Question

Explain why the most of the time IPOs are underpriced. What role do investment banks play in this process?

Answer 1

Most of the time initial public offer are underpriced because initial public offer will always be offered by the company for the first time and those who are investing into the initial public offer are always provided with price discrimination because that will be helpful for large subscription of the initial public offer and it will also attract the investor to be invested into the company for longer period of time.

Underpricing of the initial public offer also done because the investment bank want to make higher amount of money by taking the shares of the company at the lower price and its selling it in the market at a higher price and making a higher underwriter commission.

Investment bank will always be playing a role of underwriter in the initial public offering and they will be providing the valuation limits to the company who is going to issue with the initial public offer in the market and hence these investment bank will be earning though underwriting commission and they will also maximize their return through underpricing of the share they have underwritten these shares at a lower price and they will sell the shares at a higher price in the market.