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1. Introduction
Initial public offering (IPO) underpricing is a universal phenomenon, although the degree of underpricing varies across time and countries. The mean of underpricing in the USA was around 21% in the 1960s, 12% in the 1970s, 16% in the 1980s, 21% in the 1990s and 40% in the early 2000s, while across countries, underpricing varies from 5% in Luxembourg, 5.9% in New Zealand, 25% in Indonesia and 60% in the Polish market, and around 90% in Malaysia, 256% in China and 315% in Gulf Cooperation Council (Ljungqvist, 2008; Al-Hassan et al., 2010; Chi and Padgett, 2005; Hanafi, 2021). IPO underpricing does not show a decreasing or disappearing trend. Even in some countries, IPO underpricing tends to increase (Loughran and Ritter, 2004; Hanafi, 2021; Mehmood et al., 2021).[1]
With this persistent phenomenon, several theories have been advanced to explain IPO underpricing. Several theories to explain this phenomenon can be classified into four groups: the asymmetric model, institutional theory, ownership and control and behavior finance (Ljungqvist, 2008). However, none of these theories is successful in providing a comprehensive explanation of IPO underpricing. The asymmetric information-based theories, which are the dominant theories for IPO underpricing (Ljungqvist, 2008; Fohlin, 2010), can explain only around 2%–3% of the underpricing, much lower than around 30% or more of typical IPO underpricing (Ritter, 2011). Ritter and Welch (2002) argue that non-rational and agency issues may have a better potential to explain IPO underpricing.
IPOs are very difficult to evaluate. Information asymmetry abounds. The debate on the best IPO methods –fixed price, auction, book-building – still continues as regulators grapple to find optimal IPO methods. Book-building can be expected to help price discovery in the IPO process and lower underpricing in the process. However, empirical evidence seems to provide mixed results. Agency issues may complicate this result, as long-term relationships between informed investors and underwriters may grow at the expense of issuers’ interest. Thus, book-building may reduce information asymmetry problem with information productions; however, agency problem may exacerbate the conflict.
Shariah offers potential contribution to the debate on optimal IPO methods and IPO underpricing issues in general. Shariah can be expected to reduce information and agency problems. Stricter shariah screening can be expected to help reduce information asymmetry, while...