Shariah vs non-shariah IPO underpricing: evidence from Indonesia Stock Exchange

Abstract

Purpose This study aims to investigate the effect of shariah status on initial public offering (IPO) underpricing, long-term performance and relationship between short-term and long-term IPO performance, and attempt to gain an insight into the nature of shariah IPO underpricing: a signal or an overreaction. Design/methodology/approach This study uses IPOs during 1990–2018 from Indonesia. This study uses clustered regressions to address clustering phenomenon in IPO. To investigate long-term performance, this study uses cumulative returns, cumulative abnormal returns and Fama–French three factor regressions. This study also runs cross-sectional regressions on the relationship between short and long-term performances. Findings This study finds that shariah status reduces lowers non-trading returns (return from offer to open prices), suggesting that shariah status may reduce information asymmetry and compensation. This study finds that both shariah and non-shariah IPOs underperform the benchmarks, with shariah IPOs underperform more. Further analysis shows a negative relationship between initial return and long-term performance for both shariah and non-shariah IPOs, whereas the negative relationship is stronger for shariah IPOs. The results indicate that shariah compliance help reduce information asymmetry; however, shariah compliance does not necessarily signal quality. Instead, shariah compliance seems to induce investor sentiment, resulting in underperformance and reversal patterns in the long run. Research limitations/implications The results have various implications. Issuers may use shariah screening to lower underpricing. Investors may manage their investment horizons to mitigate IPO underperformance. Future research is needed to understand the nature of short and long-term performance of shariah IPO across countries. The use of ex-ante shariah definition becomes our limitation. This study also does not use buy and hold return to investigate long-term performance. Practical implications The results have various implications. Issuers may use shariah screening to lower underpricing. The results show that sharia certification may play an important role in the IPO process. However, sharia status induces individual investors, leading to more overreaction in the long term. Thus, companies need to balance between sharia certification and overreaction in the long term. Investors may manage their investment horizons to mitigate IPO underperformance. Originality/value This paper extends studies on the effect of shariah status on IPO performance using Indonesia data. Using non-trading returns, this study provides sharper analysis on the underpricing study. This study shows that shariah status leads to an overreaction, instead of a signal for quality.