This paper examines the valuation and initial price performance of Malaysian Initial Public Offerings (IPOs). A number of theoretical models have been put forward to explain why new equity issues are issued at a discount. Foremost among them are explanations involving the adverse selection problem arising from information asymmetry, moral hazard issues relating to the underwriters, and signaling incentives. In this study, three alternative reasons are considered. The first one examines the errors arising from the valuation methods used to price the IPOs. The second one looks at the market conditions at the time of the offer, and the last one tests the efficiency of the Malaysian stock market. The sample consists of 264 companies that were listed on the Malaysian Stock Exchange from 1999 to 2004. The results indicate that IPO market prices are efficient in early trading and that underpricing is not influenced by market conditions. However, the results do suggest that underpricing is the result of industry risk and errors arising from the valuation methods used.

Studies investigating the pricing of Initial Public Offerings (IPOs) have documented the existence of underpricing (Logue, 1973; and Rock, 1986; and Yong and Isa, 2003). Underpricing refers to the situation where a private company seeking to list its shares on a stock exchange prices its shares to the public at a discount relative to its true value. This allows investors to earn positive abnormal returns if they were to sell their shares once trading commences. The initial abnormal returns are typically measured by taking the difference between the offering price and the opening market price on the first trading day (Yong and Isa, 2003), or closing market price at the end of the first day (Logue, 1973; Ritter, 1984; and Ritter and Welch, 2002), or first week or first month after listing (Cheung and Krinsky, 1994). Although there are a number of explanations as to why IPO shares are underpriced, the most widely accepted one relates to information asymmetry in the IPO market. Due to information gap between the company and the investing public, issuers deliberately price their shares below intrinsic value to induce investors to reveal their demand (Benveniste and Spindt, 1989) or to compensate uninformed investors for the costs of gathering information regarding the company (Rock, 1986). Rock found that the greater the information gap, the greater the extent to which the US IPO shares are underpriced. Other underpricing theories involve a signaling model where issuers underprice their offerings in order to charge a higher price in the subsequent Seasoned Equity Offerings (SEOs). In the signaling models proposed by Grinblatt and Hwang (1989) and Welch (1989), high quality firms may deliberately underprice their IPOs in order to signal their quality and recoup the reduction in IPO proceeds from subsequent equity offerings. An alternative reason for underpricing relates to the moral hazard problem where investment bankers/underwriters underprice new equity issues to minimize their risk of under subscription (Ibbotson, 1975) or to reduce the effort they have to expend in marketing the new issue (Baron, 1982).

Applied Finance Journal,Initial Public Offerings, IPOs, Seasoned Equity Offerings, SEOs, Net Asset Value, NAV, Cross-Correlation, Discounted Cash Flow, DCF, Information Technology, IT, Cross-Correlation Function, CCF, Seasoned Equity Offerings , SEOs, Autocorrelation Function, ACF.