Ownership Retention, Number of Risk Factors and Underpricing in Indonesian Initial Public Offerings
Tatang A Gumanti and Marentin Nita Niagara
University of Jember
This study examines whether the level of ownership retained by the issuers of IPO and the number of risk factors available in the issue prospectus are associated with the variation of the level of underpricing. Using a sample of 288 IPOs that went public between 1990 and 2004 in Indonesian capital market, this study finds that the level of ownership retention has negative correlation with the level of underpricing.
In line with the expectation, this study finds that the number of risk factors is positively related to the level of underpricing. This finding implies that the riskier the IPO firm as indicated by the number of risk factors, the higher the level of underpricing.
Keywords: underpricing, ownership retention, number of risk factors, initial public offerings.
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A detailed prospectus is required before new securities can be offered to the public in an initial public offering (IPO). It provides information about the offering itself, a brief history of the firm’s business, information related to past financial performance, ownership details, and the risks associated with the investment. The investment community recognizes that the most detailed and precise information about the issuing firm is found in the offering prospectus. In addition, the prospectus is a legal document that protects the issuer and the underwriter because it is written proof that the investor was provided with all the material facts related to the offering.
However, very little is known about how useful prospectus information is to investors in their decision to invest in an individual IPO. Because a number of issuers lack a history of past revenues or earnings, investors are likely to be quite skeptical about the value of prospectus information. Recent evidence in Teoh et al. (1998), that earnings management prior to going public is related to long-run underperformance, could further erode the investor’s confidence in the value of the information contained in the prospectus, because it shows that firms could resort to window dressing prior to going public. Nevertheless, information contained in a prospectus is often the first window to a potential investor about the firm’s past and its projected future performance.
Underpricing or positive initial returns of initial public offers of equity securities is a general phenomenon. According to Loughran et al. (1994) underpricing is a world-wide phenomenon and not specific to one equity market or to a particular time-period. There are a number of theories that attempt to explain the existence of underpricing. Explanations range from signaling on one hand to the monopsonistic power of the underwriters on the other.