Underpricing of IPOs in Saudi Arabia and Sharia compliance

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.