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Impact of Disclosure of Risk Factors On The Initial Returns of Initial Public O Fferings (Ipos)
Impact of Disclosure of Risk Factors On The Initial Returns of Initial Public O Fferings (Ipos)
www.emeraldinsight.com/1030-9616.htm
ARJ
31,1 Impact of disclosure of risk
factors on the initial returns of
initial public offerings (IPOs)
46 Shaista Wasiuzzaman
Faculty of Management, Multimedia University, Cyberjaya, Malaysia
Received 26 September 2016
Revised 6 May 2017 Fook Lye Kevin Yong
13 July 2017
14 September 2017 Graduate School of Management, Multimedia University, Cyberjaya, Malaysia
Accepted 5 October 2017
Sheela Devi D. Sundarasen
Accounting Department, College of Business Administration,
Prince Sultan University, Riyadh, Saudi Arabia, and
Noor Shahaliza Othman
Faculty of Management, Multimedia University, Cyberjaya, Malaysia
Abstract
Purpose – When a firm goes public for the first time, its prospectus serves as an important reference for
investors. It is required by regulation that the risk factors which have significant influence on the business be
disclosed in the prospectus. The purpose of this study is to analyze how disclosure of these risk factors
influences the initial returns of initial public offerings (IPOs).
Design/methodology/approach – To do this, a sample of 96 Malaysian new equity offerings (IPOs)
from year 2009 to year 2013 is used. Ordinary least squares regression technique is used to regress initial
returns against risk disclosures. Aside from overall risk disclosure, individual dimensions of risk (internal
risk, external risk and investment risk) are also considered.
Findings – Results of the regression analyses reveal a direct relationship between the IPO initial returns
and the disclosure of risk. Overall risk disclosure is found to be highly significant in influencing initial
returns. However, further investigation into the individual group of risks shows that only investment risk is
highly significant in influencing IPO initial returns.
Originality/value – The results found in this study are interesting as, unlike prior studies, it is shown that
disclosures of internal and external risks are not significant in influencing investors’ actions possibly because
of their generalizability, whereas disclosures related to investment risks are significant. Equity of firms which
disclose more of its risk factors can be expected to generate higher initial returns.
Keywords Malaysia, Initial public offerings, Risk disclosure
Paper type Research paper
1. Introduction
Initial public offerings (henceforth, IPOs) such as those of Facebook in 2012 and Alibaba
Group in 2014 have made headlines around the world mainly because of the uncertainty
surrounding the IPO environment (Ljungqvist, 2007). In that regard, governments around
the world have mandated that any firm wishing to go public must prepare a prospectus
Accounting Research Journal
Vol. 31 No. 1, 2018
pp. 46-62
© Emerald Publishing Limited The authors wish to acknowledge the feedback and contributions from the participants of the
1030-9616
DOI 10.1108/ARJ-09-2016-0122 ICABEC2016 which helped to significantly improve this paper.
which discloses relevant information pertaining to its background, financial performance Disclosure of
and risk factors for potential investors to better understand the firm before they invest in it risk factors
(Beatty, 1989). Investors therefore perceive the prospectus as an important source of
reference to mitigate uncertainty and risk exposure and they depend on the information
disseminated in the prospectus to make necessary investment decisions (Bhabra and
Pettway, 2003; Abdou and Dicle, 2007). Extensive and quality information disclosed in the
prospectus is found to lead to superior IPO pricing thus minimizing pricing error (Hanley
and Hoberg, 2010).
47
The Securities Commission Malaysia provides specific guidelines which set out the
minimum contents required in a prospectus. Information pertaining to the offering, the risk
factors, the corporation and the group, shareholders/promoters/directors/key management,
related party transactions/conflict of interest, financial information and reports from
accountants/experts/directors are some of the items required to be included in the
prospectus. Among these, the guidelines related to the disclosure of risk factors are the least.
The guidelines simply require that:
A prospectus should contain information about risk factors which are specific to the
corporation/group and its industry and to the securities being offered. These are
risk factors which had or could materially affect, directly or indirectly, the business,
operating results and financial condition of the corporation/group.
The listing of risk factors in order of priority is encouraged.
Disclaimers on the risk factors should not be so wide that the risk disclosures are of
little or no beneficial use to investors.
The inadequacy of guidelines related to risk disclosures may result in different levels of
disclosures among firms and, in some cases, the disclosures may be insufficient, ineffective
and of no importance to investors. Amran et al. (2008) find that risks disclosed in annual
reports by Malaysian firms are very much less than those in the UK, while Zadeh et al.
(2016) find significant increase in the level of risk disclosures by firms from year 2001 to
2011 but the level still needs to be improved.
The presence of risk in an IPO environment is inevitable because of the uncertainty in
terms of the market price of the IPO in the secondary market post issuance. Previous studies
(Abdul Rashid et al., 2012; Bartov et al., 2002; Bhabra and Pettway, 2003; Chen, 2014; Chua,
2014; Loughran and Ritter, 2004; Sundarasen, 2013) have considered many factors
influencing initial returns of IPOs but relatively few have examined how disclosure of risk
factors can influence initial returns. Studies have not fully explored the possibility of risk
disclosures mitigating risk perceived by potential investors, thus impacting the first day’s
closing price and the IPO initial returns. This study therefore analyzes the content of risk
factors disclosed in the prospectus of 96 companies in the Bursa Malaysia from years 2009
to 2013 and how these risk factors influence IPO initial returns.
The results of the study show a highly significant positive relationship between the
overall risk disclosures and IPO initial returns. However, the relationship is found to be
significant only for investment risk factors. Internal and external risk factors are found to be
insignificant in influencing IPO initial returns. These results have important implications
for investors, issuers and policymakers in the Malaysian market.
The rest of the study is structured as follows. Section 2 presents a discussion of previous
literature on IPO initial returns and how the returns may be affected by risk disclosures.
This leads to the development of the hypotheses of the study. Section 3 describes the data
collection methods and methodology employed and this is followed by Section 4 which
ARJ presents the analysis results and a discussion of the finding. Section 5 finally concludes this
31,1 study.
2013 16
2012 17
2011 21
2010 30 Table I.
2009 12 IPOs per year
ARJ
31,1
52
Figure 1.
Sample of the
published table of
content in a
prospectus with a
section on the risk
factors
first incorporated while IPO offer size is the logarithm of the number of shares offered by the
firm for the IPO. Firm size and firm age are established factors affecting the initial returns of
IPOs and it is now a common practice to include them as control variables in existing
literature (Carter et al., 1998; Ibbotson et al., 1994). However, it is found in this study that
firm size (measured by the logarithm of total assets), market capitalization (measured as
Risk categories No. of companies
Disclosure of
risk factors
Business and operations 37
Business only 27
Operations only 16
Operations and market 1
Operations and financial 3
Company only 4 53
Group only 3
Group and industry 1
Business and industry 18
Industry only 47
Market only 1
Malaysia 1
Financial only 3
Technological 1
Shares only 67
IPO only 17
Listing only 1
Units 4
Table II.
Listing and shares 4
Shares and IPO 1 Risk categorization
Global offering only 2 mentioned in the
Securities 2 prospectuses from
Others 26 2009 to 2013
logarithm of the number of shares outstanding multiplied by the price per share) and the
IPO offer size are highly correlated with correlation values greater than 0.8, thus indicating
that they are close proxies to each other. As this study is on IPOs, the IPO offer size is taken
as the most appropriate control variable to control for the size of the IPOs. Underwriters’ and
auditors’ reputation are also common control variables in the literature (Albring et al., 2007;
Michaely and Shaw, 1995) but in the Malaysian context, most companies going public are
underwritten by the same investment bank and audited by the big-4 auditors, thus both are
redundant. Market condition is another common control variable (Baker and Wurgler, 2006;
Yung and Colak, 2008), but as there were no major fluctuations in the market during the
period of study, the impact is minimal thus this variable is excluded.
þ b ð5ÞIPO_SIZE þ « (1)
where:
IR is the dependent variable which is the IPO first day return;
a is the constant;
b (1-3) are the coefficients of each independent variable and control variable;
OVER is the extent of the overall risk disclosure;
ARJ INTERNAL is the extent of disclosure regarding the internal risks faced by the firm;
31,1 EXTERNAL is the extent of disclosure regarding the external risks faced by the firm;
INVEST is the extent of disclosure regarding the investment risks faced by the investors;
AGE is used for firm age;
IPO_SIZE is used for the size of the IPO offering; and
« is the error term.
56 Table IV presents the descriptive statistics for all the variables in the study.
The statistics show that on average the IPO initial returns (IR) are positive (0.161), implying
underpricing of IPOs. The lowest IR is 0.35 while the highest is 4.04. The average IPO offer
size is 18.400 (in logarithms). The average firm is around 6 (or e1.771) years old. On average,
firms disclose around 10 total risk factors with 3 being internal risk factors, another 3 being
external risk factors and 4 being investment risk factors. Although there are a total of 16
keywords for internal risk factors, 12 external risk factors and 5 investment risk factors, firms
disclose a maximum of 7 internal risk factors, 7 external risk factors and all 5 investment risk
factors. This does not however mean that the firms are refraining from disclosing more
information, it may simply be that some of the risk factors may not be relevant to certain firms.
Notes: IR is the initial returns (or first day return) of the IPO calculated as the difference between the first
day closing price and the IPO offer price divided by the IPO offer price. IPO_SIZE refers to the IPO offer
size which is calculated as the logarithm of the number of shares offered by the firm for the IPO. AGE is the
age of the firm calculated as the logarithm of one plus the number of years since the firm was first
Table IV. incorporated. OVER, INTERNAL, EXTERNAL and INVEST are the number of risk factors reported by the
Descriptive statistics firms based on the overall, internal, external and investment risks reported by the firms, respectively
Variable IR IPO_SIZE AGE OVER INTERNAL EXTERNAL INVEST VIF
Disclosure of
risk factors
IR 1
IPO_SIZE 0.224** 1 1.31
AGE 0.017 0.058 1 1.07
OVER 0.078 0.442*** 0.057 1 1.25
INTERNAL 0.040 0.144 0.207** 0.660*** 1 1.10
EXTERNAL 0.035 0.419*** 0.126 0.681*** 0.044 1 1.29 57
INVEST 0.176* 0.312*** 0.041 0.493*** 0.099 0.313*** 1 1.19
N 96
Notes: **Indicates significance at 5% level, ***indicates significance at 1% level. IR is the initial returns
(or first day return) of the IPO calculated as the difference between the first day closing price and the IPO
offer price divided by the IPO offer price. IPO_SIZE refers to the IPO offer size which is calculated as the
logarithm of the number of shares offered by the firm for the IPO. AGE is the age of the firm calculated as
the logarithm of one plus the number of years since the firm was first incorporated. OVER, INTERNAL, Table V.
EXTERNAL and INVEST are the number of risk factors reported by the firms based on the overall, Correlations between
internal, external and investment risks reported by the firms, respectively variables
INVEST and OVER is only 0.493. This is expected since out of the total 33 forms of risk
disclosed, 49 per cent are internal risk factors, 36 per cent are external risk factors while only
15 per cent are investment risk factors. The external and internal risks therefore have higher
weightage in the overall risk disclosure compared to investment risk; hence, the higher
correlations between EXTERNAL and INTERNAL with OVER. However, it should be
noted that correlation values between 0.5 and 0.7 indicate moderate correlation and do not
represent any major issue of multicollinearity in the data (Hair et al., 2010). The VIF values
show no serious issues of multicollinearity between the variables.
Constant 1.023** (0.486) 1.148** (0.487) 1.242** (0.495) 1.085** (0.471) 1.184** (0.476)
INTERNAL 0.039 (0.031) 0.025 (0.032) – – –
EXTERNAL 0.001 (0.043) – 0.026 (0.044) – –
INVEST 0.150*** (0.055) – – 0.140*** (0.053) –
OVER – – – – 0.046** (0.023)
AGE 0.031 (0.063) 0.030 (0.065) 0.014 (0.064) 0.015 (0.061) 0.030 (0.062)
IPO_SIZE 0.086*** (0.029) 0.061** (0.026) 0.065** (0.028) 0.079*** (0.026) 0.083*** (0.028)
R-Squared 0.132 0.058 0.055 0.117 0.091
Prob > F 0.024 0.14 0.158 0.009 0.032
Breusch-
Pagan
(chi2(1)) 132.31 55.38 46.28 118.50 92.32
n 96
Notes: *Indicates significance at 10% level, **indicates significance at 5% level. IR is the initial returns
(or first day return) of the IPO calculated as the difference between the first day closing price and the IPO
offer price divided by the IPO offer price. IPO_SIZE refers to the IPO offer size which is calculated as the
logarithm of the number of shares offered by the firm for the IPO. AGE is the age of the firm calculated as
the logarithm of one plus the number of years since the firm was first incorporated. OVER, INTERNAL,
EXTERNAL and INVEST are the number of risk factors reported by the firms based on the overall, Table VI.
internal, external and investment risks reported by the firms, respectively Regression results
ARJ As there is no issue of multicollinearity, the risk disclosures are regressed against IR using
31,1 the OLS regression technique. Because the data are cross-sectional in nature, only
heteroscedasticity needs to be tested to ensure that the estimates are BLUE (Best Linear
Unbiased Estimators). Heteroscedasticity is tested using the Breusch–Pagan test of
heteroscedasticity. All the models are regressed with robust standard errors. The results of
the analyses are presented in Table VI.
58 Equations 1, 4 and 5 (as shown in Table VI) have good model fit with Prob > F being less
than 0.05. Equation 1 indicates the relationship between the disclosure of all the risks
(INTERNAL, EXTERNAL and INVEST) and IPO initial returns, Equation 4 indicates the
relationship between investment risk disclosure (INVEST) and IPO initial returns, whilst
Equation 5 indicates the relationship between the overall risk disclosure (OVER) and IPO
initial returns. Age is found to be insignificant in influencing IPO initial returns but IPO
offer size (IPO_SIZE) is highly significant. The relationship is found to be negative in all
cases, i.e. the larger the IPO, the lower the difference between the offer price and the initial
returns.
Analysis of the overall risk factor shows a highly significant positive relationship with
IPO initial returns, i.e. an increase in the disclosure of risk factors results in higher initial
returns. Delving deeper into the individual risk categories, the insignificant results (p-values
greater than 0.05) of INTERNAL and EXTERNAL but significance ( p-value less than 0.05)
of INVEST indicate that internal and external risk disclosures have no significance on IPO
initial returns but investment risk does have a significantly positive impact. Therefore, only
H3 and H4 are supported, whereas H1 and H2 are not supported. The results are consistent
with the study by Abdou and Dicle (2007) and Murugesu and Santhapparaj (2010).
Based on the empirical evidence, it is noted that both the ex ante uncertainty and
signaling models are able to explain the influence of risk factors on IPO initial returns. The
positive relationship between the overall risk factor and IPO initial returns means that
investors in the Malaysian IPO environment perceive high disclosure of risk in the
prospectus as increased uncertainty. In line with the ex ante uncertainty model, investors
therefore demand higher compensation because of the presence of uncertainty in the future
performance of the IPOs in the secondary market. Issuers and underwriters may therefore
also intentionally underprice the offer price of IPOs to compensate investors for the risks
assumed and to entice investors to increase the demand for the IPOs. Additionally, the risk
disclosure is used by investors as signals related to managerial competency and control. The
positive relationship between the overall risk and IPO returns means that risk disclosure is
perceived negatively by the investors as a signal of lack of managerial control; therefore,
investors expect to be compensated accordingly.
The significance of the investment risk disclosure (INVEST) indicates that this risk is
very relevant to investors who are concerned about the returns on their investment.
Therefore, investors expect that a firm which discloses more investment risks is signaling
higher uncertainty and lack of managerial control and therefore they ought to be
compensated with higher returns. Disclosures of internal and external risks faced by the
firms are found to be insignificant in affecting IPO initial returns possibly because of the
inability of the investors to analyze these risks as the disclosures are considered
“boilerplate”, providing almost no information to the investors. Further, when overall risk is
calculated as the sum of the internal and external risk factors only, it is found to be
insignificant. Indeed, the internal and external risk factors provided in Table III seem to be
very general in nature. The significance of INVEST and insignificance of EXTERNAL and
INTERNAL is interesting, as the total number of INTERNAL and EXTERNAL forms of
risks disclosed are much higher than those of INVEST (only 5 forms of risk) yet the
disclosure of these risks are insignificant, further confirming that it is not the quantity of Disclosure of
risks disclosed that is important but rather the quality of the information disclosed. risk factors
This study conjectures that investors in the Malaysian IPO environment are concerned
about the risks facing the firm and react to the risks disclosed in the IPO prospectus.
However, they tend to focus mainly on the investment risk rather than the internal and
external risks which tend to be generic in nature providing almost no meaningful
information to the investors.
59
5. Conclusion
This study is conducted to understand the impact of risk disclosures on IPO initial returns
of Malaysian firms. A total of 96 IPOs between year 2009 and 2013 are considered for this
purpose. Using OLS regression, the study finds that the overall risk disclosure in an IPO
prospectus and disclosure of investment risks have significant positive impacts on IPO
initial returns. Unlike previous studies, other risk factors such as internal risk and external
risk are insignificant in influencing IPO initial returns. When considering the overall risk
disclosure, which is calculated at the total sentences disclosed for all the risk factors, a
highly significant positive relationship is found with IPO initial returns. Further
investigation into the individual risks finds that investment risk is the only significant risk.
This seems to indicate that, especially when investing in IPOs, Malaysian investors are
concerned mainly about the investment risks disclosed by the firms. It also seems to indicate
that the risk information provided with regard to the internal and external factors seem to
be generic in nature, providing little to no significant information to the investors to enable
them to evaluate the risk of the IPO. The results confirm the applicability of the ex ante
uncertainty model and the signaling hypothesis in explaining the effect of risk disclosures
on IPO initial performance.
The results of the study serve as a guide to potential investors in their choice of IPOs;
risk-averse investors may be more inclined towards lower disclosure of risk factors as this
tends to minimize uncertainty and they are willing to settle for a lower premium on the first
day of trading. On the contrary, risk-taking investors who are more concerned about high
initial returns may be willing to invest in firms with high disclosures of risk factors in the
prospectus, with the expectation of being compensated with higher initial returns on the
first day enabling them to earn higher capital gains in the short-run. From the perspective of
issuers, firms may be willing to disclose their risk factors and compensate investors
accordingly via underpricing but with the hope of recovering the underpricing cost in the
medium term in the secondary market. Policymakers, on the other hand, may find the
results insightful if they wish to develop deep and well-diversified financial markets and
attract international listings to their stock markets. The generic nature of internal and
external risk factors and the insignificant reaction of investors toward the disclosure of
these risk factors indicate the need for policymakers to provide more specific guidelines on
the risk factors so that the risk factors provide more meaningful information to potential
investors, thus allowing proper evaluation of the IPO. It also provides a basis for future
studies in understanding of risk factor disclosures and how narrative information testing is
used in this study.
This study has its limitations. First, it is based on a small sample size of 96 companies. A
larger sample size is very much desired to achieve better generalizability of the results. The
sample period can be extended further taking into consideration newer firms going for IPO,
thus increasing the total sample size. Second, it is based on risk information disclosed in the
prospectus which does not have a standard format of disclosure. Some companies may have
described similar risk factors in different categories, while others may have disclosed
ARJ irrelevant risk factors under the risk categories. Narrative information method requires
31,1 manual reading and understanding of the risk factors in relation to the keywords used and
there is no advanced system or software available to interpret the risk factors accurately.
Some companies report distinct risk factors which are not disclosed by any other company
and such information may skew the results. Finally, the control variables are limited (only
age and IPO offer size are controlled for); hence, it is suggested that further studies should
60 include other control variables such as profitability, growth, leverage and others to further
strengthen the results.
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