Question

Briefly explain the underpricing phenomenon concerning IPOs. Why does it happen? Who benefits/suffers from it, and why?

Answer 1

A company's initial public offering of its stock is underpriced if its shares close above the offering price on its first day of trading.It is a process of listing the shares price below its market value.This is reflective of the closing stock price of the company on the day of it's listing.In other words we can also say that underpricing is also defined as the IPO return relative to the average market return without an IPO.Underpricing is short lived because investors demand will drive the price upwards to it's market value.

Generally,it is a common phenomenon to list securities with a premium to the IPO issuance price but underpricing of an IPO is completely different.It issues securities with a discount to closing price of listing day.The true market price of the shares is constantly derived by twin mechanism of demand and supply through price discovery.

It happens due to an inefficient valuation techniques adopted to value the issue price of security by different merchant bankers.The inefficiency in valuation can also be attributed to lack of application techniques to judge different market factors like grey market premium and subscription demand.

Direct beneficiaries of underpricing of an IPO are the people who subscribe for it as well as it can be underwriters at times, when the issues was not fully subscribed.

People who lost from underpricing of an IPO are those who offloaded their stake using IPO.There are lot of promoters and venture capitalists who wish to offload their preheld stakes through IPO listing and those people lose when the IPO is underpriced.