Accounting Research Journal

Impact of disclosure of risk factors on the initial returns of initial public offerings
(IPOs)
Shaista Wasiuzzaman, Fook Lye Kevin Yong, Sheela Devi D. Sundarasen, Noor Shahaliza Othman,
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ARJ
31,1
46
Received 26 September 2016
Revised 6 May 2017
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13 July 2017
14 September 2017
Accepted 5 October 2017
Accounting Research Journal
Vol. 31 No. 1, 2018
pp. 46-62
© Emerald Publishing Limited
1030-9616
DOI 10.1108/ARJ-09-2016-0122
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1030-9616.htm
Impact of disclosure of risk
factors on the initial returns of
initial public offerings (IPOs)
Shaista Wasiuzzaman
Faculty of Management, Multimedia University, Cyberjaya, Malaysia
Fook Lye Kevin Yong
Graduate School of Management, Multimedia University, Cyberjaya, Malaysia
Sheela Devi D. Sundarasen
Accounting Department, College of Business Administration,
Prince Sultan University, Riyadh, Saudi Arabia, and
Noor Shahaliza Othman
Faculty of Management, Multimedia University, Cyberjaya, Malaysia
Abstract
Purpose – When a firm goes public for the first time, its prospectus serves as an important reference for
investors. It is required by regulation that the risk factors which have significant influence on the business be
disclosed in the prospectus. The purpose of this study is to analyze how disclosure of these risk factors
influences the initial returns of initial public offerings (IPOs).
Design/methodology/approach – To do this, a sample of 96 Malaysian new equity offerings (IPOs)
from year 2009 to year 2013 is used. Ordinary least squares regression technique is used to regress initial
returns against risk disclosures. Aside from overall risk disclosure, individual dimensions of risk (internal
risk, external risk and investment risk) are also considered.
Findings – Results of the regression analyses reveal a direct relationship between the IPO initial returns
and the disclosure of risk. Overall risk disclosure is found to be highly significant in influencing initial
returns. However, further investigation into the individual group of risks shows that only investment risk is
highly significant in influencing IPO initial returns.
Originality/value – The results found in this study are interesting as, unlike prior studies, it is shown that
disclosures of internal and external risks are not significant in influencing investors’ actions possibly because
of their generalizability, whereas disclosures related to investment risks are significant. Equity of firms which
disclose more of its risk factors can be expected to generate higher initial returns.
Keywords Malaysia, Initial public offerings, Risk disclosure
Paper type Research paper
1. Introduction
Initial public offerings (henceforth, IPOs) such as those of Facebook in 2012 and Alibaba
Group in 2014 have made headlines around the world mainly because of the uncertainty
surrounding the IPO environment (Ljungqvist, 2007). In that regard, governments around
the world have mandated that any firm wishing to go public must prepare a prospectus
The authors wish to acknowledge the feedback and contributions from the participants of the
ICABEC2016 which helped to significantly improve this paper.
 which discloses relevant information pertaining to its background, financial performance Disclosure of
and risk factors for potential investors to better understand the firm before they invest in it risk factors
(Beatty, 1989). Investors therefore perceive the prospectus as an important source of
reference to mitigate uncertainty and risk exposure and they depend on the information
disseminated in the prospectus to make necessary investment decisions (Bhabra and
Pettway, 2003; Abdou and Dicle, 2007). Extensive and quality information disclosed in the
prospectus is found to lead to superior IPO pricing thus minimizing pricing error (Hanley
and Hoberg, 2010).
47
The Securities Commission Malaysia provides specific guidelines which set out the
minimum contents required in a prospectus. Information pertaining to the offering, the risk
factors, the corporation and the group, shareholders/promoters/directors/key management,
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related party transactions/conflict of interest, financial information and reports from

accountants/experts/directors are some of the items required to be included in the
prospectus. Among these, the guidelines related to the disclosure of risk factors are the least.
The guidelines simply require that:

A prospectus should contain information about risk factors which are specific to the
corporation/group and its industry and to the securities being offered. These are
risk factors which had or could materially affect, directly or indirectly, the business,
operating results and financial condition of the corporation/group.

The listing of risk factors in order of priority is encouraged.

Disclaimers on the risk factors should not be so wide that the risk disclosures are of
little or no beneficial use to investors.

The inadequacy of guidelines related to risk disclosures may result in different levels of
disclosures among firms and, in some cases, the disclosures may be insufficient, ineffective
and of no importance to investors. Amran et al. (2008) find that risks disclosed in annual
reports by Malaysian firms are very much less than those in the UK, while Zadeh et al.
(2016) find significant increase in the level of risk disclosures by firms from year 2001 to
2011 but the level still needs to be improved.
The presence of risk in an IPO environment is inevitable because of the uncertainty in
terms of the market price of the IPO in the secondary market post issuance. Previous studies
(Abdul Rashid et al., 2012; Bartov et al., 2002; Bhabra and Pettway, 2003; Chen, 2014; Chua,
2014; Loughran and Ritter, 2004; Sundarasen, 2013) have considered many factors
influencing initial returns of IPOs but relatively few have examined how disclosure of risk
factors can influence initial returns. Studies have not fully explored the possibility of risk
disclosures mitigating risk perceived by potential investors, thus impacting the first day’s
closing price and the IPO initial returns. This study therefore analyzes the content of risk
factors disclosed in the prospectus of 96 companies in the Bursa Malaysia from years 2009
to 2013 and how these risk factors influence IPO initial returns.
The results of the study show a highly significant positive relationship between the
overall risk disclosures and IPO initial returns. However, the relationship is found to be
significant only for investment risk factors. Internal and external risk factors are found to be
insignificant in influencing IPO initial returns. These results have important implications
for investors, issuers and policymakers in the Malaysian market.
The rest of the study is structured as follows. Section 2 presents a discussion of previous
literature on IPO initial returns and how the returns may be affected by risk disclosures.
This leads to the development of the hypotheses of the study. Section 3 describes the data
collection methods and methodology employed and this is followed by Section 4 which
 ARJ presents the analysis results and a discussion of the finding. Section 5 finally concludes this
31,1 study.

2. Literature review and hypothesis development

The IPO prospectus is generally broken down into several sections and there would usually
be a certain standard or order on how they are published. In most cases, the front pages of
48 the IPO prospectus would publish the number of shares offered, IPO allocation and the
corresponding offer prices. Several studies over the years have considered these attributes to
understand the pattern of IPO performance (Logue, 1973; Downes and Heinkel, 1982; Carter
et al., 1998; Aggarwal et al., 2002; Intintoli et al., 2014). Further down the IPO prospectus is
normally the listing of the names for Board of Directors and their respective designations.
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The legal agencies and underwriters or investment banks responsible to publish and sell the
IPO shares on behalf of the firms or “issuers” are also listed. Studies have analyzed the
influence of board characteristics (Abdul Rashid et al., 2012), underwriters and their
reputation (Chua, 2014; Sundarasen, 2013), historical financial data prior to listing (Chen,
2014) and other financial details derived from the financial statements such as companies’
assets, their corresponding sales’ revenues and earnings per share to determine first-day
performance of IPOs (Bartov et al., 2002; Loughran and Ritter, 2004; Bhabra and Pettway,
2003). The extensiveness of IPO underpricing has also been studied via variables such as
market capitalization (Leitterstorf and Rau, 2014) and the relevancy of “use of proceeds”
disclosure (Ljungqvist and Wilhelm, 2003; Hanley and Hoberg, 2012; Wyatt, 2014).
Despite the large number of studies conducted on IPO initial performance, very few have
looked at the influence of risk disclosures on IPO initial returns especially in Malaysia. One
such study is by Abdou and Dicle (2007). Risk is categorized into six distinct factors and
the impact of these risk factors on the pricing of the shares is studied. Their results conclude
that risk factors published in the IPO prospectus cannot be entirely discounted from IPO
performance. Deumes (2008) finds the possibility that the price of IPOs in the Amsterdam
Stock Exchange drops drastically within a two-three years’ timeframe after the prospectus
has been published. In the Malaysian context, Murugesu and Santhapparaj (2010) analyze
the effect of risk disclosures published in the prospectus of 210 firms listed on the various
boards of the Bursa Malaysia toward the initial returns of IPOs in Malaysia. Using 15 risk
measurements, they find that risk information provided in the prospectus is reflected in the
offer price and initial market returns.
The study by Abdou and Dicle (2007) investigates the disclosure of risk factors but in the
US environment and focuses only on retail and high-tech firms. Although Murugesu and
Santhapparaj (2010) study this issue in the Malaysian environment, the risk variables taken
in the study are merely “proxies” and not directly related to the “risk factors” section in the
prospectus. The 15 proxies are firm-specific and IPO-specific, which according to them
reveal the total risk, or the risk involved in the implementation of the firm’s strategy. The
lack of studies conducted on the impact of the disclosure of risk factors on IPO performance
in Malaysia motivates this study. This study adopts the approach of Abdou and Dicle (2007)
to examine the disclosure of the risk factors published in the prospectus of IPO firms in
Malaysia and its impact on IPO performance but focuses on internal, external and
investment risks. It extends the study further by not just focusing on each individual risk
factor but also the overall risk factor.
Early studies on IPO pricing analyze the impact of asymmetric information on initial
returns because when a firm goes public, asymmetric information between all stakeholders
(the issuers, investors and the underwriters) creates uncertainty. Asymmetric information
models assume that one of these parties is privy to certain information not known to the rest
 of the stakeholders thus causing in-equilibrium in the pricing of the IPOs. While exposing Disclosure of
relevant information to potential investors could garner their interest, it may also pose risk factors
substantial risk as a result of the disclosure of the firm’s strategies and important
information to their competitors (Bhattacharya and Ritter, 1983; Bhattacharya and Chiesa,
1995). IPO pricing literature analyzes asymmetric information in four dominant
perspectives: between the issuers and investors, known as “Signaling Hypothesis” (Leland
and Pyle, 1977); between the issuers and the underwriters, known as “Agency Problem”
(Baron, 1982; Baron and Holmström, 1982; Loughran and Ritter, 2004); and between the 49
informed and uninformed investors, known as the “Winner’s Curse” (Rock, 1986) and an
extension of Rock’s model, known as “Ex-ante Uncertainty” (Beatty and Ritter, 1986). This
study mainly focuses on the “Ex-ante Uncertainty” model and “Signaling Hypothesis” in
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explaining the effect of risk disclosures on IPO initial returns.

From the perspective of the “ex-ante uncertainty” model, as argued by Beatty and Ritter
(1986, p. 213), “there is an equilibrium relation between the expected underpricing of an
initial public offering and the ex ante uncertainty about its value.” Ex ante uncertainty in the
context of an IPO refers to the uncertainty on the IPO price in the secondary market post-
issuance. As ex ante uncertainty increases, potential investors will demand that “more
money is left on the table” to compensate for the higher risk assumed. In the context of this
study, ex ante uncertainty arises from the extent of risk disclosures published in the
prospectus; potential investors will perceive high disclosure of the risk factors in the
prospectus as higher uncertainty, thus expecting to be highly compensated. Consequently, if
the extent of disclosure is low, ex ante uncertainty is expected to be low and thus investors
will expect lower compensation for the lower risk resulting in lower initial returns.
Theoretical work in the context of the “Signaling Hypothesis” provides mixed results.
While some studies contend that the risk disclosures are “boilerplate”, i.e. they do not have
any effect on investor perception, others find that risk disclosures do provide meaningful
information which can either increase or decrease investor’s risk perceptions. Campbell et al.
(2014) and Kravet and Muslu (2013) argue that risk disclosures may simply be “boilerplate”,
as managers have more information about the firm than its investors do but they tend to
have a self-serving bias to disclose favorable information and avoid disclosing unfavorable
information. However, as risk disclosure is mandatory and its purpose is to convey
information related to the unfavorable risks faced by the firm, managers would then tend to
be biased towards providing vague and meaningless risk disclosures that may be used to
catalog all possible risks and uncertainties but provide almost no information to the
investor. Risk disclosures that are too vague and generic therefore do not provide any
significant information to investors and do not reduce information asymmetries between
issuers and investors, thus having no significant impact on the IPO initial returns.
Kravet and Muslu (2013) also argue that risk disclosures may reveal unknown risk
factors and contingencies that will influence investor’s risk perceptions. Assuming
managers do disclose meaningful risks, the disclosures would not be informative to the
investors if the risks disclosed are already known by the market hence resulting in
information that has very little or no effect on the ex ante beliefs of the investor about the
firm’s risk (Campbell et al., 2014). Disclosures that do reveal unknown risk factors and
meaningfully reflect the risks faced by the firm will provide information to the investors,
thus reducing information asymmetries among issuers and investors and among informed
and uninformed investors. Unfortunately, in certain circumstances, investors tend to react
negatively to disclosure of negative information, therefore management tends to downplay
the significance of the negative outcomes or attribute the failures to external factors such as
general business climate, inflation, market prices and government policy. Managers may
 ARJ use defensive explanatory devices such as excuses, justifications and causality denials in
31,1 order “to minimize the apparent severity of a negatively perceived performance outcome”
(Aerts and Cheng, 2012, p. 51).
The disclosure of negative or undesirable qualities however depends on what they are
perceived to reflect and how they fit with investor’s expectations and beliefs (Scott and
Lyman, 1968). If the disclosure of negative or undesirable qualities is perceived as reflecting
50 lack of managerial control, then investors should expect higher returns to compensate for
the risk taken. However, if the disclosure is intended to project an image of control,
suggesting that the management is able to rationalize these short-term negative
developments and remedy them in the future, this “signals competence, the ability to plan
and enact changes in the face of negative events, and thus future viability” (Aerts and
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Cheng, 2012, p. 54).

Signaling hypothesis thus suggests that the extent of risk disclosures may be perceived
either positively or negatively by investors depending on the circumstances and this will
ultimately influence IPO initial returns. If risk disclosures are perceived positively
(negatively) by the investors, then lower (higher) compensation is expected and hence lower
(higher) returns. However, if the risks disclosed do not provide any relevant information and
investors are not able to extract meaningful information out of these disclosures, then an
insignificant relationship between risk disclosure and IPO initial returns may exist.
Therefore, based on the ex ante uncertainty model and signaling hypothesis arguments,
the following hypotheses are formulated:
H1. There is a significant relationship between the extent of disclosure of internal risk
factors and IPO initial returns.
H2. There is a significant relationship between the extent of disclosure of external risk
factors and IPO initial returns.
H3. There is a significant relationship between the extent of disclosure of investment
risk factors and IPO initial returns.
H4. There is a significant relationship between the extent of disclosure of the overall
risk factors and IPO initial returns.

3. Data and methodology

3.1 Data collection
To test the hypotheses, a sample of 102 Malaysian firms undergoing the IPO process to be
listed on the Bursa Malaysia between January 1, 2009 and December 31, 2013 is taken. The
IPO Summary page in the Bursa Malaysia website (www.bursamalaysia.com) lists all IPOs
for a period of five years. Although it is possible to obtain IPO information and the
prospectus of the firms from the Bursa Malaysia starting from year 2000, this study only
covers IPOs from year 2009 as there was a new board structure and various other initiatives
implemented in the Bursa Malaysia in year 2009. Additionally, the Malaysian market
started showing signs of recovery from the global financial crisis of year 2008. Hence, to
avoid any possible impact of the changes taking place in the market and also the effects of
the global financial crisis, only IPOs from year 2009 are considered. Although a total of 102
firms went public between years 2009 and 2013, firms with missing data are excluded from
the final sample, resulting in only 96 firms finally. Extreme values are winsorized. The final
number of firms going public each year in the sample is provided in Table I.
 The risk information required is obtained from the prospectus of each firm, which is Disclosure of
downloaded from the Bursa Malaysia website. Every prospectus has a section on “Risk risk factors
Factors” which outlines the major risks associated with the companies’ businesses,
operations, industry and IPO initiatives. The risks disclosed cover all areas of potential
events that may impact their businesses, operations, financial conditions and even the IPO
listing itself. Figure 1 illustrates an example of the Table of Contents published in one of the
prospectuses which has a section on “Risk Factors”.
Data collection is based on the risks published under the various risk categories in the 51
companies’ prospectus. It is expected that because of the differences in firm structure and
operations across diversified industries, the risk categories mentioned in the prospectuses
would differ from each other. Table II illustrates the actual risk categorization mentioned
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under the “Risk Factors” section of the prospectus for the firms from year 2009 to 2013.
The data for risk factors are collected using narrative information method, where the
prospectus is read manually and the risks disclosed under the “Risk Factors” section are
identified. The firms have different ways of reporting their risk factors therefore the unit of
analysis is “sentence” not “word” (Dobler et al., 2011). Sentences referring to the same risk
are grouped as one item. Three different categories of risk are identified – internal risk,
external risk and investment risk. Internal risk refers to the risks faced by the firm as a
result of its internal conditions such as its management, personnel, operations-related risk,
among others. This risk is within the control of the firm. External risk factors are those risk
factors resulting from the external environment and are not within the control of the firm
such as competition, government policies and legislations and the economic environment.
Investment risk refers to the risks faced by the shareholders such as the non-payment of
dividends, dilution of shareholdings and the failure of the IPO.
The risk factors are categorized based on specific key sentences (in bold), as provided in
Table III. The number of firms disclosing each risk factor is also provided.
There are a maximum of 16 forms of risks identified as internal risks, 12 forms of risk as
external risks and 5 forms of risk as investment risks. If a particular form of risk is present,
it is assigned a value of 1, otherwise 0. For each risk category, the sum is then calculated.
The overall risk is calculated as the total value of all the keywords (from all risk categories).
It can be observed that among the three forms of risk, the risk factors categorized under
Investment risk are disclosed by most companies. The internal and external risk factors
tend to be generic in nature and tend to attribute the risks to external factors such as general
business climate, inflation, market prices and government policy.
Data for the dependent variable (first-day or initial returns) are sourced from Yahoo!
Finance website. Similar to the study by Abdou and Dicle (2007), the initial return is
calculated as the difference between the first day closing price and the IPO offer price,
divided by the IPO offer price.
Two control variables are also included in the model – age of the firm and IPO offer size.
The age is calculated as the logarithm of one plus the number of years since the firm was

Year No. of newly listed firms on Bursa Malaysia

2013 16
2012 17
2011 21
2010 30 Table I.
2009 12 IPOs per year
 ARJ
31,1

52
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Figure 1.
Sample of the
published table of
content in a
prospectus with a
section on the risk
factors

first incorporated while IPO offer size is the logarithm of the number of shares offered by the
firm for the IPO. Firm size and firm age are established factors affecting the initial returns of
IPOs and it is now a common practice to include them as control variables in existing
literature (Carter et al., 1998; Ibbotson et al., 1994). However, it is found in this study that
firm size (measured by the logarithm of total assets), market capitalization (measured as
 Risk categories No. of companies
Disclosure of
risk factors
Business and operations 37
Business only 27
Operations only 16
Operations and market 1
Operations and financial 3
Company only 4 53
Group only 3
Group and industry 1
Business and industry 18
Industry only 47
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Market only 1
Malaysia 1
Financial only 3
Technological 1
Shares only 67
IPO only 17
Listing only 1
Units 4
Table II.
Listing and shares 4
Shares and IPO 1 Risk categorization
Global offering only 2 mentioned in the
Securities 2 prospectuses from
Others 26 2009 to 2013

logarithm of the number of shares outstanding multiplied by the price per share) and the
IPO offer size are highly correlated with correlation values greater than 0.8, thus indicating
that they are close proxies to each other. As this study is on IPOs, the IPO offer size is taken
as the most appropriate control variable to control for the size of the IPOs. Underwriters’ and
auditors’ reputation are also common control variables in the literature (Albring et al., 2007;
Michaely and Shaw, 1995) but in the Malaysian context, most companies going public are
underwritten by the same investment bank and audited by the big-4 auditors, thus both are
redundant. Market condition is another common control variable (Baker and Wurgler, 2006;
Yung and Colak, 2008), but as there were no major fluctuations in the market during the
period of study, the impact is minimal thus this variable is excluded.

3.2 Empirical models and descriptive statistics

The relationship between the risk factors and IPO initial returns can be modeled as per the
following equations:

IR ¼ a þ b ð1ÞINTERNAL þ b ð2ÞEXTERNAL þ b ð3ÞINVEST þ b ð4ÞAGE

þ b ð5ÞIPO_SIZE þ « (1)

IR ¼ a þ b ð1ÞINTERNAL þ b ð2ÞAGE þ b ð3ÞIPO_SIZE þ « (2)

IR ¼ a þ b ð1ÞEXTERNAL þ b ð2ÞAGE þ b ð3ÞIPO_SIZE þ « (3)

 ARJ
31,1 No. of firms
Risk factor Keywords disclosing risk

Internal Dependence on Executive and senior Directors 48

Risk Dependence on key management and personnel 39
Dependent on firm’s ability to attract and retain personnel on a cost- 25
54 effective basis, especially senior management team and highly-skilled
talent
Shortage of skilled and experienced manpower in the particular 8
industry
Operational Risk 33
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Operations could be disrupted by unexpected network interruptions 15

caused by system failures, natural disasters, terrorist attacks,
unauthorized tampering or security
Exposed to risks in relation to management of costs, IT and technology 11
Reliance on computer software and hardware systems in managing our 5
business operations/Highly reliant on automated systems and the
Internet to conduct our business
Breakdown of fire, energy crisis and other emergency crisis 7
Production delay/Disruptions to processing facilities and business 14
operations
Brand infringements/Inadvertent infringement of third-party 15
intellectual-property rights
Our brand names and intellectual property are important assets which 23
do not belong to us and the licenses for their use may be terminated or
not extended
Brand protection/Trademarks/Brand Loyalty 7
Availability of funds to sustain operations and growth/We may need 16
additional capital in the future, and we cannot assure you that we will
be able to obtain such capital on acceptable terms or at all/Funding,
especially on terms acceptable to us, may not be available to meet our
future capital needs
If our company acquires a target asset which is located outside of 27
Malaysia, we could be subject to a variety of additional risks that may
negatively impact our operations/Risk of expansion into foreign
markets
May not gain acceptance or be able to replicate our business strategies 5
successfully outside our current markets, all of which may place us at
a competitive disadvantage and limit our growth opportunities
External Competition/Strong competition for access to oil and gas resources/ 89
Risk Competition with other fuel substitutes such as coal, diesel, LPG and
MFO
Government measures and regulations in response to financial and 11
other crises may materially and adversely affect our business
Government initiatives and policies towards the oil and gas industry 8
may affect the level of E and P activities in the regions of interest/
Risks in relation to future energy policy changes
Failure to comply with country’s regulations covering E and P activities 6
could reduce our profitability following a Qualifying Acquisition and
Table III. such non-compliance could result in the imposition of penalties, fines
Categories of risk or restrictions on operations and remedial liabilities
and associated 14
sentences (continued)
 Disclosure of
No. of firms risk factors
Risk factor Keywords disclosing risk

Government policies, legislation, regulations and requirements/Law and

Regulations
Changes in taxation law or exchange controls may materially and 16
adversely affect our business, financial condition and results of 55
operations/Certain tax incentives or exemptions from the GOM may
no longer be available in the future
Any outbreak or infectious disease or fear of an outbreak, or any other 15
serious public health concerns in Southeast Asia or elsewhere may have
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an adverse effect on the economies of certain Southeast Asian

countries and may adversely affect us/May be affected by the outbreak
of infectious diseases
Risks in relation to HSE/Health, safety and environmental (HSE) 36
issues/Regulation of greenhouse gas emissions and climate change
could have a negative impact on our business/Subject to
environmental protection laws
Political and local and global economic considerations 67
Unfavorable financial and economic developments in Malaysia may 18
have an adverse effect on us/Economic downturn/May be affected by
the global financial crisis/Global economic crisis
Affected by market fluctuations and general economic, social and 11
political conditions, in particular affecting Southeast Asia from which
we generate a substantial amount of our operating revenue/Highly
dependent on global trading volumes, regional and global economic,
financial and political conditions
Market performance 10
Investment Potential delay in or failure of our listing/There may be a delay in or 91
Risk termination of our listing
Payment of dividends/We may not be able to pay dividends 59
Disclosure regarding forward-looking statements/Forward-looking 64
statements may not be reflective of our future prospects
Future fundraisings may dilute shareholders’ equity or restrict our 35
operations/New investors will incur immediate dilution and may
experience further dilution/Purchasers of our shares in our listing will
experience immediate and substantial dilution because the Institutional
Price and Final Retail Price are higher than our NAV per share
No prior market for our shares/There has been no prior market for our 95
shares and the offering of our shares may not result in an active liquid
market for our shares Table III.

IR ¼ a þ b ð1ÞINVEST þ b ð2ÞAGE þ b ð3ÞIPO_SIZE þ « (4)

IR ¼ a þ b ð1ÞOVER þ b ð2ÞAGE þ b ð3ÞIPO_SIZE þ « (5)

where:
IR is the dependent variable which is the IPO first day return;
a is the constant;
b (1-3) are the coefficients of each independent variable and control variable;
OVER is the extent of the overall risk disclosure;
 ARJ INTERNAL is the extent of disclosure regarding the internal risks faced by the firm;
31,1 EXTERNAL is the extent of disclosure regarding the external risks faced by the firm;
INVEST is the extent of disclosure regarding the investment risks faced by the investors;
AGE is used for firm age;
IPO_SIZE is used for the size of the IPO offering; and
« is the error term.
56 Table IV presents the descriptive statistics for all the variables in the study.
The statistics show that on average the IPO initial returns (IR) are positive (0.161), implying
underpricing of IPOs. The lowest IR is 0.35 while the highest is 4.04. The average IPO offer
size is 18.400 (in logarithms). The average firm is around 6 (or e1.771) years old. On average,
firms disclose around 10 total risk factors with 3 being internal risk factors, another 3 being
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external risk factors and 4 being investment risk factors. Although there are a total of 16
keywords for internal risk factors, 12 external risk factors and 5 investment risk factors, firms
disclose a maximum of 7 internal risk factors, 7 external risk factors and all 5 investment risk
factors. This does not however mean that the firms are refraining from disclosing more
information, it may simply be that some of the risk factors may not be relevant to certain firms.

4. Results and discussion of findings

Equations (1) to (5) are tested using ordinary least squares (OLS) regression. The correlation
values between the variables (Table V) are first calculated to ensure no problems of
multicollinearity. The variance inflation factor (VIF) values are also provided in the table.
The correlation coefficients between the independent and the dependent and control
variables are very low, with the highest being 0.224 between IPO_SIZE and IR. Among
the variables, only IPO_SIZE and INVEST are found to be significantly correlated with IR
at the 1 and 10 per cent level, respectively. Among the independent and control variables,
IPO_SIZE has highly significant correlations with OVER, EXTERNAL and INVEST but
not with INTERNAL. Only INTERNAL has significant negative correlation with AGE of
the firm at the 5 per cent level. This is not surprising since as a firm matures, it is able to
manage its internal risk and therefore there is less to disclose with respect to this risk.
EXTERNAL and INVEST risks are not significantly correlated with AGE as these risks are
not within the control of the firm. The highest correlations are between INTERNAL and
OVER (0.660) and between EXTERNAL and OVER (0.681). The correlation between

Variable Mean SD Minimum Maximum Skewness Kurtosis

IR 0.161 0.496 0.35 4.04 5.560 41.367

IPO_SIZE 18.400 1.944 15.81 23.25 0.887 2.729
AGE 1.771 0.796 0 3.5 0.379 2.067
OVER 9.823 2.424 5 16 0.560 2.781
INTERNAL 3.104 1.638 1 7 0.511 2.615
EXTERNAL 3.135 1.278 1 7 0.627 3.493
INVEST 3.583 0.959 2 5 0.023 2.051
N 96

Notes: IR is the initial returns (or first day return) of the IPO calculated as the difference between the first
day closing price and the IPO offer price divided by the IPO offer price. IPO_SIZE refers to the IPO offer
size which is calculated as the logarithm of the number of shares offered by the firm for the IPO. AGE is the
age of the firm calculated as the logarithm of one plus the number of years since the firm was first
Table IV. incorporated. OVER, INTERNAL, EXTERNAL and INVEST are the number of risk factors reported by the
Descriptive statistics firms based on the overall, internal, external and investment risks reported by the firms, respectively
 Variable IR IPO_SIZE AGE OVER INTERNAL EXTERNAL INVEST VIF
Disclosure of
risk factors
IR 1
IPO_SIZE 0.224** 1 1.31
AGE 0.017 0.058 1 1.07
OVER 0.078 0.442*** 0.057 1 1.25
INTERNAL 0.040 0.144 0.207** 0.660*** 1 1.10
EXTERNAL 0.035 0.419*** 0.126 0.681*** 0.044 1 1.29 57
INVEST 0.176* 0.312*** 0.041 0.493*** 0.099 0.313*** 1 1.19
N 96

Notes: **Indicates significance at 5% level, ***indicates significance at 1% level. IR is the initial returns
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(or first day return) of the IPO calculated as the difference between the first day closing price and the IPO
offer price divided by the IPO offer price. IPO_SIZE refers to the IPO offer size which is calculated as the
logarithm of the number of shares offered by the firm for the IPO. AGE is the age of the firm calculated as
the logarithm of one plus the number of years since the firm was first incorporated. OVER, INTERNAL, Table V.
EXTERNAL and INVEST are the number of risk factors reported by the firms based on the overall, Correlations between
internal, external and investment risks reported by the firms, respectively variables

INVEST and OVER is only 0.493. This is expected since out of the total 33 forms of risk
disclosed, 49 per cent are internal risk factors, 36 per cent are external risk factors while only
15 per cent are investment risk factors. The external and internal risks therefore have higher
weightage in the overall risk disclosure compared to investment risk; hence, the higher
correlations between EXTERNAL and INTERNAL with OVER. However, it should be
noted that correlation values between 0.5 and 0.7 indicate moderate correlation and do not
represent any major issue of multicollinearity in the data (Hair et al., 2010). The VIF values
show no serious issues of multicollinearity between the variables.

Dependent variable: IPO initial returns

Variables Model 1 Model 2 Model 3 Model 4 Model 5

Constant 1.023** (0.486) 1.148** (0.487) 1.242** (0.495) 1.085** (0.471) 1.184** (0.476)
INTERNAL 0.039 (0.031) 0.025 (0.032) – – –
EXTERNAL 0.001 (0.043) – 0.026 (0.044) – –
INVEST 0.150*** (0.055) – – 0.140*** (0.053) –
OVER – – – – 0.046** (0.023)
AGE 0.031 (0.063) 0.030 (0.065) 0.014 (0.064) 0.015 (0.061) 0.030 (0.062)
IPO_SIZE 0.086*** (0.029) 0.061** (0.026) 0.065** (0.028) 0.079*** (0.026) 0.083*** (0.028)
R-Squared 0.132 0.058 0.055 0.117 0.091
Prob > F 0.024 0.14 0.158 0.009 0.032
Breusch-
Pagan
(chi2(1)) 132.31 55.38 46.28 118.50 92.32
n 96
Notes: *Indicates significance at 10% level, **indicates significance at 5% level. IR is the initial returns
(or first day return) of the IPO calculated as the difference between the first day closing price and the IPO
offer price divided by the IPO offer price. IPO_SIZE refers to the IPO offer size which is calculated as the
logarithm of the number of shares offered by the firm for the IPO. AGE is the age of the firm calculated as
the logarithm of one plus the number of years since the firm was first incorporated. OVER, INTERNAL,
EXTERNAL and INVEST are the number of risk factors reported by the firms based on the overall, Table VI.
internal, external and investment risks reported by the firms, respectively Regression results
 ARJ As there is no issue of multicollinearity, the risk disclosures are regressed against IR using
31,1 the OLS regression technique. Because the data are cross-sectional in nature, only
heteroscedasticity needs to be tested to ensure that the estimates are BLUE (Best Linear
Unbiased Estimators). Heteroscedasticity is tested using the Breusch–Pagan test of
heteroscedasticity. All the models are regressed with robust standard errors. The results of
the analyses are presented in Table VI.
58 Equations 1, 4 and 5 (as shown in Table VI) have good model fit with Prob > F being less
than 0.05. Equation 1 indicates the relationship between the disclosure of all the risks
(INTERNAL, EXTERNAL and INVEST) and IPO initial returns, Equation 4 indicates the
relationship between investment risk disclosure (INVEST) and IPO initial returns, whilst
Equation 5 indicates the relationship between the overall risk disclosure (OVER) and IPO
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initial returns. Age is found to be insignificant in influencing IPO initial returns but IPO
offer size (IPO_SIZE) is highly significant. The relationship is found to be negative in all
cases, i.e. the larger the IPO, the lower the difference between the offer price and the initial
returns.
Analysis of the overall risk factor shows a highly significant positive relationship with
IPO initial returns, i.e. an increase in the disclosure of risk factors results in higher initial
returns. Delving deeper into the individual risk categories, the insignificant results (p-values
greater than 0.05) of INTERNAL and EXTERNAL but significance ( p-value less than 0.05)
of INVEST indicate that internal and external risk disclosures have no significance on IPO
initial returns but investment risk does have a significantly positive impact. Therefore, only
H3 and H4 are supported, whereas H1 and H2 are not supported. The results are consistent
with the study by Abdou and Dicle (2007) and Murugesu and Santhapparaj (2010).
Based on the empirical evidence, it is noted that both the ex ante uncertainty and
signaling models are able to explain the influence of risk factors on IPO initial returns. The
positive relationship between the overall risk factor and IPO initial returns means that
investors in the Malaysian IPO environment perceive high disclosure of risk in the
prospectus as increased uncertainty. In line with the ex ante uncertainty model, investors
therefore demand higher compensation because of the presence of uncertainty in the future
performance of the IPOs in the secondary market. Issuers and underwriters may therefore
also intentionally underprice the offer price of IPOs to compensate investors for the risks
assumed and to entice investors to increase the demand for the IPOs. Additionally, the risk
disclosure is used by investors as signals related to managerial competency and control. The
positive relationship between the overall risk and IPO returns means that risk disclosure is
perceived negatively by the investors as a signal of lack of managerial control; therefore,
investors expect to be compensated accordingly.
The significance of the investment risk disclosure (INVEST) indicates that this risk is
very relevant to investors who are concerned about the returns on their investment.
Therefore, investors expect that a firm which discloses more investment risks is signaling
higher uncertainty and lack of managerial control and therefore they ought to be
compensated with higher returns. Disclosures of internal and external risks faced by the
firms are found to be insignificant in affecting IPO initial returns possibly because of the
inability of the investors to analyze these risks as the disclosures are considered
“boilerplate”, providing almost no information to the investors. Further, when overall risk is
calculated as the sum of the internal and external risk factors only, it is found to be
insignificant. Indeed, the internal and external risk factors provided in Table III seem to be
very general in nature. The significance of INVEST and insignificance of EXTERNAL and
INTERNAL is interesting, as the total number of INTERNAL and EXTERNAL forms of
risks disclosed are much higher than those of INVEST (only 5 forms of risk) yet the
 disclosure of these risks are insignificant, further confirming that it is not the quantity of Disclosure of
risks disclosed that is important but rather the quality of the information disclosed. risk factors
This study conjectures that investors in the Malaysian IPO environment are concerned
about the risks facing the firm and react to the risks disclosed in the IPO prospectus.
However, they tend to focus mainly on the investment risk rather than the internal and
external risks which tend to be generic in nature providing almost no meaningful
information to the investors.
59
5. Conclusion
This study is conducted to understand the impact of risk disclosures on IPO initial returns
of Malaysian firms. A total of 96 IPOs between year 2009 and 2013 are considered for this
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purpose. Using OLS regression, the study finds that the overall risk disclosure in an IPO
prospectus and disclosure of investment risks have significant positive impacts on IPO
initial returns. Unlike previous studies, other risk factors such as internal risk and external
risk are insignificant in influencing IPO initial returns. When considering the overall risk
disclosure, which is calculated at the total sentences disclosed for all the risk factors, a
highly significant positive relationship is found with IPO initial returns. Further
investigation into the individual risks finds that investment risk is the only significant risk.
This seems to indicate that, especially when investing in IPOs, Malaysian investors are
concerned mainly about the investment risks disclosed by the firms. It also seems to indicate
that the risk information provided with regard to the internal and external factors seem to
be generic in nature, providing little to no significant information to the investors to enable
them to evaluate the risk of the IPO. The results confirm the applicability of the ex ante
uncertainty model and the signaling hypothesis in explaining the effect of risk disclosures
on IPO initial performance.
The results of the study serve as a guide to potential investors in their choice of IPOs;
risk-averse investors may be more inclined towards lower disclosure of risk factors as this
tends to minimize uncertainty and they are willing to settle for a lower premium on the first
day of trading. On the contrary, risk-taking investors who are more concerned about high
initial returns may be willing to invest in firms with high disclosures of risk factors in the
prospectus, with the expectation of being compensated with higher initial returns on the
first day enabling them to earn higher capital gains in the short-run. From the perspective of
issuers, firms may be willing to disclose their risk factors and compensate investors
accordingly via underpricing but with the hope of recovering the underpricing cost in the
medium term in the secondary market. Policymakers, on the other hand, may find the
results insightful if they wish to develop deep and well-diversified financial markets and
attract international listings to their stock markets. The generic nature of internal and
external risk factors and the insignificant reaction of investors toward the disclosure of
these risk factors indicate the need for policymakers to provide more specific guidelines on
the risk factors so that the risk factors provide more meaningful information to potential
investors, thus allowing proper evaluation of the IPO. It also provides a basis for future
studies in understanding of risk factor disclosures and how narrative information testing is
used in this study.
This study has its limitations. First, it is based on a small sample size of 96 companies. A
larger sample size is very much desired to achieve better generalizability of the results. The
sample period can be extended further taking into consideration newer firms going for IPO,
thus increasing the total sample size. Second, it is based on risk information disclosed in the
prospectus which does not have a standard format of disclosure. Some companies may have
described similar risk factors in different categories, while others may have disclosed
 ARJ irrelevant risk factors under the risk categories. Narrative information method requires
31,1 manual reading and understanding of the risk factors in relation to the keywords used and
there is no advanced system or software available to interpret the risk factors accurately.
Some companies report distinct risk factors which are not disclosed by any other company
and such information may skew the results. Finally, the control variables are limited (only
age and IPO offer size are controlled for); hence, it is suggested that further studies should
60 include other control variables such as profitability, growth, leverage and others to further
strengthen the results.

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About the authors

Dr Shaista Wasiuzzaman is a Senior Lecturer at the Faculty of Management, Multimedia University,
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Cyberjaya, Malaysia. She obtained her PhD (Management) in the area of Finance from Multimedia
University, Malaysia. Her research interests include issues in corporate finance, corporate governance
and Islamic finance. Shaista Wasiuzzaman is the corresponding author and can be contacted at:
shaista@mmu.edu.my
Fook Lye Kevin Yong completed his MBA (Multimedia Finance) studies from Multimedia
University, Cyberjaya, Malaysia. His research interests include IPOs, risk factors and investment
returns.
Dr Sheela Devi D. Sundarasen is an Assistant Professor of Accounting at Prince Sultan University,
Riyadh, Saudi Arabia. She obtained her PhD in Finance from Monash University. Her research
interests include IPOs, financial planning and governance.
Noor Shahaliza Othman is a Lecturer at the Faculty of Management, Multimedia University,
Cyberjaya, Malaysia. Her research interests are in the area of economics, financial planning and
entrepreneurship.

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