Question

Justin Barlow, wearing a white lab coat with FOY emblazoned on the left side, smiled broadly as he rang the bell to begin the day’s trading on NASDAQ. In a few hours, FOY (ticker: FOY) would commence trading, and he would be the CEO of a publicly traded firm.   He would also be a multi-millionaire, at least on paper. Looking back over the five years, Justin realized that he knew a lot more about biochemistry than business and finance. Thankfully, ITM had recruited seasoned professionals to serve as COO and CFO. Justin knew that he could never have gotten this far without Joe Init’s help and the support of his staff. Sure, Joe took a little more ownership at every financing stage (Justin now owned about 22% of the company), but Justin supposed that was just the cost of playing the game. One thing still puzzled him, however. For the last three weeks, he had been traveling around the country with staff from ITM and the investment banker, Platinum Baggs, to meet prospective investors. Demand for the stock was very high and every institutional investor that they visited made strong commitments to purchase shares at the IPO. Based in this information, they raised the offer price by $4 per share compared to the midpoint of the initial estimated price range ($17.50 - $19.50). Still, the investment banker estimated that the stock price would increase 30-35% on the first day of trading. Justin suggested that they further increase the price or the number of shares offered to raise more capital (and further increase his personal wealth), but Platinum argued strongly that they should not raise the price even higher. Justin did not understand why they insisted that he leave so much money on the table, but Joe Init did not seem to mind too much so. In the end, Justin decided that the investment bankers knew more about the IPO process than he did, so he agreed to an offer price of $22.50. The price of the stock at the close of first-day trading was $30.75.

Why would Platinum Baggs insist that FOY underprice the offer and leave money on the table?

Answer 1

The current case study deals with UNDER-PRICING the 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.

Reasons for underpricing

An IPO may be underpriced deliberately to boost the demand for shares and encourage investors to buy shares in the new company.

However, there are alwys two opposing goals at play. The company's executives and early investors want to price the shares as high as possible in order to raise the most capital and reward themselves most lavishly. The investment bankers who are advising them may hope to keep the price low in order to sell as many shares as possible since higher volume means higher trading fees for them.

Thus, in current case Platinum Bagg can be insisting FOY to underprice the IPO because of the 2 reasons mentioned above.

First ,to boost the demand.

Second, the more the trading volume, higher the trading fees Platinum Bagg gets