Underpricing of IPOs in Saudi Arabia and Sharia compliance

Abstract

Purpose – The purpose of this paper is to explore the extent of underpricing in the Saudi Arabian market of initial public offerings (IPOs), offer explanations and consider whether Sharia-compliance had a significant impact on the initial returns. Design/methodology/approach – A comprehensive sample of 72 IPOs in Saudi Arabia between 2004 and September 2010 is used to analyse the initial return after adjusting it to the market movement as well as controlling for some common factors. Findings – This paper finds that not only underpricing occurs but it is also among the highest levels in the world. While traditional factors affecting initial returns include age, market timing and firm size, it is found that Sharia compliance significantly reduces underpricing in Saudi Arabia. This may imply that Sharia compliance helps to reduce the uncertainty and consequences of the limited information inherent in IPOs. Research limitations/implications – Further research is needed to see if the effect of Sharia compliance status on the short-run performance of IPOs extends to other Islamic countries or is a country-specific characteristic. More firms need to be examined to identify the market characteristics that drive the returns. Practical implications – Very substantial sums are being “left on the table” and more efficient pricing of IPOs would be of considerable benefit to firms. Social implications – By considering two different regimes, this paper offers some important lessons for the treatment of risk-taking, particularly in Islamic countries. Originality/value – This paper is among the first to provide an empirical evidence of the impact of Sharia compliance on the initial return pattern in the IPO market.

The Short and Long-Run Performance of Sharia-Compliant Initial Public Offerings (IPOs) in the Emerging Market: Evidence from the Saudi Arabia Share Market

“…Second, the present study finds overperformance of IPO shares in the long-run where the marketadjusted buy and hold abnormal return (BHAR) outperformed both market indices; (a) positive and significant when benchmarked against equal weight index (EWI); and (b) positive but not significant when benchmarked against VWI (value weight index). To some extent, this study is consistent with earlier findings by Mayes and Alqahtani (2015) about the underpricing phenomenon in the Saudi market. Nonetheless, the magnitude of underpricing in the present study is substantially lower, at almost one-half the amount found by Mayes and Alqahtani (2015).…”

“…To some extent, this study is consistent with earlier findings by Mayes and Alqahtani (2015) about the underpricing phenomenon in the Saudi market. Nonetheless, the magnitude of underpricing in the present study is substantially lower, at almost one-half the amount found by Mayes and Alqahtani (2015). And as for the long-run performance, the Sharia-compliant IPO companies overperformed the market index as expected from an emerging market that does not necessarily operate in complete symmetrical information and efficient market condition (Mayes & Alqahtani, 2015).…”

“…The said initial return is calculated based on the following two studies namely, Ahmed S. Alanazi et al (2011) and Faisal Alqahtani (2011) for a total of 80 IPOs in the period of 2003 to 2011. A more recent study in Saudi Arabia was conducted by Mayes and Alqahtani (2015) for 72 IPO companies between 2004 and September 2010. Mayes and Alqahtani (2015) also found a substantial level of underpricing at 267.14% initial return, even after adjusting for market movements.…”

“…A more recent study in Saudi Arabia was conducted by Mayes and Alqahtani (2015) for 72 IPO companies between 2004 and September 2010. Mayes and Alqahtani (2015) also found a substantial level of underpricing at 267.14% initial return, even after adjusting for market movements. Both findings corroborate an earlier study by Al-Hassan, Delgado, and Omran (2010) who also reported substantial IPO underpricing in the GCC countries, reporting an average initial return of 290% after adjusting for market size.…”

“…Since the heart of Sharia law is in Saudi Arabia, the present study exploits this opportunity to investigate the IPO performance of Sharia-compliant companies. While an earlier study by Mayes and Alqahtani (2015) has explored a similar issue, their sample data between 2004 to 2010, is arguably concentrated in the period of economic boom; prior to the onset of financial crisis of 2008. Notably, this study attempts to provide sample of IPO activities and performance encompassing much longer period between 2004 to 2017.…”