Research in International Business and Finance 50 (2019) 171–190

Contents lists available at ScienceDirect

Research in International Business and Finance

journal homepage: www.elsevier.com/locate/ribaf

Are IPOs underpriced or overpriced? Evidence from an emerging

T
market
Dilesha Nawadali Rathnayakea,b, , Pierre Axel Louembéc, Diby François Kassia,
⁎

Gang Suna, Ding Ninga

a
School of Finance, Dongbei University of Finance & Economics, 217, Jianshan Street, Shahekou, Dalian, PR of China
b
School of Economics, Shandong University of Technology, No. 88, Gongqingtuan west road, Zhangdian, Zibo, Shandong Province, PR of China
c
School of Accounting, Dongbei University of Finance & Economics, 217, Jianshan Street, Shahekou, Dalian, PR of China

ARTICLE INFO ABSTRACT

JEL classification: Underpricing of Initial Public Offerings (IPOs) is one of the most widely studied anomalies in the
G32 literature on financial economics. This paper examines the short-run IPO performance in an
G24 emerging market by using the data of 148 IPOs listed on the Colombo Stock Exchange (CSE) from
1991 to 2017. We found that IPOs on average were underpriced by 47% and that 32 IPOs were
Keywords: overpriced by approximately 17%–18%. The stepwise multiple regression results showed that
IPO
offer risk, investor sentiment, firm size, market volatility prior to the IPOs, the time lag between
CSE
IPO issue date and CSE listing date, and hot-issue periods have a significant relationship with IPO
Underpricing
Overpricing returns. The outcomes are hence consistent with the prediction of ex-ante uncertainty, windows
Ex-ante uncertainty of opportunity and the investor sentiment hypotheses. Overall, the results indicate that in Sri
Lanka, underpricing accounts for a greater percentage of the IPOs than overpricing.

1. Introduction

Many academics have devoted considerable time to studying Initial Public Offering (IPO) behavior (Loughran and Ritter, 2004;
Loughran et al., 1994; Ritter and Welch, 2002). The value of IPOs is determined by the amount of IPO underpricing and overpricing.
Underpricing is the difference between the IPO issue price and the first trading day’s closing price on the stock market: this is the most
commonly studied scenario throughout the literature. Loughran et al. (1994) found that initial underpricing is a common phe-
nomenon in stock markets all over the world, although it differs by country and is more pronounced and significant in developing
countries. However, researchers to date have given very little attention to analyzing the initial overpricing issue, although there have
been studies presenting some evidence of the existence of first-day overpricing in the USA (Peavy, 1990; Purnanandam and
Swaminathan, 2004; Ritter and Welch, 2002; Wang et al., 1992; Weiss, 1989).
Numerous theoretical models have been introduced in previous studies to describe the behavior of IPO initial returns. The most
reasonable explanations for the phenomenon of underpricing is based on the information asymmetry theories, posited in the form of
share price ex-ante uncertainty (Chen et al., 2004; Loughran et al., 1994; Yu and Tse, 2006). Further, former academics have
hypothesized that positive initial returns were motivating less informed investors who were looking forward to avoid the “winner's
curse”, a concept that was introduced by Rock (1986).
Although rarely studied, to the best of the author’s knowledge, the only published article on the short run performance of IPOs on

⁎
Corresponding author at: School of Finance, Dongbei University of Finance & Economics, 217, Jianshan Street, Shahekou, Dalian, PR of China.
E-mail addresses: dileshausj@yahoo.com, dileshausj@sdut.edu.cn (D.N. Rathnayake).

https://doi.org/10.1016/j.ribaf.2019.04.013
Received 17 October 2018; Received in revised form 23 April 2019; Accepted 25 April 2019
Available online 30 April 2019
0275-5319/ © 2019 Elsevier B.V. All rights reserved.
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

the Colombo Stock Exchange (CSE) was the one concerning the study by Samarakoon (2010). The author studied initial IPO behavior
by considering the main four independent variables, namely, issue size, investor sentiment, privatization issues, and industry effect.
In addition to the research by Samarakoon (2010), this study considers nine more variables, namely, offer risk, lag period, the age of
the company, IPO volume, market volatility, IPO offer price, hot and cold issues, and the listed board effect. Thus, the main objective
of this study is to fill the research gap by analyzing the amount of IPO underpricing in Sri Lanka, focusing on the IPOs’ raw initial
returns and their market-adjusted abnormal returns. Additionally, we expect to identify the reasons for the underpricing of stocks and
the association among the initial returns and the independent variables. Currently, this study will be the first that analyzes the effects
of thirteen independent variables together in an emerging market that is subject to political instability but high growth prospects.
Additionally, to identify two pricing levels, this study splits the amount of IPO underpricing and overpricing from the value of an
IPO’s average initial returns. The current study further extends the existing literature focusing on the war and postwar experiences of
IPO underpricing. This study collects new updated evidence to add to the IPO literature by using a recent and detailed sample to
conduct a comprehensive analysis of IPO behavior in the emerging market of Sri Lanka.
During the last two decades, 202 firms decided to issue public IPOs in Sri Lanka. We used a sample of 148 IPOs on the CSE from
1991 to 2017. In this period, we found that IPOs were on average underpriced by 47% and that 32 IPOs were overpriced by
approximately 17%–18%. An ordinary least squares (OLS) regression model and a cross-sectional analysis were used to investigate
the relationships between initial returns and thirteen independent variables. We found a significant relationship between the initial
IPO returns and the firm’s issue size, investor sentiment, offer risk, market volatility and hot issue periods, while other variables,
namely, the age of IPO firms, IPO offer price, the time-lag, and listed boards, were not statistically associated with IPO initial returns
on the CSE. The outcomes are consistent with the prediction of ex-ante uncertainty, windows of opportunity and investor sentiment
hypotheses and previous international studies. Interestingly, average underpricing rates in the postwar period were lower than those
before this period (22%–24%).
We believe the outcomes will convey a full understanding of current trends for IPOs in Sri Lanka. Moreover, it is hoped that the
findings of this study will deliver some meaningful insights to many parties, such as the firms that are planning to go public, potential
investors and the members of the general public who might be interested in obtaining general knowledge about the stock market of
Sri Lanka. Moreover, for the academic field, the results of this study should strengthen the theoretical framework of the determinants
of IPO underpricing from the perspective of emerging economies, such as Sri Lanka. Notably, this study will also be of significance to
other emerging countries.
The study is organized into six sections, including the introduction section. Section 2 provides detailed information regarding the
CSE, as well as its historical development, and Section 3 includes the literature review, focusing on previous research, theoretical
background, and the determinants of the initial performance. Section 4 outlines the data, variables and research methodology.
Section 5 presents the empirical results and analysis. Last, Section 6 presents the study’s conclusions and suggestions for further
research.

2. Institutional characteristics

The Colombo Stock Market has sustained operations for nearly 100 years. The outstanding performance of the CSE with its fully
automated trading platform has enhanced the trading efficiency and competency among the other emerging markets. The CSE return
indices have increased rapidly, creating new milestones just after the end of the Sri Lankan civil war on May 18, 2009. CSE was the
best performing stock exchange in the world in 2009, as its total return index jumped 125.2% during 2009.1 Furthermore, the year
2014 was a remarkable milestone for CSE, as in that year, it was one of the top six best-performing markets internationally, with the
All Share Price Index (ASPI) showing annual growth of 23.4% in 2014. Similarly, in 2014, the CSE was awarded by Capital Finance
International (CFI) for being the "Most Sustainable Growth Exchange" in Asia.2 The CSE is a registered company limited by guarantee
and is licensed by the Securities and Exchange Commission of Sri Lanka (SEC), which was established to regulate the securities
market in Sri Lanka and to grant licenses to stock exchanges, stockbrokers, stock dealers, and unit trusts that engage in the business of
trading in securities. Sri Lanka was one of the first South Asian countries to establish a capital market’s regulator. Foreign investors
are freely allowed to invest in CSE, except in the very few circumstances imposed by listed companies, and the capital gains are free
from government exchange control regulations.
Generally, the fixed-price method is used for IPO share pricing, even though auction and book-building methods are also
available. Recently, Lanka IOC and Dialog Telecom used the Dutch auction method. Although underwriting is not compulsory, the
IPO issuing firms tend to have a CSE licensed underwriter. Investors can subscribe for any number of shares by applying via a
registered stock brokering firm. There are mainly two price indices calculated by CSE, namely, the All Share Price Index (ASPI) and
the Milanka Price Index (MPI). Further, sectoral price indices are calculated for each of the 20 Business sectors. Total return indices
(TRI) are also calculated to measure the market performance on a total return basis. CSE publishes TRI based on the ASPI, MPI, and
the 20 sector price indices with the dividend adjustments. For the listing of equity, there are two boards at the CSE, namely, the Main
Board and the Diri Savi Board: their listing requirements are not the same (Table 1).

1
See www.cse.lk.
2
See www.cse.lk.

172
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

Table 1
Listing rules.
Criteria Main Board Large and mature firms Diri Savi Board Innovative and growing start-ups

Stated Capital Minimum Rs. 500 Million issued capital at the time of listing Minimum Rs 100 Million issued capital at the time of listing
Net Profit Net profits after tax for three consecutive years -Not Relevant -
Public holding A 25% public shareholding of the IPO issue should be subscribed, with a A minimum 10% public shareholding of the IPO issue should
minimum of 1000 shareholders holding not less than 100 shares each. be subscribed, with a minimum of 200 shareholders.
Operating History At least three years. At least one year.

Table 2
Average underpricing levels from emerging countries.
Country Source Sample size Period Average initial return (%)

Bahrain Alanazi and Al-Zoubi (2015) 7 2003–2010 24.4

Bangladesh Islam et al. (2010) 117 1995–2005 179.3
Brazil Nogueira et al. (2008) 30 2004–2006 3.3
China Chen et al. (2004) 818 1992–1997 145.0
China Anderson et al. (2015) 281 2009–2011 33.5
Hungary Lyn and Zychowicz (2003) 103 1991–1998 15.1
India Marisetty and Subrahmanyam (2010) 2713 1990–2004 94.0
India Darmadi and Gunawan (2013) 362 2003–2014 23.0
Indonesia Lyn and Zychowicz (2003) 101 2003–2011 22.2
Iran Karami et al. (2014) 91 2001–2011 11.1
Kuwait Alanazi and Al-Zoubi (2015) 9 2003–2010 182.6
Malaysia Rahim and Yong (2010) 386 1999–2007 32.0
Malaysia Wong et al. (2017) 313 2008-2016 9.4
Mexico Boulton et al. (2011) 11 1998–2008 7.7
Nepal Pradhan and Shrestha (2016) 61 2005–2011 200.2
Nigeria Adjasi et al. (2011) 80 1990–2006 43.3
Oman Alanazi and Al-Zoubi (2015) 11 2003–2010 49.6
Pakistan Sadaqat et al. (2011) 73 2000–2009 42.2
Philippines Boulton et al. (2010) 18 2000–2004 14.0
Poland Lyn and Zychowicz (2003) 33 1991–1998 54.5
Qatar Alanazi and Al-Zoubi (2015) 12 2003–2010 215.1
Saudi Arabia Mayes and Alqahtani (2015) 72 2004–2010 266.7
South Africa Heerden and Alagidede (2012) 138 2006–2010 108.3
Sri Lanka Samarakoon (2010) 105 1987–2008 34.0
Taiwan Lin and Chuang (2011) 525 2000–2005 16.3
Thailand Komenkul and Siriwattanakul (2016) 246 2001–2012 25.4
Turkey Durukan (2002) 173 1990–1997 14.6
United Arab Emirates Alanazi and Al-Zoubi (2015) 24 2003–2010 270.1
Vietnam Tran et al. (2014) 69 2005–2012 49.1

Note: The average initial returns are calculated from the difference between the IPO offer price and the first trading day’s closing price.

3. Literature review

The value of an IPO’s initial returns is determined by the amount of IPO underpricing and overpricing, which is considered
separately in this section. Initial returns are measured by the difference between the IPO issue price and the first trading day’s closing
price on the stock market. If the first-day trading closing price is greater than the issue price, then the offering is considered to be
underpriced; conversely, if the closing price is lower than the offer price, the IPO is considered to be overpriced.

3.1. IPO underpricing

According to the literature, initial underpricing is a common phenomenon in global stock exchanges. Nevertheless, there is a vast
discrepancy in underpricing across the stock markets. Collected from several recent studies, the average IPO underpricing in 26
selected emerging markets is shown in the list in Table 2.3 Since this study is focused on Sri Lanka, one of the emerging stock markets,
we give greater attention to the emerging economies’ initial returns. As illustrated in Table 2, the average initial returns differ
considerably among the countries. For example, the average first-day return for IPOs in the United Arab Emirates is 270% (Alanazi
and Al-Zoubi, 2015), whereas, in several countries, it is less than 10%. The 3.3% premium level in Brazil is an example of a low
underpricing level (Nogueira et al., 2008). Regarding the previous work relating to Asian countries, underpricing levels are recorded

3
Emerging markets are chosen according to the Emerging Markets Index published by Morgan Stanley Capital International (MSCI) for the year
2017.

173
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

Table 3
Average overpricing levels from previous studies.
Country Source Sample size Period Average initial return (%)

Bangladesh Islam et al. (2010) 117 1995–2005 (15.30)

China Huang et al. (2016) 45 2010 (4.27)
2011 (23.44)
2012 (22.97)
China Song et al. (2014) 948 2006–2011 (44-53)
Greece Gounopoulos (2003) 225 1990–2001 (13.30)
USA Purnanandam and Swaminathan (2004) 2288 1980–1997 (14-50)
USA Wang et al. (1992) 87 1971–1988 (2.82)
USA Peavy (1990) 29 1986–1987 (1.11)

Note: The average initial returns are calculated from the difference between the IPO offer price and the first trading day’s closing price. Negative
values are recorded in parentheses.

as high in the following countries: 179% in Bangladesh (Islam et al., 2010), 200% in Nepal (Pradhan and Shrestha, 2016) and 94% in
India (Marisetty and Subrahmanyam, 2010). Most recently, relying on sentiment-based models, Clarke et al. (2016) found an average
23% underpricing level in 362 Indian IPO offerings. In the Sri Lankan context, Samarakoon (2010) investigated the short-run un-
derpricing of Sri Lankan IPOs and found IPOs are underpriced by 34%. Moreover, mostly as a result of huge underpricing in Kuwait,
Qatar, Saudi Arabia, and the United Arab Emirates, the Gulf Cooperation Council (GCC) countries have experienced an unusually
high underpricing level that is larger than that of any other regional market (Alanazi and Al-Zoubi, 2015; Mayes and Alqahtani,
2015).

3.2. IPO overpricing

The overall evidence, however, reveals that average overpricing also occurs, and while the underpricing phenomenon is relatively
well-documented, the overpricing phenomenon is not (Table 3). There is some evidence for the existence of first-day overpricing in
the USA. Specifically, Weiss (1989) found initial overpricing for US stock funds and that for market adjusted abnormal returns
(MAAR), the results were significant at the 10% level. Peavy (1990) also found similar significant results for closed-end stock funds in
the US. Moreover, for a sample including 87 real estate investment trust (REIT) IPOs, Wang et al. (1992) showed the existence of a
significant 2.82% overpricing at the 5% level. Moreover, Ritter and Welch (2002) stated that the mean returns during the period 1980
to 2001 were 18.8%, with 30% of the sample showing negative initial returns. Furthermore, Purnanandam and Swaminathan (2004)
examined a more extensive sample consisting of 2288 IPOs and found that IPOs were overpriced by 14%–50%. However, Zheng
(2006) reviewed the Purnanandam and Swaminathan (2004) study for methodological issues and found that after the corrections,
IPOs on average were not overpriced. Gounopoulos (2003) analyzed a sample of 225 Greek IPOs from 1990 to 2001 and found that
IPOs are 13.3% overpriced. Similarly, Islam et al. (2010) recognized overpricing levels of 15.3%, for new stocks in Bangladesh.
Notably, in a sample of 948 IPOs, which took place during the 2006–2011 period, Song et al. (2014) showed that IPOs were
overpriced by 44%–53% in China. More recently, in their study with a sample of 45 IPOs listed on the secondary board, Huang et al.
(2016) studied IPO overpricing and found that initial returns were 4.27%, 23.44% and 22.97% in 2010, 2011 and 2012, respectively.

3.3. Theoretical background

Many theoretical models have been introduced in previous studies to describe the behavior of IPO initial returns. The empirical
review of this paper mainly focuses on selected theoretical foundations. Thus, it is essential to provide a brief explanation of the
theoretical background of the study. The most important factor causing underpricing is the uncertainty that exists within the IPO
issuing firm. The positive relationship expected between underpricing and ex-ante uncertainty is well documented (Chen et al., 2004;
Loughran et al., 1994; Yu and Tse, 2006). Notably, Wang et al. (1992) found a significant positive association among the overpricing
level and ex-ante uncertainty, which was inconsistent with the ex-ante uncertainty theory. Scholars have used the age of the firm
(Kirkulak and Davis, 2005; Loughran et al., 1994), the offer size (Alanazi and Al-Zoubi, 2015; Chi and Padgett, 2005; Pradhan and
Shrestha, 2016; Yu and Tse, 2006), the offer price (Chalk and Peavy, 1987; Krishnamurti and Kumar, 2002) and the time lag between
the IPO offer date and the first trading date (Chen et al., 2004; Yu and Tse, 2006) as proxies for the ex-ante uncertainty measures.
One of the most popular universal theories is the asymmetric information theory. In finance theory, this topic has been highly
debated by practitioners and academicians. This theory suggests that there are two groups of investors in the investment world: the
first group includes the investors who have accessibility to the valuable information that is relevant for the investment decision, and
the second group includes the investors who have no valuable information relevant to their investment decision. Rock (1986)
introduced a model, namely, the ‘winners curse hypothesis’ model, which was based on the information asymmetry between in-
vestors. He identified uninformed investors as the losers, as they were not alerted to which IPOs are profitable and thus would buy a
high volume of overpriced shares, while he identified informed investors as those investors who are dealing with the most under-
priced IPOs.
Most recently, Signori (2018) found that zero-revenue European firms’ IPOs are more underpriced at the initial day and

174
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

experience more volatile aftermarket trading than the IPOs of those firms who have recorded profits before issuing IPOs; thus,
information-based models of the IPO decisions can inform investors that it is inefficient for a firm to go public before having
generated revenues. Furthermore, this researcher indicated that zero-revenue firms’ IPOs have high levels of information asymmetry
and uncertainty that increase the cost of raising capital and the risk of an early delisting. However, Ritter and Welch (2002) argued
that IPO initial returns cannot be fully explained by the information asymmetry theory and that more theoretical explanations based
on the internal and external firm environment are needed. Moreover, Loughran and Ritter (2002) asserted an explanation based on a
conflict between the IPO issuers and the underwriters, namely, the principal-agent problem, where an agent (underwriter) will not
always act in the best interests of the company. More recently, Liu and Ritter (2011) stated that reputed underwriters would un-
derprice more, as they gain an advantage from underpricing. However, the empirical evidence as to whether more prestigious
underwriters are associated with lower underpricing is mixed. It is possible to mitigate the agency problem faced by IPO issuers by
determining the underwriting service fees as a percentage of the IPO proceeds.
Conversely, researchers have used the investor sentiment theory to explain the influence of investor sentiment on the initial
returns (Boulton et al., 2011; Ritter and Welch, 2002; Song et al., 2014). When the investors assume the overall market to trend
positively, they will increase the demand for the IPO stocks, resulting in the generation of high initial returns. Similarly, when
investors assume that the overall market will decline, the initial returns will be less. Empirically, many researchers used market
returns prior to the first trading day as a proxy for investor sentiment (Boulton et al., 2011; Kiymaz, 2000; Mumtaz et al., 2016; Wong
et al., 2017) because investor sentiment is difficult to recognize without some investigation. Interestingly, Clarke et al. (2016) tested
sentiment-based models in the Indian market by using most recent IPOs, and the results were consistent with this theory.
Compared with cold-issue period IPOs, the IPOs in a hot-issue period will produce abnormal initial returns (Günther and Rummer,
2006; Purnanandam and Swaminathan, 2004; Ritter, 1991); therefore, IPO issuers will take advantage of the opportunity to gain the
“window of opportunity” of the hot markets. The windows of opportunity hypothesis suggest that issuing companies try to time their
IPO issues during the periods when investors are positive about the IPO firms and when there is a large IPO volume. Stakeholders are
looking to obtain benefits in a competitive market during a concise period before the window will close. Additionally, to gain the
advantage of abnormal initial returns, better quality firms will strategically wait and issue IPOs during hot-issue periods (Agathee
et al., 2012; Loughran and Ritter, 2004).

3.4. Determinants of IPO initial performance

It is important to examine in the broader framework the theoretical contributory factors to IPO underpricing and overpricing.
Previously, many researchers have examined the determinants that can impact the IPO initial returns. In the Sri Lankan context,
Samarakoon (2010) investigated the short-run underpricing of IPOs and found that initial returns had a negative relationship with
issue size and a positive relationship with investor sentiment and privatization issues. In this study, the choice of independent
variables was based on the previous research (Table 4).
Age represents the operating history of a firm before the IPO issue. Ritter (1991) suggested that age seems to be a better proxy for
ex-ante uncertainty than issue size. As there is more publicly available information on mature firms, they are anticipated to have
lower ex-ante uncertainty than the younger firms have (Chen et al., 2004; Kirkulak and Davis, 2005; Loughran et al., 1994).
Therefore, following Ritter (1991), a negative association between age and initial returns is expected.
Size is the magnitude of the offering and is used to identify the ex-ante uncertainty associated with an IPO issue. Based on
previous studies, the higher the issue size is, the lower the initial return, and vice versa (Alanazi and Al-Zoubi, 2015; Chi and Padgett,
2005; Yu and Tse, 2006). However, a positive relationship between issue size and initial returns is also found in a few studies
(Boonchuaymetta and Chuanrommanee, 2013; Heerden and Alagidede, 2012; Mumtaz et al., 2016). In the studies hypothesizing a
negative association, the IPO size was calculated by multiplying the IPO offer price by the number of shares issued.
Following previous studies regarding the relationship between size and initial returns (Bradley and Jordan, 2002; Colak, 2012;
Song et al., 2014), we consider the listed-board effect as a substitution for the issuing firm’s size impact since based on the firm’s
stated capital, there is a clear division of the two listed boards on the CSE (Table 1). Chen et al. (2004) and Rahim and Yong (2010)
reported that Main Board firms have significantly lower returns than do the secondary board firms. In contrast, Gounopoulos (2003)
reported that the Main Board listed firms have higher initial returns than the other boards have. In general, compared to small-size
firms, large-size firms are associated with more investor-available information and less uncertainty regarding the firms’ future ex-
istence. Therefore, consistent with the size effect, we hypothesized a negative relationship between firm size and initial returns, with
a dummy variable taking a value of one (1) if the firm is listed on the Main Board and otherwise taking a value of zero (0).
The difference in days between the IPO announcement date and the first trading date also affects the ex-ante uncertainty level and
the initial returns. Chen et al. (2004) and Yu and Tse (2006) explained that a longer time lag results in IPO underpricing and high ex-
ante uncertainty. Recently, Komenkul and Siriwattanakul (2016) found that the time-lag variable is not statistically related to the
initial returns in Thailand stock market. Consequently, we consider the time lag from the IPO offer date to the first trading date as an
independent variable by expecting it to have a positive relationship with initial returns.
According to the prediction of the investor sentiment hypothesis, investor sentiment and IPO initial returns are positively related
(Boulton et al., 2011; Mumtaz et al., 2016; Samarakoon, 2010; Wong et al., 2017). Additionally, Song et al. (2014) found that
investor sentiment has a positive influence on overvaluation but has no relation to underpricing. To measure how sound the market is
currently performing compared to its recent past, a change of the value of ASPI one month prior to the offering day is considered as a
proxy for a market return.
Companies will adjust their IPOs during the hot periods to gain the benefit from the “windows of opportunity”. In their studies,

175
 D.N. Rathnayake, et al.

Table 4
Previous studies on determinants of IPO initial returns.
Study Country IR /MAAR AGE SIZE LAG SENT VOL RISK/PRC HOT PRIV BRD IND MVL Methodology

Adjasi et al. (2011) Nigeria Y Y Y Y Y Y Multiple Regression

Agathee et al. (2012) Mauritius Y Y Y Y Multiple Regression
Alanazi and Al-Zoubi (2015) 6 Gulf nations Y Y Y Multiple Regression
Anderson et al. (2015) China Y Y Y Multiple Regression
Badru and Zaluki (2018) Malaysia Y Y Y Y Y Multiple Regression
Boulton et al. (2010) 29 Countries Y Y Y Y Y Y Cross-sectional analysis
Bradley and Jordan (2002) USA Y Y Y Y Y Y Multiple Regression
Chen et al. (2004) China Y Y Y Y Cross-sectional analysis
Cho and Lee (2013) Korea Y Y Y Y Y Y Multiple Regression
Colak (2012) USA Y Y Y Y Y Y Y Y Multiple Regression
Deng and Zhou (2016) China Y Y Y Y Y Y Y Multiple Regression
Durukan (2002) Turkey Y Y Y Y Multiple Regression
Gounopoulos (2003) Greece Y Y Y Y Y Y Y Cross-sectional analysis
Gounopoulos et al. (2007) Cyprus Y Y Y Y Y Multiple Regression
Heerden and Alagidede (2012) South Africa Y Y Y Y Multiple Regression
Islam et al. (2010) Bangladesh Y Y Y Y Y Multiple Regression

176
Kiymaz (2000) Turkey Y Y Y Y Y Y Cross-sectional analysis
Komenkul and Siriwattanakul (2016) Thailand Y Y Y Y Y Multiple Regression
Lyn and Zychowicz (2003) Hungary, Poland Y Y Y Y Y Cross-sectional analysis
Marisetty and Subrahmanyam (2010) India Y Y Y Multiple Regression, ANOVA
Mayes and Alqahtani (2015) Saudi Arabia Y Y Y Y Y Multiple Regression
Mumtaz et al. (2016) Pakistan Y Y Y Y Y Y Y Y Multiple Regression
Rahim and Yong (2010) Malaysia Y Y Y Y Cross-sectional analysis
Samarakoon (2010) Sri Lanka Y Y Y Y Y Cross-sectional analysis
Signori (2018) Europe Y Y Y Y Y Y Multiple Regression
Song et al. (2014) China Y Y Y Y Y Y Multiple Regression
Tran et al. (2014) Vietnam Y Y Y Y Y Multiple Regression
Wong et al. (2017) Malaysia Y Y Y Y Y Multiple Regression
Yu and Tse (2006) China Y Y Y Y Y Multiple Regression

Note: Y means parameters are included in the empirical study IR denotes the initial returns; MAAR denotes the market adjusted abnormal return; AGE denotes the history of the firm from its
incorporation; SIZE denotes the gross proceeds from the IPO; LAG denotes the time gap between the IPO listing date and the first trade date; SENT is a proxy for investor sentiment; VOL denotes the annual
volume of listings in the stock market; MVL denotes the standard deviation of the daily ASPI for the first 30 trading days prior to the IPO issue; RISK is the reciprocal of the nominal offer price; PRC
denotes the offer price of the IPO; HOT denotes the hot-period issues; PRIV denotes the privatization issues; BRD denotes the listed board types and IND denotes industry effect, respectively. Multiple
regression models are mainly focused on Ordinary Least Squares (OLS) method, and ANOVA denotes to The Analysis of Variance.
Research in International Business and Finance 50 (2019) 171–190
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

Cho and Lee (2013); Loughran et al. (1994), and Lowry and Schwert (2002) found that IPO volume and average initial returns had a
strong positive relationship. To control the stock market effects, this study has included the annual volume of IPOs as an independent
variable, and a positive relationship is expected.
Gounopoulos et al. (2007) and Loughran et al. (1994) stated that during the hot-issue periods, IPOs generated high initial returns
because of the increase in the new IPO risk and total market risk. Alanazi and Al-Zoubi (2015), and Colak (2012) proposed that rather
than selecting cold periods to issue IPOs, a firm may benefit from higher initial returns from issuing IPOs in hot periods. In contrast,
Mumtaz et al. (2016) investigated the hot-issue market and found an insignificant negative relationship with initial returns. We
categorize hot-issue years as those with a higher volume of IPOs, while the years with a lesser volume of IPOs are recognized as cold-
issue years: we include the hot dummy variable that takes on a value of one (1) for the hot years and a value of zero (0) otherwise.
Market volatility is used as a measure of market risk and uncertainty, supporting the risk-return trade-off theory. High ex-ante
market volatility reflects substantial uncertainty in the market returns, which may cause an underpricing of the initial returns.
Following Paudyal et al. (1998), market volatility is computed as “the standard deviation of daily market returns over the first 30
trading days prior to the closing date of subscription”. Therefore, this study expects a positive relationship between these two
variables, which is supported by previous studies (Al-Hassan et al., 2010; Butler et al., 2014; Deng and Zhou, 2016; Mumtaz et al.,
2016; Wong et al., 2017).
The risk-return trade-off theory states that companies with higher offer risk are expected to have a higher return. In the literature
(Badru and Zaluki, 2018; Bradley and Jordan, 2002; Rahim and Yong, 2010), a commonly used proxy measure for the risk linked with
each IPO return is the reciprocal of the IPO offer price (RISKi0 = P , where Pi0= offer price of the i company). Previous studies
1
i0
found that IPO risk is positively associated with IPO underpricing (Badru and Zaluki, 2018; Mayes and Alqahtani, 2015; Wong et al.,
2017). In contrast, Rahim and Yong (2010) showed a significant negative relationship between offer risk and initial returns. Fol-
lowing the theory, we expect a positive association between offer risk and initial returns.
Similarly, the offer price of an IPO can be used as a separate variable and a proxy for ex-ante uncertainty and is expected to be
negatively related to initial performance. Studies suggest that the offer price is a proxy for uncertainty about the value and that as the
offer price increases, it signals less uncertainty, and the expected level of underpricing should decrease. Chalk and Peavy (1987), and
Krishnamurti and Kumar (2002) found that the smaller offer prices are usually more underpriced. Moreover, Daily et al. (2003)
suggested that higher offer prices are associated with lower uncertainty regarding the future performance of the firm.
To increase their productivity, most of the government-owned enterprises were fully privatized in Sri Lanka during the last
decades. Biais and Perotti (2002) explained that governments might deliberately set privatization issues at lower prices to receive
political benefits from the voting public. Because of the high ambiguity related with privatization issues, many previous studies
(Adjasi et al., 2011; Boulton et al., 2011; Kiymaz, 2000; Lyn and Zychowicz, 2003; Samarakoon, 2010) stated a positive relationship
between privatization issues and initial returns. Therefore, in line with the literature in this study, based on the ex-ante uncertainty
hypothesis, we expected that privatization issues would be more underpriced.
Previous studies found that IPO performance may vary significantly across industries (Badru and Zaluki, 2018; Cho and Lee, 2013;
Colak, 2012; Gounopoulos, 2003; Mumtaz et al., 2016; Song et al., 2014). This study mainly considers three industry dummies to
investigate the industry effects on firms issuing IPOs on the CSE.

4. Data and methodology

There are more than 290 companies listed on the CSE.4 The sample consists of 27 years of observations of data for the 1991–2017
period. The data was collected from the CSE databank, the company annual reports, and the IPOs’ prospectus. The IPOs of nonvoting
common shares, preferred shares and the listings made through introductions are omitted from sample consideration. The sample
includes 148 IPO issues, which cover more than 70% of the total 202 IPOs.
Panel A in Table 5 reveals the distribution of the sample IPOs by year. A total of 103 of the 148 sample IPOs (69.59%) occurred in
1991–1996, 2002, 2004, 2005, 2010 and 2011. A total of 82.1% (Rs. 62,373 Mn. of the Rs. 75,756 Mn. total) of the aggregate gross
proceeds in the sample were collected in the abovementioned 11 years alone. Therefore, we consider these 11 years as hot periods
and the remainder of the 14 years as cold periods (1997–2000, 2003, 2006, 2008, 2009 and 2012–2017). Similarly, displaying both
the number of offers and the gross proceeds, Panel B in Table 5 gives the distribution of the sample by industry. The sample covers 14
different industries with firms listed on the CSE: the financial sector has a higher contribution than the other industries have.
Approximately 28% of the aggregate gross proceeds in the sample were raised by the bank, finance and insurance industry, whereas
the information technology sector represents 16.5% of the aggregate proceeds in the sample. Hotels and travel, plantation and
manufacturing industries represent 57 out of the 148 IPOs (38.5% of the sample).
To be consistent with existing literature (Aggarwal et al., 1993; Anderson et al., 2015; Chi and Padgett, 2005), for this study, the
IPO initial returns are calculated by using two measures. First, the raw initial returns (IR) are calculated as the variation between the
first-day closing price and the IPO offer price, reflected as a percentage of the offer price (Eq.1). Second, the market-adjusted
abnormal return (MAAR) is calculated by adjusting the market return index with the initial returns (Eq. 2).
IRi1 = [(Pi1 Pi0 ) / (Pio)] * 100 (1)

MAARi1 = {[(1 + IRi1 ) / (1 + Rm1)] 1}*100 (2)

4
The author’s calculation is based on the website https://www.cse.lk as at 31st December 2017.

177
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

Table 5
Sample of IPOs in Sri Lanka.
No of IPOs Aggregate proceeds
Total Sample Rs. Millions %

Panel A: by year
1991 7 7 2061 2.71
1992 13 13 8815 11.60
1993 11 11 3130 4.12
1994 15 15 3260 4.29
1995 13 13 2214 2.91
1996 11 10 1823 2.40
1997 6 5 583 0.77
1998 7 6 349 0.46
1999 6 5 536 0.71
2000 3 2 60 0.08
2001 1 0 – –
2002 9 5 3690 4.86
2003 7 4 857 1.15
2004 6 3 4252 5.86
2005 7 3 9698 12.77
2006 3 2 500 0.66
2008 3 3 1574 2.07
2009 3 2 896 1.18
2010 12 9 4298 5.66
2011 27 14 18936 24.92
2012 14 3 965 1.27
2013 3 2 2144 2.82
2014 6 5 1639 2.16
2015 4 2 1000 1.32
2016 3 2 1148 1.51
2017 2 2 1328 1.75
Total 202 148 75,756 100
Panel B: by industry
Bank, finance and insurance 59 35 21084 27.83
Beverage, food, and tobacco 15 12 7488 9.88
Diversified holdings 15 8 9768 12.89
Footwear and textiles 7 5 753 0.99
Health care 8 5 1323 1.75
Hotels and travel 25 18 3622 4.78
Information technology 4 4 12526 16.53
Land and property 6 5 1280 1.69
Manufacturing 23 22 7012 9.26
Motors 1 1 136 0.18
Plantations 19 17 896 1.18
Power and energy 11 8 7676 10.13
Services 2 2 169 0.22
Trading 7 6 2023 2.67
Total 202 148 75,756 100

Note: The sample consists of 148 IPOs listed on the CSE from January 1991 through April 2017. The IPOs are categorized by the IPO listing date and
industry. The proceeds from the IPO issues are calculated as the IPO issue price * the number of shares issued. There were no IPOs in 2007 and 2001
in the sample. Rs. refers to Sri Lankan Rupees.

where Pi1= the closing price on the first trading day of the i company, Pi0= the offer price of the i company, and IRi1= the initial
returns of the first trading day of the i company. Rm1= the first trading day’s market return, which is calculated by using Rm1=
[(Pm1 -Pm0)/ Pm0] *100 formula, Pm1= the closing market index value on the first trading day of the ith stock, and Pm0= the closing
market index value on the listed day of the ith stock.
There is no formal theoretical guidance in choosing the appropriate group of variables to be included in the regression model. The
measurement and predicted signs of variables considered in this paper are given in Table 6. In an attempt to stabilize the mean and
variance of a variable and simplify the calculation, the natural logarithm is used to convert financial data.
Following the methodology adopted by Loughran et al. (1994), we first analyze the initial returns and independent variables
(cross-sectional analysis). Then, in line with previous studies, we adopt the univariate regression and stepwise multiple regression
analysis (Table 4). Here, we use the forward regression model, where variables will be added one at a time to the model.
The multiple regressions used are as follows:

IRit = 0 + 1 lnAGE + 2 lnSIZE + 3 lnLAG + 4 SENT + 5 lnVOL + 6 MVL + 7 RISK + 8 PRC + 9 BRD + 10 PRIV

+ 11 HOT + 12 IND + it (3)

178
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

Table 6
Independent variables in the study.
Variable Symbol Measurement Ex. sign

Firm Age AGE The age of the firm from incorporation –

IPO price PRC The offer price of the IPO share –
Issue size SIZE The gross proceeds from the IPO –
Gap of Days LAG The gap between the IPO listed date and the first trading date +
Investor Sentiment SENT The % change of ASPI last month before the IPO issue. +
IPO volume VOL The annual volume of the listing +
Offer Risk RISK The reciprocal of the nominal offering price (1/IPO offer price) +
Market Volatility MVL The standard deviation of the daily ASPI for the first 30 trading days prior to the IPO +
Privatization issue PRIV A dummy variable for privatization issues +
Hot issue period HOT A dummy variable for hot period issues +
Board Type BRD A dummy variable for Main Board Listed Firms –
Issuer’s industry HTL Dummy variables for hotel, plant and bank Industry Firms +
PLNT
BNK

MAARit = 0 + 1 lnAGE + 2 lnSIZE + 3 lnLAG + 4 SENT + 5 lnVOL + 6 MVL + 7 RISK + 8 PRC + 9 BRD + 10 PRIV

+ 11 HOT + 12 IND + it (4)

where the IR initial returns and the MAAR market adjusted abnormal returns are the dependent variables. There are twelve ex-
planatory variables: AGE represents the history of the firm from its incorporation; SIZE denotes the gross proceeds from the IPO; LAG
denotes the time gap between the IPO listing date and the first trade date; SENT is the proxy for investor sentiment; VOL denotes the
annual volume of listings in the stock market; MVL denotes the standard deviation of the daily ASPI for the first 30 trading days prior
to the IPO issue; RISK is the reciprocal of the nominal offer price; PRC represents the offer price of the IPO; HOT denotes hot-period
issues; PRIV denotes privatization issues; BRD denotes the listed board types; and IND indicates three dummies for the main in-
dustries. β0 is the vertical intercept, β denotes the regression coefficients, and ε is the error term.

5. Empirical results

5.1. IPO initial returns: underpricing or overpricing

Using data from the IPOs of 148 firms between 1991 and 2017, the average initial return in Sri Lanka is found to be 47.1%, and
the average MAAR is 40.83% (Table 7). The returns in our results are higher than those in the findings of Samarakoon (2010) where
the average initial returns are 33.5% from 1987 to 2008 in Sri Lanka. Interestingly, our results show that the initial underpricing is
approximately 73.98% and 57.1% for the IR and MAAR, respectively. The results show that 32 IPO issues are overpriced on average
by 18% for both the IR and the MAAR. There are 14 IPO issues that are neither underpriced nor overpriced and where the issue price
and the first trading day closing prices are almost the same. The range of difference between the maximum and minimum is rea-
sonably high. The difference between the underpriced and overpriced IPOs is significant at the 1% level for the IR and the MAAR.
Further, the self-explanatory descriptive statistics (Appendix Table A1) show that the highest value of initial overpricing (IR = 70%
and MAAR = 65%) was for an IPO from the hotel industry in 1996 and that the highest underpricing (IR = 950% and MAAR =
519%) was recorded in the year of 1991 for an IPO in the banking sector.

5.2. IPO initial returns: war and postwar periods

Dayaratne and Wijethunga (2015) stated that the CSE had achieved outstanding growth after the successful finish of the civil war.
While their study implied that during the postwar periods, stock market investors had enjoyed more capital gains than dividends, the
analysis of IPO initial returns during the following periods are not considered by authors. Thus, in this study, we categorize the initial

Table 7
IPO initial performance: underpricing and overpricing.
Average IR (%) No. of IPOs Average MAAR (%) No. of IPOs

Underpriced 73.98 102 57.10 116

Overpriced −17.98 32 −18.14 32
Fair priced 00.00 14 – –
Overall 47.10 148 40.83 148
The difference (Underpriced – Overpriced) 91.96*** 75.24***

Note: The sample consists of 148 IPOs listed on the CSE from 1991 to 2017. The IR refers to the initial returns, and the MAAR refers to the market
adjusted abnormal returns. Two-tails sample t-statistics were used for testing the difference in means (assuming unequal variances). ***, **, *
denote significance at the 1%, 5% and 10% level, respectively.

179
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

Table 8
IPO initial performance for war and postwar period.
Average initial return (%) No. of IPOs %
IR MAAR

War period (1991-2009) 55.27 47.61 109 73.65

Post War period (2010- 2017) 24.29 21.89 39 26.35
Difference 30.98** 25.72**

Note: The sample consists of 148 IPOs listed on the CSE from 1991 to 2017. The IR refers to the initial returns, and the MAAR refers to market
adjusted abnormal returns. Two-tails sample t-statistics are used for testing the difference in means (assuming unequal variances). ***, **, * denotes
significance at the 1%, 5% and 10% level, respectively.

returns based on the war and postwar periods (Table 8). From the sample, the period 1991–2009 is considered as the war period, and
eight years following 2009 is considered as the postwar period.
The results show that based on the IR and the MAAR, the underpricing rate for the war periods were 55% and 48%, respectively.
Interestingly, based on the IR, the underpricing rate in the postwar period was 24%. Further, for the postwar period, the underpricing
rate for the MAAR is 22%. It is clear that compared with the underpricing level in the war period, the underpricing level in the
postwar period was reduced, and the difference was significant at the 5% level for both IR and MAAR. The reason for the decrease of
underpricing in postwar could be the reduction of the country’s risk: a stable and peaceful environment could have generated lower
first day returns to the investors.

5.3. IPO initial performance categorized by years and industry

Panel A in Table 9 reveals the distribution of initial returns on a yearly basis. It is clear that except for the years 2006 and 2013, in
which average negative initial returns occurred, underpricing is a common phenomenon in Sri Lanka. First, the highest average initial
returns in 1991 were mainly generated by two privatization issues and a conventional issue, namely, the issues for Ceylon Oxygen,
Pugoda Textiles Lanka and the Merchant Bank of Sri Lanka. Second, the high initial underpricing levels recorded for the IPOs listed in
the year 1998 were caused by the abnormal high initial returns of four privatized plantation IPOs. Additionally, the changes of the
market liberalization policies had a significant influence in creating an optimistic investor sentiment in 1991. The initial returns in
1991 and 1998 are significant. Furthermore, Table 9 shows the aggregate amount of money left on the table, which represents the
total IPO buyers’ accumulated wealth based on the first trading day closing prices: the most substantial amount was in 2004 (Rs.
3339.1 Mn.) followed by 1991 (Rs. 3226.46 Mn.).
Panel B Table 9 shows the average IPO initial returns categorized by industries, and the evidence shows that except for the
information technology industry, underpricing is common across the 13 industries. The plantation industry has the highest initial
returns (101.47%), and the difference between overall average returns and plantation industry returns is significant at the 5% level.
In addition, the other industries with high initial returns are footwear and textiles (81.06%), services (67.50%), motors (63.64%) and
banks, finance & insurance (60.59%), while the MAAR rates are slightly different from the IR rates. The largest aggregate amount of
money left on the table (Rs. 5756.4 Mn.) and the highest contribution to the aggregate proceeds (28%) are from the banks, finance &
insurance industry. The wide variation of the initial returns among the industries is consistent with previous studies (Badru and
Zaluki, 2018; Cho and Lee, 2013; Colak, 2012; Gounopoulos, 2003).

5.4. IPO initial performance categorized by individual variables

Table 10 displays the detailed analysis of the average initial returns categorized separately by eleven individual variables. First,
IPO firms are segmented into four classes depending on their AGE at the time of IPO issue. IPO firms with ages of 1–4 years have
lower initial returns than the abnormal returns of IPOs of firms in operation for 5–9 years. The results indicate that the level of
underpricing remains highest for the 5–9 years old firms, a finding that is significant at 5% in both measures and tends to decrease for
the matured IPOs. Furthermore, following the research of Loughran et al. (1994), firms that have operated less than ten years from
their incorporation are classified as young and as old otherwise. The results show that younger firms (56.78%) have higher initial
returns than do old firms (35.29%). Although the difference between the initial returns of the two age groups is not significant, the
firm age seems to negatively affect the initial returns which is similar to those of previous studies (Chen et al., 2004; Kirkulak and
Davis, 2005; Loughran et al., 1994; Yu and Tse, 2006). The initial returns are categorized into three subgroups by SIZE, with the
almost equivalent number of IPOs into each subgroup. Based on the results exhibited in Table 10, the issues less than Rs. 100 Mn.
have an IR of 91% and a MAAR of 74%, which are returns that are statistically significant at a 5% level. It is evident that when the
issue size is smaller, the initial returns are larger, whereas the other two subgroups’ returns are lower. Moreover, to investigate this
size effect, the sample is divided into two groups, with firms with an issue size equal to Rs. 200 Mn. categorized as small issues and
those above that amount categorized as large issues. The outcomes indicate that small issues are more underpriced than large issues
by 34% and 28% concerning the IR and the MAAR, respectively, where the difference is significant at 5%. In the sample, there is on
the average a 60-day delay between the IPO issue date and the listing date (Appendix-Table A1). The IPO firms are segmented into
four classes based on their LAG time. Based on the figures revealed in Table 10, the highest initial returns of 98.43% and the highest
MAAR of 76.26%, which are both significant at the 5% level, were achieved in the most extended lag period of 90 days or more.

180
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

Table 9
IPO performance categorized by year and Industry.
Year or industry No. of IPOs Average initial returns (%) Aggregate money left on the table
IR MAAR Rs. Millions

Panel A: by year
1991 7 307.00*** 174.17*** 3226.46
1992 13 36.57 47.43 468.06
1993 11 81.98 59.66 2,962.46
1994 15 16.07 20.51 579.97
1995 13 7.59 16.81 −81.58
1996 10 21.48 26.71 −294.73
1997 5 43.83 55.85 101.14
1998 6 166.23** 160.03** 406.05
1999 5 12.00 13.79 64.00
2000 2 15.00 22.04 8.00
2002 5 11.66 4.52 271.93
2003 4 19.22 12.78 500.75
2004 3 90.11 92.52 3339.10
2005 3 37.57 40.37 2,632.01
2006 2 −7.81 −8.55 −62.50
2008 3 16.44 15.83 −7.93
2009 2 42.22 24.59 299.20
2010 9 74.41 62.82 2,016.65
2011 14 14.93 16.32 −503.40
2012 3 5.57 5.58 50.98
2013 2 −16.19 −17.21 −341.69
2014 5 11.45 10.34 163.31
2015 2 0.33 4.52 −5.00
2016 2 11.00 9.45 36.45
2017 2 2.92 −1.02 51.07
Overall 148 47.10 40.83 15880.77
Panel B: by industry
Banks, finance and insurance 35 60.59 44.53 5756.40
Beverage, food, and tobacco 12 28.50 30.11 706.76
Diversified Holdings 8 18.86 11.34 −436.61
Footwear and textiles 5 81.06 57.66 445.00
Health care 5 43.05 49.35 742.77
Hotels and travels 18 20.11 16.01 561.41
Information technology 4 −0.42 −5.73 2,320.26
Land and property 5 4.50 0.14 48.23
Manufacturing 22 43.05 36.30 1,218.40
Motors 1 63.64 33.73 86.63
Plantations 17 101.47** 103.52*** 740.05
Power and energy 8 27.25 25.17 3,355.37
Services 2 67.50 65.73 49.06
Trading 6 44.24 51.41 287.05
Overall 148 47.10 40.83 15,880.77

Note: IPOs are categorized by the year of IPO issue. There were no IPOs in 2007 and 2001 in the sample. The sample consists of 148 IPOs by firms
listed on the CSE from 1991 to 2017. The IR refers to the initial returns, and the MAAR refers to the market adjusted abnormal return. The aggregate
amount of money left on the table is calculated by multiplying the price difference (first-day closing price - the issue price) * a number of shares
offered. Rs. refers to Sri Lankan Rupees. Two-tails sample t-statistics are used for testing the difference in the average initial returns in a given year/
industry and the overall average initial returns in the sample (assuming unequal variances). ***, **, * denote significance at the 1%, 5% and 10%
level, respectively.

Between 60 and 90-day lag periods, the initial returns are still higher than those of the other two classes of less than 60-day lag
periods, even though the returns are insignificant. Approximately 50% of the sample of IPOs has a lower value of initial returns than
those of the IPOs above the average lag period of 60 days. Thus, a lag produces a time benefit, where our results show that the IPOs
offered in a long lag period are more underpriced than those offered in a shorter lag period (Yu and Tse, 2006).
The SENT values in Table 10 reports the average initial returns segmented by negative and positive investor sentiment. When the
ASPI change is negative in the previous month of the IPO, the SENT values indicate that the IPOs are underpriced by 29%, and when
there is a rise in the ASPI, the IPOs are underpriced by approximately 73%. Therefore, it is clear that the initial returns are positively
correlated with the market sentiment. The return difference between the positive and negative sentiment of the IR and the MAAR is
44% and 26%, respectively, which are both statistically significant at 5%. The outcome is in line with the previous studies (Boulton
et al., 2011; Mumtaz et al., 2016; Wong et al., 2017).
Table 10 reveals the average initial returns of the firms classified by annual IPO volume (VOL). During the sample period
1991–2017, the average IPO volume per year is nine issues: the maximum, 15 issues, occurred in 1994, and the minimum, two issues,
occurred in several years. The results indicate that the level of underpricing remains highest for the situation in which there were 5–7

181
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

Table 10
IPO initial performance categorized by individual variables.
Variable Category Average initial return (%) No. of IPOs
IR MAAR

AGE 1–4 36.61 33.12 45 (31%)

5– 9 82.20** 70.41** 36 (24%)
10–19 24.21* 22.09* 36 (24%)
19 < 48.17 39.46 31 (21%)

AGE: Young vs. Old Young 56.87 49.69 81 (55%)

Old 35.29 30.12 67 (45%)
Young-Old difference 21.58 19.57

SIZE 0 - 99 90.81** 73.85** 49 (33%)

100 - 339 19.10 19.56 50 (34%)
339 < 31.98 29.53 49 (33%)

SIZE: Small vs. Large Small 63.86 54.62 76 (51%)

Large 29.42 26.28 72 (49%)
Small – large difference 34.44** 28.34**

LAG Days ≤ 30 25.59 24.42 28 (19%)

30 < Days ≤ 60 15.78* 15.89** 50 (34%)
60 < Days ≤ 90 61.90 56.44 39 (26%)
90 < Days 98.43** 76.26** 31 (21%)

SENT Negative 29.29 30.45 88 (60%)

Positive 73.23 56.07 60 (40%)
Negative – Positive difference −43.93** −25.62*

VOL 2-4 20.65 19.39 30 (20%)

5-7 107.31*** 78.85*** 33 (22%)
9 - 11 59.55 49.62 30 (20%)
12-13 22.08 32.12 26 (18%)
14 -15 15.52 18.49 29 (20%)

RISK 1≥ RISK ≥ 0.09 72.99 58.99 49 (33%)

0.09 > RISK ≥ 0.05 46.88 41.26 49 (33%)
0.05 > RISK ≥ 0.00 21.96 22.62 50 (34%)

MVL MVL ≤ 15 27.79 31.89 37(25%)

15 < MVL ≤ 36 77.29** 60.92* 38(26%)
36 < MVL ≤ 84 59.27 50.02 36(24%)
84 < MVL ≤ 285 23.58 20.21 37(25%)

HOT Hot year issues 52.44 43.69 103 (70%)

Cold year issues 34.90 34.29 45 (30%)
hot-cold difference 17.54 9.40

PRIV Privatization 88.96 78.50 33 (22%)

Conventional 35.09 30.03 115 (78%)
Privatization –Conventional difference 53.87** 48.47**

BRD Main 57.14 47.61 82 (55%)

Secondary 34.63 32.42 66 (45%)
Main-Secondary difference 22.50 15.19

Note: The sample consists of 148 IPOs by firms listed on the CSE from 1991 to 2017. IR denotes the initial returns; MAAR denotes the market
adjusted abnormal return; AGE denotes the history of the firm from its incorporation; SIZE denotes the gross proceeds from the IPO; LAG denotes the
time gap between the IPO listing date and the first trade date; SENT is a proxy for investor sentiment; VOL denotes the annual volume of listings in
the stock market; MVL denotes the standard deviation of the daily ASPI for the first 30 trading days prior to the IPO issue; RISK denotes the
reciprocal of the nominal offer price; PRC denotes the offer price of the IPO; HOT denotes hot-period issues; PRIV denotes privatization issues and
BRD denotes listed board types. The detailed definitions of variables are reported in Table 6. Two-tails sample t-statistics are used for testing the
difference in means (assuming unequal variances). ***, **, * denote significance at the 1%, 5% and 10% level, respectively.

issues per year: both return measures are significant at the 1% level and tend to decrease with an increase in the IPO volume. It is
obvious that when the volume is higher, the initial returns are smaller, as the returns for the other three subgroups are lower.
Similarly, a strong positive relationship between IPO volume and average initial returns is found by several previous studies (Cho and
Lee, 2013; Loughran et al., 1994).
The initial returns are categorized into three subgroups for RISK, with an almost equal number of IPO issues in each subgroup
categorized based on the IPO issue price. As per the results, Table 10 shows that when the RISK is greater or equal to 0.09, the IR is
73%, and the MAAR is 59%. It is evident that when the RISK decreases, the initial returns also decrease. Therefore, we found that IPO
risk is positively related to initial returns, even though it is statistically insignificant. Further, our results are consistent with the risk-
return trade-off theory. Moreover, the RISK variable can be used to explain the expected negative relation between the IPO offer price

182
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

and first-day returns.5 The IPO shares priced lower or equal to 11 rupees exhibit greater initial returns than the IPOs issued at a price
in between 12 rupees to 20 rupees or at a price more than 20 rupees. It is thus seen that the underpricing is higher with lower offer
prices.
Next, we categorized initial returns into four subgroups based on the MVL, with an almost equal number of IPO issues in each
subgroup categorized based on the market volatility values. The results in Table 10 show that when the MVL is lower or equal to 15,
the IR is 23%, and the MAAR is 33%. Only the second subgroup’s average IR of 77% and MAAR of 61% are significant: for this
subgroup, the MVL is greater than 15 and less than or equal to 36. After the second subgroup, the other last two subgroups show a
negative relationship: when MVL increases, the initial returns are tending to decrease. Finally, when MVL is at its highest, the lowest
initial returns for both IR and MAAR are realized. It is evident that when the RISK is increasing, the initial returns are also increasing
up to some extent and then decreasing again. Therefore, we found that MVL has a “U-shaped” relationship with initial returns, even
though the finding is not statistically significant.
The HOT values in Table 10 indicate the average initial returns segmented by HOT and COLD issues. A higher proportion of the
IPOs (70%) from the sample occurred during the hot-issue periods and had higher initial returns (52%) than the other cold issues had
(35%). Therefore, it is expected that the initial returns are positively related to the hot issues. The return difference between hot- and
cold-issue periods in terms of IR and MAAR is 17% and 9%, respectively, and is not statistically significant. The outcome is consistent
with previous studies by Loughran et al. (1994), and Gounopoulos et al. (2007) who stated that during the hot-issue periods, due to
the increase in the new IPO risk and total market risk, the IPOs generated high initial returns.
For a total of 33 privatization issues, the average IR and MAAR are 89% and 78%, respectively: these returns are higher than those
for the corporate IPOs in the sample. The difference between private and corporate issues in terms of IR and MAAR is 54% and 48%,
respectively, and is statistically significant at 5%. Therefore, these results indicate that for IPO returns, whether the IPO is a pri-
vatization issue or non-privatization issue makes a difference. Further, our results are consistent with the findings of Samarakoon
(2010) who found similar results for Sri Lankan IPOs that occurred before 2010.
Following previous studies (Bradley and Jordan, 2002; Colak, 2012; Song et al., 2014), we considered the listed board effect on
initial returns as a proxy for the issuing firm’s size. In general, there is more information available to investors and less uncertainty
regarding the firm’s future existence for large-size firms than for small-size firms. However, in Table 10, our results show that the
Main Board listed firms have higher initial returns than the firms on the secondary board have. Gounopoulos (2003) found a similar
positive association between Main Board listed firms and initial returns. The differences in the returns between the two different
boards regarding IR and MAAR are 23% and 15%, respectively, and is not statistically significant.

5.5. Univariate regression

Subsequent to the study of the behavior of IPO initial returns, the next step focuses on the determination of the individual factors
that are predicted to have a relationship with the IPO initial returns. The individual thirteen factors measured in the prior sections are
used in simple regressions with the two dependent variables, namely, IR and MAAR. The regression results are shown in Table 11.
White’s heteroscedasticity-consistent standard errors and covariance values were used to correct the heteroscedasticity problem in
the univariate regression models.
These individual regression results provide collaborative evidence for the initial IPO performance analyzed in the first section of
the empirical results. The regression results show that the lnSIZE, lnLAG, SENT, HOT, PRIV, HTL, and PLNT variables have significant
explanatory power on the dependent variables. Except for the RISK variable, which has a significant negative relationship with MAAR
but no significant relationship with IR, almost similar results are found for IR and MAAR. The initial returns and other variables, such
as lnAGE, lnVOL, BRD, BNK, MVL and lnPRC, have rather low explanatory power, which is not statistically significant. Although the
estimated coefficients on age and the volume of the listings have opposite signs, which differs from what was expected, those findings
are not statistically significant. The sign of the coefficients on the SIZE and lnPRC variables are negative, while lnLAG has a positive
coefficient, demonstrating the existence of the ex-ante uncertainty hypothesis.
Investor sentiment is positively related to the IPO initial returns, and this relationship is significant at the 1% level. As given in
models (7) and (9), we show that the privatization issue and the hot issue period dummy variables are positively related to the first-
day returns in the sample. The coefficients on PRIV and HOT are positive and significant at a 5% significant level. For the industry
effect, only IPOs in plantation firms are positively significant at a 5% level, showing that plantation IPOs can produce a higher initial
return than can the IPOs in the other industries. Conversely, the hotel industry IPOs have a significant negative relationship with
initial returns at the 10% level. Furthermore, the banking industry IPOs are not statistically significant. In contrast, the univariate
regression results are not consistent with the risk-return trade-off theory since the RISK variable has a significant negative re-
lationship with the MAAR at the 5% level.

5.6. Multiple regression analysis

As shown in the correlation matrix, the initial returns are interrelated with each of the independent variables. However, based on
the sample correlation coefficients (Table 12), the variables do not appear to be substituted for each other since the correlation

5
Based on the three categories of market risk, we can rewrite that categorization in terms of the IPO offer price. Then, three subgroups will be as
follows: PRC≤ 11, 11 < PRC ≤ 20 and 20 < PRC.

183
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

Table 11
Univariate regression results.
1 2 3 4 5 6 7 8 9 10 11 12 13 14

Panel A: dependent variable IR

C 0.43** 4.60*** −1.68* 0.49*** 0.47*** 0.74*** 0.35*** 0.35*** 0.28*** 0.51*** 0.43*** 0.40*** 0.53*** 0.74**
lnAGE 0.02
lnSIZE −0.22***
lnLAG 0.54**
SENT 0.34***
lnVOL −0.02
RISK −0.60
PRIV 0.54**
BRD 0.23
HOT 2.14***
HTL −0.31*
BNK 0.18
PLNT 0.61**
MVL −0.01
lnPRC −0.09
Panel B: dependent variable MAAR
C 0.41*** 3.64*** −1.12** 0.42*** 0.34** 0.58*** 0.30*** 0.32*** 0.29*** 0.44*** 0.40*** 0.33*** 0.47*** 0.58***
lnAGE 0.00
lnSIZE −0.17***
lnLAG 0.38***
SENT 0.21***
lnVOL −0.01
RISK −0.53**
PRIV 0.48***
BRD 0.15
HOT 1.39***
HTL −0.28**
BNK 0.05
PLNT 0.71***
MVL −0.01
lnPRC −0.06

Note: The sample consists of 148 IPOs by firms listed on the CSE from 1991 to 2017. IR denotes initial returns; MAAR denotes the market adjusted
abnormal return; AGE denotes the history of the firm from its incorporation; SIZE denotes the gross proceeds from the IPO; LAG denotes the time gap
between the IPO listed date and the first trade date; SENT is the proxy for investor sentiment: VOL denotes the annual volume of listings in the stock
market; MVL denotes the standard deviation of the daily ASPI for the first 30 trading days prior to the IPO issue; RISK denotes the reciprocal of the
nominal offer price; PRC denotes the offer price of the IPO; HOT denotes the hot-period issues; PRIV denotes the privatization issues; BRD denotes
the listed board types and HTL, PLNT, and BNK are three dummies for the hotel, plantation and banking industries, respectively. The detailed
definitions of the variables are reported in Table 6. ln refers to the natural logarithm values of the selected variables. White heteroskedasticity-
consistent standard errors & covariance are used. ***, **, * denote significant at the 1%, 5%, and 10% level, respectively.

between variables is less than 0.5. Although the dependent variables IR and MAAR are 94% positively correlated, this will not affect
the multiple regression results since we do not consider those dependent variables simultaneously. According to the Augmented
Dickey-Fuller (ADF) unit root test results, which are given in Table 13, all the non-dummy variables are stationary at the level. We
employed the White heteroskedasticity-consistent standard errors and covariances to eliminate the heteroskedasticity problem from
the multiple regression model. In line with previous studies (Table 4), we adopted a Stepwise Forward Multiple Regression analysis.
Table 14 shows the coefficient of the lnSIZE has a significant negative relationship with IR and MAAR, both relationships showing
significance at the 1% level. Similarly, the relationship between the lnLAG variable and the dependent variables (IR and MAAR) is
significant at a 5% level in the model (1) and (2). Thus, these findings for lnSIZE and lnLAG are consistent with previous studies
(Alanazi and Al-Zoubi, 2015; Chen et al., 2004; Chi and Padgett, 2005; Pradhan and Shrestha, 2016; Yu and Tse, 2006), and our
results support the ex-ante uncertainty hypothesis in terms of the SIZE and LAG variables. The age of the IPO firms (lnAGE) and the
IPO offer price (lnPRC) variables are not statistically related to IPO initial returns in the CSE stock market. The sign of the lnAGE
variable is positive, while lnPRC has a negative sign coefficient. Nevertheless, for ex-ante uncertainty, these two independent vari-
ables are insignificant and not associated with the initial returns. Further, this outcome is not consistent with previous researchers’
findings (Chen et al., 2004; Kirkulak and Davis, 2005; Yu and Tse, 2006).
First-day initial returns are positively related with SENT across the models (1) through (3). The coefficient SENT is significant at
the 1% level and consistent with the investor sentiment hypothesis. Similar results in previous studies (Boulton et al., 2011; Mumtaz
et al., 2016; Samarakoon, 2010; Wong et al., 2017) also showed the existence of a positive relationship between stock market returns
before the IPO issue and underpricing. A negative sign of the lnVOL coefficient remains unchanged throughout (2) and (3) models.
The lnVOL coefficients are statistically not significant and opposite to the expected positive sign.
The results are consistent with the risk-return trade-off theory, as the variable RISK has a significant positive relationship at the
5% level with IR and MAAR in models (1) to (3), which is statistically significant and thus allows us to accept the risk and return

184
 D.N. Rathnayake, et al.

Table 12
Correlation matrix.
IR MAAR AGE SIZE SENT VOL LAG RISK PRIV BRD HOT HTL BNK PLNT MVL PRC

IR 1.00
MAAR 0.94*** 1.00
AGE 0.02 0.00 1.00
SIZE −0.27*** −0.29*** 0.14 1.00
SENT 0.31*** 0.27*** −0.02 −0.09 1.00
VOL 0.00 0.03 0.01 −0.07 −0.10 1.00
LAG 0.31*** 0.31*** −0.03 −0.40*** 0.05 0.27*** 1.00
RISK −0.07 −0.08 0.00 0.16* −0.36*** −0.33*** −0.21*** 1.00
PRIV 0.20 0.25 −0.07 −0.22 0.04 0.06 0.36 −0.12 1.00

185
BRD 0.10 0.09 −0.01 0.10 0.10 0.00 0.17** −0.27*** 0.31 1.00
HOT 0.54*** 0.50*** 0.08 −0.23*** 0.30*** −0.07 0.34*** −0.05 0.23 0.04 1.00
HTL −0.09 −0.12 −0.20 −0.12 0.06 0.03 −0.02 −0.01 −0.15 −0.09 0.10 1.00
BNK 0.07 0.02 0.04 0.13* 0.07 −0.08 −0.05 −0.05 −0.19 0.08 −0.06 −0.21 1.00
PLNT 0.18** 0.29*** −0.12 −0.36*** 0.06 −0.07 0.28*** −0.06 0.57 0.15 0.26* −0.14*** −0.20** 1.00
MVL −0.06 −0.09 0.10 0.39*** 0.00 −0.09 −0.50*** 0.24** −0.30*** −0.17** −0.08 −0.13 0.14* −0.24*** 1.00
PRC −0.08 −0.07 0.20** 0.19** −0.12 0.33*** 0.21*** −0.23*** −0.05 0.18** 0.30*** 0.02 0.06 −0.13 −0.24*** 1.00

Note: The sample consists of 148 IPOs by firms listed on the CSE from 1991 to 2017. IR denotes initial returns; MAAR denotes the market adjusted abnormal return; AGE denotes the history of the firm
from its incorporation; SIZE denotes the gross proceeds from the IPO; LAG denotes the time gap between the IPO listed date and the first trade date; SENT is the proxy for investor sentiment: VOL denotes
the annual volume of listings in the stock market; MVL denotes the standard deviation of the daily ASPI for the first 30 trading days prior to the IPO issue; RISK denotes the reciprocal of the nominal offer
price; PRC denotes the offer price of the IPO; HOT denotes the hot-period issues; PRIV denotes the privatization issues; BRD denotes the listed board types and HTL, PLNT, and BNK are three dummies for
the hotel, plantation and banking industries, respectively. The detailed definitions of the variables are reported in Table 6. ***, **, * denote significant at the 1%, 5%, and 10% level, respectively.
Research in International Business and Finance 50 (2019) 171–190
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

Table 13
ADF unit root test results.
Variable Intercept Trend and Intercept

IR −9.76*** −10.28*** Level

MAAR −10.84*** −11.43*** Level
AGE −11.28*** −11.25*** Level
SIZE −8.81*** −9.51*** Level
SENT −11.16*** −11.23*** Level
VOL −10.29*** −10.34*** Level
LAG −3.17** −11.89*** Level
RISK −3.29** −12.20*** Level
MVL −3.22** −12.06*** Level
PRC −9.27*** −11.01*** Level

Note: The Augmented Dickey-Fuller test statistic values are recorded in the table. The sample consists of 148 IPOs by firms
listed on the CSE from 1991 to 2017. IR denotes the initial returns; MAAR denotes the market adjusted abnormal return;
AGE denotes the history of the firm from its incorporation: SIZE denotes the gross proceeds from the IPO; LAG denotes the
time gap between the IPO listing date and the first trade date: SENT is the proxy for investor sentiment; VOL denotes the
annual volume of listings in the stock market; MVL denotes the standard deviation of the daily ASPI for the first 30 trading
days prior the IPO issue; RISK is the reciprocal of the nominal offer price and PRC denotes the offer price of the IPO. The
detailed definitions of the variables are reported in Table 6. ***, **, * denote significance at the 1%, 5%, and 10% level,
respectively.

Table 14
Estimation results of multiple regression analysis.
Model 1 2 3
IR MAAR IR MAAR IR MAAR

lnAGE – – – – 0.05 (0.81) 0.03 (0.60)

lnSIZE −0.15 (-2.39)*** −0.12 (-2.39)*** −0.19 (-2.79)*** −0.14 (-2.74)*** −0.19 (-2.72)*** −0.13 (-2.57)***
lnLAG 0.55 (2.13)** 0.36 (2.26)** 0.55 (2.09)** 0.35 (2.13)** 0.44 (1.58) 0.25 (1.47)
lnPRC −0.01 (-0.13) −0.01 (-0.08)
SENT 0.34 (2.91)*** 0.21 (2.96)*** 0.33 (3.02)*** 0.21 (3.03)*** 0.33 (3.07)*** 0.21(3.08)***
lnVOL −0.36 (-1.54) −0.14 (-0.89) −0.35 (-1.86)* −0.18 (-1.24)
RISK 0.99 (2.17)** 0.53 (1.77)* 0.87 (2.09)** 0.52 (1.78)* 1.08 (2.08)** 0.64 (1.95)**
MVL 0.01 (1.89)** 0.01 (1.49) 0.01 (2.03)** 0.01 (1.59) 0.01 (2.20)** 0.01 (1.65)
PRIV – – – – 0.22 (0.73) 0.15 (0.74)
BRD – – – – 0.04 (0.22) 0.01 (0.01)
HOT – – 0.59 (1.65) 0.27 (0.98) 0.70 (2.34)** 0.43 (1.89)**
HTL – – – – −0.15 (-0.85) −0.16 (-1.17)
PLNT – – – – 0.27 (0.76) 0.48 (1.57)
BNK – – – – 0.26 (1.09) 0.15 (0.99)
Constant 0.94 (0.70) 1.23 (1.12) 1.90 (1.52) 1.64 (1.54) 2.09 (1.71)* 1.62 (1.54)
Adj-R2 0.23 0.21 0.25 0.22 0.28 0.28
Prob(F-stat) 0.00 0.00 0.00 0.00 0.00 0.00
DW stat 1.81 1.80 1.86 1.81 1.83 1.84

Note: The sample consists of 148 IPOs by firms listed on the CSE from 1991 to 2017. IR denotes the initial returns; MAAR denotes the market
adjusted abnormal return; AGE denotes the history of the firm from its incorporation; SIZE denotes the gross proceeds from the IPO; LAG denotes the
time gap between the IPO listing date and the first trade date; SENT is a proxy for investor sentiment; VOL denotes the annual volume of listings in
the stock market; MVL denotes the standard deviation of the daily ASPI for the first 30 trading days prior to the IPO issue; RISK is the reciprocal of
the nominal offer price; PRC denotes the offer price of the IPO; HOT denotes the hot-period issues; PRIV denotes the privatization issues; BRD
denotes the listed board types; and HTL, PLNT, and BNK are three dummies for the hotel, plantation, and banking industries, respectively. The
detailed definitions of variables are reported in Table 6. The t-statistics are recorded in parenthesis. White heteroskedasticity-consistent standard
errors and covariance OLS estimates are used in the above models. ***, **, * denote significance at the 1%, 5%, and 10% level, respectively.

hypothesis. Previously, based on the empirical study on Malaysian IPOs, Badru and Zaluki (2018) and Wong et al. (2017) showed that
IPO risk is positively associated with IPO underpricing. As expected, the initial returns are significantly affected by the market
volatility observed at the time of setting the offer price. Although the sign of this variable is positive in the case of MAARs, it is not
statistically significant at any meaningful level. However, this market volatility exerts a significant impact on the IR at the 5% level.
Therefore, the risk and return hypothesis is accepted, and the results are consistent with previous studies (Butler et al., 2014; Deng
and Zhou, 2016; Mumtaz et al., 2016; Wong et al., 2017).
Although in accordance with Samarakoon (2010) who found a significant positive association between initial returns and pri-
vatization issues in case of Sri Lanka, the PRIV records a positive sign of the coefficient, and we do not find significant results. In
addition, while the positive sign of the coefficient is in line with the findings of Gounopoulos (2003), the BRD is statistically in-
significant in the CSE market. For the hot-issue market dummy, the coefficient is significant at the 5% level in the (3) model. This is

186
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

parallel to the outcomes of previous work (Alanazi and Al-Zoubi, 2015; Gounopoulos et al., 2007; Loughran and Ritter, 2004;
Loughran et al., 1994), which found that there is a positive connection between IPO underpricing and hot-issue periods. Therefore,
based on our results, we support the windows of opportunity hypothesis.
For the industry effect, only the IPOs in the hotel industry (HTL) are negatively related with the initial returns but have an
insignificant coefficient, suggesting that hotel firms produce lower initial returns than do other industries. On the other hand, also not
statistically significant, the plantation (PLNT) and banking (BNK) industries have a positive relationship with initial returns. Further,
with the aim of testing the joint hypothesis for industry effect, we used the Wald test.6 The test results indicated that three industry
coefficients are simultaneously equal to zero, and the hypothesis for industry effect is not accepted.
In the IPO sample, for the first-day returns, the forward regression models (1)-(3) explain approximately 21% to 28% of the
overall variations, which are measured by the adjusted R2. Further, the overall F-statistics are used to determine the fit of the
regression models.7 The estimated multiple regression models (1) to (3) significantly explain the determinants of initial returns at the
1% level. Moreover, the estimated results are free from autocorrelation errors since the Durbin Watson tests values almost equal to 2,
and there is no autocorrelation error in the regression models in Table 14.8

5.7. Robustness check

Mainly, we considered the OLS framework for the estimation of regresses while dealing with the heteroscedasticity problem. The
Feasible Generalized Least Squares (FGLS) method is used here as a robustness check while estimating the structure of hetero-
scedasticity from the OLS, which is discussed by Wooldridge (2015). The FGLS empirical results are found to be identical with the
general OLS results (Table 14), and the conclusions are almost similar to the FGLS results, with a very few exceptions (OLS coeffi-
cients have varied very slightly). Therefore, we do not report the FGLS results in the paper.9 Hence, we conclude that our results are
robust.

6. Conclusions

Many academics have dedicated their entire careers to studying IPO behavior (Loughran and Ritter, 2004; Loughran et al., 1994;
Ritter and Welch, 2002). Loughran et al. (1994) found that underpricing is common in stock markets all over the world and differs by
country: the phenomenon is more pronounced and significant for developing countries. Some theoretical models were introduced in
previous studies to describe the behavior of IPO initial returns. The most reasonable explanation for the phenomenon of underpricing
is based on the information asymmetry theories, posited mostly in the form of share price ex-ante uncertainty. In parallel, previous
academics have hypothesized that positive initial returns have motivated fewer informed investors who were looking forward to
avoiding the “winner's curse” (Rock, 1986).
We use a sample of 148 IPOs on the CSE from 1991 to 2017. The secondary data was collected from company annual reports and
the CSE official website. On the average, we found that IPOs are underpriced by 47% and, in addition, that 32 IPOs are overpriced by
between 17%–18%. The OLS regression model and a cross-sectional analysis were used to investigate the relationships between initial
returns and thirteen independent variables. Further, the FGLS method was used as a robustness check while estimating the structure
of heteroscedasticity from OLS. We found that the firm’s issue size, time-lag, investor sentiment, offer risk, market volatility and hot-
issue periods have a significant relationship with IPO returns, while other variables, namely, the age of IPO firms, the offer price, and
the listed board are not statistically related to IPO initial returns on the CSE. The results are in line with the prediction of ex-ante
uncertainty, windows of opportunity and the investor sentiment hypotheses and previous international studies. In the capital market,
stock indices increased rapidly, creating new milestones after the end of the Civil War. Interestingly, the average underpricing rates in
the postwar period are lower than those before the war (22%–24%). Overall, the results indicate that in Sri Lanka, underpricing
occurs for a higher percentage of the IPOs than overpricing.
In addition to the Samarakoon (2010), this paper delivers some new insights into the behavior of IPO initial returns in Sri Lanka.
Unfortunately, individual firm financial data is poorly explained in the sample data and our analysis. For further study, we suggest
the consideration of the effect of underwriters, firm-specified characteristics and the effect of macroeconomic factors on IPOs. A cross-
country analysis of short-term IPO performance within the South Asia Region will be appropriate for a better understanding since
there are still many unanswered questions relating to IPOs.

6
The Wald test is used to test the joint significance of three industry coefficients, namely, the plantation, hotel and banking coefficients. The null
hypothesis is that the three industry coefficients simultaneously equal to zero. The chi-squared value 2.925 < chi statistic (χ2) 7.814, with df=3,
α=0.05 and the p-value > 0.05; therefore, we do not reject the null hypothesis.
7
The F-test explains the overall model fit and joint significance of a group of variables. Further, it tests whether or not added coefficients improved
the model. The null hypothesis is that all the regression coefficients are equal to zero. The overall F-test p-value < the significance level, and the null
hypothesis is rejected.
8
The null hypothesis of the Durbin Watson test is that there is no first-order autocorrelation in residuals. The value range of 1.5 to 2.5 is relatively
normal, and no autocorrelation is found in the models.
9
The FGLS results obtained are available from the authors upon request.

187
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

Funding

This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors.

Acknowledgment

We are thankful to Editor (John W. Goodell) and an anonymous referee for many helpful and insightful comments.

Appendix A

Table A1
Descriptive statistics.
Mean Median Max Min SD Observations

IR 47.10 16.75 950.00 −70.00 111.40 148

MAAR 40.83 16.10 519.46 −65.14 79.29 148
AGE 14 8 115 1 17 148
SIZE 512 194 8,550 8 1,130 148
LAG 67 55 303 12 49,82 148
SENT −0.05 −0.13 3.15 −4.11 1.02 148
RISK 0.09 0.07 1 0 0.12 148
VOL 8.96 10 15 2 4.5 148
BOARD (0 = 66, 1 = 82) 0.55 na 1 0 na 148
PRIV (0 = 115, 1 = 33) 0.22 na 1 0 na 148
HOT (0 = 63, 1 = 85) 0.09 na 1 0 na 148
HOTEL (0 = 130, 1 = 18) 0.12 na 1 0 na 148
BANK (0 = 113, 1 = 35) 0.24 na 1 0 na 148
PLANT (0 = 131, 1 = 17) 0.11 na 1 0 na 148

Note: The sample consists of 148 IPOs by firms listed on the CSE from 1991 to 2017. SIZE values are in Sri Lankan Rupee Millions. These variables
are summarized for the full sample before any transformations. IR denotes the initial returns; MAAR denotes the market adjusted abnormal return;
AGE denotes the history of the firm from its incorporation; SIZE denotes the gross proceeds from the IPO; LAG denotes the time gap between the IPO
listing date and the first trade date; SENT is a proxy for investor sentiment; VOL denotes the annual volume of listings in the stock market; MVL
denotes the standard deviation of the daily ASPI for the first 30 trading days prior to the IPO issue; RISK is the reciprocal of the nominal offer price;
PRC denotes the offer price of the IPO; HOT denotes the hot-period issues; PRIV denotes the privatization issues; BRD denotes the listed board types;
and HTL, PLNT, and BNK are three dummies for the hotel, plantation, and banking industries, respectively. The detailed definitions of variables are
reported in Table 6. The categorical variables display their basic count data in brackets (counts of code = 1 as described, otherwise 0), na = not
applicable to categorical data.

References

Adjasi, C.K.D., Osei, K.A., Fiawoyife, E.U., 2011. Explaining underpricing of IPOs in frontier markets: evidence from the Nigeria Stock Exchange. Res. Int. Bus. Financ.
25 (3), 255–265. https://doi.org/10.1016/j.ribaf.2011.01.005.
Agathee, U.S., Sannassee, R.V., Brooks, C., 2012. The underpricing of IPOs on the stock exchange of mauritius. Res. Int. Bus. Financ. 26 (2), 281–303. https://doi.org/
10.1016/j.ribaf.2012.01.001.
Aggarwal, R., Leal, R., Hernandez, L., 1993. The aftermarket performance of initial public offerings in Latin America. Financ. Manag. 22 (1), 42–53. https://www.jstor.
org/stable/3665964.
Alanazi, A.S., Al-Zoubi, H.A., 2015. Extreme IPO underpricing and the legal environment in wealthy emerging economies. J. Multinatl. Financ. Manag. 31, 83–103.
https://doi.org/10.1016/j.mulfin.2015.05.004.
Al-Hassan, A., Delgado, F., Omran, M., 2010. The underpricing of IPOs in the Gulf cooperation council countries. Res. Int. Bus. Financ. 24 (3), 344–360. https://doi.
org/10.1016/j.ribaf.2010.03.002.
Anderson, H., Chi, J., Wang, Q., 2015. IPO performance on China’s newest stock market (ChiNext). Chinese Econ. 48 (2), 87–113. https://doi.org/10.1080/10971475.
2015.993215.
Badru, B.O., Zaluki, N.A., 2018. Explaining IPO initial returns in Malaysia: ex-ante uncertainty vs. signaling. Asian Rev. Account. 26 (1), 84–106. https://doi.org/10.
1108/ARA-11-2016-0133.
Biais, B., Perotti, E., 2002. Machiavellian privatization. Am. Econ. Rev. 92 (1), 240–258. https://doi.org/10.1257/000282802760015694.
Boonchuaymetta, E., Chuanrommanee, W., 2013. Management of the IPO performance in Thailand. J. Multinatl. Financ. Manag. 23 (4), 272–284. https://doi.org/10.
1016/j.mulfin.2013.05.004.
Boulton, T.J., Smart, S.B., Zutter, C.J., 2010. IPO underpricing and international corporate governance. J. Int. Bus. Stud. 41 (2), 206–222. https://doi.org/10.1057/
jibs.2009.38.
Boulton, T.J., Smart, S.B., Zutter, C.J., 2011. Earnings quality and international IPO underpricing. Spanish J. Financ. Account. / Rev. Espaã ± ola Financ. Y Contab. 86
(2), 483–505. Available at: https://www.jstor.org/stable/29780243.
Bradley, D.J., Jordan, B.D., 2002. Partial adjustment to public information and IPO underpricing. J. Financ. Quant. Anal. 37 (4), 595–616. https://doi.org/10.2307/
3595013.
Butler, A.W., Keefe, M.O.C., Kieschnick, R., 2014. Robust determinants of IPO underpricing and their implications for IPO research. J. Corp. Finance 27, 367–383.
https://doi.org/10.1016/j.jcorpfin.2014.06.002.

188
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

Chalk, A.J., Peavy, J.W., 1987. Initial public offerings: daily returns, offering types and the price effect. Financ. Anal. J. 43 (5), 65–69. Available at: https://www.jstor.
org/stable/4479063.
Chen, G., Firth, M., Kim, J.B., 2004. IPO underpricing in China’s new stock markets. J. Multinatl. Financ. Manag. 14 (3), 283–302. https://doi.org/10.1016/j.mulfin.
2003.07.007.
Chi, J., Padgett, C., 2005. The performance and long‐run characteristics of the chinese IPO market. Pacific Econ. Rev. 10 (4), 451–469. https://doi.org/10.1111/j.
1468-0106.2005.00285.x.
Cho, J., Lee, J., 2013. The venture capital certification role in R&D: evidence from IPO underpricing in Korea. Pacific-Basin Financ. J. 23, 83–108. https://doi.org/10.
1016/j.pacfin.2013.01.005.
Clarke, J., Khurshed, A., Pande, A., Singh, A.K., 2016. Sentiment traders & IPO initial returns: the Indian evidence. J. Corp. Finance 37, 24–37. https://doi.org/10.
1016/j.jcorpfin.2015.10.007.
Colak, G., 2012. IPO characteristics of index firms. Manag. Financ. 38 (12), 1134–1159. https://doi.org/10.1108/03074351211271265.
Daily, C.M., Certo, S.T., Dalton, D.R., Roengpitya, R., 2003. IPO underpricing: a Meta–analysis and research synthesis. Entrep. Theory Pract. 27 (3), 271–295. https://
doi.org/10.1111/1540-8520.00015.
Darmadi, S., Gunawan, R., 2013. Underpricing, board structure, and ownership: an empirical examination of Indonesian IPO firms. Manag. Financ. 39 (2), 181–200.
https://doi.org/10.1108/03074351311294016.
Dayaratne, D., Wijethunga, A., 2015. Stock Market Development and Economic Growth: War and Post-war Evidence From Sri Lanka. Available at:. http://ir.lib.seu.
ac.lk/handle/123456789/1845.
Deng, Q., Zhou, Z.G., 2016. The pricing of first day opening price returns for ChiNext IPOs. ev. Quant. Financ. Account. 47 (2), 249–271. https://doi.org/10.1007/
s11156-015-0500-x.
Durukan, M.B., 2002. The relationship between IPO returns and factors influencing IPO performance: the case of the Istanbul Stock Exchange. Manag. Financ. 28 (2),
18–38. https://doi.org/10.1108/03074350210767672.
Gounopoulos, D., 2003. The initial performance of IPOs: evidence from Athens stock Exchange. May 14, 2003). EFMA 2003 Helsinki Meetings. https://doi.org/10.
2139/ssrn.406702.
Gounopoulos, D., Nounis, C., Paris, S., 2007. The short- and long-term performance of initial public offerings in the Cyprus Stock Exchange. J. Financ. Decis. Mak. 4 (1)
Available at: http://epubs.surrey.ac.uk/id/eprint/154539.
Günther, S., Rummer, M., 2006. 14 - the Hot-issue Period in Germany: What Factors Drove IPO Underpricing? In Initial Public Offerings. Butterworth-Heinemann,
Oxford, pp. 215–245. https://doi.org/10.1016/B978-075067975-6.50017-7.
Heerden, G.V., Alagidede, P., 2012. Short run underpricing of initial public offerings (IPOs) in the Johannesburg Stock Exchange (JSE). Rev. Dev. Financ. 2 (3-4),
130–138. https://doi.org/10.1016/j.rdf.2012.10.001.
Huang, H., Li, Y., Zhang, Y., 2016. Investors’ attention and overpricing of IPO: an empirical study on China’s growth enterprise market. Inf. Syst. E-bus. Manag. 16 (4),
761–774. https://doi.org/10.1007/s10257-017-0351-1.
Islam, M.A., Ali, R., Ahmad, Z., 2010. Underpricing of IPOs: the case of Bangladesh. Glob. Econ. Financ. J. 3 (1), 44–61. Available at: http://www.gefjpapers.com/
static/documents/March/2010/4.Aminul.pdf.
Karami, G., Kordlar, A.E., Amini, Y., Hajipour, S., 2014. Earnings management and underpricing of initial public offerings (IPO), evidence from Iran. Int. Bus. Res. 7
(7), 156. https://doi.org/10.5539/ibr.v7n7p156.
Kirkulak, B., Davis, C., 2005. Underwriter reputation and underpricing: evidence from the Japanese IPO market. Pacific-Basin Financ. J. 13 (4), 451–470. https://doi.
org/10.1016/j.pacfin.2004.09.004.
Kiymaz, H., 2000. The initial and aftermarket performance of IPOs in an emerging market: evidence from Istanbul stock exchange. J. Multinatl. Financ. Manag. 10 (2),
213–227. https://doi.org/10.1016/S1042-444X(99)00027-4.
Komenkul, K., Siriwattanakul, D., 2016. How the unremunerated reserve requirement by the Bank of Thailand affects IPO underpricing and the long-run performance
of IPOs. J. Financ. Regul. Compliance. 24 (3), 317–342. https://doi.org/10.1108/JFRC-09-2015-0052.
Krishnamurti, C., Kumar, P., 2002. The initial listing performance of Indian IPOs. Manag. Financ. 28 (2), 39–51. https://doi.org/10.1108/03074350210767681.
Lin, C.P., Chuang, C.M., 2011. Principal‐principal conflicts and IPO pricing in an emerging economy. Corp. Gov. An Int. Rev. 19 (6), 585–600. https://doi.org/10.
1111/j.1467-8683.2011.00870.x.
Liu, X., Ritter, J.R., 2011. Local underwriter oligopolies and IPO underpricing. J. financ. econ. 102 (3), 579–601. https://doi.org/10.1016/j.jfineco.2011.01.009.
Loughran, T., Ritter, J.R., 2002. Why don’t issuers get upset about leaving money on the table in IPOs? Rev. Financ. Stud. 15 (2), 413–444. https://doi.org/10.1093/
rfs/15.2.413.
Loughran, T., Ritter, J.R., 2004. Why has IPO underpricing changed over time? Financ. Manag. 33 (3), 5–37. Available at: https://www.jstor.org/stable/3666262.
Loughran, T., Ritter, J.R., Rydqvist, K., 1994. Initial public offerings: international insights. Pacific-Basin Financ. J. 2 (2-3), 165–199. https://doi.org/10.1016/0927-
538X(94)90016-7.
Lowry, M., Schwert, G.W., 2002. IPO market cycles: Bubbles or sequential learning? J. Finance 57 (3), 1171–1200. https://doi.org/10.1111/1540-6261.00458.
Lyn, E.O., Zychowicz, E.J., 2003. The performance of new equity offerings in Hungary and Poland. Glob. Financ. J. 14 (2), 181–195. https://doi.org/10.1016/S1044-
0283(03)00011-5.
Marisetty, V.B., Subrahmanyam, M.G., 2010. Group affiliation and the performance of IPOs in the Indian stock market. J. Financ. Mark. 13 (1), 196–223. https://doi.
org/10.1016/j.finmar.2009.09.001.
Mayes, D., Alqahtani, F., 2015. Underpricing of IPOs in Saudi Arabia and sharia compliance. J. Islam. Account. Bus. Res. 6 (2), 189–207. https://doi.org/10.1108/
JIABR-12-2013-0042.
Mumtaz, M.Z., Smith, Z.A., Maqsood, A., 2016. An examination of short-run performance of IPOs using Extreme Bounds Analysis. Estud. Econ. (Sao Paulo) 43 (1),
71–95. Available at: https://revistatrabajo.uchile.cl/index.php/EDE/article/view/41865/43413.
Nogueira, F.Ad.P., Ferreira, S.J.R., Montini, Ad.Á, 2008. The aftermarket performance of initial public offerings: the Brazilian Experience. Lat. Am. Bus. Rev. 8 (4),
97–114. https://doi.org/10.1080/10978520802114797.
Paudyal, K., Saadouni, B., Briston, R.J., 1998. Privatisation initial public offerings in Malaysia: initial premium and long-term performance. Pacific-Basin Financ. J. 6
(5), 427–451. https://doi.org/10.1016/S0927-538X(98)00018-3.
Peavy, J.W., 1990. Returns on initial public offerings of closed-end funds. Rev. Financ. Stud. 3 (4), 695–708. https://doi.org/10.1093/rfs/3.4.695.
Pradhan, R.S., Shrestha, K., 2016. Performance of the Initial Public Offering (IPO) in the Nepalese Stock Market. Available at:. https://doi.org/10.2139/ssrn.
2793490.
Purnanandam, A.K., Swaminathan, B., 2004. Are IPOs really underpriced? Rev. Financ. Stud. 17 (3), 811–848. https://doi.org/10.1093/rfs/hhg055.
Rahim, R.A., Yong, O., 2010. Initial returns of malaysian IPOs and Shari’a-compliant status. J. Islam. Account. Bus. Res. 1 (1), 60–74. https://doi.org/10.1108/
17590811011033415.
Ritter, J.R., 1991. The long‐run performance of initial public offerings. J. Finance 46 (1), 3–27. https://doi.org/10.1111/j.1540-6261.1991.tb03743.x.
Ritter, J.R., Welch, I., 2002. A review of IPO activity, pricing, and allocations. J. Finance 57 (4), 1795–1828. https://doi.org/10.1111/1540-6261.00478.
Rock, K., 1986. Why new issues are underpriced. J. financ. econ. 15 (1-2), 187–212. https://doi.org/10.1016/0304-405X(86)90054-1.
Sadaqat, M.S., Akhtar, M.F., Ali, K., 2011. An analysis on the performance of IPO–a study on the karachi stock exchange of Pakistan. Int. J. Res. Bus. Soc. Sci. 2 (6),
275–285. Available at: http://ijbssnet.com/journals/Vol._2_No._6;_April_2011/30.pdf.
Samarakoon, L.P., 2010. The short-run underpricing of initial public offerings in the Sri Lankan stock market. J. Multinatl. Financ. Manag. 20 (4-5), 197–213. https://
doi.org/10.1016/j.mulfin.2010.07.003.
Signori, A., 2018. Zero-revenue IPOs. Int. Rev. Financ. Anal. 57, 106–121. https://doi.org/10.1016/j.irfa.2018.03.003.
Song, S., Tan, J., Yi, Y., 2014. IPO initial returns in China: underpricing or overvaluation? China J. Account. Res. 7 (1), 31–49. https://doi.org/10.1016/j.cjar.2013.12.
001.

189
D.N. Rathnayake, et al. Research in International Business and Finance 50 (2019) 171–190

Tran, T.H.L., Le, D.C., Hoang, T.P.T., 2014. The underpricing and long-run underperformance of initial public offerings: evidence from Vietnam. Int. J. Bus. Emerg.
Mark. 7 (1), 3–24. https://doi.org/10.1504/IJBEM.2015.066076.
Wang, K., Chan, S.H., Gau, G.W., 1992. Initial public offerings of equity securities: anomalous evidence using REITs. J. financ. econ. 31 (3), 381–410. https://doi.org/
10.1016/0304-405X(92)90039-Z.
Weiss, K., 1989. The post-offering price performance of closed-end funds. Financ. Manag. 18 (3), 57–67. Available at: http://www.jstor.org/stable/3665649.
Wong, E.S., Wong, R.W., Ting, L.S., 2017. Initial public offering (IPO) underpricing in Malaysian settings. J. Econ. Financ. Stud. 5 (2), 14–25. https://doi.org/10.
18533/jefs.v5i02.276.
Wooldridge, J.M., 2015. Introductory econometrics. Nelson Education 277–285.
Yu, T., Tse, Y.K., 2006. An empirical examination of IPO underpricing in the Chinese A-share market. China Econ. Rev. 17 (4), 363–382. https://doi.org/10.1016/j.
chieco.2005.07.001.
Zheng, S.X., 2006. 18 - signaling and the valuation of IPOs: Regression tests. Initial Public Offerings. Butterworth-Heinemann, Oxford, pp. 297–309. https://doi.org/
10.1016/B978-075067975-6.50021-9.

190