1
Underpricing in the Insurance Industry and the Effect of Sharia
Compliance
Evidence from Saudi Arabian Market
Faisal Alqahtania,
f.alqahtani@auckland.ac.nz
Department of Accounting and Finance, University of Auckland, Auckland, New Zealand,
Department of Economics and Finance, Taibah University, Madinah Almunawwarah, Saudi Arabia,
and
Zakaria Boulanouara,b,
zboulanouar@uqu.edu.sa
College of Business Administration, Umm Alqura University, Makkah Almukarramah, Saudi Arabia
Abstract
Purpose—The purpose of this paper is to explore the existence of underpricing in the cooperative insurance sector in the
Saudi Arabian market, and to examine whether Sharia compliance requirements have an impact on the level of underpricing.
Design/methodology/approach—Underpricing and the effect of Sharia compliance are analysed using a comprehensive
sample of 33 insurance companies with data collected between 2007 and 2013, after taking into account market movements,
as well as some factors well-known in the literature.
Findings—We find that underpricing not only exists, but is among the highest in the world (455 per cent), which contradicts
the literature on IPOs’ pricing in highly regulated sectors. In light of one of our other findings, namely the small number of
insurance underwriters, we attribute these very high levels of underpricing in part to the monopsony power of insurance
underwriters in Saudi Arabia. Regarding the Sharia compliance effect, we find that it does not significantly reduce the
underpricing of insurance offerings. We interpret this as the fact that Sharia status might not be taken into account by
underwriters when they price the offerings of insurance companies, due to a major drawback in the Implementing
Regulations of cooperative insurance which have been highly criticised by practitioners.
Research limitations/implications—Future research should try to include more factors that might explain the underpricing
and its determinants. Two important recommendations flowing from this study for regulatory and supervisory institutions
are the need to improve disclosure and transparency conditions, and to work towards reducing the monopsony power
enjoyed by the underwriters. As for Sharia effect, the Saudi central bank should resolve the issue of Sharia compliance by
adopting one of the Sharia-friendly models suggested by Islamic finance scholars, such as wakala or mudaraba.
Originality/value—To the best of our knowledge, this paper is among the first to offer empirical evidence of the impact of
Sharia compliance on the initial return of the IPOs of cooperative insurance firms.
Keywords—Investments, stocks and shares, stock returns, Saudi Arabia, IPO, Takaful, Sharia compliance.
Paper type—Research paper.
1.Introduction
Equilibrium asset pricing theory suggests that there is a normal return rate commensurate with the level of
risk of the asset(s) under consideration. An example of this reasoning is the capital asset pricing model
developed by an armada of financial scholars (Lintner, 1965; Markowitz, 1952; Mossin, 1966; Sharpe, 1964;
Treynor, 1961 & 1962). However, international research into initial public offerings (IPOs) has consistently
showed the pervasiveness of the IPOs of firms’ stocks in systematic ways. Thus, this underpricing of IPOs,
defined as the difference between the two prices (initial offer price and closing price) at the first day of
trading, and sometimes referred to as one of the puzzles in finance (Loughran & Ritter, 1995), has been
considered to be a global phenomenon. Various explanations have been suggested to answer questions on why
firms would accept to go public at a discount price. These explanations include models based on the
information asymmetry hypothesis (Rock, 1986), signalling models (Allen & Faulhaber, 1989; Grinblatt &
Hwang, 1989; Welch, 1989) and the certification hypothesis based models (Megginson & Weiss, 1991),
with the first two being the best known.
a
b
Both authors contributed equally to this work.
Corresponding author.
1
2
For example, and in line with the equilibrium asset pricing thinking, Rock’s ‘winner’s curse’ model
(1986) sees the underpricing phenomenon as an equilibrium occurrence that occurs when investors are not
equally informed. This is a situation where information asymmetries exist between informed and
uninformed investors. ‘The former invest in information production and subscribe to IPOs only when they
consider that the equilibrium price would be higher than the offer price. Uninformed investors are unable to
discriminate between ‘good’ and ‘bad’ issues and may subscribe to all of the IPOs. Therefore, they are affected
by a ‘winner’s curse problem’ and ask for a discount on the price so that they can accept the offer’
(Ferretti & Meles, 2011, p. 26).
The ability of these well-known models based on information asymmetry have been criticised, especially
recently, by Ritter (2011) for being unable to explain the magnitude of IPOs’ underpricing. Ritter (2011)
argues that underwriters intentionally underprice IPOs to minimise the sale risk, particularly in markets with
limited competition between underwriters. Issuers have no choice but to accept the discount on their issues—
especially small companies (Baron, 1982; Holme et al., 2003; and Hunt & Terry, 2011). This supports the
monopsony power of underwriters hypothesis, where investment bankers as underwriters ‘take advantage of
their superior knowledge of market conditions to underprice offerings, which permits them to expend less
marketing effort and ingratiate themselves with buy-side clients’ (Ritter, 1998).
Following on from the pioneering IPO underpricing studies, alternative theoretical models have been
developed such as those by Gompers (1996) and Gompers and Lerner (1999), and the different theoretical
explanations have been extensively tested (Aggarwal, Krigman, & Womack, 2002; Al-Hassan, Omran,
Fernando-Luciano, & Delgado-Fernandez, 2007; Allen & Faulhaber, 1989; Chemmanur, 1993; Derrien &
Womack, 2003; Ibbotson & Ritter, 1995; Jain, 1996; Jing Chi, McWha, & Young, 2010; Miller & Reilly,
1987; Rahim & Yong, 2010; Reside, Robinson, Prakash, & Dandapani, 1994; Ritter & Welch, 2002).
However, despite IPO underpricing being a well-documented phenomenon, it remains not fully explained.
For example, not all IPOs in different types of industries, with different ways of conducting business, and from
different geographical areas of the globe, have been equally tested. IPO (under)pricing in insurance and other
regulated industries is an example of a relatively under-tested area (Rahman & Yung, 1999). IPOs of
Islamic-Sharia compliant companies constitute a profound case of a non-western (conventional) way of
conducting business. Saudi Arabia is an example of a clearly understudied geographical area (Alqahtani &
Mayes, 2015), despite its capital market being, in terms of capitalisation, the sixth largest emerging market
and the eleventh largest exchange market (Euromoney, 2011). All of this is also beside the fact that Saudi
Arabia is the largest producer and exporter of oil, one of the largest economies in the world, and one of the
G20 members.
Therefore, the aim of this paper is to study IPO (under)pricing in Sharia compliant companies in a regulated
industry, namely Islamic insurance—better known as Takaful—in Saudi Arabia. More precisely, the purpose is
to investigate whether Sharia compliant status could be used as a tool to mitigate the information asymmetry
problem in the Takaful market in the emerging, Muslim-dominated country of Saudi Arabia. The underlying
questions that need to be addressed in this paper are as follows: do market regulations in the Takaful
industry help to mitigate the problem of information asymmetry inherent in IPOs and, consequently,
underpricing? Does Sharia compliance help to reduce the underpricing level in the Takaful sector?
According to Rahman and Yung (1999), there are at least three reasons why, in regulated industries such
as insurance, tighter regulations would ameliorate the problem of information asymmetry. First, the choices of
company managers are often constrained by regulation, thus reducing the likelihood of management indulging
in expedient and risky behaviour. Second, a system of checking and monitoring by regulators is stipulated by
the regulations. Third, operating and financial reports are to be filed by company managers with the regulators,
and the information contained in these reports are available to all members of the public, since the reports are
found in the public domain. It is believed that these conditions lead to a higher level of transparency, thus
increasing the certainty not found in unregulated industries, and that consequently, less money would be left on
the table in the IPOs of these regulated industries.
Sharia compliant companies are required to abide by Islamic guidance in their business dealings. This
compliance is monitored through an extra layer of supervision from a special board of Islamic scholars
2
3
(Haniffa & Hudaib, 2007). This board has both consultative and supervisory roles. The consultative role resides
mostly in the development of Sharia compliant products, whereas the supervisory functions’ aim is to make sure
the company operations and activities are being conducted in line with what has been approved in advance by the
religious board. For example, the Sharia board issues a statement in the annual report of the compliant company
to attest as to whether the company has conducted its business in compliance with the Sharia (Karim, 1990).
For Islamic insurance or Takaful companies, the factors of Sharia compliance and industry regulation leads us
to predict less underpricing of Takaful companies IPOs. Interestingly, our findings show that Sharia compliance
does not significantly reduce underpricing of insurance offerings. We argue that market investors are not able to
distinguish between the Sharia compliant and non-Sharia compliant insurance IPOs. This is due to a major
drawback in the Implementing Regulations of cooperative insurance, which has been highly criticised by
practitioners for not meeting the Sharia requirements in a community that is entirely Muslim.
The remainder of this paper is organised as follows: Section 2, the literature review, considers previous
empirical IPO studies, both in general, and of highly regulated sectors, as well as Sharia compliant ones.
Then we briefly review the Saudi insurance market, before discussing the difference between conventional
insurance and Takaful, including an explanation of why conventional insurance is prohibited under Islamic law.
Section 3 presents the data and methodology, Section 4 contains the empirical analysis and the results, and
Section 5 concludes the paper.
2. Literature review
Hand in hand with theoretical IPO studies, the empirical studies have also contributed to a better
understanding of the IPO underpricing phenomena in several ways. For example, it has been found all over the
world, in both advanced and emerging markets, with the latter showing a higher level than the former. In
advanced markets, the level of underpricing has been found to vary over time, and from one country to another.
Ritter (2002) studied this phenomenon in the US market between 1980 and 2001, and found the average first day
absolute return to be around 18.8 per cent. In New Zealand, Firth (1997) found the level of underpricing to vary
over time, and in a sample of 143 IPOs that happened between 1979 and 1987, the estimated underpricing
level was 25.87 per cent. However, Chi, McWha, and Young (2010) found that the level declined significantly to
5.92 per cent and 4.84 per cent raw and adjusted initial returns (AIRs) respectively during the period between
1996 and 2005. From 2005–2011, the level rose again, albeit only slightly, to 8.56 per cent and 9.16 per cent raw
and adjusted, respectively (Alqahtani & More, 2012).
Further, in emerging markets generally, the level of underpricing seems to be significantly higher than in
most developed markets. It has been documented that the degree of underpricing in the Gulf Cooperation
Council (GCC) countries is amongst the highest worldwide, exceeding the 315 per cent mark of absolute
return (Al-Hassan et al., 2007). However, in India, the initial return was found to be 22 per cent (Pande &
Vaidyanathan, 2009), and it was also found that the underpricing disappears within the first month of listing
(Agrawal, 2009). In China, the degree of underpricing is one of the highest of all time, exceeding 256 per
cent initial return (Chi & Padgett, 2006). In Malaysia, the level was 94.96 per cent during the period from 1990–
1998 (Yong & Isa, 2003); while Rahim and Yong (2010) found that the level later declined significantly to 31.99
per cent.
2.1 Industry Regulation and IPO Performance
Rahman and Yung (1999) examined 36 IPOs of insurance companies occurring 1983–1990 in the United
States. They found that underpricing existed at a level of 5.1 per cent. They also found that the offer size did not
alter the short or long-run market performance significantly. The authors concluded that the underpricing
phenomenon appears to be lower in highly regulated sectors such as insurance, due to the issue of information
asymmetry being lower than in other sectors. This finding is in line with that of You and Yung (1994) and
Cagle and Porter (1997), who find that IPOs in highly regulated financial institutions, such as banks and
insurance companies, are significantly less exposed to the underpricing phenomenon than their counterparts
from nonfinancial institutions. Investigating whether the industry regulation alters IPO underpricing, Cagle
3
4
and Porter (1997) used the insurance, banking and utilities sectors as the regulated industries, while the rest of
IPOs considered were from non-regulated industries. They found that the non-regulated industries experienced a
higher level of underpricing compared to their counterparts in regulated industries, showing only 1.2 per cent in
their sample of 33 insurance companies. On the other hand, Wang and Ligon (2009) found that insurance
IPOs experience similar levels of initial returns to non-insurance IPOs when they control for the level of the
price adjustment. They suggest that the book-building process is efficient in decreasing the difference in ex ante
uncertainty between insurance and non-insurance IPOs, which is in line with the findings of Tong Yu, Lin, Wang
and Feldhaus (2004).
2.2 IPOs and the Impact of Sharia Compliance.
Malaysia is particularly relevant for our study, since some Malaysian IPOs are Sharia compliant and
others are not. Rahim and Yong (2010) found that the level of underpricing declined to 31.99 per cent. Their
sample consisted of 386 IPOs, of which 333 were Sharia compliant (86.27 per cent) and the rest were
classified as non-Sharia compliant. A major finding was the significant difference in initial return according
to Sharia compliance status. They observed that compliance status does not alter the return patterns in the
Malaysian market, which might be explained by its mixed composition. Saudi Arabia offers a rare
opportunity to investigate the effect of Sharia compliance status on the performance of IPOs, since the entire
population is Muslim (Factbook, 2011b), whereas only 60.4 per cent of the Malaysian population is Muslim
(Factbook, 2011a). As a result of this fundamental contextual difference, Rahim and Yong’s (2010) outcomes
cannot be translated directly onto the Saudi Arabian Takaful market. Alqahtani and Mayes (2015) investigate
the presence of underpricing in all industries of the Saudi Arabian market and the impact of Sharia
compliance. They found a substantial level of underpricing (266 per cent), which is among the highest in the
world, similar to the level found in China and other emerging markets. With regards to Sharia compliance,
Alqahtani and Mayes (2015) found the average underpricing of Sharia and non-Sharia compliant firms to be
164 and 411 per cent respectively. They also found that (i) after controlling for some external and internal
factors such as firm’s size and age, Sharia compliance reduced the degree of underpricing significantly; and
(ii) the market timing, age and size of the firms all played significant roles in the Saudi market.
2.3 The Insurance Market In SaudiArabia
The insurance market in Saudi Arabia has experienced a significant increase, reaching a 24 per cent
average annual growth rate between 2006 and 2010, with total insurance premiums reaching SR16.4 billion
in 2010, compared to SR6.9 billion in 2006.
In Saudi Arabia, the financial markets, including the insurance market, are regulated and supervised by the
Saudi Arabian Monetary Agency (SAMA)—the central bank of the country—and its subsidiaries, the Capital
Market Authority (CMA), which supervises the financial markets, and the Cooperative Health Insurance Council
(CHIC), which supervises the health insurance sector. According to the CHIC website, there were 33 listed
insurance companies operating in the Kingdom (at the time of writing this paper). In 2005, CHIC issued the
Cooperative Health Insurance Companies Control Law and its Implementing Regulations to regulate and
supervise the sector. The Implementing Regulations stipulates, among other things, that cooperative insurance
(Takaful) companies must be run in accordance with the principles of Islamic Law. However, the Implementing
Regulations have been heavily criticised by Islamic scholars and Islamic finance experts because it is strongly
believed they do not comply with Islamic law. These concerns will be discussed a little later. First, however, is
a brief discussion on the difference between conventional insurance and cooperative, or Takaful, insurance,
which is in accord with Islamic guidance; then a discussion of why conventional insurance is prohibited in Islam.
Under a conventional insurance model, the insurer owns the premiums, whereas in a Takaful scheme, the
policyholders own those premiums and the insurer is just the custodian of them. The Takaful insurer
charges fees for the management role undertaken, and gets a stake from any profits made from investing the
policyholders’ premiums (Shubaily, 2013). When a policyholder makes a claim, the money s/he gets will come
from the pool of the policyholders’ premiums. At the end of the policyholder’s contract, if the fund yields a
surplus, (which is calculated as the difference between what the Takaful company paid to claimants on one hand,
and the premiums plus the gains generated as a result of investing those premiums, less the insurer’s managerial
4
5
fees), this surplus should be distributed among the policyholders or remain with the Takaful company as a
reserve for insuring subsequent operations (Shubaily, 2013). However, if the premiums were not sufficient to
meet the demand for compensation, then policyholders are asked to increase their contributions to make up the
difference, or else claimant(s) will be only partly compensated, according to the available funding.
Wahab, Lewis, and Hassan ( 2007) provide an excellent discussion of why conventional insurance is
prohibited under Islam. Here, we summarise the main concerns as follows:
First, conventional insurance violates the prohibition of gharar (uncertainty), since the benefits to be paid are
based on the results of future events that are unknown at the time the contract is signed. This is prohibited in
Islam. Second, conventional insurance is considered as gambling (maysir). Wahab et al. (2007) state (p. 375) that
‘policyholders are held to be betting premiums on the condition that the insurer would make payment consequent
to the circumstance of a specified event. For example, when policyholders take out a pure endowment policy,
they are taking a gamble that they will still be alive by the end of the term of the policy to receive the benefits
stated in the contract’. Third, the insurer invests the premiums in mixed classes of securities, which might be
prohibited in Islam, including interest-based (riba) bonds such as government or corporate bonds or term
deposits. Also, they may be investing in some impermissible industries such as those associated with
pornography or alcohol.
Moving on to why the Implementing Regulations are believed not to be Sharia compliant, the critics state that
they do not satisfy the three main points above. First, it obliges insurance companies to invest a minimum of 20
per cent of their total investments in interest-based securities such as government bonds, thus violating the
prohibition of usury (riba) condition. Second, article 70 obliges the insurer to return only 10 per cent of the
surplus to the policyholders and the remaining 90 per cent of the net surplus shall be transferred to the
shareholders’ income statement (Implementing Regulation, 2005). This implies that shareholders are the
owners of the Takaful fund, which violates the main goal of the cooperative insurance company (Shubaily,
2013), thus making it effectively the same as conventional insurance.
In this paper, we investigate whether the IPOs of Sharia-complaint insurance companies in Saudi Arabia
experienced a lower level of underpricing as a result of being highly regulated, compared to the overall Saudi
market. This is done by comparing our results with the results of Alqahtani and Mayes (2015), who have
investigated the presence of underpricing in the overall Saudi market as well as the impact of Sharia compliance.
We also investigate the effect of Sharia on the pricing of those IPOs after controlling for some factors suggested
by previous studies, which might explain the difference between the two sub-samples.
3. Data and Methodology
3.1 Data
This paper is a comprehensive analysis of insurance IPOs conducted between 2007 and 2013 in the Saudi
Arabian market. We choose this period because of the emergence of insurance IPOs in the Saudi market as
can be seen from Figure 1 (below).
This study sample consists of 33 IPOs, analysed for their initial return. All of the data used in this
research, including market data and prices, are sourced through the following databases: DataStream, Thomson
Banker, and the Saudi Stock Exchange (Tadawul) (Tadawul.com.sa). All of the IPO documentation is sourced
from the CMA official website (www.cma.org.sa), and to distinguish between compliant and non-compliant
firms, we use the list issued by the Sharia Board of Alrajhi Bank, the largest Islamic bank in Saudi Arabia and
the GCC states. All the statistical analysis is done using the R statistical package.
5
6
Figure 1: Number of insurance IPOs in the Saudi market between 2007 and 2013.
18
16
14
12
10
8
6
4
2
0
2007
2008
2009
2010
2011
No. Insurance IPOs in Saudi market
2012
2013
3.2 Methodology
In the literature, two main indicators are used to measure underpricing. First, the initial return (IR) is
computed as the percentage change between the first day’s closing price of the stock and its issuing price, as
follows:
𝑈𝑛𝑑𝑒𝑟𝑝𝑟𝑖𝑐𝑖𝑛𝑔1 =
𝑃𝑖,1 −𝑃𝑖,0
𝑃𝑖,0
𝑃𝑖,1 𝑏𝑒𝑖𝑛𝑔 𝑡ℎ𝑒 𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑐𝑜𝑚𝑝𝑎𝑛𝑦 𝑖 𝑎𝑡 𝑡ℎ𝑒 𝑒𝑛𝑑 𝑜𝑓 𝑡ℎ𝑒 fi𝑟𝑠𝑡 𝑡𝑟𝑎𝑑𝑖𝑛𝑔 𝑑𝑎𝑡𝑒
𝑎𝑛𝑑
𝑊𝑖𝑡ℎ: {
𝑃𝑖,0 𝑏𝑒𝑖𝑛𝑔 𝑡ℎ𝑒 𝑜ff𝑒𝑟 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑐𝑜𝑚𝑝𝑎𝑛𝑦 𝑖
Second, the adjusted initial return (AIR) adjusts the IR and takes into account the index return of the market (in
this case Tadawul [Tad], or the Saudi stock exchange) from the offer starting 𝐼0 until the first day of trading 𝐼1 . It is
calculated as follows:
𝑃𝑖,1 − 𝑃𝑖,0 𝐼𝑖,1 − 𝐼𝑖,0
𝐴𝑑𝑗𝑢𝑠𝑡𝑒𝑑 𝑈𝑛𝑑𝑒𝑟𝑝𝑟𝑖𝑐𝑖𝑛𝑔1,𝑇𝑎𝑑 =
−
𝑃𝑖,0
𝐼𝑖,0
We also have the following from the literature:
There is a negative relationship between company size and returns, since it is well documented that smaller
companies are riskier than larger companies (Alqahtani & Mayes, 2015; Chang, Chen, Chi, & Young,
2008; Rahim & Yong, 2010; Rajan & Servaes, 1995; Ritter, 1984).
Due to Sharia compliance concerns discussed earlier, there is no statistically significant difference between
the initial returns of the conventional and Takaful insurance offerings.
Previous empirical studies indicate that there is a positive relationship between demand, as measured
by oversubscription (OFFERsub), and underpricing, especially in countries where the fixed price method is used
(Bubna & Prabhala, 2006; Low & Yong, 2011; Rahim & Yong, 2010; Rock, 1986; Yong & Isa, 2003). If the
offer is small, more investors are unsatisfied, which places greater pressure on the share price on the first day of
trading and vice versa.
Start-ups tend to enjoy superior IRs, since investors are compensated for the uncertainty by a higher level of
6
7
underpricing, as opposed to existing companies that offer their new investors a track record (How, Izan, &
Monroe, 1995; Reside et al., 1994). In our sample, all the companies were newly formed. However, some of
them have foreign partners that had been operating in the industry for a long time. Given this additional piece of
information, investors might be able to estimate the quality of the company by evaluating the foreign partner,
which is not the case for new companies with no foreign partners. Therefore, we expect companies with no
foreign partners to be priced at a higher discount to compensate their investors for uncertainty.
There is a positive relationship between the level of ownership concentration and return. The owners with the
largest holdings are concerned with the company’s performance, which in turn assures new investors that the
management is well monitored. However, it is found empirically that there is no relationship between the size of
block holding and the underpricing level (Bubna & Prabhala, 2006; Field & Dennis P. Sheehan,2001).
Ordinary Least Squares (OLS) regressions are performed to determine which of the given factors alter the
initial return of the IPOs in the Saudi Arabian market. We use the AIR as our dependent variable.
The following independent variables are examined:
Company size: We use the market-value of all shares during the subscription period to compute the
company size. COMsize=(Total no. shares×offer price).
Sharia compliance: For Sharia compliant status, we add a dummy variable, equal to 1 if the firm complies
with Sharia or 0 otherwise.
Over-subscription (OFFERsub): Simply the percentage of how many times the offer is covered knowing that
all IPOs in Saudi Arabia were fully subscribed during the period we consider in this paper.
Foreign partnership (Founders): For the impact of having a foreign partner, we add a dummy variable,
equal to 1 if the firm has a foreign partner or 0 otherwise.
Block holding (ownership) is the proportion of shares held by the 20 largest shareholders of the firm. This
variable was used by Reddy, Locke and Scrimgeour (2010) as a proxy for ownership concentration. However,
because the ownership s t r u c t u r e s of firms in Saudi Arabia are highly concentrated, as in the case of family
firms, we use only the five largest shareholders as a proxy.
So the formula used for this model is as follows:
AIR = constanti + COMsize + statusSharia + OFFERsub+ FOREGIN+ COMbloc + ei
4. Empirical Results
It is clear from Table 1 (below), that IR is 454.55 per cent and that adjusting it for the market index
(Tasi/Tadawul) movement during the day of issue has a trivial effect, with the average AIR being 455.78 per
cent. The average size of the firm, which has been identified in the literature as one of the most significant effects
on the underpricing level, is SR250 million, with a broad range between the largest and the smallest firms. This
suggests that controlling for this factor is of importance in order to draw a valid conclusion.
Table 1: Descriptive statistics.
IR
AIR
COMsize(000)
Block-holding Over-subscription
Mean
454.55% 455.78%
SR 250,000
46.86%
635.55%
Median
343.00% 341.00%
SR 200,000
48.00%
550.00%
Maximum
998.00% 1008.00% SR 2,000,000
70.00%
2000.00%
Minimum
22.00%
32.00%
SR
80,000
3.00%
186.00%
Std. Dev.
295.59% 294.54%
3.31E+08
15.54%
355.05%
Skewness
61.65%
61.06%
4.69
-59.98%
187.81%
Kurtosis
239.75% 237.29%
25.23
315.60%
773.49%
Jarque-Bera
2.59
2.59
800.27
2.01
50.23
Probability
0.27
0.27
0.37
0.00
Sum
150.00
150.41
SR 8,240,000
15.46
209.73
Observations
33
33
33
33
33
7
8
The average concentration of ownership (block-holding) measured by the top five shareholders of the
firm’s shares is 46.86 per cent, which indicates that insurance companies in Saudi Arabia are highly
concentrated. The average over-subscription (demand for the firm’s shares) is 635.55 per cent (6.35 times), and
the highest is 20 times in our sample of insurance firms. This level is similar to that found by Alqahtani and
Mayes (2015) in the Saudi market as a whole. However, when comparing it with levels documented in other
markets, it does not seem very high. According to Chowdhry and Sherman (1996), over-subscription levels
of 200–300 times are fairly common in many markets. In Malaysia, the level reported between 2000 and 2007
was 33.59 times (Low & Yong, 2011).
Table 2: The correlation matrix
AIR
COMsize
1.00
-0.35
AIR
-0.35
1.00
CAPITAL
0.31
-0.32
COMBLOC
-0.02
0.14
OFFERSUB
Block-holding
0.31
-0.32
1.00
0.20
Over-subscription
-0.02
0.14
0.20
1.00
Table 2 (above) shows that, for all the continuous variables, our explanatory variables are not highly
correlated with each other, which implies that the issue of multi-collinearity is highly unlikely.
8
9
Table 3: OLS regressions
Model 1
Model 2
Model 3
Estimate t-value Estimate t-value Estimate
Intercept
Model 4
Model 5
t-value Estimate t-value
Estimate
Model 6
t-value Estimate t-value
4.5578 8.8893*** 4.9021 8.1800*** 38.9039 2.7100** 38.1785 3.2850*** 35.8150 3.2000*** 39.8055 3.6000***
StatusSharia
-
-
-1.2632
-1.1010
-1.2014
-1.1100 -1.1855
-1.1310
COMsize
-
-
-
-
-1.7836 -2.5410** -1.7527 -2.9220*** -1.6686 -2.8400*** -1.8492 -3.1600***
FOUNDERS
-
-
-
-
1.3473
1.3440
1.3290
1.3790
1.3945
1.4600
-
-
OFFERsub
-
-
-
-
-0.1076
-0.7900 -0.1088
-0.8180
-
-
-
-
Ownership
-
-
-
-
-0.3268
-0.0890
-
-
-
-
-
-
-0.9689
-0.9600
-1.2375
-1.2250
F-statistic
-
1.2120
2.8240
3.6570
4.7060
5.7750
p-value
-
0.2794
0.0355
0.0162
0.0085
0.0076
R-squared
0.0000
0.0376
0.3433
0.3432
0.3274
0.2780
Adjusted R-squared
0.0000
0.0066
0.2217
0.2493
0.2579
0.2298
WB test statistic
-
0.9730
0.9920
0.9920
0.9910
0.9870
WB p-value
-
0.0900
0.8200
0.8300
0.7700
0.5000
Note: (*) p<0.1, (**) p<0.05, (***) p<0.01
9
10
After performing OLS regressions, we performed some diagnostic tests to check for normality and
outliers. For normality, we used the Weisberg-Bingham test (WB) (Table 3, above) with values ranging
between 0 and 1; a value close to 1 indicates normality, and a p-value greater than 0.05. It is apparent from
Table 3 that our models satisfy these two criteria. With regard to outliers, it can be seen from Figure 2
( b e l o w ) that our models do not have any points with a Cook’s distance greater than 0.5. This indicates
that our regressions do not suffer from outliers.
Figure 2: The residual versus leverage of the final model and Cook’s distance
Resi duals v Leverage
1
1
0 .5
-1
0
Standardised residuals
2
13
25
0 .5
-2
10
1
C ook's distance
0.0
0.1
0.2
0.3
0.4
0.5
0.6
Leverage
lm(AIR ~ status + COMsize + OFFERsub + CO
Turning now to the underpricing results, there is a substantial degree of underpricing in the Saudi Arabian
insurance market with an adjusted initial return of 455 per cent (Table 3, model 1), and it is significant at the
1 per cent level. This level of underpricing can be considered one of the highest levels of all time, exceeding
that found in China (256 per cent) (Chi & Padgett, 2006), and the 315 per cent recorded in the GCC (AlHassan, Delgado, & Omran, 2010). This finding is not in line with, and in fact contradicts, the early
literature about highly regulated sectors (Rahman & Yung, 1999; You & Yung, 1994), which maintain that
these sectors are required to offer a higher level of transparency, thus minimising the issue of
informational asymmetry inherent in initial public offerings. However, it is similar to the underpricing level
(411 per cent) of non-Sharia compliant firms, as found by Alqahtani and Mayes (2015).
The underwriters’ monopsony power in the Saudi insurance market might help towards understanding these
results of high underpricing. Figure 3 (below) shows that there is a small number of insurance underwriters
(12) in the Saudi market, reflecting the fact that firms going public have limited choices of underwriters.
Further, Figure 4 shows that the top five of those 12 underwriting institutions dominate well over 70 per cent
of underwriting activities, thus giving issuers even less bargaining power and at the same time vesting these
top five underwriters with an oligopoly power over firms going public, forcing them to accept high
underpricing of their shares.
10
11
Figure 3: Insurance underwriters and their market shares
Figure 4: Top 5 per cent of underwriters dominating the IPOs insurance market
As for the Sharia compliance effect—our main objective in this paper—it can be seen from Table 3 model
2 that insurance IPOs of Sharia compliant firms have an underpricing level of 363 per cent, whereas their
counterparts in non-Sharia firms have 490 per cent underpricing. Therefore, the difference between the two is
not significant at the 10 per cent level, suggesting their means are not different from each other. The
explanatory power (represented by the R-squared) of our model 2 is extremely low. This suggests that this
model does not explain much of the phenomenon at hand. Therefore, we fit the full model, containing all the
suggested variables to see if these factors influence the underpricing level. It can be seen from model 3 that
our data strongly supports this argument; firm size was found to be significant at the 5 per cent level, which is
in line with the finding of Alqahtani and Mayes (2015), Chang et al. (2008) and Rahim and Yong (2010).
However, the other fivevariables are found insignificant. This might cause our estimates to suffer from over11
12
fitting, an issue that affects the efficiency of the estimates (Lee, Ihaka & Triggs, 2012). Therefore, we decided
to exclude the insignificant variables (except the Sharia variable, since it is the main interest of this paper) one
at a time, to see if it resulted in a better fit. It can be seen from models 4 and 5 that excluding the oversubscription (OFFERsub) and Ownership variables increase the explanatory power indicated by the Adjusted
R-squared criteria from 22.17 to 25.79. However, excluding foreign partner (Founders) (seen in model 6)
decreases the Adjusted R-squared, even though it is insignificant, which indicates it is needed in the overall
model. This implies that model 5, which includes Sharia compliance status, size of the company and foreign
partnership, outperforms the other models in explaining the underpricing phenomenon of insurance companies
in Saudi Arabia. Regarding Sharia compliance effect, we can see that this factor does not alter the level of
underpricing, whether before or after controlling for other factors suggested by the literature. This implies that
Sharia status is not taken into account by underwriters when they price the offerings of insurance companies
in the Saudi market, which contradicts the findings of Alqahtani and Mayes (2015), who find that Sharia
plays a significant role in the pricing decisions in the Saudi market of IPOs. This finding supports the
argument we put forward that, due to a major drawback in the Implementing Regulations of cooperative
insurance (which has been highly criticised by practitioners) both groups are priced at the same level of
discount, regardless of their Sharia status.
5. Conclusion
In this study, we investigated the short-run performance of cooperative insurance IPOs in the Saudi Arabian
market using a comprehensive sample of 33 insurance companies between 2007 and 2013 to explore the
existence of underpricing in the insurance sector. We also explored whether the Sharia compliance status of the
company has an effect on the level of underpricing. We find that underpricing not only exists, but is also
among the highest in the world (455 per cent), contradicting the literature about highly regulated sectors, where
these sectors have been described as offering a higher level of transparency, thus minimising the issue of
informational asymmetry inherent in IPOs. Traditional factors affecting initial return include only the firm
size. Unlike the findings of Alqahtani and Mayes (2015) regarding Sharia compliance’s impact on the Saudi
market, we find that Sharia compliance does not significantly reduce underpricing of insurance offerings.
Future research should try to include more factors, since the explanatory power of our model is quite low,
which suggests that we might have omitted some important factors.
However, despite this limitation, a number of recommendations can be derived from the results. Since the
level of underpricing is extremely high, the CMA and SAMA need to improve disclosure and transparency
conditions, which internationally characterises the financial sector, to minimise the issue of information
asymmetry. In addition, the CMA should 1- work towards lowering the monopsony power enjoyed by the
underwriters, for example through increasing competition by way of widening the range of institutions allowed
to offer underwriting services and thus helping a less than excessive underpricing equilibrium to be achieved;
2- encourage large insurance companies to become listed, since we found the size to reduce the amount of
‘money left on the table’. The SAMA should resolve the issue of Sharia compliance by adopting one of the
Sharia friendly models suggested by Islamic finance scholars such as wakala or mudaraba (Wahab et al.,
2007), since this factor has been found to significantly reduce the underpricing level in the Saudi Arabian
market (Alqahtani & Mayes, 2015).
12
13
6. References
Aggarwal, R. K., Krigman, L. and Womack, K. L. (2002). “ Strategic IPO underpricing, information
momentum, and lockup expiration selling”. Journal of Financial Economics, Vol.66, No.1, pp. 105–137.
Agrawal,
D.
(2009),
“IPO
underpricing,
A
literature
review”,
available
at
SSRN:
http://ssrn.com/abstract=1724762 (accessed 2 August 2012).
Al-Hassan, A. Delgado, F. and Omran, M. (2010), “The under-pricing of IPOs in the Gulf Cooperation Council
countries”, Research in International Business and Finance, Vol.24, No.3, pp. 344–360.
Al-Hassan, A. Omran, M. and Delgado-Fernandez, F-L. (2007), “IPO behaviour in GCC countries: goody-two
shoes or bad-to-the-bone?” IMF Working Papers, International Monetary Fund, 1–34, available at
SSRN: http://ssrn.com/abstract=100789 (accessed 30 October 2013).
Allen, F., and Faulhaber, G. R. (1989), “Signalling by underpricing in the IPO market”, Journal of Financial
Economics, Vol.23, No.2, pp. 303–323.
Alqahtani, F. and More, V. (2012). “Under-pricing phenomenon in New Zealand IPO market. Factors associated
with average initial return”, Available at SSRN: http://ssrn.com/abstract=2215402 (accessed 10 January
2013).
Alqahtani., F., & Mayes, D. G. (2015). “Underpricing of Initial Public Offerings in Saudi Arabia and the Effect
of Sharia Compliance”. Journal of Islamic Accounting and Business Research, (Forthcoming).
Bubna, A., and Prabhala, N. R. (2007). “When bookbuilding meets IPOs”, available at SSRN:
http://ssrn.com/abstract=972757 (accessed 9 June 2012).
Cagle, J., & Porter, G. E. (1997). “IPO Underpricing in Regulated Industries”, Journal of Economics and
Finance, Vol.20, No.1, pp. 27–37.
Chang, E., Chen, C. Chi, J. and Young, M. (2008), “IPO underpricing in China: new Evidence from the primary
and secondary markets”, Emerging Markets Review, Vol.9, No.1, pp. 1–16.
Chemmanur, T. J. (1993). “The pricing of initial public offerings: a dynamic model with information
production”, The Journal of Finance, Vol.48, No.1, pp. 285–304.
Chi, J., McWha, M. and Young, M. (2010). “The performance and the survivorship of New Zealand IPOs”,
International Review of Financial Analysis, Vol.19, No.3, pp. 172–180.
Chi, J. and Padgett, C. (2006). “Operating performance and its relationship to market performance of Chinese
initial public offerings”, The Chinese Economy, Vol.39, No.5, pp. 28−50.
Chowdhry, B.and Sherman, A. (1996). “International differences in oversubscription and underpricing of IPOs”,
Journal of Corporate Finance, Vol.2, No.4, pp. 359–381.
Derrien, F. and Womack, K. L. (2003). “Auctions vs. bookbuilding and the control of underpricing in hot IPO
markets”, Review of Financial Studies, Vol.16, No.1, pp. 31–61.
Factbook. (2011a). Malaysia available at
https://www.cia.gov/library/publications/theworldfactbook/geos/my.html.
Factbook. (2011b). Saudi Arabia, available at
https://www.cia.gov/library/publications/theworldfactbook/geos/sa.html.
Ferretti, R. and Meles, A. (2011). “Underpricing, wealth loss for pre-existing shareholders and the cost of going
public: the role of private equity backing in Italian IPOs”, Venture Capital, Vol.13, No.1, pp. 23–47.
Field, L. and Sheehan, D. (2001). “Underpricing in IPOs control monitoring, or liquidity?”, Unpublished
working paper, Penn State University.
Firth, M. (1997). “An analysis of the stock market performance of new issues in New Zealand”, Pacific-Basin
Finance Journal, Vol.5, No.1, pp. 63–85.
How, J. C., Izan, H. Y., and Monroe, G. S. (1995). “Differential information and the underpricing of initial
public offerings: Australian evidence”, Accounting & Finance, Vol.35, No.1, pp.87–105.
Ibbotson, R. G. and Ritter, J. R. (1995), “Initial public offerings”, Handbooks in OperationsResearch and
Management Science, Vol.9, pp. 993–1016.
Implementing Regulation. (2005). Available at:
http://www.sama.gov.sa/sites/samaen/Insurance/InssuranceLib/IIR_4600_C_ReguExecutive_En_2005_0
8_18_V1.pdf. (accessed 4 November 2013).
Jain, B. A. (1996). “Is Underpricing a signal of firm quality”, American Business Review, January, Vol.14, No.1,
pp.38–45.
Lee, A., Ihaka, R., and Triggs, C. (2012). “Advanced statistical modelling”. Course notes for University of
Auckland, available at https://www.stat.auckland.ac.nz/~stats330/coursebook.pdf (accessed 4 November
2013).
13
14
Loughran, T. and Ritter, J. R. (1995). “The new issues puzzle”, The Journal of Finance,Vol.50, No.1, pp. 23–51.
Low, S.-W. and Yong, O. (2011). “Explaining over-subscription in fixed-price IPOs: evidence from the
Malaysian stock market”, Emerging Markets Review, Vol.12, No.3, pp. 205–216.
Miller, R. E., and Reilly, F. K. (1987). “An examination of mispricing, returns, and uncertainty for initial public
offerings”, Financial Management, Vol. 16, No. 2, pp. 33–38.
Pande, A. and Vaidyanathan, R. (2009), “Determinants of IPO underpricing in the national stock exchange in
India”, The ICFAI Journal of Applied Finance, Vol.15, No.1, pp. 14–30.
Rahim, R. A. and Yong, O. (2010). “Initial returns of Malaysian IPOs and Shari'a-compliant
status”,
Journal of Islamic Accounting and Business Research, Vol.1, No.1, pp.60–74.
Rahman, H., and Yung, K. (1999). “ Insurance IPOs—a test of the underpricing theories”, Journal of
Insurance Issues, Vol.1, No.22, pp. 61–77.
Rajan, R., and Servaes, H. (1995). “The effect of market conditions on initial public offerings: Graduate School
of Business, University of Chicago, Chicago, USA, 1995.
Reddy, K., Locke, S. and Scrimgeour, F. (2010). “The efficacy of principle-based corporate governance practices
and firm financial performance: an empirical investigation”, International Journal of Managerial
Finance, Vol.6, No.3, pp.190–219.
Reside, M. A., Robinson, R. M., Prakash, A. J. and Dandapani, K. (1994). “A tax-based motive for the
underpricing of initial public offerings”, Managerial and Decision Economics, Vol.15, No.6, pp. 553–
561.
Ritter, J. R. (1984). “The hot issue market of 1980”, Journal of Business, Vol.57, No.2, pp.215–240.
Ritter, J. R. (1998). “ Initial public offerings”. In D. Logue and J. Seward (Eds.), Handbook of Modern
Finance Boston and New York: WGL/RIA
Ritter, J. R. (2011). “Equilibrium in the initial public offerings market”, Annual Review of Financial Economics,
Vol. 3, No.1, pp. 347–374.
Ritter, J. R. and Welch, I. (2002). “A review of IPO activity, pricing, and allocations”, The Journal of Finance,
Vol.57, No.4, pp. 1795–1828.
Rock, K. (1986). “Why new issues are underpriced”. Journal of Financial Economics, Vol 15, No.1–2, pp. 187–
212.
Shubaily, Y. A. A. (2013). The Insurance. Available from http://www.shubily.com/books/insurance.pdf
(accessed 4 October 2013).
Tong Yu, Lin, B., Wang, M., and Feldhaus, W. R. (2004). “ Capacity constraints and IPO underpricing in
the property and liability insurance industry”, Journal of Insurance Issues, Vol.2, No.27, pp.104–122.
Wahab, A. R. A., Lewis, M. K., and Hassan, M. K. (2007). “Islamic takaful: business models, Shariah concerns,
and proposed solutions”, Thunderbird International Business Review, Vol.49, No.3, pp.371–396.
Wang, Q., and Ligon, J. A. (2009). The Underpricing of Insurance IPOs. Financial Management, Vol.38, No.2,
pp.301–322.
Yong, O. and Isa, Z. (2003). “Initial performance of new issues of shares in Malaysia”, Applied Economics,
Vol.35, No.8, pp. 919–930.
You, A., & Yung, K. (1994). “The underpricing of IPOs of financial institutions”. Journal of Business,
Finance, and Accounting, Vol.21, No. pp.1013–1030.
14