Question

This is a two-part homework question. Please provide at least one reference between 2013-2018 to support your response. Thank you.

Explain underpricing and some possible reasons for its use. Additionally, assess the implications of stock underpricing on an organization’s IPO.

Answer 1

Underpricing is the listing of an initial public offering below its market value. When the offer price of a stock is lower than the price of the first trade, the stock is underpriced. Typically, a stock is temporarily underpriced because demand will eventually drive it toward its intrinsic value.

Investors may perceive an IPO as risky because of insufficient historical trading data. The less liquid and predictable an IPO's shares are, the more likely they will be underpriced to compensate investors for their assumed risk. Because an IPO's issuer tends to know more about the value of the shares than the investor, a company will underprice its stock to encourage investors to participate in the IPO.

Some other reasons are:

Information Asymmetry: Theory assumes that IPO pricing is a product of information disparities.

Entering New Markets: Underpricing to encourage investors to participate and in-turn entering new market.

Investment Banking Conflict: Investment banks arrange underpricing IPO to benefit themselves and their other clients.

Managerial Conflict: This theory postulates that management creates excessive demand for IPO to ensure that management can sell all of its holdings.

Alibaba IPO ended day one of trading with a 38% gain. The stock opened at $92.7 on its first day of trading , $24.7 more than the IPO price, and closed at $93.9.

Adyen’s first day of trading in Amsterdam, the stock popped 100 % doubling to 480 euros ($564).