Journal of Islamic Accounting and Business Research

Emerald Article: Initial returns of Malaysian IPOs and Shari'a-compliant status Ruzita Abdul Rahim, Othman Yong

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To cite this document: Ruzita Abdul Rahim, Othman Yong, (2010),"Initial returns of Malaysian IPOs and Shari'a-compliant status", Journal of Islamic Accounting and Business Research, Vol. 1 Iss: 1 pp. 60 - 74 Permanent link to this document: http://dx.doi.org/10.1108/17590811011033415 Downloaded on: 12-02-2013 References: This document contains references to 37 other documents To copy this document: permissions@emeraldinsight.com This document has been downloaded 822 times since 2010. *

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Ruzita Abdul Rahim, Othman Yong, (2010),"Initial returns of Malaysian IPOs and <IT>Shari'a-</IT>compliant status", Journal of Islamic Accounting and Business Research, Vol. 1 Iss: 1 pp. 60 - 74 http://dx.doi.org/10.1108/17590811011033415 Ruzita Abdul Rahim, Othman Yong, (2010),"Initial returns of Malaysian IPOs and <IT>Shari'a-</IT>compliant status", Journal of Islamic Accounting and Business Research, Vol. 1 Iss: 1 pp. 60 - 74 http://dx.doi.org/10.1108/17590811011033415 Ruzita Abdul Rahim, Othman Yong, (2010),"Initial returns of Malaysian IPOs and <IT>Shari'a-</IT>compliant status", Journal of Islamic Accounting and Business Research, Vol. 1 Iss: 1 pp. 60 - 74 http://dx.doi.org/10.1108/17590811011033415

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JIABR 1,1

Initial returns of Malaysian IPOs and Sharia-compliant status

Ruzita Abdul Rahim
Faculty of Economics and Business, School of Business Management, National University of Malaysia, Bangi, Malaysia, and

60

Othman Yong
Graduate School of Business, National University of Malaysia, Bangi, Malaysia
Abstract
Purpose The purpose of this paper is to investigate the initial return patterns of Malaysian initial public offerings (IPOs) and whether sharia-compliant status would alter such patterns. Design/methodology/approach The effect of sharia-compliant status on the patterns of initial return of IPOs is analyzed using a sample of 386 IPOs issued between January 1999 and December 2007. Findings The preliminary results indicate that over the study period, the initial returns of Malaysian IPOs drop substantially from 94.91 percent reported from the pre-crisis period of 1990-1998 to 31.99 percent, a level more comparable to that reported in advanced markets. Since the initial returns do not revert to pre-crisis levels, the new low IPO underpricing trend is more likely to be associated with the removal of pricing restraints. The results of regression analyses on the full sample, however, suggest that there is no drastic change with respect to factors that drive initial returns in Malaysian IPOs. With regards to sharia-compliant status, IPOs of this subsample show similar proles to those of non-sharia counterparts. However, other than demand, the two subsamples are driven by different factors. Initial returns of sharia-compliant IPOs are driven by the size and type of offers, whereas those of the non-sharia IPOs are driven by risks. Research limitations/implications Future studies should re-examine the issue by taking into consideration the extensiveness of a rms compliance to sharia rules and other predictor variables. Originality/value This paper is one of the rst to examine the effect of sharia-compliant status on the performance of IPOs. Keywords Investments, Stocks and shares, Stock returns, Malaysia Paper type Research paper

Journal of Islamic Accounting and Business Research Vol. 1 No. 1, 2010 pp. 60-74 q Emerald Group Publishing Limited 1759-0817 DOI 10.1108/17590811011033415

1. Introduction The underpricing of initial public offerings (IPOs) of stocks has been widely accepted as a universal phenomenon (Allen and Faulhaber, 1989; Baron, 1982; Chemmanur, 1993; Chowdhry and Sherman, 1996; Grinblatt and Hwang, 1989; Ibbotson, 1975; Ibbotson and Ritter, 1995; Miller and Reilly, 1987; Loughran et al., 1994, 2008; Reilly, 1977; Reilly and Hateld, 1969; Rock, 1986). Asian markets are no exception (Yong, 2007a) with underpricing in China being documented to be exceptionally high (Su and Fleisher, 1999). In the smaller circle of Southeast Asia, Malaysia has been known to report overwhelmingly high IPO underpricing (Dawson, 1987; How et al., 2007; Kim et al., 1995; Yong, 1991). While building new evidence to the existing literature on Malaysian IPOs is a natural course, this study addresses two issues. The rst is whether the IPO underpricing persists in Malaysia, given the changes that it has undergone in recent years. Other than the known fact that the market has just recovered from the 1997

Asian nancial crisis, it is also signicant that since January 1996, the IPO market has undergone a pricing deregulation (How et al., 2007; Paudyal et al., 1998; Saadouni et al., 2005; Wan-Hussin, 2006). The second issue relates to the growing concerns over sharia investment throughout the world, particularly among Islamic countries like Malaysia. Specically, this study deviates from previous research, as it examines whether sharia-compliant status would alter the initial return patterns of the IPOs. Our study also examines the possible factors that might have contributed to the levels of IPO underpricing in Malaysia including the demand, offer size and rm size effects as well as type of offer (Kim et al., 1995; Yong and Isa, 2003; Yong, 2007b) and risks (Bradley and Jordan, 2002) for sharia IPOs, separately from their non-sharia counterparts. The signicance of understanding IPOs of sharia-compliant companies separately from the generic IPO market relates well to the basic requirements of Islamic investment, which forbid any element of: . riba or interest; . gharar or uncertainty; and . maisir or gambling[1]. In the case of equity instruments, which have been approved by the Council of the Islamic Fiqh in 1993 as permissible investment vehicles (Naughton and Naughton, 2000), the respective companies must comply with two basic sets of lters: (1) The primary business activities of the company must be legitimate or halal in accordance with sharia principles. (2) The nancial management of the company must be free from riba and impurities (El-Gamal, 2000; Hakim and Rashidian, 2004; Hayat, 2006; OICU-IOSCO, 2004). While these criteria address the legitimacy and riba issues, no nancial instruments can be totally devoid of gharar. Yet, assuming that the second sharia-screening criterion serves as an additional monitoring mechanism as is the case for socially ethical or responsible investment (Bauer et al., 2006; Jin et al., 2005), then the status could be interpreted as a signal of a lower risk company and accordingly lower returns to its investors. Alternatively, the similarity could also suggest that investors in sharia IPOs behave more ethically and responsibly and be less aggressive in speculating the price run-up on the rst trading day. This is particularly so given the more conventional emphasis in Islamic principles on the haul or adequate time for the invested capital to be put into fueling the real growth of the company. On the other hand, the growing concern for Islamic investment and trend for international or global funds in Islamic equities could also result in the increasing popularity of sharia-compliant shares, which in turn creates additional pressure on prices and therefore higher return on these IPOs. The remainder of this paper is organized as follows. Section 2 presents a brief background of the underpricing phenomenon in Malaysia. Section 3 presents the data and methodology employed in this study. Section 4 reports and discusses the results, and nally Section 5 concludes and discusses the implications.

Initial returns of Malaysian IPOs

61

JIABR 1,1

62

2. Malaysian IPO market 2.1 The structure Several unique characteristics are worth noting regarding the structure of the new issues market in Malaysia before the discussion proceeds to evidence of underpricing. One of the characteristics of particular concern to this study is the pricing mechanism, which is regulated by the Securities Commission ((SC), the regulator of Malaysian securities market since 1993) instead of market. Before the pricing mechanism was liberalized in January 1996, the Capital Issues Committee (CIC)[2] had since 1988 been imposing pricing restraints whereby issuers must set the offer prices within a certain range of the prospective price to earnings ratio (for details of the P/E multiples, refer to Wan-Hussin, 2006). The removal of this pricing restraint is an attempt to improve the transparency and efciency of the Malaysian securities market (How et al., 2007; Paudyal et al., 1998; Saadouni et al., 2005; Wan-Hussin, 2006). Under the new structure, issuers and advisers are given total responsibility for setting the price, while nal approval from the SC is still required to ensure appropriateness. In addition to the pricing mechanism, IPO issuance also needs to undergo an extensive process that involves seeking listing approval from the Ministry of International Trade and Industry and the Foreign Investment Committee in addition to the SC (Paudyal et al., 1998). Other unique features include the proportion of IPOs allocated to Bumiputera investors (Malaysian indigenous), which is imposed to ensure that these investors hold at least 33 percent ownership in the company (How et al., 2007; Paudyal et al., 1998). There is also a requirement for controlling shareholders (and the adviser) of the IPO issuing company to provide a prot guarantee of not less than 90 percent of the forecast prot reported in the prospectus and 90 percent maintainable prots for two consecutive years after listing. Alternatively, the controlling shareholders must commit to a three-year moratorium or lock-up period after the date of listing during which they are prevented from selling the shares. In addition, for all issuers of the second board and issuers of the main board whose core business is either construction or property development, the SC also imposes a one-year moratorium period preventing major shareholders from selling, transferring or assigning 45 percent of nominal issued and paid-up capital (Paudyal et al., 1998; Wan-Hussin, 2006). These requirements are imposed to protect minority shareholders by ensuring active participation of the controlling and major shareholders in the management of the company throughout the lock-up period. 2.2 The evidence One of the earliest evidence on IPO underpricing in Malaysia was documented by Dawson (1987). Using 21 new issues from 1978-1983, Dawson reported that the average initial return is 166.7 percent. Similar evidence of tremendous underpricing of 167.4 percent was found by Yong (1991), who also documented that the IPOs have an average over-subscription ratio (OSR) of 45.9 times. The patterns have yet to show evidence of full exploitation by investors. In a more recent study by Ismail et al. (1993), the average initial excess return (adjusted for market movement) of 63 new issues persists at the high level of 114.6 percent from 1980 to 1989. In a separate study that concentrated only on IPOs listed in the second board, How et al. (2007) revealed that for 322 IPOs issued from 1989 to 2000, the market-adjusted initial returns are still as high as 102 percent. Among the rst studies in which the downward trend is documented is

one by Loughran et al. (2008). From a much longer study period of 1980-2006, they reported that the average initial return of Malaysian IPOs is only 69.6 percent. This lower underpricing apparently coincides well with ndings of two other studies. From 1990 to 1998, Yong and Isa (2003) reported that the average initial return is still considerably high at 94.91 percent, but the average declines to 37.23 percent from 1999 to 2003 (Yong, 2007b). 2.3 The transition The chronology described above apparently suggests that a transition occurs somewhere in 1997-1999. While one can quite conveniently relate the dramatic change to the 1997/1998 Asian nancial crisis, the fact that the trend (as shown in Figure 1) does not revert to the pre-crisis level once the market has recovered from the crisis indicates that there could be other development in the IPO market that allows this trend to persist. Note that the data for earlier periods, extracted from Table I of Yong and Isa (2003, p. 922), are for a period of an equal length to the one used in this study and thus are comparable for detecting the trend in IPO returns. It is interesting to note that in Figure 1 the highest initial returns are reported in 1996, which coincides with the year that the SC adopts the market-based pricing mechanism. This sharp increase of initial returns could explain Saadouni et al.s (2005) concern over the adverse impact of the market-based pricing mechanism on the IPO underpricing. Without showing any drastic change in the demand (measured by the over-subscription ratio, OSR), such a dramatic increase could be due to an overreaction, as market players are still trying to absorb the shock in the SC deregulation. This nding is of particular interest to this study because in past studies, pricing restraints are among the reasons commonly given for the underpricing of Malaysian IPOs. Another interesting trend shown in Figure 1 is that within a year after the price liberalization, the IPO market reverts to a more steady level before it drops tremendously by the time of the crisis. From 1999 onward, the IPO markets in general stabilize at 31.99 percent. The evidence so far suggests that because the initial returns do not revert to their pre-crisis levels, the new low IPO underpricing trend is more likely to be associated with the SCs deregulation. This argument clearly contradicts
200 180 160 140 120 100 80 60 40 20 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Note: The dotted line marks the year that segregated between the periods covered in Yong and Isa (2003) (1990-1998) and the present study (1999-2007) OSR = 43.71 IPORTN = 31.99% OSR = 32.44 IPORTN = 94.91% OSR IPORTN

Initial returns of Malaysian IPOs

63

Figure 1. Initial returns (IPORTN) and OSR of Malaysian IPOs, 1990-2007

JIABR 1,1

Variables

Mean

Range

SD 4 102 1 4 102 1 5 102 1 5 101 5 101 4 101 2 108 2 108 5 10

8

Skew 1.412 1.257 1.878 3.314 3.327 2.830 8.645

Kurt

J-Bera

t-stat.

Z-stat.

64

0.320 2 0.667 to 2.077 IPORTNA IPORTNS 0.321 2 0.489 to 1.941 N IPORTN 0.312 2 0.667 to 2.077 DEMANDA 32.439 2 0.940 to 377.960 DEMANDS 32.709 2 0.940 to 377.960 DEMANDN 30.743 2 0.400 to 229.200 OFSIZEA 6.09 107 840,000 to 3.05 109 S 7 4.45 10 840,000 to OFSIZE 2.01 109 N 8 1.64 10 1.68 106 to OFSIZE 3.05 109 IPORISKA 1.445 0.208 to 6.250 IPORISKS 1.475 0.208 to 6.250 IPORISKN 1.257 0.217 to 3.571

5.467 226 4.732 129 6.931 65 17.499 4,087 17.386 3,485 14.266 351 88.833 123,297

0.131 0.332

2 0.913 2 0.902

8.878 92.588 115,735 4.661 24.956 5.488 5.342 3.385 1,256 2 3.406 * 2 1.919 * 273 224 12

1 10 1.645 1 10 1.633 9 102 1 1.172

1.565

2 0.659

Table I. Descriptive statistics of main variables

Notes: IPORTN is IPO initial returns as calculated in equation (1), DEMAND is OSR, OFSIZE is offer size and IPORISK is risk of IPO as calculated in equation (2); superscripts A, S and N refer to all, sharia and non-sharia IPOs, respectively

earlier ndings (How et al., 2007; Saadouni et al., 2005) but is consistent with the signicantly lower IPO initial returns reported earlier in Japan after the removal of price limits and introduction of public auction (Pettway and Kaneko, 1996). In a separate study of IPOs in the USA, Bossaerts and Hillion (2001) suggested that in the absence of price limits, the IPO returns are lower because the market prices the assets more efciently. 3. Data and methodology In Malaysia, IPOs are commonly issued either in the form of a public issue, offer for sale, or combination of these two[3]. Other less-commonly issued IPOs are offers like private placement, restricted offer for sale or public, special issues, and restricted offer for sale to Bumiputera investors. In line with Yong (2007b), the current study excludes IPO issuances that are exclusively from such types of offers. This study also excludes IPOs with incomplete data for the nal selection of the sample IPOs. The data required for this study are offer prices, rst trading day opening and closing prices, OSR, units offered, types of offer, and listing board. These criteria provide us with a pool of 386 IPOs, representing 94.84 percent of the total 407 IPOs that were actually issued from 1999-2007 in our study. To examine the extent to which sharia-compliant status has an implication on proles of the Malaysian IPOs, the sample is classied into two sub-samples according to the status of sharia compliance of the issuing companies. This classication provides two sub-samples of 333 sharia-compliant and 53 non-sharia-compliant IPOs. The sharia sub-sample constitutes 86.27 percent, a representation consistent with the percentage of sharia-compliant companies currently listed in Bursa Malaysia (Securities Commission Malaysia, 2007). The data for this study are compiled from Investors Digest, web sites of Bursa Malaysia and various securities management rms such as the OSK and the Malaysian Investment House as well as the STAR newspaper.

We calculate the initial returns (IPORTN) for the ith IPO as: pi;l 2 pi;O IPORTNi pi;O

Initial returns of Malaysian IPOs

where PO is offer price and Pl is opening price on the rst listing day of the ith IPOs. Where, there is a different offer price between retail and institutional investors, the weighted average of the offer prices is used. The main predictor variable is the demand factor (DEMAND), which is proxied by the OSR. We hypothesize a positive relationship between demand for the new issues and returns to the investors, due to investor sentiment. The supply factor is proxied by the size of IPOs (OFSIZE), obtained by multiplying the offer price and the total units of IPOs offered. We hypothesize that offer size affects initial returns negatively, considering the pressure on the rst day prices is less intense, as greater supply allows more subscriptions to be satised. Following Yong (2007b), the effect of the issuing company size (COSIZE) is approximated using board of listing. The main board requires a minimum issued and paid-up capital of RM60 million and therefore represents the largest and least risky companies. Companies listed on the second board are required to have a minimum issued and paid-up capital of RM40 million and therefore may be considered medium in both size and riskiness. MESDAQ companies represent, the smallest and most risky companies (issued and paid-up capital of at least RM2 million). In line with size effect, which associates greater risks with smaller companies, we hypothesize a negative relationship between company size and returns to investors. Type of offer (OFTYPE) denes whether IPOs issued are offer for sale, public issue or a combination of both. Since public issue offers involved totally new issues (not originally sold to a companys stockholders prior to listing), we hypothesize that they are offered at a lower price and accordingly, positively related to returns. Finally, adopting the method used by Bradley and Jordan (2002), the risk of the IPOs (IPORISK) is calculated as the reciprocal of the IPO offer price that is: 1 2 IPORISKi P i;0 Following the risk-return trade-off, we hypothesize a positive relationship between risks and returns to investors. To quantify the role of the ve predictor variables on initial returns of IPOs, this study performs cross-sectional multiple regression, which generally is estimated using the following linear regression: IPORTNi ai b1 DEMANDi b2 OFSIZEi b3 COSIZEi b4 OFTYPEi b5 IPORISKi 1i 3

65

This model specication is used to determine which (if any) of the predictor variables has a signicant role in explaining initial returns on the sharia IPOs, separately from the non-sharia IPOs. 4. Empirical results Table I presents the descriptive statistics of the main variables for the full sample, sharia and non-sharia IPOs over the study period. The initial returns (IPORTN),

JIABR 1,1

66

demand (OSRs) and risks (IPORISK) of the sharia IPOs are obviously very similar to those reported for the full sample, and only slightly higher than those of the non-sharia IPOs. With values of initial returns and demand closely resembling that of the full sample, further discussion seems a repetition of the description of Figure 1. Our focus is then on an interesting result concerning the IPO risk, which in contrast to our earlier prediction indicates that sharia IPOs (1.475) appear to be riskier than non-sharia IPOs (1.257). However, as indicated by the t- and Z-statistics, the only difference detected between the two sub-samples is the size of the offer (OFSIZE). The average offer size of a sharia IPO is RM44.5 million while that of a non-sharia IPO is RM164.01 million. Table I also reports the results of the distribution of the observations, which all tend to be positively skewed and have fat tails. The resulting Jarque-Bera statistics for all variables reject the null hypothesis that the data are normally distributed. Accordingly, the subsequent differences between the two subsamples are tested using both parametric (t-test) and non-parametric (Mann-Whitney U-test) methods. Table II shows the proles of sharia and non-sharia IPOs in greater detail based on company size, which is proxied using board of listing. Since both the t-test and the Mann-Whitney U-test produce similar results, our discussion proceeds according with the t-test to be more consistent with the reported mean values. Panel A of Table II shows that the initial returns of sharia IPOs listed on the main board (22.49 percent) are signicantly lower than those of the second board (31.83 percent) and the MESDAQ (41.10 percent). Even though the difference between the initial returns of the second board and MESDAQ IPOs is not signicant, the trend consistently indicates a negative relationship between IPO returns and rm size. There are two possible explanations for this phenomenon. The rst links with the risk-return trade-off whereby smaller rms are commonly associated with greater risks, which implies higher returns are necessary to compensate the investors. The second associates with the resulting prices (or returns) in a particular supply-demand relationship. As also shown in Panel A, Main Board sharia companies seem to have greater supply (offer size) compared to those of the second board, which in turn have greater supply than those of MESDAQ. Assuming a constant pool of investable funds or a constant demand for investment in IPO, more rather than less supply is likely to generate less pressure on prices. This proposition is further reinforced by the next nding on the signicant negative relationship between demand (OSR) and rm size. Integrated with earlier ndings, the negative relationship implies that IPOs of larger rms report lower initial returns because the larger supply-lower demand combination subsequently creates less pressure on their prices. With respect to risk, the mean values that show lowest risk for main board IPOs (0.7813) and highest risk for MESDAQ IPOs (2.8109) consistently support our earlier proposition associating company size and risk. The difference test results conrm the risk difference of IPOs of different company size. Unlike the more comparable number of cases of IPOs issued by listing board, Table III indicates a leniency towards public issue IPOs. Public issue represents 60.62 percent of the sample (234), with 85.90 percent of them issued by sharia-compliant rms. Before we proceed with the discussion, it is worthwhile to note that as in the case of Table III, the results of the t-test and Mann-Whitney U-test are similar, except only stronger in a few cases involving comparisons between public issue and combination of non-sharia IPOs. This to some extent supports our nding regarding comparison

Variables 2 2.259 * 2 1.877 2 1.273 2 8.036 * * 2 1.880 2 15.35 * * 2 11.57 * * 2 15.78 * * 2 12.06 * * 3.699 * * 2 10.80 * * 4.421 * * 2 9.218 * * 2 5.208 * * 2 5.103 * * 2 4.491 * * 2 4.481 * * 2 1.588 2 1.075 2 0.940 3.313 * * 2 2.154 * 22.49% 31.83% 41.10% 19.83x 24.07x 55.51x 1.20 108 2.05 107 8.93 106 0.7813 0.9290 2.8109 2 2.514 * 2 1.804 2 3.078 * * 2 1.400 5.074 * * 5.503 * * 2.359 * 7.937 * * 2 4.809 * * 2 5.042 * * 2 3.789 * * 0.276 2 2.950 * * 2.288 * 2 0.421 2 0.586 2 4.026 * * 2 3.226 * * 2 2.520 * 2 2.413 * 2 0.062 2 1.372 2 4.032 * * 2 3.996 * * 11.41% 49.25% 43.01% 11.19x 35.32x 57.64x 3.63 108 1.67 107 6.11 106 0.8251 0.9019 2.3722 2 3.191 * * 2 2.452 *

Listing board

Mean

Main vs second t-stat. Z-stat.

Main vs Mesdaq t-stat. Z-stat.

Second vs Mesdaq t-stat. Z-stat.

Panel A: Sharia IPOs IPORTN Main board Second board MESDAQ DEMAND Main board Second board MESDAQ OFSIZE Main board Second board MESDAQ IPORISK Main board Second board MESDAQ Panel B. non-Sharia IPOs IPORTN Main board Second Board MESDAQ DEMAND Main board Second board MESDAQ OFSIZE Main board Second board MESDAQ IPORISK Main board Second board MESDAQ

Notes: IPORTN is IPO returns as calculated in equation (1), DEMAND is OSR, OFSIZE is size of offer and IPORISK is IPO risk as calculated in equation (2); signicant at * *1 and *5 percent levels, respectively. In all sharia cases, N equals to 93, 136, and 104 for the main, second boards and MESDAQ, respectively; In all non-sharia cases, the number of observations (N) equals to 23, 16, and 14 for the main, second boards and MESDAQ, respectively; only public issue type is allowed for IPOs listed on MESDAQ

67

Initial returns of Malaysian IPOs

Table II. proles of sharia versus non-sharia IPOs by board of listing

68

JIABR 1,1

Variables 2 1.577 2 4.169 * * 2 0.842 0.867 0.074 2 0.073 7.202 * * 2 0.851 2 2.321 * 2 0.621 1.174 2 2.743 * * 2 2.581 * * 2 3.527 * * 2 2.021 * 2.528 * 2 3.035 * * 2 9.727 * * 2 6.019 * * 27.48% 37.44% 23.53% 15.76x 38.53x 24.95x 1.69 108 2.46 107 6.18 107 0.9079 1.8538 0.8983 2 0.394 2 0.661 1.158 0.034 0.000 2 0.414 2 1.580 0.441 2 0.764 2 0.335 2 0.260 2 1.474 2 0.434 2 0.663 2 0.091 2 0.610 1.369 1.707 2 0.793 1.747 2 1.731 2 2.214 * 2 3.278 * * 2 1.141 16.00% 38.60% 19.10% 9.40x 38.02x 19.23x 5.43 108 1.14 108 2.30 108 1.000 1.4247 0.9790 2 0.445 0.507 2 1.158 3.316 * * 2 3.045 * *

Panel A: Sharia IPOs IPORTN Offer for sale Public issue Combination DEMAND Offer for sale Public issue Combination OFSIZE Offer for sale Public issue Combination IPORISK Offer for sale Public issue Combination Panel B: Sharia IPOs IPORTN Offer for sale Public issue Combination DEMAND Offer for sale Public issue Combination OFSIZE Offer for sale Public issue Combination IPORISK Offer for sale Public issue Combination

Notes: IPORTN is IPO returns as calculated in equation (1), DEMAND is OSR, OFSIZE is size of offer, IPORISK is IPO risk as calculated in equation (2); signicant at * *1 and *5 and percent levels, respectively; in all sharia cases, the number of observations (N) equals to 16, 201, and 116 for offer for sale, public issue and their combination, respectively; in all non-sharia cases, N equals to 1, 33, and 19 for offer for sale, public issue and their combination, respectively

Table III. Proles of sharia versus non-sharia IPOs by types of offers Mean value Offer for sale vs public issue t-stat. Z-stat. Offer for Sale vs combination t-stat. Z-stat. Public Issue vs Combination t-stat. Z-stat.

Type of offer

based on type of offer, which shows that signicantly higher initial returns of IPOs are consistently associated with public issue. In Panel A, public issue of sharia IPOs report average initial returns of 37.44 percent, which is more than 36.24 percent higher compared to those of offers for sale (27.48 percent) or combination (23.53 percent). Differences in the demand and supply of each type of IPO strengthen the argument put forth earlier for comparison at the board level. That is, initial returns are highest for IPOs that have the greatest demand and smallest supply. As shown in Panel A, public issue IPOs report the highest average OSR (38.53) and at the same time the smallest average offer size (RM246 million). However, given that the offer size of a public issue is only signicantly smaller than that of a combination, it seems more appropriate to conclude that the signicantly higher returns on public issue IPOs tend to be driven by demand rather than supply. The mean values of risks of the IPO indicate that risks are higher for totally new issues (i.e. public issues) and signicantly lower for IPOs that are initially sold to the original stockholders (i.e. offers for sale). The results for non-sharia IPOs reported in Panel B indicate some similarities. However, the IPO initial returns-rm size and demandsupply relationships are less denitive than those of their sharia counterparts, as indicated by the insignicant differences between types of IPOs. We nally perform regression analyses to quantify the distinctive characteristics of second board and public issues in the form of dummy variables. The company size dummy variable (DCOSIZE) takes a value of 1 if the IPOs are issued by the second board companies and zero otherwise. Meanwhile, the type dummy variable (DOFTYPE) takes a value of 1 if the IPOs are public issue offers and zero otherwise. The distinctive proles of public issue are also captured in an earlier study (How et al., 2007), which concentrates only on Malaysian IPOs listed in the second board. The resulting coefcients are estimated by employing the Newey-West procedure, which addresses both heteroscedasticity and autocorrelation problems. Consistent with earlier observations, the results in Table IV indicate that the demand factor (DEMAND) as measured by OSR plays a dominant role (consistently and highly signicant with coefcients of at least 4.8010 standard errors from zero) in explaining variations in initial returns on IPOs, at the overall level and regardless of the classication of sharia and non-sharia IPOs. This nding is consistent with our hypothesis that initial returns of IPOs are driven by a demand factor and with results of previous studies (How et al., 2007; Paudyal et al., 1998; Wan-Hussin, 2006; Yong and Isa, 2003). Except for the non-sharia IPOs, the results also show that there is a negative relationship between size of offer (OFSIZE) and initial returns. This relationship is consistent with our proposition that the upward pressure on price of IPOs on its rst listing day (therefore high-initial returns) is partly due to the post-offer date demand from investors whose subscriptions to the IPOs are initially declined. It is also consistent with earlier ndings by Yong (2007b). Meanwhile, the positive coefcients of DCOSIZE indicate that high-initial returns are an attribute of second board IPOs[4]. This nding is consistent with our prediction but contradictory to an earlier nding by Hiau Abdullah and Mohd (2004), who asserted that the positive association between rm size and initial returns is because larger rms are more capable of providing greater discounts. Nonetheless, the ndings from this study can only be considered preliminary since none of the coefcients are signicant. Next, the coefcients of DOFTYPE

Initial returns of Malaysian IPOs

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Variables Constant DEMAND

Predicted sign

Full sample 0.1887 (3.9926) * * 0.0037 (5.1183) * * 2 8.41 102 11 (2 1.9242) 0.0680 (1.5473) 2 0.0812 (2 2.4564) * 2 0.0013 (2 0.0454) 0.2209 21.5534 0.0000 1.4031 1.100-1.358

Sharia IPOs 0.2100 (4.0101) * * 0.0033 (4.8010) * * 2 2.09 102 10 (2 2.7789) * * 0.0311 (0.6436) 2 0.0734 (2 2.1693) * 0.0103 (0.3532) 0.2118 17.5725 0.0000 1.2830 1.107-1.370

Non-Sharia IPOs 0.1699 (1.8178) 0.0071 (7.0230) * * 7.99 102 13 (0.0457) 0.1828 (1.7766) 2 0.0859 (2 0.7984) 2 0.1195 (2 2.1258) * 0.3716 5.5598 0.0000 2.4302 1.081-1.457

Positive Negative Positivea Positive Positive

70

OFSIZE DCOSIZE DTYPE IPORISK R2 F-statistic p(F-statistic) Durbin-Watson Range of variable VIF

Table IV. Results of regressions of IPORTN on selected predictor variables

Notes: IPORTN is IPO returns as calculated in equation (1), DEMAND is OSR and OFSIZE is size of offer, IPORISK is IPO risk as calculated in equation (2), DCOSIZE is the dummy variable for company size which is proxied using board of listing and DOFTYPE is dummy variable for offer type; superscript a is to indicate that the expected sign differs from stated earlier in methodology section since DCOSIZE represents small rms; the number of observations (N) equal to 386, 333 and 53 for full sample, sharia and non-sharia subsamples, respectively; signicant at * *1 and *5 percent levels, respectively

consistently indicate negative relationships between initial returns and type of offer, even though the result for the non-sharia IPOs is not signicant. Given that DOFTYPE of 1 represents a public issue, this nding suggests that high-initial returns are attributes of offers for sale and/or combination types of offers. The tendency for the former is slightly higher because offers for sale IPOs record higher average initial returns than those of combination (data for the full sample is not reported). The strong results reported for sharia IPOs also contradict the patterns of average initial returns reported earlier in Table III, which suggest that higher initial returns on sharia IPOs are attributes of public issue offers. Finally, the coefcients of IPORISK suggest mixed results regarding the relationships between risk and returns of IPOs. The negative and weak relationship detected in the overall IPOs seems to be inuenced by the negative and signicant relationship reported for the non-sharia subsample. For this sub-sample, other things equal, lower risks (which imply a higher offer price) are signicantly associated with higher underpricing. Putting aside the appropriateness of the risk measure used in this study, the positive relationship from the sharia IPOs is more consistent with the risk-return theory and ndings by Bradley and Jordan (2002), but the evidence is weak. The ndings from the regression analyses so far lead us to the following conclusions. First, regardless of the status of compliance with sharia, initial returns of Malaysian IPOs are driven by demand (OSR) factors. This conclusion lends strong support to earlier ndings (How et al., 2007; Paudyal et al., 1998; Wan-Hussin, 2006; Yong and Isa, 2003). Second, despite the preliminary evidence relating high-initial returns to smaller rms, such a relationship is only supported as far as second board IPOs are concerned,

particularly when involving non-sharia IPOs. Unlike Kim et al. (1995), who suggest an association between initial returns and nancial variables like type of offer, the results of this study indicate that the association between initial returns and public issue (which seem to be detected in preliminary results) tends to be an attribute unique to sharia IPOs. The negative coefcients of public issue in the overall sample and sharia sample in the meantime are consistent with results by How et al. (2007). In contrast to the risk-return trade-off proposition, risk is signicantly negative in the case of non-sharia IPOs, probably because more non-sharia IPOs (43 percent) are listed on the main board than sharia IPOs (28 percent), and larger rms are more commonly associated with lower risks. In general, the regression models explain at best 37.16 percent of the variations in initial returns of Malaysian IPOs, indicating a great need for additional predictors. 5. Conclusion and implications for future studies This paper examines the proles of the initial returns of Malaysian IPOs in the aftermath of the 1997/1998 Asian nancial crisis with a focus on the implications of sharia-compliant status. This is done by examining the initial return proles of sharia-complaint IPOs separately from non-sharia-compliant IPOs from 1999 to 2007. Overall, this study uses 386 IPOs issued during the study period, 333 of which are issued by sharia-compliant rms. The preliminary results show that there is a substantial decline in the initial returns of Malaysian IPOs. Compared to the average initial returns of 94.91 percent reported from the nine years prior to the crisis period (Yong and Isa, 2003), the initial returns (31.99 percent) reported from the nine-year period after the crisis are more similar to those in more mature markets. Given that the initial returns do not revert to their pre-crisis levels after the temporary impact shown in 1998, it appears that a factor other than the crisis contributes to the new lower IPO underpricing trend. To a certain extent, the underpricing could be associated with the SCs decision to deregulate the IPO pricing mechanism. A similar effect of signicantly lower IPO initial returns has been reported earlier in Japan (Pettway and Kaneko, 1996) and in the US (Bossaerts and Hillion, 2001) after the removal of price limits. A possible explanation is that in the absence of price limits, the markets price the IPOs more efciently. This is consistent with the objectives behind the SC deregulation, i.e. to improve the transparency and efciency of the Malaysian security markets. While the proles of initial returns of the sharia and non-sharia IPOs barely show any signicant distinctions, there are some indications that sharia IPOs have higher returns and risks compared to their non-sharia counterparts. While the higher returns are consistent with the growing popularity of sharia investment, the co-existence of the higher risk-return duo seems to be more in line with the risk-return trade-off theory. The results of the multivariate analyses indicate that initial returns of IPOs issued by the sharia compliant companies are explained by the same factors that explain initial returns of general IPOs but only share one common factor with their non-sharia counterparts. Specically, there is a very high tendency that the performance of Malaysian IPOs, regardless of sharia classication, is driven by the demand factor (as measured by the OSR). However, other than demand, the initial returns of the two subsamples appear to be explained by distinct factors. Initial returns of sharia IPOs are more dependent on size and type of offer, whereas those of non-sharia IPOs are more dependent on risks. Overall, the results of this study suggest that despite the

Initial returns of Malaysian IPOs

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emphasis given to the classication of sharia-compliant companies, the status does not alter the patterns of initial returns of IPOs in Malaysia signicantly. However, a closer examination of the predictor variables of the sharia as opposed to non-sharia IPOs revealed that they are explained by different factors. The difference shown in non-sharia IPOs may be attributed to the behavior of the investors who are not governed by the Islamic rules and also the fact that more non-sharia IPOs are larger in size and supply (offer size). However, further research examining the greater details of the compliance to sharia rules and including more predictive variables should be undertaken to verify whether such a conclusion holds.
Notes 1. The prohibition of riba is unequivocal in Islam not only to avoid injustice due to its exploitative nature of the rich capital provider of the poor debtor but also to avoid injustice to the capital provider from suffering diminution on the lent capital (El-Gamal, 2000). Gharar refers to the sale of probable items whose existence or characteristics are not certain, due to risky nature which makes the trade similar to maisir or gambling (El-Gamal, 2000, p.7). Unlike riba, the prohibition of gharar is somewhat less-strictly imposed for the very reason that no investment (direct or indirect) can be totally free from risk of losses (El-Gamal, 2000). A special case of gharar is maisir, or gambling, which is prohibited for its obvious nature of gaining merely by chance, without any underlying productive activity taking place (El-Gamal, 2000). The fact that equity capital invested in productive activities of Sharia-compliant companies generates prots, of which a portion (dividend) will be distributed proportionately among equity holders and that the seemingly speculative common stock trading is a standard arbitrage opportunity sought in any productive business transaction (El-Gamal, 2000) have allowed common stocks to be one of the permissible investments. 2. Since March 1993, CICs functions have been ofcially taken over by the SC with the tabling of the Securities Commission Bill 1992 by the Minister of Finance in October 1992. 3. Public issue refers to new shares of stocks offered to the public for the rst time and therefore results in an increase in the paid-up capital of the issuing company. Offer for sale refers to shares that are already sold to the original stockholders, who in turn offer their shares for sale to the public. Accordingly, there is no change in the paid-up capital of the issuing company, as the proceeds from sale go to the original owner. The purpose of offer for sale is to restructure the ownership structure of the company in line with the governments rules and regulations. 4. In a separate test, the results of which are not reported to conserve space, we group MESDAQ and second board IPOs together to take a value of 1 to capture the small rm effect on the initial returns. Surprisingly, despite the earlier results in Table II, which show that there is no initial return difference between second board and MESDAQ IPOs, we nd results that consistently show that DCOSIZE has no signicant role in explaining initial returns on IPOs. References Allen, F. and Faulhaber, G.R. (1989), Signaling by underpricing in the IPO market, Journal of Financial Economics, Vol. 23, pp. 303-23. Baron, D.P. (1982), A model of the demand for investment banking and distribution services for new issues, Journal of Finance, Vol. 37, pp. 955-76. Bauer, R., Koedijk, K. and Otten, R. (2006), International evidence on ethical mutual fund performance and investment style, Journal of Banking & Finance, Vol. 29, pp. 1751-67.

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