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Ever since grading for initial public offers was introduced, industry participants have been divided over its effectiveness.
Now, perhaps for the first time, an analysis by the capital market regulator has concluded there is no correlation between the grades and the performance of the shares after listing.
People familiar with the development, however, say it is unlikely the regulator will do away with the mechanism.
The Securities and Exchange Board of India introduced optional IPO grading in April 2006. In May 2007, it made grading mandatory for all unlisted companies.
The cost is borne by the issuer. Rating agencies such as Crisil and Care grade companies on a scale of one to five, with five indicating strong fundamentals.
Some months ago, a Sebi department was asked to analyse the efficiency of the mechanism and the correlation, if any, with the performance of the shares.
When the initial analysis revealed lack of any correlation, the officials were asked to refer to similar studies done by the rating agencies.
The conclusion remained unchanged. Sources say the report has been given to the Sebi board.
"There is no correlation, which clearly proves IPO gradings do not serve any purpose," said a person privy to the analysis.
"If the post-listing price movement is more dependent on the secondary market movement, what is the point of getting IPOs graded? Also, India is perhaps the only country in the world where such a system exists," he adds.
The study has been circulated to all Sebi board members for comments and, if approved, will be presented to the Primary Market Advisory Committee.
However, it is believed the regulator is in no mood to revisit the grading process in the near future.
"IPO grading was introduced on an experimental basis and we need to wait and watch for some more time before arriving at a conclusion," said a senior Sebi official, on condition of anonymity.
Interestingly, the Sebi analysis is in sharp contrast to that done by Crisil in July. Crisil concluded that companies with higher IPO grades commanded a higher price to earnings multiple.
"Companies with a high IPO grade of four/five (indicating above-average fundamentals) command an average P/E multiple of 28x, compared to 11.2x for companies with an IPO grade of 1/5 (indicating poor fundamentals).
Companies with IPO grades of 2/5 and 3/5 have been trading at average P/E multiples of 17.4x and 23.5x, respectively," said the report.
Interestingly, IPO grading does not consider the price at which the shares are offered in an issue.
"Since IPO grading does not consider the issue price, the investor needs to make an independent judgment regarding the price at which to bid for/subscribe to the shares," says the 'Frequently Asked Questions' section of the IPO grading part on Sebi's website.
