CREAM - Current Research in Malaysia Vol.2, No. 1, January 2013:

Transcription

1 CREAM - Current Research in Malaysia Vol.2, No. 1, January 2013: Winner's Curse, Size Effect and Bandwagon Effect in Explaining the Under-Pricing Phenomenon of Malaysian Ipos (Sumpahan Pemenang, Kesan Saiz dan Kesan Ikatan dalam Menjelaskan Fenomena Terkurang Harga pada Tawaran Awam Awal (TAA) Malaysia) OTHMAN YONG Graduate School of Business, Universiti Kebangsaan Malaysia othmanyo@ukm.my ABSTRACT This study examines the issues of winner's curse, size effect and bandwagon effect in explaining the under-pricing phenomenon of Malaysian IPOs, for the period from January 2001 to December The average initial return for the Malaysian private placement IPOs (a proxy for informed investors) is significantly lower than that of the non-private placement IPOs (a proxy for uninformed investors), which gives support to the winner's curse hypothesis, where uninformed investors demand a higher initial return in the absence of informed investors. Using listing board as proxy for size of companies, we find that the smaller the company, the higher the average initial return, thus giving support to size effect, where investors usually demand higher initial return for smaller companies due to their higher perceived risk. The study also finds that the presence of a large number of informed investors as compared to uninformed investors in an IPO exercise will result in an increase in demand for that particular stock in the secondary market, which gives support to the bandwagon effect. Keywords: Initial Public Offering, Malaysian IPOs, winner's curse, bandwagon effect. JEL Classification: G12, G14, G24 and G32 ABSTRAK Kajian ini meneliti isu sumpahan pemenang, kesan saiz dan kesan ikut serta bagi menerangkan fenomena terkurang harga bagi tawaran awam awal (TAA) Malaysia, bagi tempoh Januari 2001 hingga Disember Purata pulangan awal bagi TAA jenis peletakan persendirian (proksi 101

2 Othman Yong bagi pelabur berpengetahuan) adalah lebih rendah secara ketara berbanding TAA bukan peletakan persendirian (proksi bagi pelabur kurang berpengetahuan), yang mana ini menyokong hipotesis sumpahan pemenang, iaitu pelabur kurang berpengetahuan mahukan pulangan awal yang lebih tinggi dengan ketiadaan pelabur berpengetahuan. Dengan menggunakan papan penyenaraian sebagai proksi bagi saiz syarikat, kajian ini mendapati bahawa lebih kecil sesebuah syarikat lebih tinggi purata pulangan awalnya, yang menyokong kesan saiz, iaitu para pelabur selalunya mahukan pulangan awal yang lebih tinggi bagi syarikat kecil disebabkan persepsi risiko yang lebih tinggi terhadapnya. Kajian ini juga mendapati bahawa kehadiran para pelabur berpengetahuan yang besar berbanding pelabur kurang berpengetahuan dalam sesuatu TAA akan menyebabkan peningkatan pada permintaan terhadap saham syarikat tersebut di pasaran sekunder, yang mana keadaan ini menyokong kesan ikut serta. Kata Kunci: Tawaran awam awal (TAA), TAA Malaysia, sumpahan pemenang, kesan saiz, kesan ikutan INTRODUCTION The existence of under-pricing (or positive initial return) in initial public offerings (IPOs) is well documented both in the developed and underdeveloped markets. A comprehensive review can be found in Ritter (2003) and Yong (2007a). Ritter reported the extent of under-pricing in 38 countries, including 11 Asian countried, and concludes that the average initial returns of Asian IPOs are significantly higher than the average initial return of U.S. IPOs. Yong reviewed the IPO research in Asia. In the early days, explanations such as the winner's curse model, lawsuit avoidance, dynamic information acquisition, prospect theory, and bandwagon effect, to name a few, have been offered to try to explain the under-pricing phenomenon. In the 1990s, behavioral and agency explanations of under-pricing have been more acceptable in explaining the under-pricing. On the other hand, Derrien (2005) showed that an IPO can exhibit positive initial returns even-though it is over-priced, due to what he terms as bullish investor sentiment regarding the intrinsic value of the company. In Malaysia, studies such as underwriters' reputation (see Jelic et al. (2001)), proportion of IPO shares allocated to Bumiputra investors (see Saadouni et al. (2005)), privatization IPOs versus other IPOs (see Paudyal 102

3 Winner's Curse, Size Effect and Bandwagon Effect et al. (1998)), firm size (see Yong (1996)), over-subscription ratio (see Yong (1996) and Yong and Isa (2003)) and share lock-up (see Wan-Hussin (2005) ), have been carried out to determine the possible relationship between these variables and the initial returns of Malaysian IPOs. Quite recently, Yong (2007b) examined the issues of over-subscription ratio (i.e. investor demand) and firm size (i.e. size effect) on the performance of Malaysian IPOs after the 1997 Asian financial crisis. Dawson (1994) used a revised measure of IPO under-pricing, namely under-pricing as measured from the issuer's viewpoint. In a later study, Dawson (1995) examined the difference in initial performance between the two common types of IPOs in Malaysia, namely offer for sale and public offer. Mohamad et al. (1994b) examined the accuracy of profit forecasts of Malaysian IPOs as reported in prospectuses. Saadouni et al. (2005) examined the change in regulation in 1996 towards a market-based pricing mechanism, and its effect on the under-pricing of Malaysian IPOs. Finally, studies on the long run performances of Malaysian IPOs were also carried out (see, for example Dawson (1987), Wu (1993), Ismail et al. (1993) Mohamad et al. (1994a), Yong (1997), Nasir and Zin (1998) and Yong et al. (2001)). The current study focuses on the type of initial public offering called private placement, which has become quite popular since Private placement, as suggested by its name, usually refers to the sale of IPOs directly to institutional investors. The opposite of institutional investor is individual investor, or retail investor as commonly referred to in Malaysia. None of earlier studies on Malaysian IPOs dealt with private placement. Most of them either focused on two major types of IPOs, namely public offer and offer for sale (studies such as Dawson (1995) and Yong and Isa (2003) ), or did not make any differentiation among the IPOs. The current study fills this void in the past studies. Information on private placement enables us to analyze performance of IPOs based on the proportion of an IPO exercise allocated to institutional investors compared to the proportion of the IPO allocated to individual investors (or retail investors). Information on the proportion of an IPO subscribed by the individual investors as opposed to the proportion of the IPO subscribed by the institutional investors enables us to the test the winner's curse hypothesis. As suggested by Rock (1986), with fixed-price IPOs, the uninformed investors (or retail investors) always face a winner's 103

4 Othman Yong curse, that is, they get all of the shares which they ask for because the informed investors (or institutional investors) do not want them. Thus, faced with this adverse selection problem, the uninformed investors will only buy if IPOs are under-priced to compensate them for the bias in the IPO allocation. In line with this line of argument, we hypothesize that the larger the proportion of an IPO subscribed by the retail investors as opposed to the proportion of the IPO subscribed by the institutional investors, the larger is the level of IPO under-pricing. Information on the proportion of IPOs subscribed by the institutional investors, via private placement, enables us to test another hypothesis called informational cascades or better known as the bandwagon effect. According to Welch (1992), the bandwagon effect may develop if potential investors pay attention not only to their own information about an IPO, but also to whether other investors are purchasing. In this case, other investors are the informed investors or the institutional investors. If an investor sees that no one else wants to buy, he may not buy even when he possesses favorable information. In order to prevent this situation, an issuer may have to under-price the IPO to induce the first few potential buyers, and later induce a cascade in which all subsequent investors want to buy irrespective of their own information. Along with this line of argument, we hypothesize that the higher the proportion of an IPO subscribed by the informed investors (i.e. the institutional investors) as opposed to the proportion of the IPO subscribed by the uninformed investors (i.e. the retail investors), the higher is the level of price movement (as measured by the increase in price from the beginning to the closing of the first's day of trading) during the first day of trading due to higher demand for that particular issue. The remainder of this paper is organized as follows. Review of past studies is presented in Section 2, whilst Section 3 discusses the data and methodology used. Section 4 presents the findings, and Section 5 summarizes and concludes the paper. REVIEW OF THE LITERATURE Basically, there are three groups involved in the IPO process, namely the issuing firms, the underwriters, and the investors. Since the objectives of each group are often different or contradictory, there have been a number 104

5 Winner's Curse, Size Effect and Bandwagon Effect of different reasons for explaining IPO under-pricing, such as dynamic information acquisition (see Benveniste and Spindt (1989) ), prospect theory (see Kahneman and Tversky (1979), the winner's curse (see Rock (1986), bandwagon effect (see Welch (1992), lawsuit avoidance (see Tinic (1988), and signaling (Welch (1989). Since the focus of this paper is the winner's curse and the bandwagon explanations of the IPO under-pricing, a brief description of both models is presented here. With fixed-price offers, potential investors face adverse selection, or better known as "winner's curse" problem (see Rock (1986). Uninformed investors (i.e. retail investors) face the winner's curse, namely, if they get all of the shares which they ask for, it is because the informed investors (i.e. institutional investors) do not want them. Therefore, having to face with this adverse selection problem, the uninformed investors will buy only if IPOs are under-priced in order to compensate them for the bias in the IPO allocation. If potential investors pay attention not only to their own information about a new issue, but also to whether other investors are purchasing, according to Welch (1992), bandwagon effect (also known as information cascades) may develop. Welch argues that an investor may not buy an IPO even-though he has favorable information about it, if he sees no one else wants to buy. As a result, an issuer may purposely under-price the IPO as a strategy to induce the first few potential buyers, which hopefully will be followed by other investors who buy, irrespective of their own information (good or bad) regarding the issue. In Malaysia, attempts have not been made to explain IPO underpricing based on models developed in the West. Past research in Malaysia has mostly dealt with trying to relate certain variable (s) or factor (s) with the IPO initial returns. For example, Mohamad et al. (1994b) examined the accuracy of profit forecasts reported in prospectuses of Malaysian IPOs. They find no significant relationship between forecast errors and stock price premium upon listing. Both Yong et al. (1999) and Yong and Isa (2003) found that over-subscription ratio (a measure for investor demand for IPOs) is a variable that consistently explains the levels of initial return in Malaysian IPOs. Quite recently, Yong (2007b) has shown that investor demand is still an important factor that contributes significantly to the level of under-pricing in the Malaysian IPOs. Other factors, such as 105

6 Othman Yong underwriter reputation, ownership structure, and lock-up provision have also been examined. It seems that the reputation of an underwriter has an effect on the levels of initial returns. Empirical evidence seems to suggest that underwriters with a better reputation tend to reduce the initial underpricing (see, for example, Beatty and Ritter (1986), Johnson and Miller (1988), Beatty and Welch (1996), and Carter et al. (1998)). A study by Paudyal et al. (1998) on Malaysian IPOs also confirms this phenomenon. On the other hand, Jelic et al. (2001), using Malaysian IPO data from 1980 to 1995, initially reported that underwriters with a better reputation tend to, on average, increase initial under-pricing. However, results of both parametric and non-parametric tests reveal no significant difference between average initial returns of IPOs underwritten by reputable underwriters and IPOs underwritten by less reputable underwriters. With an IPO, the ownership structure will change and the shares sold in the IPO are designated as primary shares (known as public issue in Malaysia), which are new shares, and secondary shares (known as offer for sale in Malaysia), which are shares that were previously owned by existing shareholders, usually founders and managers of the firm. The size of the new issue relative to the existing shares and their distribution will change the ownership structure. Saadouni et al. (2005), using 322 Malaysian IPOs listed on the Second Board for the period , found that under-pricing is inversely related to the proportion of shares allocated to Bumiputra (literally means "sons of the soil" or natives) investors. On average, Bumiputra investors and the Malaysian public are allocated almost an equal proportion and make similar profits per issue. However, institutional Bumiputra investors appear to be allocated a higher proportion of the over-priced issues than the most under-priced ones. Dawson (1995) reports that, on average, from 1979 through 1993, Malaysian IPOs involving offer for sale of existing shares had less underpricing and were smaller in offer size than public offer of new shares. Nevertheless, it was the original shareholders selling shares in offer for sale who incurred the greatest loss from IPO under-pricing, 32.5 percent on average compared to 13.6 percent for public offer, while the original shareholders who did not participate in the offer for sale incurred no loss at all from the under-pricing. 106

7 Winner's Curse, Size Effect and Bandwagon Effect Lock-up period refers to a period where insiders are prohibited from selling shares without the written permission of the lead underwriter. In the US, the average period is 180 days or 6 months. The lock-up provision is an attempt to control the supply of shares sold during the period after the IPO by the insiders or the existing shareholders. Mohan & Chen (2001) and Bray & Gompers (2003) argue that the structure of the lock-up agreements reflects the degree of the adverse selection or moral hazard problem, and thus resulting in IPOs being under-priced. In Malaysia, share lock-up is commonly known as share moratorium. Wan- Hussin (2005), using 154 IPOs listed on the Main Board and the Second Board of the Kuala Lumpur Stock Exchange from 1996 to 2000, found that the greater the burden of lock-up imposed on the directors, the higher is the Malaysian IPO under-pricing. During the period of this study, Wan Hussin states that major shareholders were not allowed to sell 45 percent of IPOs within one year, and in every subsequent year, they were allowed to dispose one third of the shares that were under the moratorium. Finally the issue of long-run (mostly under-performance in the West) performance of Malaysian IPOs is briefly discussed here. In Malaysia, an early study by Dawson (1987) reported a positive long-run performance (18.2%) of Malaysian IPOs. Wu (1993) reported that, using data from the Main Board from January 1974 to December 1989, IPOs with low initial returns performed better than those with high initial returns and small firms tend to out-perform big firms in the long-run. Ismail et al. (1993), using data from January 1980 to December 1989, reported that returns after the initial listing of IPOs are not significant. Mohamad et al. (1994a), using data from 1975 to 1990, reported an average initial under-pricing of 135% and significant positive cumulative abnormal returns after 2 and 3 years. Yong (1997), using data from January 1990 to December 1994, reported that the benefits of under-pricing do not accrue to the secondary market traders. Nasir and Zin (1998), using Main Board data for the period , report that insignificant price fluctuation after the first day of trading conforms to the efficient market hypothesis. Yong et al. (1999), using IPO listed on the Main Board and the Second Board between 1991 and 1995, found that average initial returns had no relation with the average annual return over the longer-term periods; the only exception was the negatively significant correlation between average initial returns and average annual returns over the three-year period. 107

8 Othman Yong DATA AND METHODOLOGY Auctions, fixed-priced offers, and book building are the three common mechanisms by which IPOs are sold around the world. In auctions, the market-clearing price is determined after bids are submitted. In a fixedpriced offer, the price is set prior to the allocation. If there is excess demand, shares are rationed on a pro rata or lottery basis. In book building, the investment banker or underwriter canvasses (solicit or go through) potential buyers and thens set an offer price. In the U.S. and most other countries the most common mechanism by which IPOs are sold has been book building. In Malaysia, the most common mechanism is the fixed-price offer, and book-building is a very rare occurrence in the Malaysian scenario, and as such they are excluded from this study. Basically, there are two types of IPOs in Malaysia, namely offer for sale and public issue. Prior to 2004, Bursa Malaysia (or Kuala Lumpur Stock Exchange as it was previously known) usually classified Malaysian IPOs based on these two categories. Beginning 2004, Bursa Malaysia added another category of IPOs called "private placement." The offer for sale refers to shares that have already been issued to the original stockholders, who in turn offer their shares for sale to the public. As such, there is no change in the company's paid-up capital; the money received from the sale of the stock does not go to the company. Its purpose is to restructure the company's ownership in line with the government's rules and regulations. Public issue refers to new shares of stock offered to the public for the first time; as such, it results in an increase in the paid-up capital of the company concerned. The current study does not specifically focus on these two types of IPOs since most past studies (such as Yong and Isa (2003)) have dealt with this issue. The current study focuses only on private placement, which can be reclassified as either offer for sale or public issue. Private placement, as suggested by its name, refers to the sale of IPOs directly to institutional investors. In actuality, an institutional investor is the opposite of individual investor, or retail investor as commonly referred to in Malaysia. Private placement has become increasingly popular since 2001, and since 2004 it has been included in its own separate section called "private placement," apart from the regular "offer for sale" and "public offer" sections of information on IPO listing provided by Bursa Malaysia 108

9 Winner's Curse, Size Effect and Bandwagon Effect on its website ( The period for this study is from January 2001 to December 2008, and the sample comprises of all fixed-price IPOs (357 IPOs in total, with 151 private placement IPOs) listed on the Main Board, Second Board, and the MESDAQ of Bursa Malaysia. January 2001 has been chosen as the beginning period for the current study since most effect of the 1997 financial crisis has dissipated since then, plus the fact that private placement IPOs has become increasingly popular since then. The information used in this study is compiled from Investors Digest (a monthly publication of the KLSE), the KLSE website (with the change of name of the Malaysian stock market from Kuala Lumpur Stock Exchange to Bursa Malaysia beginning January 2004, the website has become bursamalaysia.com) and the Star Online website ( biz.thestar.com. my/marketwatch/ipo). In cases where the offer price for retail investors is different from the offer price for institutional investors, which is a very rare occurrence, a "weighted" average offer price is used. In a nutshell, the weighted-average offer price is calculated as the total proceeds (from both the retail investors and the institutional investors) divided by the total units of shares issued (to both groups of investors). Information on private placement enables us to differentiate between the number of IPOs allocated to institutional investors and those allocated to individual investors. In addition, information on the proportion of an IPO subscribed by the individual investors as opposed to the proportion of the IPO subscribed by the institutional investors enables us to the test the winner's curse hypothesis. As suggested by Rock (1986), with fixed-price IPOs, the uninformed investors (or retail investors) face a winner's curse, that is, they get all the shares which they ask for because the informed investors (or institutional investors) do not want them. Thus, faced with this adverse selection problem, the uninformed investors will only buy if the IPOs are under-priced to compensate them for the bias in the IPO allocation. We hypothesize that the larger the proportion of an IPO subscribed by the retail investors, the higher the level of IPO underpricing. Information on the proportion of IPOs subscribed by the institutional investors, via private placement, enables us to test the bandwagon effect. 109

10 Othman Yong According to Welch (1992), the bandwagon effect may develop if potential investors pay attention not only to their own information about an IPO, but also to whether other investors are purchasing. In this case, other investors are the informed investors or the institutional investors. If an investor sees that no one else wants to buy, he may not buy even when he possesses favorable information. In order to prevent this situation, an issuer may have to under-price the IPO to induce the first few potential buyers, and later induce a cascade in which all subsequent investors want to buy irrespective of their own information. Along with this line of argument, we hypothesize that the higher the proportion of an IPO subscribed by the institutional investors, the larger is the level of price movement during the first day of trading due to higher demand for that particular issue. Initial return is calculated as the percentage change in price from the offer price to the opening price of the first day of trading. First day return is calculated as the percentage change from the opening price on the first day of trading to the closing price of that day. A significant and positive first day return indicates that there is a bandwagon effect, or put another way, a secondary trader can still benefit from the under-pricing of IPOs. On the other hand, a significant and negative first day return indicates that the market is over-reacting to the pricing of IPOs. Detailed analysis of initial returns is made based on the type of offer (private placement versus non-private placement), listing board, and size of offer (ratio of private placement over overall offer). EMPIRICAL RESULTS Table 1 reports the descriptive statistics of initial return (offer-to-open) for 357 fixed-price IPOs listed on Bursa Malaysia from January 2001 to December 2008, by year. Panel A reports the descriptive statistics of initial returns (offer-to-open) for 151 private placement IPOs, Panel B presents the summary statistics of the initial returns for 206 non-private placement IPOs, and Panel C reports the summary statistics for the overall 357 IPOs. For private placement IPOs, the highest initial return (offer-to-open) of percent was registered in 2005, and the lowest initial return of 110

11 Winner's Curse, Size Effect and Bandwagon Effect Table 1: Descriptive Statistics of Initial Return (Offer-To-Open) for Private Placement IPOs Versus Non-Private Placement IPOs, By Year Year n Mean Std. Dev. Min. Max. A. Initial return (offer-to-open) of private placement IPOs, in percent @ * * ** ** ** ** B. Initial return (offer-to-open) of non-private placement IPOs, in percent ** ** ** * * n.a. n.a. n.a ** C. Initial return (offer-to-open) of all IPOs combined, in percent ** ** ** ** ** ** ** Note. - CO) Even -though this figure is quite big, it is not significantly different from zero even at the 5 percent level, due to its small number of observation (n=4). n.a. not applicable. * Significant at the 5 percent level, under the null hypothesis that the mean initial return (offer-to-open) is zero. ** Significant at the 1 percent level, under the null hypothesis that the mean initial return (offer-to-open) is zero. 111

12 Othman Yong was also registered in The overall mean initial return for the 151 private placement IPOs is percent and this figure is significantly different from zero at the 1 percent level. For non-private placement IPOs, the highest initial return (offer-to-open) of percent was registered in 2004, and the lowest initial return of was registered in The overall mean initial return for the 206 non-private placement IPOs was percent and this figure is significantly different from zero at the 1 percent level. The largest number of private placement IPOs was registered in 2005 with a total of 62 IPOs, and the lowest number of 4 registered in The highest number of non-private placement IPOs of 58 was registered in 2004, and the lowest number of 1 registered in Table 2 presents the detailed analysis of the average initial returns (offer-to-open) for the period based on the type of offer, and the listing board. As shown in Panel A, there are 151 private placement IPOs, with an average initial return (offer-to-open) of percent. Non-private placement IPOs contributed 206 of the total 357 IPOs for the period, with an average initial return (offer-to-open) of percent. When a comparison is made based on the type of offer, there is a significant difference (at the 5 percent level) between the average initial return (offer-to-open) of percent for the private placement IPOs and the average of percent for the non-private placement IPOs. This result seems to indicate that the uninformed investors (retail investors or the general public) demand a higher premium (as indicated by the higher average initial return) when the informed investors (as indicated by the presence of private placement offers) are not present; this finding seems to support the winner's curse argument. Panel B presents the average initial returns based on the listing board. Main Board registered the lowest average initial return (offer-to-open) of percent, and MESDAQ the highest average of percent. Second Board registered the middle average of percent. On Bursa Malaysia, the Main Board represents big companies, in relation to those companies listed on the Second Board, whereas small and speculative (usually technology stocks) companies are listed on MESDAQ. The result of the F-test (F-statistic = and p-value = 0.000) on the differences among these averages is significant at the 1 percent level. This means that 112

13 Winner's Curse, Size Effect and Bandwagon Effect Table 2: Average Initial Returns (Offer-to-Open) for the Period Based on the Type of Offer, and Board of Listing Average Initial Returns (offer-to-open) n (%) A. Type of Offer Private Placement Non-Private Placement Result of Independent t-test# t-statistic = * (p-value = 0.047) B. Listing Board Main Board Second Board MESDAQ Result of F-test## F-statistic = ** (p-value = 0.000) Note - # Independent t-test between average initial returns (offer-to-open) of private placement IPOs and the non-private placement IPOs. ## Result of F-test among the three listing boards. * Significant at the 5 percent level. ** Significant at the 1 percent level. the smaller the company, the greater its required initial return because of its perceived higher risk. This finding supports the size effect hypothesis on IPOs. For comparison, Yong and Isa (2003) reported an average initial return (offer-to-open), for the period , of percent for 183 IPOs listed on the Main Board, and percent for 288 IPOs listed on the Second Board of the then Kuala Lumpur Stock Exchange (KLSE). Table 3 presents the results of the F-test for the difference in average initial returns (offer-to-open) among the four groups (namely, percentage private placement IPO compared to overall IPO issued of less than 25 percent, the percentage between 25 to 50 percent, the percentage between 50 to 75 percent and the group with 75 to 100 percent) of 151 companies that offered private placement IPO together with other non-private placement IPOs. The group with less than 25 percent private placement compared to the overall IPO issued had the lowest average initial return 113

14 Othman Yong Table 3: Result of F-test on the Average Initial Returns (Offer-to-Open) for the 151 Issuing Companies that Offer Private Placement IPO, based on the Percentage of Private Placement IPO compared to the overall IPO Issued by a Company Percentage of Private Placement IPO Compared to Average Initial Return (offer-to-open) Overall IPO Issued n (%) Less than 25 percent percent to less than 50 percent percent to less than 75 percent percent to 100 percent Result of F-Test# F-value = 5.435** (p-value = 0.001) Note. - # F-test among the groups. ** Significant at the 1 percent level. of 5.17 percent, followed by the group with 50 to 75 percent of private placement and the group with 25 to 50 percent private placement IPOs. All of these three groups had average below the percent for the overall 151 private placement IPOs, as shown in Panel A of Table 2. Surprisingly, the group with the percentage of private placement between 75 to 100 percent registered the highest average initial return of percent. One would expect this group to have the lowest average initial return due to its high proportion of informed investors compared to uninformed investors. The F-statistic of and its corresponding p-value of indicate that the difference in average initial returns among these groups is significant at the 1 percent level. This finding seems to suggest that the presence of a large number of informed investors as compared to uninformed investors (as shown in the last group comprising 75 percent to 100 percent private placement IPOs) in the initial offering of a new issue (and this information is known to the public before the first day's trading of the said IPO) brings with it an increase in demand for that particular stock, and thus its increase in initial return. This finding, in a way, indicates support for the bandwagon effect. To further investigate the difference in mean initial returns among these four groups we ran the independent t-test. The results 114

15 Winner's Curse, Size Effect and Bandwagon Effect of the independent t-test are shown in Table 4. From the results of the independent Rest, it is quite clear that Group 4 always outperforms other groups, in terms of its average initial returns (offer-to-open), especially when compared to Group 1 and Group 3, where the significance level is at 1 percent, and at 5 percent when comparison is made with Group 2. Table 4: Results (t-statistics) of Independent t-test on the Average Initial Returns between Groups with Different Percentage of Private Placement IPO Group Group 1. Less than @ @ **@@ 25 percent (0.068) (0.239) (0.000) Group percent to *@@ < 50 percent (0.483) (0.040) Group percent to **@@ < 75 percent (0.005) Group percent to 100 percent NOTE. Using pooled variance estimate, based on the Levene's test for equality of variances at 1 percent level of significance. " Using separate variance estimate, based on the Levene's test for equality of variances at 1 percent level of significance. * Significant at the 5 percent level. ** Significant at the 1 percent level. p-values are shown in the parentheses underneath t-statistics. To further investigate the possible existence of the bandwagon effect, the first-day return, as measured by the price change from the opening price to the closing price during the first day of trading, was analyzed, and the results are presented in Table 5. Even-though our interest is in the price increase, the results for the price decrease are also shown for comparison. Overall, there are 93 price decreases compared to only 48 price increases, with 10 IPOs with no change in price, that somewhat gives an early indication that bandwagon effect is perhaps not prominent. In the case of price increase, the average increase in price from the opening to the closing of the first day of trading seems to be larger as the percentage 115

16 Othman Yong of private placement IPO increases. This result, in a way, suggests that the existence of a large group of informed investors creates a bandwagon effect on a given initial public offering. Price decreases which outnumber price increases indicate that the market, in general, over-reacts to the pricing of an IPO. With the price decrease, the average decrease in price from the opening to the closing of the first day of trading also seems to be larger as the percentage of private placement IPO increases, which means that the level of over-reaction seems to be larger as the percentage of private placement IPO increases. This in a way, also suggests that the existence of a large group of informed investors also creates a bandwagon effect when the market over-reacts to the pricing of an IPO. Table 5: Price Change (in Percent) from Opening Price to Closing Price on the First Day of Trading, for the 151 Private Placement IPOs, According to Different Groups, Based on the Percentage of Private Placement IPO Issued Compared to the Overall IPO Issued in an IPO Exercise of a Company Percentage of Price Change From Opening Price to Closing Price Private Placement Increase in Price Decrease in Price IPO Compared to Overall IPO Issued n mean (%) n mean (%) Less than 25 percent * ** (0.037) (0.000) 25 percent to < 50 percent ** ** (0.009) (0.000) 50 percent to < 75 percent ** ** (0.001) (0.000) 75 percent to 100 percent * ** (0.035) (0.000) Overall@ ** " (0.000) (0.000) Note. - Total number of IPOs does not equal 151 due to 10 IPOs having first day return, measured from opening to closing of first day of trading, equal zero percent. * Significant at the 5 percent level, under the null hypothesis that the mean increase in price is zero. ** Significant at the 1 percent level, under the null hypothesis that the mean increase in price is zero. p-values are shown in the parentheses underneath t-statistics. 116

17 Winner's Curse, Size Effect and Bandwagon Effect SUMMARY AND CONCLUSION The current study focuses on the type of initial public offering called private placement, which has become quite popular in Malaysia since 2001, and the availability of relevant data since then made this study possible. The period of the study is from January 2001 to December 2008, and the sample comprises of all 357 fixed-price IPOs listed on the Main Board, Second Board, and MESDAQ of Bursa Malaysia. Information on private placement IPOs enabled us to analyze performance of IPOs based on the proportion of an IPO allocated to institutional investors compared to the proportion of the IPO allocated to individual investors. Furthermore, this information enabled us to the test the winner's curse hypothesis. In line with the winner's curse hypothesis, we hypothesize that the larger the proportion of IPOs subscribed by the retail investors as opposed to the proportion of IPOs subscribed by the institutional investors, the bigger is the level of IPO under-pricing. Finally, the information on the proportion of an IPO subscribed by the institutional investors, via private placement, enabled us to test another hypothesis called informational cascades or the bandwagon effect. We hypothesize that the higher the proportion of an IPO subscribed by the informed investors as opposed to the proportion of the IPO subscribed by the uninformed investors, the higher is the level of price movement during the first day of trading due to higher demand for that particular issue. The average initial returns (offer-to-open) for the 151 Malaysian private placement IPOs is percent, as opposed to the average initial returns of percent for the 206 non-private placement IPOs. The higher average initial return for the non-private placement IPOs gives an early indication that winner's curse hypothesis is somewhat valid in the case of Malaysian IPOs, where investors in general demand a higher initial return in the absence of informed investors. The Main Board registered the lowest average initial return (offerto-open) of percent, MESDAQ recorded the highest average of percent, and Second Board registered the middle average of percent. On Bursa Malaysia, Main Board represents large companies, in relation to those companies listed on the Second Board, whereas small and speculative (usually technology stocks) companies are listed on MESDAQ. This finding supports the size effect hypothesis on IPOs. 117

18 Othman Yong Even-though we initially hypothesized that the larger the proportion of an IPO subscribed by the retail investors as opposed to the proportion of the IPO subscribed by the institutional investors, the bigger is the level of IPO under-pricing, we nevertheless found the opposite. The group with the largest ratio of private placement IPO to overall IPO issued registered the highest average initial returns (offer-to-open). One would expect this group to have the lowest average initial returns due to its high proportion of informed investors compared to uninformed investors. This finding seems to suggest that the presence of a large number of informed investors as compared to uninformed investors in an IPO (and this information is known to the public before the first day's trading of the said IPO) brings with it an increase in demand for that particular stock, and thus its increase in initial returns. This finding, in a way, indicates support for the bandwagon effect. To further investigate the possible existence of the bandwagon effect, the first-day return, as measured by the price change from the opening price to the closing price during the first day of trading, was also analyzed. In the case of IPOs with price increase, the average increase in price seems to be larger as the percentage of private placement IPO increases. This result, in a way, suggests that the existence of a large group of informed investors creates a bandwagon effect on a given initial public offering. Price decreases which outnumber price increases indicate that the market, in general, over-reacts to the pricing of an IPO. With the price decrease, the average decrease in price from the opening to the closing of the first day of trading also seems to be larger as the percentage of private placement IPO increases, suggesting that the level of over-reaction seems to be larger as the percentage of private placement IPO increases. This result somehow suggests that the existence of a large group of informed investors can also create a bandwagon effect when the market over-reacts to the pricing of an IPO. ACKNOWLEDGEMENT The author is grateful to the Malaysia's Ministry of Higher Education for the financial support provided under the Fundamental Research Grant Scheme (Research Code: UE.M-EP-05-FRGS ) 118

19 Winner's Curse, Size Effect and Bandwagon Effect REFERENCES Beatty, Randolph P. & Jay R. Ritter Investment Banking, Reputation, and the Under-Pricing of Initial Public Offerings. Journal of Financial Economics 15: Beatty, Randolph P. & Ivo Welch Issuer Expenses and Legal Liability in Initial Public Offerings. Journal of Law and Economics 34 (2): Benveniste, Lawrence M. and Paul A. Spindt How Investment Bankers Determine the Offer Price and Allocation of New Issues. Journal of Financial Economics 24: Bray, Alon, & Paul A. Gompers The Role of Lock-ups in Initial Public Offerings. The Review of Financial Studies 16 (1): Carter, Richard B., Frederick H. Dark, & Ajai K. Singh, A Underwriter Reputation, Initial Returns, and the Long-Run Performance of IPO Stocks. Journal of Finance 53: Dawson, Steven M Secondary Stock Market Performance of Initial Public Offers, Hong Kong, Singapore and Malaysia: Journal of Business Finance and Accounting, Spring: Measuring the Costs of IPO Under-pricing: The Issuer's View. Capital Markets Review 2 (1): Measuring the Costs of IPO Under-pricing: The Original Shareholders View. Capital Markets Review 3 (1): Derrien, Francois IPO Pricing in "Hot" Market Conditions: Who Leaves Money on the Table? Journal of Finance 60 (1): Ismail, Ku Nor Izah, Faudziah Zainal Abidin & Nasruddin Zainudin Performance of New Stock Issues on the KLSE. Capital Markets Review 1(1): Jelic, Ranko, Brahim Saadouni & Richard J. Briston Performance of Malaysian IPOs: Underwriters' Reputation and Management Earnings Forecast. Pacific-Basin Finance Journal 9: Johnson, James, M. & Robert E. Miller Investment banker prestige and the under-pricing of initial public offerings. Financial Management 17: Kahneman, Daniel and Amos Tversky Prospect Theory: An Analysis of Decision Under Risk. Econometrica 47: Mohamad, Shamsher, Annuar M. Nassir & Mohamed Ariff. 1994a. Analysis of Under-Pricing in the Malaysian New Issue Market During : Are New Issues Excessively Priced? Capital Markets Review 2 (2): Mohamad, Shamsher, Annuar M. Nassir, Tan Kung Kuing & Mohamed Ariff. 1994b. The Accuracy of Profit Forecasts of Malaysian IPOs. Capital Markets Review 2 (2): Mohan, Nancy & Carl R. Chen Information content of lock-up provisions in initial public offerings. International Review of Economics and Finance 10:

20 Othman Yong Nasir, Norita Mohd & Rosliza Mat Zin The Examination of the Under- Pricing of Initial Public Offerings (IPOs) in Malaysia: Capital Markets Review 6 (1 & 2): Paudyal, Krishna, Brahim Saadouni & Richard J. Briston Privatisation Initial Public Offerings in Malaysia: Initial Premium and Long-Term Performance. Pacific-Basin Finance Journal 6 (5): Ritter, Jay R Investment Banking and Securities Issuance. In Handbook of the Economics of Finance, ed. G. Constantinides, M. Harris and R. Stulz, Amsterdam: Elsevier B. V. Rock, Kevin Why IPOs are Under-priced. Journal of Financial Economics 15: Saadouni, Brahim, Janice How & Ranko Jelic Share Allocation and the Performance of the KLSE Second Board IPOs. Paper presented at the Asian Finance Association 2005 Conference, Kuala Lumpur, Malaysia, July Tinic, Seha M Anatomy of Initial Public Offerings of Common Stock. Journal of Finance 43: Wan-Hussin, Wan Nordin The Effect of Owner's Participation and Share Lock-up on IPO Under-pricing in Malaysia. Paper presented at the Asian Finance Association 2005 Conference, Kuala Lumpur, Malaysia, July Welch, Ivo Seasoned Offerings, Imitation Costs and the Under-Pricing of Initial Public Offerings. Journal of Finance 44 (2): Sequential Sales, Learning and Cascades. Journal of Finance 47 (2): Wu, Tay Seng The Long-Run Performance of Initial Public Offerings in Malaysia. Capital Markets Review 1 (1): Yong, Othman Size of the Firm, Over-Subscription Ratio and Performance of IPOs. Malaysian Management Review 31 (2): Initial Public Offerings: The Malaysian Experience In Advances in Pacific-Basin Capital Markets, ed. T. Bos and T. Fetherston, vol. 3, Connecticut: JAI Press. 2007a. A Review of IPO Research in Asia: What's next? Pacific-Basin Finance Journal 15: b. Investor Demand, Size Effect and Performance of Malaysian Initial Public Offerings: Evidence from Post-1997 Financial Crisis. Jurnal Pengurusan 26: Yong, Othman & Zaidi Isa Initial Performance of New Issues of Shares in Malaysia. Applied Economics 35: Yong, Othman, Puan Yatim, & Ros Zam Zam Sapian Significance of Board of Listing and Type of Issue on the Under-Pricing and After-Market Performance of Malaysian IPOs. Capital Markets Review 7 (1 & 2): Initial and Long-Run Performance of New Issues on the Malaysian Stock Market. Corporate Finance Review 5 (6):