The current issue and full text archive of this journal is available at

www.emeraldinsight.com/1759-0817.htm

JIABR
1,1 Initial returns of Malaysian IPOs
and Shari’a-compliant status
Ruzita Abdul Rahim
60 Faculty of Economics and Business, School of Business Management,
National University of Malaysia, Bangi, Malaysia, and
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 shari’a-compliant status would alter such patterns.
Design/methodology/approach – The effect of shari’a-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 shari’a-compliant status, IPOs of this subsample show similar
profiles to those of non-shari’a counterparts. However, other than demand, the two subsamples are
driven by different factors. Initial returns of shari’a-compliant IPOs are driven by the size and type of
offers, whereas those of the non-shari’a IPOs are driven by risks.
Research limitations/implications – Future studies should re-examine the issue by taking into
consideration the extensiveness of a firm’s compliance to shari’a rules and other predictor variables.
Originality/value – This paper is one of the first to examine the effect of shari’a-compliant status on
the performance of IPOs.
Keywords Investments, Stocks and shares, Stock returns, Malaysia
Paper type Research paper

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 Hatfield, 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
Journal of Islamic Accounting and overwhelmingly high IPO underpricing (Dawson, 1987; How et al., 2007; Kim et al.,
Business Research 1995; Yong, 1991). While building new evidence to the existing literature on Malaysian
Vol. 1 No. 1, 2010
pp. 60-74 IPOs is a natural course, this study addresses two issues. The first is whether the IPO
q Emerald Group Publishing Limited
1759-0817
underpricing persists in Malaysia, given the changes that it has undergone in recent
DOI 10.1108/17590811011033415 years. Other than the known fact that the market has just recovered from the 1997
Asian financial crisis, it is also significant that since January 1996, the IPO market has Initial returns of
undergone a pricing deregulation (How et al., 2007; Paudyal et al., 1998; Saadouni et al., Malaysian IPOs
2005; Wan-Hussin, 2006). The second issue relates to the growing concerns over shari’a
investment throughout the world, particularly among Islamic countries like Malaysia.
Specifically, this study deviates from previous research, as it examines whether
shari’a-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 61
underpricing in Malaysia including the demand, offer size and firm 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 shari’a IPOs, separately from their non-shari’a counterparts.
The significance of understanding IPOs of shari’a-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 filters:
(1) The primary business activities of the company must be legitimate or halal in
accordance with shari’a principles.
(2) The financial 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 financial instruments can
be totally devoid of gharar. Yet, assuming that the second shari’a-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 shari’a IPOs
behave more ethically and responsibly and be less aggressive in speculating the price
run-up on the first 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 shari’a-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 finally Section 5 concludes and discusses the implications.
JIABR 2. Malaysian IPO market
1,1 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
62 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 efficiency 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 final
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 profit guarantee of not less than 90 percent of the
forecast profit reported in the prospectus and 90 percent maintainable profits 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 first 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 Initial returns of
reported that the average initial return of Malaysian IPOs is only 69.6 percent. This Malaysian IPOs
lower underpricing apparently coincides well with findings 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).
63
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 financial 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
finding 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 SC’s deregulation. This argument clearly contradicts

200
180 OSR IPORTN
160
140
IPORTN = 94.91%
120
100
80 IPORTN = 31.99%
OSR = 43.71 OSR = 32.44
60
40
20
0 Figure 1.
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Initial returns (IPORTN)
and OSR of Malaysian
Note: The dotted line marks the year that segregated between the periods covered in Yong and Isa (2003) IPOs, 1990-2007
(1990-1998) and the present study (1999-2007)
JIABR
Variables Mean Range SD Skew Kurt J-Bera t-stat. Z-stat.
1,1
IPORTNA 0.320 2 0.667 to 2.077 4 £ 102 1 1.412 5.467 226
IPORTNS 0.321 2 0.489 to 1.941 4 £ 102 1 1.257 4.732 129
N
IPORTN 0.312 2 0.667 to 2.077 5 £ 102 1 1.878 6.931 65 0.131 2 0.913
DEMANDA 32.439 2 0.940 to 377.960 5 £ 101 3.314 17.499 4,087
64 DEMANDS 32.709 2 0.940 to 377.960 5 £ 101 3.327 17.386 3,485
DEMANDN 30.743 2 0.400 to 229.200 4 £ 101 2.830 14.266 351 0.332 2 0.902
OFSIZEA 6.09 £ 107 840,000 to 2 £ 108 8.645 88.833 123,297
3.05 £ 109
S 7
OFSIZE 4.45 £ 10 840,000 to 2 £ 108 8.878 92.588 115,735
2.01 £ 109
N 8
OFSIZE 1.64 £ 10 1.68 £ 106 to 5 £ 10 8
4.661 24.956 1,256 2 3.406 * 2 1.919 *
3.05 £ 109
IPORISKA 1.445 0.208 to 6.250 1 £ 10 1.645 5.488 273
IPORISKS 1.475 0.208 to 6.250 1 £ 10 1.633 5.342 224
IPORISKN 1.257 0.217 to 3.571 9 £ 102 1 1.172 3.385 12 1.565 2 0.659
Table I. Notes: IPORTN is IPO initial returns as calculated in equation (1), DEMAND is OSR, OFSIZE is offer
Descriptive statistics size and IPORISK is risk of IPO as calculated in equation (2); superscripts A, S and N refer to all,
of main variables shari’a and non-shari’a IPOs, respectively

earlier findings (How et al., 2007; Saadouni et al., 2005) but is consistent with the
significantly 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 efficiently.

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 final selection of the sample IPOs. The data required
for this study are offer prices, first 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 shari’a-compliant status
has an implication on profiles of the Malaysian IPOs, the sample is classified into
two sub-samples according to the status of shari’a compliance of the issuing
companies. This classification provides two sub-samples of 333 shari’a-compliant and
53 non-shari’a-compliant IPOs. The shari’a sub-sample constitutes 86.27 percent, a
representation consistent with the percentage of shari’a-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 firms 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: Initial returns of
IPORTNi ¼
pi;l 2 pi;O
ð1Þ
Malaysian IPOs
pi;O
where PO is offer price and Pl is opening price on the first 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. 65
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 first day prices is less intense, as greater supply allows
more subscriptions to be satisfied. 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) defines 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 company’s 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
IPORISKi ¼ ð2Þ
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 five predictor variables on initial returns of IPOs, this
study performs cross-sectional multiple regression, which generally is estimated using
the following linear regression:

IPORTNi ¼ ai þ b1 DEMANDi þ b2 OFSIZEi þ b3 COSIZEi þ b4 OFTYPEi

þ b5 IPORISKi þ 1i ð3Þ
This model specification is used to determine which (if any) of the predictor variables
has a significant role in explaining initial returns on the shari’a IPOs, separately from
the non-shari’a IPOs.

4. Empirical results
Table I presents the descriptive statistics of the main variables for the full sample,
shari’a and non-shari’a IPOs over the study period. The initial returns (IPORTN),
JIABR demand (OSRs) and risks (IPORISK) of the shari’a IPOs are obviously very similar to
1,1 those reported for the full sample, and only slightly higher than those of the non-shari’a
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 shari’a IPOs (1.475) appear to be riskier than non-shari’a IPOs
66 (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 shari’a IPO is RM44.5 million while that of a non-shari’a 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 profiles of shari’a and non-shari’a 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 shari’a IPOs listed on the main board (22.49 percent)
are significantly 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 significant, the trend consistently indicates a negative
relationship between IPO returns and firm size. There are two possible explanations
for this phenomenon. The first links with the risk-return trade-off whereby smaller
firms 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 shari’a 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
finding on the significant negative relationship between demand (OSR) and firm size.
Integrated with earlier findings, the negative relationship implies that IPOs of larger
firms 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 confirm 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 shari’a-compliant
firms. 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-shari’a IPOs. This to some extent supports our finding regarding comparison
 Main vs second Main vs Mesdaq Second vs Mesdaq
Variables Listing board Mean t-stat. Z-stat. t-stat. Z-stat. t-stat. Z-stat.

Panel A: Shari’a IPOs

IPORTN Main board 22.49% 22.259 * 21.877 23.191 * * 2 2.452 * 2 1.588 2 1.075
Second board 31.83%
MESDAQ 41.10%
DEMAND Main board 19.83x 20.940 21.273 25.208 * * 2 5.103 * * 2 4.491 * * 2 4.481 * *
Second board 24.07x
MESDAQ 55.51x
OFSIZE Main board 1.20 £ 108 3.313 * * 28.036 * * 3.699 * * 2 10.80 * * 4.421 * * 2 9.218 * *
Second board 2.05 £ 107
MESDAQ 8.93 £ 106
IPORISK Main board 0.7813 22.154 * 21.880 2 15.35 * * 2 11.57 * * 2 15.78 * * 2 12.06 * *
Second board 0.9290
MESDAQ 2.8109
Panel B. non-Shari’a IPOs
IPORTN Main board 11.41% 22.514 * 22.520 * 21.804 2 2.413 * 0.276 2 0.062
Second Board 49.25%
MESDAQ 43.01%
DEMAND Main board 11.19x 22.950 * * 23.226 * * 23.078 * * 2 3.789 * * 2 1.400 2 1.372
Second board 35.32x
MESDAQ 57.64x
OFSIZE Main board 3.63 £ 108 2.288 * 24.026 * * 2.359 * 2 5.042 * * 5.074 * * 2 4.032 * *
Second board 1.67 £ 107
MESDAQ 6.11 £ 106
IPORISK Main board 0.8251 20.421 20.586 7.937 * * 2 4.809 * * 5.503 * * 2 3.996 * *
Second board 0.9019
MESDAQ 2.3722
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); significant at * *1 and *5 percent levels, respectively. In all shari’a cases, N equals to 93, 136, and 104 for the main, second boards and MESDAQ,
respectively; In all non-shari’a 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

profiles of shari’a versus

non-shari’a IPOs by
board of listing
Malaysian IPOs

67

Table II.
Initial returns of
 1,1

68
JIABR

Table III.

by types of offers
Profiles of shari’a
versus non-shari’a IPOs
Offer for Sale vs
Offer for sale vs public issue combination Public Issue vs Combination
Variables Type of offer Mean value t-stat. Z-stat. t-stat. Z-stat. t-stat. Z-stat.

Panel A: Shari’a IPOs

IPORTN Offer for sale 27.48% 21.577 20.445 0.507 21.158 3.316 * * 2 3.045 * *
Public issue 37.44%
Combination 23.53%
DEMAND Offer for sale 15.76x 24.169 * * 22.021 * 2 0.842 20.621 2.528 * 2 3.035 * *
Public issue 38.53x
Combination 24.95x
OFSIZE Offer for sale 1.69 £ 108 1.174 23.527 * * 0.867 20.851 22.321 * 2 9.727 * *
Public issue 2.46 £ 107
Combination 6.18 £ 107
IPORISK Offer for sale 0.9079 22.743 * * 22.581 * * 0.074 20.073 7.202 * * 2 6.019 * *
Public issue 1.8538
Combination 0.8983
Panel B: Shari’a IPOs
IPORTN Offer for sale 16.00% 20.394 20.663 2 0.091 20.610 1.369 2 1.731
Public issue 38.60%
Combination 19.10%
DEMAND Offer for sale 9.40x 20.661 20.764 2 0.335 20.260 1.707 2 2.214 *
Public issue 38.02x
Combination 19.23x
OFSIZE Offer for sale 5.43 £ 108 1.158 21.580 0.441 21.474 20.793 2 3.278 * *
Public issue 1.14 £ 108
Combination 2.30 £ 108
IPORISK Offer for sale 1.000 0.034 0.000 2 0.414 20.434 1.747 2 1.141
Public issue 1.4247
Combination 0.9790
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);
significant at * *1 and *5 and percent levels, respectively; in all shari’a 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-shari’a cases, N equals to 1, 33, and 19 for offer for sale, public issue and their combination,
respectively
based on type of offer, which shows that significantly higher initial returns of IPOs are Initial returns of
consistently associated with public issue. Malaysian IPOs
In Panel A, public issue of shari’a 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 69
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 significantly smaller than
that of a combination, it seems more appropriate to conclude that the significantly
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 significantly lower for IPOs that are initially sold to the original
stockholders (i.e. offers for sale). The results for non-shari’a IPOs reported in Panel B
indicate some similarities. However, the IPO initial returns-firm size and demand-
supply relationships are less definitive than those of their shari’a counterparts, as
indicated by the insignificant differences between types of IPOs.
We finally 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 profiles
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
coefficients 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 significant with coefficients 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 classification of shari’a and non-shari’a IPOs. This finding 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-shari’a 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 first
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 findings by Yong (2007b). Meanwhile, the positive coefficients of
DCOSIZE indicate that high-initial returns are an attribute of second board IPOs[4]. This
finding is consistent with our prediction but contradictory to an earlier finding by Hiau
Abdullah and Mohd (2004), who asserted that the positive association between firm size
and initial returns is because larger firms are more capable of providing greater
discounts. Nonetheless, the findings from this study can only be considered preliminary
since none of the coefficients are significant. Next, the coefficients of DOFTYPE
JIABR
Variables Predicted sign Full sample Shari’a IPOs Non-Shari’a IPOs
1,1
Constant 0.1887 0.2100 0.1699
(3.9926) * * (4.0101) * * (1.8178)
DEMAND Positive 0.0037 0.0033 0.0071
(5.1183) * * (4.8010) * * (7.0230) * *
70 OFSIZE Negative 28.41 £ 102 11 22.09 £ 102 10 7.99 £ 102 13
(21.9242) (22.7789) * * (0.0457)
DCOSIZE Positivea 0.0680 0.0311 0.1828
(1.5473) (0.6436) (1.7766)
DTYPE Positive 20.0812 20.0734 2 0.0859
(22.4564) * (22.1693) * (2 0.7984)
IPORISK Positive 20.0013 0.0103 2 0.1195
(20.0454) (0.3532) (2 2.1258) *
R2 0.2209 0.2118 0.3716
F-statistic 21.5534 17.5725 5.5598
p(F-statistic) 0.0000 0.0000 0.0000
Durbin-Watson 1.4031 1.2830 2.4302
Range of variable VIF 1.100-1.358 1.107-1.370 1.081-1.457
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
Table IV. size which is proxied using board of listing and DOFTYPE is dummy variable for offer type; superscript
a
Results of regressions is to indicate that the expected sign differs from stated earlier in methodology section since DCOSIZE
of IPORTN on selected represents small firms; the number of observations (N) equal to 386, 333 and 53 for full sample, shari’a
predictor variables and non-shari’a subsamples, respectively; significant 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-shari’a IPOs is not significant. Given that DOFTYPE of
1 represents a public issue, this finding 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 shari’a IPOs also contradict the patterns of average initial returns reported
earlier in Table III, which suggest that higher initial returns on shari’a IPOs are
attributes of public issue offers. Finally, the coefficients 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 influenced by the negative
and significant relationship reported for the non-shari’a subsample. For this
sub-sample, other things equal, lower risks (which imply a higher offer price) are
significantly associated with higher underpricing. Putting aside the appropriateness of
the risk measure used in this study, the positive relationship from the shari’a IPOs is
more consistent with the risk-return theory and findings by Bradley and Jordan (2002),
but the evidence is weak.
The findings from the regression analyses so far lead us to the following conclusions.
First, regardless of the status of compliance with shari’a, initial returns of Malaysian
IPOs are driven by demand (OSR) factors. This conclusion lends strong support to
earlier findings (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
firms, such a relationship is only supported as far as second board IPOs are concerned,
particularly when involving non-shari’a IPOs. Unlike Kim et al. (1995), who suggest an Initial returns of
association between initial returns and financial variables like type of offer, the results Malaysian IPOs
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
shari’a IPOs. The negative coefficients of public issue in the overall sample and shari’a
sample in the meantime are consistent with results by How et al. (2007). In contrast to
the risk-return trade-off proposition, risk is significantly negative in the case of 71
non-shari’a IPOs, probably because more non-shari’a IPOs (43 percent) are listed on the
main board than shari’a IPOs (28 percent), and larger firms 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 profiles of the initial returns of Malaysian IPOs in the
aftermath of the 1997/1998 Asian financial crisis with a focus on the implications of
shari’a-compliant status. This is done by examining the initial return profiles of
shari’a-complaint IPOs separately from non-shari’a-compliant IPOs from 1999 to 2007.
Overall, this study uses 386 IPOs issued during the study period, 333 of which are
issued by shari’a-compliant firms. 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
SC’s decision to deregulate the IPO pricing mechanism. A similar effect of significantly
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
efficiently. This is consistent with the objectives behind the SC deregulation, i.e. to
improve the transparency and efficiency of the Malaysian security markets.
While the profiles of initial returns of the shari’a and non-shari’a IPOs barely show
any significant distinctions, there are some indications that shari’a IPOs have higher
returns and risks compared to their non-shari’a counterparts. While the higher returns
are consistent with the growing popularity of shari’a 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 shari’a compliant companies are explained by the same factors that explain initial
returns of general IPOs but only share one common factor with their non-shari’a
counterparts. Specifically, there is a very high tendency that the performance of
Malaysian IPOs, regardless of shari’a classification, 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 shari’a IPOs
are more dependent on size and type of offer, whereas those of non-shari’a IPOs are
more dependent on risks. Overall, the results of this study suggest that despite the
JIABR emphasis given to the classification of shari’a-compliant companies, the status does
1,1 not alter the patterns of initial returns of IPOs in Malaysia significantly. However,
a closer examination of the predictor variables of the shari’a as opposed to non-shari’a
IPOs revealed that they are explained by different factors. The difference shown in
non-shari’a 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-shari’a IPOs are larger in
72 size and supply (offer size). However, further research examining the greater details of
the compliance to shari’a 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 Shari’a-compliant companies generates
profits, 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, CIC’s functions have been officially 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 first 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 government’s
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 firm
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 find
results that consistently show that DCOSIZE has no significant 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.
Bossaerts, P. and Hillion, P. (2001), “IPO post-issue markets: questionable predilections but Initial returns of
diligent learners?”, Review of Economics and Statistics, Vol. 83, pp. 333-47.
Malaysian IPOs
Bradley, D.J. and Jordan, B.D. (2002), “Partial adjustment to public information and IPO
underpricing”, Journal of Financial and Quantitative Analysis, Vol. 37 No. 4, pp. 595-616.
Chemmanur, T.J. (1993), “The pricing of initial public offerings: a dynamic model with
information production”, Journal of Finance, Vol. 48, pp. 285-304.
Chowdhry, B. and Sherman, A. (1996), “International differences in oversubscription and 73
underpricing of IPOs”, Journal of Corporate Finance, Vol. 2, pp. 359-81.
Dawson, S.M. (1987), “Secondary stock market performance of initial public offers, Hong Kong,
Singapore and Malaysia: 1978-1984”, Journal of Business Finance & Accounting, Vol. 14,
pp. 65-76.
El-Gamal, M.A. (2000), A Basic Guide to Contemporary Islamic Banking and Finance, Rice
University, Houston, TX, available at: www.ya-hussain.com/int_col1/Islambnkg (accessed
July 10, 2007).
Grinblatt, M. and Hwang, C.Y. (1989), “Signaling and the pricing of new issues”, Journal of
Finance, Vol. 43, pp. 393-420.
Hakim, S. and Rashidian, M. (2004), “Risk and return of Islamic stock market indexes”, available
at: www.mafhoum.com/press4/136E15.pdf (accessed July 12, 2007).
Hayat, R. (2006), “An empirical assessment of Islamic equity fund returns”, unpublished thesis,
Free University, Amsterdam, October available at: www.failaka.com/downloads/RHayat_
IEFReturns_Thesis.pdf (accessed July 10, 2007).
Hiau Abdullah, N.A. and Mohd, K.N.T. (2004), “Factors influencing the underpricing of initial
public offerings in an emerging market: Malaysian evidence”, IIUM Journal of Economics
and Management, Vol. 12 No. 2, pp. 1-21.
How, J., Jelic, R., Saadouni, B. and Verhoeven, P. (2007), “Share allocations and performance of
KLSE second board IPOs”, Pacific-Basin Finance Journal, Vol. 15, pp. 292-314.
Ibbotson, R.G. (1975), “Price performance of common stock new issues”, Journal of Financial
Economics, Vol. 2, pp. 235-72.
Ibbotson, R.G. and Ritter, J. (1995), “Initial public offerings”, in Jarrow, R., Maksimovic, V. and
Ziemba, W. (Eds), Handbooks in Operations Research and Management Science: Finance,
Elsevier, Amsterdam, pp. 993-1016.
Ismail, K.N.I., Abidin, F.Z. and Zainudin, N. (1993), “Performance of new stock issues on the
KLSE”, Capital Markets Review, Vol. 1 No. 1, pp. 81-95.
Jin, H.H., Mitchell, O.S. and Piggot, J. (2005), “Socially responsible investment in Japanese
pensions”, Pacific-Basin Finance Journal, Vol. 14, pp. 427-38.
Kim, J.B., Krinsky, I. and Lee, J. (1995), “The roles of financial variables in pricing of Korean
initial public offerings”, Pacific Basin Finance Journal, Vol. 3, pp. 449-64.
Loughran, T., Ritter, J.R. and Rydqvist, K. (1994), “Initial public offerings: international insights”,
Pacific-Basin Finance Journal, Vol. 2, pp. 165-99.
Loughran, T., Ritter, J.R. and Rydqvist, K. (2008), “Initial public offerings: international insights”,
available at: http://bear.cba.ufl.edu/ritter/Int2008.pdf (accessed November 20, 2007).
Miller, R.E. and Reilly, F.K. (1987), “An examination of mispricing, returns, uncertainty, for initial
public offerings”, Financial Management, Vol. 16, pp. 33-8.
Naughton, S. and Naughton, T. (2000), “Religion, ethics and stock trading: the case of Islamic
equities market”, Journal of Business Ethics, Vol. 23, pp. 145-59.
JIABR OICU-IOSCO (2004), Report of the Islamic Capital Market Task Force of the International
Organization of Securities Commission, available at: www.iosco.org/library/pubdocs/pdf
1,1 (accessed July 12, 2007).
Paudyal, K., Saadouni, B. and Briston, R.J. (1998), “Privatisation initial public offerings in
Malaysia: initial premium and long-term performance”, Pacific-Basin Finance Journal,
Vol. 6, pp. 427-51.
74 Pettway, R.H. and Kaneko, T. (1996), “The effects of removing price limits and introducing
auctions upon short-term IPO returns: the case of Japanese IPOs”, Pacific Basic Finance
Journal, Vol. 4, pp. 241-58.
Reilly, F.K. (1977), “New issues re-visited”, Financial Management, Vol. 4, pp. 28-42.
Reilly, F.K. and Hatfield, K. (1969), “Investor experience with new stock issues”, Financial
Analyst Journal, Vol. 25, pp. 73-80.
Rock, K. (1986), “Why new issues are underpriced?”, Journal of Financial Economics, Vol. 15,
pp. 1051-69.
Saadouni, B., How, J. and Relic, R. (2005), “Share allocation and the performance of the KLSE
second board IPOs”, paper presented at the AFA 2005 Conference, Kuala Lumpur,
July 11-13.
Securities Commission Malaysia (2007), List of Shari’a-compliant Securities by the Shari’a
Advisory Council of the Securities Commission, Securities Commission Malaysia, Kuala
Lumpur, available at: www.sc.com.my/ENG/html (accessed September 15, 2007).
Su, D. and Fleisher, B.M. (1999), “An empirical investigation of underpricing in Chinese IPOs”,
Pacific-Basin Finance Journal, Vol. 7, pp. 173-202.
Wan-Hussin, W.N. (2006), “IPO valuation, investor protection and deregulation: evidence from
Bursa Malaysia”, available at: www.ssrn.com/906973 (accessed August 10, 2009).
Yong, O. (1991), “Performance of new issues of securities in Malaysia”, The Malaysian
Accountant, June, pp. 3-6.
Yong, O. (2007a), “A review of IPO research in Asia: what’s next?”, Pacific-Basin Finance Journal,
Vol. 15, pp. 253-75.
Yong, O. (2007b), “Investor demand, size effect and performance of Malaysian initial public
offerings: evidence from post-1997 financial crisis”, Jurnal Pengurusan, Vol. 26, pp. 25-47.
Yong, O. and Isa, Z. (2003), “Initial performance of new issues of shares in Malaysia”, Applied
Economics, Vol. 35, pp. 919-30.

Corresponding author
Ruzita Abdul Rahim can be contacted at: ruzitaar@ukm.my

To purchase reprints of this article please e-mail: reprints@emeraldinsight.com

Or visit our web site for further details: www.emeraldinsight.com/reprints