports and from data collected from SDC, Datastream, SKINDIA, and Prowess sources. Desirable features of the issue will make the issue more attractive to investors, lead to ease of placement, and is likely to have a positive impact on the domestic stock price. The summary data reported in Table 7 refer to the characteristics of the convertible debt and the GDR/ADR issues. The majority of the convertible debt issues have 5 years maturity with few going to 7 years. Most allow for first conversion within six months of issue. Majority of the convertible issues are zero coupon issues. Low coupon rate is particularly attractive to the Indian issuer since he faces relatively high interest rates at home. There is a widespread belief in the Indian media that a foreign currency convertible bond (FCCB) enables the issuer to raise funds cheaper than domestic issuance as evidenced in the following excerpt from the Business Line dated January 29, 2007: “… M&M's (Mahindra and Mahindra) five-year FCCB issue of $200 million in April 2006 had a yield-tomaturity of five per cent, while Ranbaxy's $400-million February 2006 FCCB issue, again with a five-

6 The level of leverage employed by the sample of Indian firms, however, appears to be high. Inter-country differences in the use of debt have been reported in the literature. Fan, Titman, and Twite (2012) rank India as 4th highest in terms of the use of corporate leverage in their sample of 39 countries in Fig. 1 of their paper.

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Table 6 Financial characteristics of issuing firms. This table presents financial characteristics of the issuing firms. In Panel B, we present the debt– equity (D/E) ratio of the issuers for the year preceding the issue and the change in the debt–equity Δ(D/E) ratio following the issue year. Panel C shows summary of gross fixed assets as percentage of total assets. The operating profit margin is also shown. In Panel D we present the past 3-year growth rates in sales, assets, and profit before depreciation interest and taxes. All these items are based on the Indian rupee reported numbers. The last row presents a summary of the dummy variable that compares the growth rates of sales with that of assets between year −1 to +1 relative to the issue year (year 0). Panel A: Issue size in relation to assets and foreign activity Debt issue

Issue size ($ mn) Assets ($mn) Relative size Sales ($ mn)

Equity issue

All issues

Mean

Median

Mean

Median

Mean

Median

95 697 68% 436

60 146 36% 102

103 453 311% 311

46 121 39% 93

99 581 183% 377

55 138 37% 94

118% 21%

86% 37%

111% −40%

83% −21%

115% −6%

86% 3%

406 56% 25%

74 57% 20%

247 52% 112%

59 48% 19%

332 54% 65%

68 54% 19%

28% 27% 30% 47

16% 17% 21%

25% 29% 30% 48

18% 15% 20%

27% 28% 30% 95

17% 16% 20%

Panel B: D/E ratio and Δ(D/E) ratio following capital issuance Debt–equity (pre) Change in D–E ratio Panel C: Profitability and asset ratios Gross fixed asset ($mn) (GFA/total assets) % (PBDITA/sales) % Panel D: Growth in assets, sales, and profitability Asset growth – 3 years Sales growth – 3 years PBDITA growth – 3 years Cases with sales growth Exceeding asset growth

year tenor, had a yield-to-maturity of 4.8 per cent, much cheaper than the rates at which debt can be leveraged in the domestic markets. …In comparison, blue-chip PSUs (Public Sector Undertakings) that borrowed from the domestic market were offering a much higher 8.5–9 per cent for 10-year maturity, while banks were offering 8–8.5 per cent for one-year bulk deposits.” (italics added) The yield on the GOI bond ranged between 13.9% and 5.1% with an average of 7.7% and median of 7.5%. The coupon commitment is low on a FCCB, and its yield is substantially lower than that of the domestic government bond.7 The low coupon rate makes the convertible issues attractive to the Indian issuers with potential deferral of payments to the maturity date. The issuer is subject to foreign exchange risk, however, in the event of rupee depreciation. Improvements in the cost of debt to the Indian issuer provide evidence in support of the cost of capital arguments of market integration (see; Doidge, Karolyi, Lins, Miller, & Stulz, 2009; Karolyi, 2006; and Stulz, 1999). Indian issuers raising capital abroad at a lower cost improve their cost structure when competing in the product market with foreign firms, as the new economic policy of the Indian Government implicitly intended them to do. We summarize the conversion premium for the convertible debt issues. A high conversion premium makes the convertible issue less attractive to the buyer since the option value of conversion is lower. A high conversion premium provides less of a sweetener, and the offered YTM has to be higher in that case. The average conversion premium is 24.8% with a median of 26.1%. A high GDR premium would make the issue less attractive to the foreign investor, but it would make the domestic shareholders happier as the Indian firm experiences a larger cash inflow. A higher offer price reduces 7 We compare YTM of the convertible foreign bond against the Indian Govt. Bond rate is for illustrative purpose only. The YTM of a convertible debt is not comparable to that of a straight debt due to the call feature. Also, the risk classes are different. Finally, the reported YTM is in nominal dollars, whereas the Govt. T-Bond Rate is a Rupee-denominated interest rates and thus the two are not directly comparable.

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Table 7 Descriptive statistics regarding issues. Summary distribution of issue characteristics is shown. We provide summary statistics of; coupon rate for the issues from SDC; distribution of the YTM from news reports; distribution of the YTM on 10 year Indian govt. bonds from Datastream and matched with corporate debt issues by month; the conversion premium of the convertible bonds reported by SDC; and the GDR/ADR premium comparing the offer price to the average stock price in India between days t = −20 to −10 relative to the announcement. We use the exchange rate on the announcement date from Bloomberg, the offer price from SDC, and the exchange ratio from the news stories to compute the GDR/ADR premium.

Stated coupon rate for debt issues Distribution of YTM at issue as available Ten year Indian govt. bond yield Conversion premiums for convertible bonds GDR/ADR offer premiums relative to stock

N

Average

Median

Max

Min

182 76 111 177 179

1.0% 6.3% 7.7% 24.8% −3.5%

0.0% 6.6% 7.5% 26.1% −3.2%

7.9% 8.6% 13.9% 71.0% 12.3%

0.0% 2.3% 5.1% −62.8% −20.8%

the cost of equity to the issuer. Hence, we expect a positive relationship between the GDR offer premium and the domestic stock price response. GDR premium at issue can be positive unlike the discount seen in a domestic secondary offer, since the capital markets are not fully integrated, and the GDR cannot be converted to the domestic stock or vice-versa. In subsequent secondary market trading, the premium of the GDR relative to the domestic stock price can be positive or negative depending on local demand conditions and sentiments regarding the securities in either markets (Kadapakkam & Misra, 2003; Pinegar & Ravichandran, 2002). The offer premium is the ratio of offer price to the stock price appropriately adjusted by the exchange rate and the exchange ratio. First, we compute the average price of the Indian stock between t = −20 and −10 relative to the announcement date. Assume that ABC's average stock price is Rs. 300, the exchange ratio is 4 shares per GDR, the exchange rate on the announcement date is Rs. 40/$, and the offer price is $33. The premium is 10% [(33/(300*4/40)) − 1 = 10%]. As shown in Table 7, the offer premium averages − 3.51% (median −3.20%). There are 56 cases (31% of total) where the GDR is offered at a positive premium relative to the domestic Indian price. There are 17 ADR issues in our sample. Capital raising ADR issues were initiated in 1997, long after the first GDR issues. Many information technology firms issued ADRs as NASDAQ was believed to provide a better venue for pricing the securities, and the issuers expected success in placement due to their name and product recognition. Some of the issues were large and for Infosys in excess of $1 billion. While Infosys raised the funds, it also enabled its Indian shareholders to diversify their holding and participate in the ADR to the tune of 55% of the total. Some of the Indian hi-tech ADRs participated in the dot com bubble and burst experience in the latter part of the 1990s.

4.7. Role of the IB The role of the IB is critical in the successful placement of foreign issues in view of the foreign investor's lack of knowledge about the Indian issuer, issue specifics, and the uncertainties associated with investing in an emerging market. Success of the issue would typically imply higher visibility for the Indian firm during the road-show, greater foreign investor interest, increased ease of placement of the issue, better offer prices for equity issues (or lower yield for debt issues), greater potential for larger sized issues, and subsequent informational and price support in the secondary markets potentially paving the path to success in subsequent issues abroad made by the Indian firm. The foreign IBs help in all these dimensions. Additionally, the foreign IB has a beneficial positive impact on the domestic stock price suggesting that the domestic investors view the presence of reputable foreign IBs as an indicator of the issue's potential success as it mitigates information asymmetry (Bris, Cantale, Hrnjic, & Nishiotis, 2012) or the liability of foreignness (Bell et al., 2012). We have collected the IB data from SDC as one source. Data regarding the use of IBs as summarized in Table 8 provide interesting insights into the role of Indian and non-Indian banks in the foreign capital raising efforts of Indian firms. Some of the better known foreign IBs that were engaged in more than 20 placements include JP Morgan, Merrill Lynch, Deutsche Bank, and Citigroup. Most of the early transactions were done by foreign IBs with some representation by Indian IBs in non-lead roles and as part of the syndication. Over time,

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Table 8 Use of investment bankers in foreign capital issuance. This table provides a summary of the number and types of investment bankers (IB) used in foreign capital issuances made by Indian firms between 1993 and June 2009. IB use data is obtained from SDC. Panel A shows the number of IBs used in debt versus equity issues cross tabulated with foreign and Indian IBs. Panel B shows the firm size and issue size according to the type of capital issuance and the use of Indian versus non-Indian IBs. An issue using at least one foreign IB is counted as a foreign IB issue. Panel A: Investment bankers country of origin: Indian and non-Indian (foreign)

Total cases Cases using foreign IB Cases using Indian IB Cases missing IB data Average number of IB Median number of IB Average number of foreign IB Median number of foreign IB Average percent of foreign IB

Debt issue

Equity issue

All issues

214 138 49 27 1.64 1 1.13 1 69.9%

193 108 40 45 4.20 2 3.06 2 61.2%

407 246 89 72 2.77 1 1.99 1 66.1%

662 233 234 64 156 87 43 32

681 224 198 55 138 85 40 21

Panel B: Foreign investment bankers usage: Firm and issue size Avg assets (at least one foreign IB) Med assets (at least one foreign IB) Avg assets (no foreign IB) Med assets (no foreign IB) Avg issue size (at least one foreign IB) Med issue size (at least one foreign IB) Avg issue size (no foreign IB) Med issue size (no foreign IB)

696 214 168 52 123 80 37 20

the Indian banks have increasingly taken the lead role in many of the offerings. We provide some examples below regarding the use or non-use of foreign IBs in the issue process.8 Arvind Mills made a $125 million GDR issue in 1994. The involved IBs were Goldman Sachs, Jardine Fleming, Lehman Brothers, Bear Stearns, HSBC Markets, SBI European Bank, UBS Ltd, Ssangyong Securities, International Nederlanden Bank, and Citicorp International. Eight out of these ten investment banks are well-known reputable foreign IBs. We examine the names of the IB for all issues for which data is available in a similar manner. We record cases where at least one reputable non-Indian IB was involved in the placement of the issue and assign it a code of 1. Arvind Mills is thus assigned a code of 1. Accentia Technologies made a 2008 GDR issue which was placed by Athena Capital Partners. This case is coded as zero since no reputable foreign IB was involved. Data shown in Table 8 permit the following conclusions: larger Indian firms make larger issues and are more likely to be assisted in the placement efforts by foreign banks. Conversely, smaller Indian firms are more likely to choose smaller Indian IBs in their issuance. Foreign IBs are associated with Indian firms that are approximately 3.5 times as large as the firms that use Indian IBs. The issue size is approximately 3.5 times larger for the foreign IBs as well. The number of IBs involved in equity issues is larger than the number involved in debt type issues, 4.2 versus 1.64. Fewer IBs are involved in debt issues presumably due to the negotiated nature of these instruments and the smaller base of investors for debt issues. Compared to debt issuance, relatively larger selling effort is required for equity issues necessitating the involvement of a larger number of IBs in the syndication process. We also obtained the IB usage data by examining news reports and stories in LexisNexis. Some stories make a prominent point of the presence of important IBs involved in the transactions and provide a first source for investor information. Equally important, not all stories indicate the name of the IB. We employ this classification in the cross-sectional regressions as well. Both the SDC and the LexisNexis classifications provide comparable types of response.

8 Indian banks such as SBI Capital Markets, PNB, IDBI Capital Markets, Fortune Financial, Edelweiss Capital, Axis Bank Ltd, Marwadi Shares, ICICI Bank, and Bank of India are now Indian partners in foreign offerings.

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Table 9 Choice of foreign investment banker: Logistic regression results. This table shows the results of two logistic regressions with the choice of the foreign investment banker as the binary dependent variable. The independent variables are debt versus equity issuance, early period versus late period issuance (folded at the mid-point of issues), size of the issuing firm, relative size of the issue, whether the firm belongs to a multiple issuer group. The z-statistics and corresponding significance levels are indicated below the coefficient estimates. The sample size, pseudo R2 and the LR Chi-square-statistic are shown in the panel below the coefficient estimates. ⁎, ⁎⁎, ⁎⁎⁎ refer to significance levels at better than 10%, 5%, and 1% respectively.

Equity issuer Size of the issuer (log sale) Issue size relative to assets Early time period Multiple issuer group firm Multiple issuer group firm × large size dummy Intercept N LR Chi-square statistic Pseudo-R2 statistic

Logistic regression 1

Logistic regression 2

−0.5662 −2.21⁎⁎ 0.6560 5.80⁎⁎⁎ 1.1177 6.62⁎⁎⁎

−0.5852 −2.25⁎⁎ 0.6274 5.49⁎⁎⁎ 1.2099 6.89⁎⁎⁎

1.0069 3.69⁎⁎⁎ 1.1273 3.78⁎⁎⁎

1.0985 3.93⁎⁎⁎ 0.2608 0.59 1.2635 2.52⁎⁎

−2.9437 −5.31⁎⁎⁎ 400 125.03⁎⁎⁎ 23.22%

400 131.19⁎⁎⁎ 24.37%

We estimate two logistic regressions and report the results in Table 9. The dependent variable is the choice of the foreign IB, and the independent variables include firm and issue characteristics. Equity issuers are less likely to choose foreign IB than debt issuers. Larger sized issuers are more likely to choose foreign IB. Larger sized issuers are more likely to choose foreign IB. In the first half of our sample, there is a greater likelihood of using a foreign IB. Multiple issuer group firms, particularly the larger kinds, are more likely to employ foreign IB. These models are highly significant. 5. Analysis of market response 5.1. Authorization process for issuance and event date We examined stories regarding capital issuance for specific firms, which may occur over a long period exceeding a year, in some cases. There were cases where the issuer did not go through a planned issue on advice of the IB or due to adverse foreign market conditions. Some of the firms with Indian Government part ownership were subject to lengthy political discussions regarding the timing and pricing of the issues at the ministerial or secretarial levels; discussions that attempted, and usually failed, to provide political or bureaucratic resolutions to the IBs' dilemma. The issuance process typically follows this sequence. The management puts a proposal for capital issuance to the board of directors; the firm issues a press release, usually through the Bombay Stock Exchange, regarding the date of the board meeting. The firm issues a press release subsequent to the board meeting describing the outcome. The shareholders consider the proposal at the Annual General Meeting (AGM) or, more likely, at an Extra-ordinary General Meeting (EGM) specifically called for the purpose of authorizing the foreign capital issuance. Announcement of the call for the EGM and the outcome of the meeting are released in the media on respective dates. The EGM (AGM) often provides a general authorization of raising capital to a maximum limit, and the board is authorized to work out the details. In some instances the firm may seek a postal ballot of authorization from its shareholders without specifically calling an EGM (AGM). Subsequent to the EGM, the board chooses and engages with the IB regarding issue details. Periodic announcements are made regarding the impending issue; its size and pricing details. The issue is offered to the foreign investors for a period of three days to two weeks, with the information to the Indian investors released before, during, or after the issue. The specific number of equities for the GDR issues or bonds for

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convertible issues are authorized and recorded in another board meeting following the issue after the total issue size including the green shoe options is tallied. Prior to 2000, most issues needed government approval of the issue details. Permissions from various departments of GOI made the process long. Subsequent to mid-1995, the process was simplified, and new regulations by 2000 permitted the equivalent of a “shelf-registration” process where the issuer obtained permission for an amount that could be issued in smaller sizes in response to prevailing market conditions. The issue sequence is long with multiple announcements to the investors due to transparency and legal concerns. Many of the news dates are informative regarding the issue and, thus, have an impact on the stock price. Since the announcement is not on one date, the price response occurs over an extended period, and there is some smearing of response. We have attempted to identify the final shareholder approval date as the event date for announcement. If there are government clearances needed subsequent to the EGM, that date is used as the announcement date. The announcement effect is smeared if there is a pre-event information leakage. Bhattacharya, Daouk, Jorgenson, and Kehr (2000) discuss the issue of pre-announcement information leakage in the Mexican Bolsa and argue that such reactions are endemic in emerging stock markets. Pre-event insider trading may reduce the response on the event day. It is, however, more likely that multiple information dates cause the smearing. The traditional measure of three-day announcement period abnormal return understates the informational impact of capital issuance. We use the 22-day event period from t = − 20 to + 1 as a compromise period of one calendar month that is likely to capture the issuance effects. There are 311 cases where the announcement news is obtained from press reports. The number of days between the announcement date and the issue date of the security averages 36.6 days (median of 20 days). There are a number of cases where the first news report is on the issue date. For these cases we use the

Table 10 Market adjusted abnormal returns. This table shows the market adjusted cumulative abnormal returns and the significance levels of the corresponding t-statistics with ⁎, ⁎⁎, ⁎⁎⁎ referring to significance levels at better than 10%, 5%, and 1% respectively. The BSE100 index is the market index employed here. We report results corresponding to two windows: CAR3 for the announcement period (t = −1 to +1), and CAR22 of the announcement period or the issue period, if the announcement date preceding the issue is not available in news reports (t = −20 to +1). Cross-sectional analysis reported in subsequent tables is based on CAR22. Equity issues consist of 187 cases; GDR (163 cases), ADR (14 cases), GDR and Debt (10 cases). Debt consists of 212 cases; convertible (202 cases) and non-convertible (10 cases). Panel A: Abnormal returns for debt vs. equity issues Debt issues

CAR3 CAR22

Equity issues

Mean

Median

N

Mean

0.73⁎ 4.18⁎⁎⁎

0.29 2.32⁎⁎⁎

158 214

1.01⁎ 3.50⁎⁎⁎

All issues Median

N

Mean

Median

N

0.49 3.17⁎⁎⁎

153 185

0.87⁎⁎⁎ 3.87⁎⁎⁎

0.48⁎⁎ 2.73⁎⁎⁎

311 399

4.17⁎⁎ 7.61⁎⁎⁎

13 14

0.80⁎ 4.17⁎⁎⁎

123 148

0.87⁎⁎⁎ 3.87⁎⁎⁎

133 188

1.21⁎⁎⁎ 4.03⁎⁎⁎

Panel B: Abnormal returns for GDR, ADR, and convertible debt issues GDR issues CAR3 CAR22

0.80 2.83⁎⁎

ADR issues 0.32 2.10⁎⁎

131 163

3.52⁎⁎ 9.21⁎⁎⁎

188 251

0.34 3.59⁎⁎⁎

Convertible issues 0.30⁎ 2.32⁎⁎⁎

151 202

0.48⁎⁎ 2.73⁎⁎⁎

311 399

Panel C: Group vs. non-group issuers Group issuers CAR3 CAR22

1.21⁎⁎⁎ 4.03⁎⁎

Non-group issuers 0.74⁎⁎⁎ 2.73⁎⁎⁎

−0.39 2.21⁎⁎⁎

All issuers

Panel D: Group issuers — One time vs. many time issuers One time issuers CAR3 CAR22

1.20 5.43⁎⁎⁎

0.92⁎ 4.98⁎⁎

Many time issuers 55 63

1.22⁎⁎ 3.56⁎⁎⁎

0.68⁎⁎ 2.64⁎⁎⁎

All group issuers 0.74⁎⁎⁎ 2.73⁎⁎⁎

188 251

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Table 11 Size, investment banker, and leverage related regression results. This table shows the weighted least squares regression results with CAR22 (t = −20 to +1) as the dependent variable weighted by the inverse of firm size (log sales) for the year preceding the capital issuance. The regressors are issue size relative to assets (log); foreign investment banker (dummy) which takes on a value of 1 if the investment banker is a known US or European entity based on LexisNexis news stories (148 cases); and the increase in leverage (dummy) which takes a value of one if the debt-to-equity ratio of the firm is reported to be higher in the year following the issuance compared to the year preceding the issuance in the PROWESS database (234 cases). Foreign investment banker (dummy) is an alternative measure of the foreign investment bankers involved in the issue from SDC (246 cases). The t-statistics and corresponding significance levels are indicated below the coefficient estimates. The sample size, adjusted R2 and the F-statistic are shown in the panel below the coefficient estimates. ⁎, ⁎⁎, ⁎⁎⁎ refer to significance levels at better than 10%, 5%, and 1% respectively. Model 1 Issue size relative to assets Foreign investment banker LexisNexis (dummy) Foreign investment banker SDC (dummy) Increase in leverage (dummy) Intercept N Adjusted R-square F-statistic

0.0199 2.43 ⁎⁎

0.0540 2.90 ⁎⁎⁎ 0.0439 2.25 ⁎⁎ 0.0120 0.60 394 12.17% 14.65 ⁎⁎⁎

Model 2 0.0201 2.47 ⁎⁎ 0.0637 3.32 ⁎⁎⁎

0.0412 2.13 ⁎⁎ 0.0189 1.04 394 12.73% 15.37 ⁎⁎⁎

22 day CAR with the issue date coded as day 0 and enhance the sample size by 90 cases for better crosssectional reliability. Our final sample consists of 399 cases.9 There is positive announcement period CAR3 and CAR22 for domestic stocks for both foreign debt and equity issues as shown in Table 10. We show that level III ADR issues have substantially stronger positive response than do GDR and 144A, Regulation S issues. For ADR issues, the domestic stock price run-up is sustained and averages 9.2% for CAR22. CAR3 is larger for group issuers but CAR22 is comparable across group and non-group issuers. CAR22 is also larger for one time issuers compared to multiple time issuers whereas the CAR3 is of comparable magnitude. The bivariate cuts on the CAR provide support for the positive response hypotheses for debt and equity securities and show that ADR issues respond more than GDR issues. First issues are more informative than subsequent issues only for CAR3 similar to the non-significant price impact of the seasoned global equity offerings subsequent to cross-listing reported by Errunza and Miller (2003). More careful examination of the hypotheses is possible with regression analysis. 5.2. Cross-sectional regressions We report cross-sectional regressions employing various combinations of variables in 6 models shown in Tables 11 to 13. The dependent variable is CAR22, and the regressions are weighted with the inverse of the log of sales, a size variable, as the weight. Independent variables including dummy variables are appropriately weighted in the reported regressions. 5.2.1. Issue size, banker reputation, and leverage We focus on the issue size and IB reputation in two regressions reported in Table 11. We examine the role of issue size relative to assets, a measure of relative size. In both Models 1 and 2, and we find a positive significant coefficient attached to this variable. This variable is one of our basic control variables and appears in all

9 Until mid-1995, the news coverage in LexisNexis is spotty. For the early cases we obtain the date/details of the issue from the SKINDIA database which is the most authoritative source of information on Indian GDRs.

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Table 12 Growth and groups regression results. This table shows the weighted least squares regression results with CAR22 (t = −20 to +1) as the dependent variable weighted by the inverse of firm size (log sales) for the year preceding the capital issuance. Previously defined variables are Issue size, foreign investment banker (dummy), and increase in leverage (dummy). Variables new to this table are sales growth exceeding asset growth (dummy), which takes on a value of 1 if the sales growth rate computed between year +1 and year −1 relative to the capital issuance year exceeds the asset growth rate over the same period (95 cases); Multiple-issuer group companies (dummy) takes on a value of 1 if a group made multiple issues (191 cases); and the interaction between multiple issuer group and high size (dummy). The t-statistics and corresponding significance levels are indicated below coefficient estimates. The sample size, adjusted R2 and the F-statistic are shown in the panel below the coefficient estimates. ⁎, ⁎⁎, ⁎⁎⁎ refer to significance levels at better than 10%, 5%, and 1% respectively.

Issue size relative to assets Foreign investment banker Sales growth exceeds asset growth Multiple issuer Group Cos (dummy) Multiple issuer × large size (dummy) Intercept

Model 3

Model 4

0.0277 3.46 ⁎⁎⁎ 0.0488 2.54 ⁎⁎

0.0304 3.27 ⁎⁎⁎ 0.0486 2.51 ⁎⁎

0.0305 1.87 ⁎ 390 14.49% 17.52 ⁎⁎⁎

390 14.94% 12.42 ⁎⁎⁎

0.0547 2.83 ⁎⁎⁎

N Adjusted R-square F-statistic

0.0462 2.35 ⁎⁎ −0.0656 −2.01 ⁎⁎ 0.0663 1.65 0.0480 3.27 ⁎⁎⁎

models. We use the foreign IB dummy variable, from LexisNexis in Model 1, and from SDC in Model 2. Both variables have significantly positive coefficients. This is a second control variable that we employ in most of the subsequent models in addition to the relative size variable. We introduce the increase in debt–equity ratio dummy and find a significant positive coefficient attached to it. Why does an increase in leverage lead to increased value? We conjecture that increased leverage would be desirable if the new debt capital is raised abroad at a lower cost of capital than if the capital were raised domestically in India.

Table 13 Issue type and pricing related regression results. This table shows the weighted least squares regression results with CAR22 (t = −20 to +1) as the dependent variable weighted by the inverse of firm size (log sales) for the year preceding the capital issuance. The variables new to this table are GDR Premium measured as offer price relative to the average stock price prevailing between t = −20, −10; first time issuer, a dummy variable that takes on a value of 1 for first time issuance of convertible security. ADR or combined issuer (dummy) takes a value of 1 if it is an ADR or a combined GDR and convertible issue (27 cases). The t-statistics and corresponding significance levels are indicated below coefficient estimates. The sample size, adjusted R2 and the F-statistic are shown in the panel below the coefficient estimates. ⁎, ⁎⁎, ⁎⁎⁎ refer to significance levels at better than 10%, 5%, and 1% respectively. Debt issue model 5 Issue size relative to assets Foreign investment banker GDR premium

0.0305 2.55 ⁎⁎

First time convertible Bond issuer (dummy) ADR or combined Issuer (dummy) Intercept

0.0845 2.65 ⁎⁎⁎

N Adjusted R-square F-statistic

0.0485 1.75 ⁎

Equity issue model 6 0.0117 1.11 0.0938 3.80 ⁎⁎⁎ 0.6052 3.58 ⁎⁎⁎

0.0858 2.70 ⁎⁎⁎ −0.0010 −0.03 210 15.04% 10.30 ⁎⁎⁎

0.0363 2.07 ⁎⁎⁎ 170 20.06% 9.53 ⁎⁎⁎

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5.2.2. Growth, foreign demand, and groups As we discussed earlier, Pilotte (1992) has shown that in the U.S. domestic context, firms that raise capital to support growth are rewarded. Denis (1994) also reports a positive relationship between announcement period abnormal returns to equity issuance and the issuing firm's growth opportunities. We compute a dummy variable that indicates if the realized sales growth of a firm exceeds its asset growth, as the asset growth is presumably brought about by the additional capital. We report the results in Model 3 of Table 12 and show a significant positive response between growth and value creation. Khanna and Palepu (2000) in their study of Indian group affiliated companies note that group affiliations do not necessarily create operating value. However, large sized group companies create value based on their investment in better management, better processes, and the development of potential for regulatory/political capture. In the present context, the larger group firms can exploit the regulatory constraints and are likely better positioned to deploy the capital. Conversely, for smaller sized Indian firms the access to foreign capital would be of greater immediate value as they may have greater difficulty in raising capital in India – a difficulty unlikely to be faced by large domestic groups due to their ability to access Indian capital and manage their own internal capital markets. We examine this issue in Model 4. The dummy variable Multiple Issuer has a significant negative coefficient suggesting that group firms, on average, generate lower values or, conversely, that non-group firms generate greater value when they issue foreign securities. The rationale for one-time issuers/smaller issuers having greater positive domestic stock price response compared to group companies rests on their success in raising capital abroad. There are potentially two aspects to domestic investors' greater liking for the success. First, the smaller firm by issuing securities abroad bonds itself to higher standards and mitigates significant informational asymmetries in the domestic market. Second, it is possible that the cost of capital differential is more substantial for the smaller firm between the domestic and foreign issues compared to the differential experienced by a larger, and better capitalized, group firm. In a cross-tabulation of firm size against the number of security issues, we find that 73% of the high sized firms are multiple issuers, and 79% of the low sized firms are single issuers. We obtain an interaction term between multiple issuers and high sized firms. Extending Khanna and Palepu (2000), we expect to see a positive coefficient for the interaction term. That is, we expect that the larger sized group companies to develop appropriate expertise in foreign capital issuance and capture the value gains corresponding to such improvements. In Model 4, we do see a positive coefficient whose significance is marginal with a t-statistic of 1.65. The control variables, relative size of issue, and the foreign IB involvement continue to be significant.

5.2.3. Issue type and issue characteristics If reducing the cost of capital is one of the primary interests of the issuer, then we would be able to observe this more readily for those issuers for whom the cost of capital is likely to be significantly lowered. Errunza and Miller (2003) report that seasoned equity offerings lead to lower value increases compared to first time issuance. We examine this hypothesis for convertible bond issuance with a dummy variable that captures the first time issuers. As shown in Model 5 of Table 13, the first time issuers obtain a significantly higher CAR compared to the subsequent issuers. The control variables, relative issue size and foreign IB continue to be positive and significant. For equity a high GDR premium at the time of issuance reduces the issuer's cost of capital. One measure of the gain to GDR issue would be to compute the premium difference between the GDR and a comparable domestic equity issue. The latter is not available, so we employ the GDR premium in our equity issuance model 6. The GDR Premium is measured as offer price relative to the average stock price between t = −20, −10, adjusted by the exchange ratio and the prevailing exchange rate. As shown in Model 6, this variable has a highly significant positive coefficient. 10 In this model, we also examine the marginal effect of ADR issues compared to GDR issues. ADRs show a significantly higher positive abnormal return than do GDRs. This result is due to the substantially greater and more stringent disclosure requirements associated with ADRs and the high quality of issuers. As discussed 10 We examine the benefits to issuing foreign bonds, typically at a lower YTM than available in India. We do not present the model based on reported YTM in 74 cases. We compute the YTM Gain relative to Indian rate as (1-(YTM/PRATE)). The YTM gain is significantly positively related with abnormal returns. This supports the cost of capital reduction hypothesis presented in the literature.

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earlier, capital raising ADRs must adhere to the stricter U.S. disclosure standards (FASB, GAAP) whereas GDR issues in the Euro markets support to weaker disclosure requirements. We have included other variables including industry fixed effects, not reported, and get robust results. As we have discussed in Section 3.2, it is not feasible to pair-match the foreign and domestic issuing firms as they differ significantly by firm size and issue size. 6. Conclusions At a broad level of analysis, we investigate issues of capital market segmentation. At the beginning of our sample period, the Indian capital market is segmented from the world market. Over time as the liberalization process unfolds, the barriers are slowly removed, and some firms can better exploit the removal of the barriers than others. We examine issues of capital market integration, which differs from the approach followed in the literature in two major respects. 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