Question

“Why has IPO underpricing changed over time?” The authors give three possible explanations for IPO underpricing. Which one do you find most plausible, and why? Look at the paper(s) that support that theory and cite some of the results that support your assertion that this is the best IPO underpricing theory of the three.

(PLEASE MAKE IT A SEVERAL SENTENCE ANSWER)

Answer 1

Underpricing of IPO

Underpricing is the practice of listing an initial public offering (IPO) at a price below its real value in the stock market. When a new stock closes its first day of trading above the set IPO price, the stock is considered to have been underpriced.

Underpricing is short-lived because investor demand will drive the price upwards to its market value.

In theory, any IPO that increases in price on its first day of trading was underpriced, whether it was deliberate or accidental. The shares may have been deliberately underpriced to boost demand. Or, the IPO underwriters may have underestimated investor demand.

Overpricing is much worse than underpricing. A stock that closes its first day below its IPO price will be treated as a failure.

An IPO can be underpriced if its sponsors are genuinely uncertain about the reception that the stock will receive. After all, in the worst case, the stock price will immediately climb to the price that investors consider that it's worth. Investors willing to take a risk on a new issue are rewarded. The company's executives are pleased.

That is considerably better than the company's stock price falling on its first day and its IPO being blasted as a failure.

Whether it was underpriced or not, once the IPO debuts the company becomes a publicly traded entity owned by its shareholders. Shareholder demand will determine the stock’s value in the open market going forward.

For example, a company has a current market value of $1700,000. It decides to price its IPO at $10.00 per share. The IPO has a total of 150,000 shares. At this IPO price, the company has valued itself at $10.00 * 150,000 = $1500,000. That's $200,000 less than its current market value.