BWFF 6013 SEMINAR IN FINANCE

COLLEGE OF BUSINESS

SECOND SEMESTER 2021/2022 (A212)

BWFF 6013 SEMINAR IN FINANCE

GROUP ASSIGNMENT

CLASS DISCUSSANT

TOPIC: INITIAL PUBLIC OFFERING (IPO)

PREPARED FOR:

ASSOCIATE PROFESSOR DR. ZAHIRUDDIN BIN GHAZALI

PREPARED BY: GROUP 3

NAME MATRIC NUMBER

MOHAMAD ABDIQANI ABQIRAHMAN 828789 DATE

OF GAYATHIRI A/P SELVARAJU 829191

SARANIYA A/P ESUDAS 829194

ABDIFATAH IBRAHIM HASSAN 829241

SUBMISSION:
27th FEBRUARY 2022
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Table of Contents
1.0 Introduction.....................................................................................................................................2
2.0 Main Issue.......................................................................................................................................3
3.0 Literature Review............................................................................................................................7
4.0 Recommendations...........................................................................................................................9
5.0 References.....................................................................................................................................11
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1.0 Introduction

To go public, a private company must first issue equity securities to outside investors, in

what is called an initial public offering (IPO). Prior to a firm going public, underwriters must correctly

determine its offer price so that the issues could be fully subscribed by potential shareholders. The

type of pricing mechanism determines the pricing of IPOs. In the Malaysian market, most IPOs adopt

a fixed-price mechanism for pricing, indicating that underwriters and issuers undertake the role of

determining the offer price.

Moreover, the book-building pricing mechanism was only introduced in Malaysia in year

2002. The final offer price of Malaysian IPOs is subject to the approval of the Securities Commission

(SC) in ensuring the IPO price is determined on a fair value basis. Indeed, the offer price is set below

the share prices of IPOs. This is due to the existence of information asymmetry problem between

issuers and potential investors as the private information on actual values of firms are not

incorporated into the offer prices. The investors’ perception towards the IPO market values varies as

the heterogeneity of investors’ opinions will exhibit different behavioural tendencies when the IPO

firms go public. Further, stated that high level of underpricing could influence the heterogeneity of

investors’ opinions on the firm’s intrinsic value among fixed-price IPOs in Malaysia. The high level of

underpricing is triggered by the disagreement among investors on the ex-ante information that was

available prior to the IPO listing. In this study, a high degree of underpricing corresponds to the IPO

offer prices being set lower than the firms’ prices during the first-day of trading. Potential investors

have the opportunity to obtain information and make subscription decisions on new issues.

Investors’ opinions then will trigger IPO values on the first trading day in the secondary market.

Investors act as the value indicator for IPOs which is based on several factors including accounting

information, firm characteristics, market condition, corporate governance, and non-financial

characteristics such as auditor or underwriters’ reputations. However, there are no studies on how

investors’ interest influences the values on the first trading day of Malaysian IPOs over the past

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three decades, a huge number of theoretical and empirical studies have been published on the topic

of IPO initial return which will be explained further in the third section of this report.

Why Do Firms Go Public?

The decision to go public marks a significant landmark in the life of unlisted or private firms.

The interesting question is why a privately owned company decides to go public. There are three

main reasons explaining why a firm decides to list its shares on a stock market as follows.

Firstly, by going public, a firm’s owners can sell part of their shareholdings in the company in

exchange for cash, enabling them to utilize the proceeds of the sale for other expenditures or to

diversify their investments. Secondly, by going public, a firm can access public equity capital to

obtain funding for new investment plans, finance further business expansion, and repay outstanding

loans. That is, when a private firm reaches a stage where the financial capacity of the current

shareholders is limited, and cannot finance further growth plans, entering the equity market

provides an alternative financing choice.

Thirdly, by going public, firms can reap other indirect benefits, such as increasing corporate

publicity, enhancing the promotion, or advertising of the firm’s trademarks and products, and

attracting a different caliber of skilled employees. However, as well as certain advantages for going

public, there are some disadvantages associated with this decision. For instance, a loss of control by

business founders and current shareholders can be an obvious consequence due to public flotation

of part of their shareholding. That is, as the shareholding base is widened with public flotation, new

shareholders gain voting rights that could dilute the voting rights of the founders and current

shareholders.

2.0 Main Issue

a) Initial Public Offering has an offering price and opening price.

The price fixed by a company to issue their shares to the public is known as offering price.

Meanwhile, the price at which those shares begin to trade in the open market is classified as the

opening price. The offering price is set by the underwriter based on the capital amount the company

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plans to raise and the demand level from the investors. Whereas supply and demand level

determines the opening price. The difference between the offering price and opening price is the

amount of profit or loss for investors in that Initial Public Offering of stock where it often indicates

whether the Initial Public Offering shares are likely to surge or downfall.

Offering price of Initial Public Offering is classified either at intrinsic value or under-priced or

overpriced value. The offering is considered as under-priced when the first day of trading’s closing

price is greater than the issued price. If the closing price is lower than the offer price, then the Initial

Public Offering is considered as over-priced. There are several factors that influence the Initial Public

Offering price. Firstly, the quantitative factors of the company. This includes the company’s financial

numbers such as sales, expenses, earnings, cash flow and projected earnings. Secondly, the IPO price

is also considered as the reflection of the company’s Price to Earnings Ratio (P/E ratio). It is priced

comparably to the industry peers of the company. Other IPO pricing factors that have been

considered are the size of the existing and near-future product or service demand created by the

company and the marketability of the company's stock in the current economic environment.

As explained above, Initial Public Offering merely depends on pricing variables such that the

pricing ability represents the intrinsic value of a company. Whenever a company’s offer price is

overpriced, it will trigger the sale of shares to the public to decline. There exists a theory that over-

priced Initial Public Offering is worse compared to under-priced Initial Public Offering. This is because

a stock that closes its first day below its IPO price will be labelled a failure. Under-pricing occurs to

boost demand intentionally or the IPO underwriters may have underestimated investor demand. If

the investors are truly uncertain about the response that the stock would get, an IPO may be under-

priced.

Overall, in the worst-case situation, when Initial Public Offering is under-priced, the stock price

will immediately rise to the price that investors believe is worth it. That is significantly better than

the stock price of the company crashing on the first day and its IPO being blasted as a loss. Whether

it was an under-priced or overpriced IPO, once the Initial Public Offering debuts, the company

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becomes a publicly traded entity owned by its shareholders. The stock’s value in the open market is

now determined by the shareholder demand and also underwriters playing a vital role in reducing

the risk of pricing and allocating shares.

b) IPO Performance of SGX

Singapore has one of the world's most competitive economies and is a high-income country.

Singapore’s IPO market (SGX) 2020 mid-year performance report was published in July 2020 by

Deloitte, the leading global provider of audit and assurance, accounting and financial advisory, risk

advisory, consultation, tax and related services. Performance of the IPO on the SGX was analyzed in

many aspects.

On the first half of 2019, Singapore had 9 IPOs with S$1.55 billion proceeds and an IPO

market capitalization of S$2.24 billion. Whereas, in the first half of 2020, Singapore’s capitalization

was S$1.19 billion. This registered a 53.2% drop. IPO amount raised and IPO market capitalization in

the first half of 2021 is relatively underperformed compared to the first half of 2019. Four of the IPO

raised in the first half of 2020 were listed on Catalist while the rest two funds raised were mainly

contributed by the Real Estate Investment Trusts (REITs) listed on the SGX Mainboard.

Below is the first quarter year on year comparison of number of IPOs and amount raised of

SGX Initial Public Offering:

Q1 Q1 Q1 Q1

2017 2018 2019 2020

No. of IPOs 3 3 4 5

Amount raised(S$’m) 201 462 39 706

Table 1: First quarter year on year comparison of number of IPOs and amount raised of SGX Initial

Public Offering

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At the end of first quarter 2020, worldwide nations were attacked by the coronavirus Covid-

19. Based on the table above, the values explain that Singapore's IPOs raised more money before

the market’s slump. Compared to the same periods in prior years, there has been an increase in the

number of IPOs and amounts raised. This shows that this momentum was interrupted by COVID-19

and the circuit breaker. The unprecedented effect of COVID-19 has been felt on the IPO market in

Singapore, just as it has prompted global market uncertainty to hit its highest level since the global

financial crisis.

According to Deloitte’s report, REITs and Business Trusts continue to be the main

contributors of listing proceeds on the SGX in recent years. REITs seem to be beneficial by being

resilient. This is because it was able to continue fundraising amidst COVID-19. One of recent

fundraising activities includes Mapletree Industrial Trust. This launched a private placement equity

exercise in June 2020 and is expected to raise gross proceeds of about S$410 million. Despite giving

a higher return of average dividend yield of 7.2% which is higher than interest rates in the bond

market, REITs provide fixed income and diversify risk.

SGX also imposed new measures for listed companies to deal with IPO related issues as to

alleviate the burden on them. Examples of measures that were imposed are removing minimum

trading price and abolishing quarterly reporting. This was to provide support to businesses disrupted

by COVID-19 and to remain competitive. On the other hand, market factors also affected the

investor’s sentiment. Companies that were going for IPO, had to analyze those market factors that

would impact their operations and business values.

In addition, REITs continue to be a big contributor to SGX IPOs as they are being more

favourable in the current low interest rate environment. As to cushion the impact of the challenging

business environment, companies that are in the final stage of IPO preparation are likely to raise

funds from the capital market. Even as the economy goes into post COVID-19 recovery mode, SGX

companies are keen to adopt a prudent approach. The approach goes like the companies monitoring

the market and looking for the optimal opportunity to launch their listing plan. As the time of

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recovery of this pandemic is unpredictable, the companies are giving more importance to IPO by

using the downtime to prepare internally as they can tap on the window of opportunity when the

favourable time emerges to enter the market.

3.0 Literature Review

First of all, Sindelar and Ritter (1988, 1994) and Ibbotson and Jaffe (1975) documented that

the market of Initial Public Offerings (IPO) has always fluctuated dramatically. The number of firms

going public and average initial returns vary significantly, with periods of highest initial returns

followed by peaks in the number of IPOs many months later. According to Fama and French (2004),

whereas 17 percent of companies that went public in 1973 were delisted within ten years due to

poor performance, this jumped to 44 percent of enterprises coming public between 1980 and 1991

(Lowry, Michaely, & Volkova, August 15, 2017).

Furthermore, Lowry (2003) focuses on the first three of these potential explanations: capital

demands, investor sentiment, and information asymmetry, in an attempt to understand why so

many companies go public during some periods and so few during others. She finds high support for

the first two components, with modest evidence for the third, in a series of regressions of IPO

volume on proxies for each of these parameters, along with assessments of post-IPO returns of

companies going public over various eras. The number of IPOs is significantly positively related to

future sales growth of all publicly traded firms and the change in the number of new companies

incorporating, a measure of new business creation, which is consistent with more companies going

public when economic conditions are favourable and thus firms' demands for capital are higher

(Lowry, Michaely, & Volkova, August 15, 2017).

Besides, there is much other financial literature being discussed on why the firms are going

public in the market. Beyond the cycles in the number of firms going public, the significant

autocorrelation in first returns, along with the fact that the periods of highest initial returns are

followed by the periods of largest number of IPOs some months later, is probably even more

perplexing. This seemingly basic statistical pattern raises an intriguing question: why would

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companies want to go public when underpricing is so high? Several theories have been proposed,

yet many of them share some characteristics. To summarise, the answer to the apparent puzzle

posed at the beginning of this paragraph, "why would companies choose to go public when

underpricing is particularly high," is that high recent underpricing does not indicate that a company

will be more underpriced; rather, it indicates that high information asymmetry companies have been

going public, and it suggests that the company will be able to raise more money than previously

expected. For instance, the company will be able to raise more money than previously expected.

Following research that looked into whether these hot markets represent periods when the market

fundamentally overvalues these IPO enterprises (for example, by looking at post-IPO returns) came

to different conclusions, as detailed below.

Purnanandam and Swaminathan's (2004) findings provide another possible explanation

for this link. They illustrate that, while IPOs are priced in contrast to their trading peers (e.g., industry

comparables), they are also valued in comparison to the trading peers' left tail. As a result, there is a

phenomenon of strong first-day returns when the market is overvalued, as we saw earlier. When the

market is overvalued, more companies go public as a result of the high valuations. Thus, the positive

relationship between IPO volume and huge first-day returns is due to the concealed overvaluation of

all firms in the economy or industry, which causes additional firms to go public (Lowry, Michaely, &

Volkova, August 15, 2017).

Moreover, focusing on post-IPO performance is an alternative to directly assessing

corporate characteristics. According to Yung, Colak, and Wang (2008), companies that go public in

hot markets have a higher standard deviation of long-run abnormal returns (measured for the first

five years after the IPO) and a higher standard deviation of short-run abnormal returns (measured

for the first five years after the IPO). For example, in the three to twelve months following the IPO)

and are much more likely to have delisting for poor performance has a very negative outcome. This

evidence points to a wider diversity in the types of companies that go public in hot markets. The

evidence presented by Lowry et al (2010) is valuable, but it does not address the extent to which

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shifting investor sentiment (and enterprises' ability to capture overvaluation) contributes to IPO

volume cycles. Apart from that, Ritter (1991) and Loughran and Ritter (1995) found that hot market

IPOs perform much worse in the long run. Ritter (1991) shows a significantly negative coefficient on

IPO volume in a cross-sectional regression of post-IPO three-year raw returns on market returns over

the same period, IPO volume, and other covariates (Lowry, Michaely, & Volkova, August 15, 2017).

In addition, Loughran and Ritter (1995) found that firms going public in hot markets

underperformed by 60 basis points per month, compared to only 17 points per month for firms

going public in cold markets, using Fama-MacBeth regressions of monthly stock returns on firm size,

book-to-market, and an issue dummy equal to one if the firm had an IPO or SEO over the past five

years (1970– 1990 period). This result about hot market IPOs underperforming is sensitive to test

specificity, according to Lowry (2003). She verifies that firms going public in the lowest IPO volume

quartile periods tend to do the best, but finds little evidence that abnormal returns are monotonic

across the other quartiles or that firms going public in the highest IPO volume quartile times are

likely to perform the worst. In addition to this, when utilising raw returns, the negative relationship

between IPO volume and post-IPO performance is largest, and when using size and book-to-market

abnormal returns, it is least (and insignificant). She finds that corporations are more likely to go

public when the market values them and other similar enterprises more highly.

It is important to highlight, however, that most of the researchers agree that companies

that go public during hot cycles perform poorly, and that investing in those IPOs yields a negative

return on investment. The question is whether this underperformance is specific to IPOs or is shared

by other non-IPOs that have similar features (Lowry, Michaely, & Volkova, August 15, 2017).

4.0 Recommendations

This way provides several recommendations to various parties. For owners (shareholders) of

a closed company, going public is a means to get fresh funds to support the development and

sustainability of the company. At present, the capital market authority has provided adequate

facilities and eased some requirements. Nevertheless, it is better for companies to prepare adequate

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human resources to be able to use IPO funds optimally. For investors, buying shares that have just

gone public is a very profitable opportunity for a very short term. If you invest for the long term (3

years), you should carefully examine the fundamentals of the company and corporate governance

because there is a tendency for companies to be too optimistic in making financial projections. For

the government, as the stock exchange authority, it is necessary to ensure that those who will

become directors and commissioners of companies that have just gone public have sufficient

competence. Exchange authorities should not only rely on the independence of directors or

commissioners to ensure the sustainability of the company.

Firstly, it is good to conduct regression analysis to examine more factors in the phenomenon

of underpricing and underperformance in IPO. Secondly, governance, particularly structure of

boards, should be addressed in the next studies because the rise and fall of an organization (firm)

depends on decisions taken in the boardroom. Businesses interested in eventually going public are

advised to begin acting like a large corporation well in advance of an IPO. Although many deals

involving small businesses are sealed with an informal handshake, investors like to see a pattern of

formal, professional contracts with customers, suppliers, and independent contractors. They also

favour formal human resource programs, including hiring procedures, performance reviews, and

benefit plans. It is also important for businesses to protect their unique products and ideas by

applying for patents and trademarks as needed. All these steps, when taken in advance, can help to

smooth a business's passage to becoming a public entity.

The study recommends that the government and regulatory bodies conduct a thorough

audit of companies seeking to be listed, particularly the three years right before going public, to

discourage management from "window dressing" their financial statements in order to avoid

misinforming the public about the company's true financial position.

Additionally, investors should exercise caution when investing in initial public offerings

(IPOs), since corporations arrange their offerings to coincide with times of particularly strong

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performance, which they know cannot be maintained in the future. As a result, investors should pay

close attention to the performance patterns of the organizations in which they desire to invest.

5.0 References

Albada, A., & Yong, O. (2018). IPO Research in Malaysia: A Review of Under-Pricing Phenomenon.

International Journal of Banking and Finance. https://doi.org/10.32890/ijbf2017.13.1.8502

Lowry, M., Michaely, R., & Volkova, E. (August 15, 2017). Initial Public Offerings: A Synthesis of the

Literature and Directions for Future Research. Forthcoming Foundations and Trends in

Finance. Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2912354

Jamaani, F., & Alidarous, M. (2019). Review of Theoretical Explanations of IPO Underpricing. Journal

of Accounting, Business and Finance Research, 6(1), 1–18.

https://doi.org/10.20448/2002.61.1.18

Zi Ong, C., Mohd-Rashid, R., & Taufil-Mohd, K. N. (2020). Growth Opportunity and IPO Value: An

Empirical Study of Malaysian IPOs. Jurnal Pengurusan, 58, 15–25.

https://doi.org/10.17576/pengurusan-2020-58-02

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