Drawing upon risk-return and signaling literature, this paper tests the relationship between Initial Public Offering (IPO) risk disclosed in the prospectus and its offer price and initial market returns. Based on 210 samples of IPOs offered in Malaysian stock market during the period 1999-2004, weighted least-square regression analysis (book value of the company after the IPO as weight) has been applied. The results indicate that the prospectus does provide risk information that reflects offer price and initial market returns.

Finance theory suggests that in any share pricing decision, two characteristics of shares need to be considered, namely risk and return (Markowitz, 1952). Under the assumption that investors are risk-averse and seek to minimize the risk for any level of expected return, additional return must compensate investors for assuming additional risk. Risk can be defined as the inability to predict the outcome of a forthcoming event with complete certainty (Fisher and Hall, 1969). In the context of an Initial Public Offering (IPO), it is the uncertainty regarding the company's market clearing price, once trading commences. Investors can assess its attractiveness through proper understanding of the risks undertaken by the company (Aaker and Jacobson, 1987). Therefore, risk reporting and disclosure practices of IPO companies need to provide investors with information not only on the risks involved, but also the company's ability to control or influence these risks. Without adequate information of these factors, investors cannot properly judge if potential returns are adequate compensation for the risks they are expected to assume.

Risk disclosure takes on a greater significance for new listings, compared to seasoned equity offerings, because the information asymmetry that investors face in the primary equity market is more severe compared to the secondary market (Leland and Pyle, 1977; Downes and Heinkel, 1982; and Chemmanur, 1993). IPO investors know what the offer price is but are uncertain if future market prices will exceed the offer price. Conversely, investors in secondary equity offerings have the benefit of knowing what the market price is, as trading has already commenced. Therefore, information asymmetry is greater in the primary market, as a majority of investors have not yet revealed their demand through public trading. Moreover, IPO companies reveal significantly less information about themselves to the public prior to listing; hence, risk that investors bear is likely to be higher for IPO shares compared to secondary share issues (Leland and Pyle, 1977).

Applied Finance Journal, Initial Public Offerings, Finance Theory, Primary Equity Market, Information asymmetry, Capital Asset Pricing Model, Systematic Risk, Investment Bankers, Risk Management, Initial Market Returns, IPO Companies, Multiple Regression Analysis, Market Capitalization, Investment Decisions, Financial Risks.