Ipo Underpricing Theory

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2. Theories explaining IPO underpricing Initial public offerings are becoming one of the most investigated topics and interesting to financial economists worldwide. Several prior researches related to IPOs report the tendency to be underpriced. However, it is doubt that why firms sacrifice huge amounts of money on the table for investors' high return and what the price is optimal for IPO shares in the primary market. Many theories have been put forward to explain and test the IPO underpricing against the sample of various countries in different time. According to Ljungqvist (2007), there are four arguments involved in explanation of IPO underpricing: asymmetric information, institutional explanations, ownership and control, and behavioral…show more content…
This is defined as one of these participants is better informed than the others. Rock (1986) proposes a model which is called a winner's curse by assuming some investors whose information are superior than other investors as well as the issue firms. Generally, informed investors participate the market when attractive shares are offered, while unformed investors buy IPO shares intuitively but they will be unwilling to buy overpriced IPOs or negative return IPOs. In the winner's curse, the informed do not participate the IPO market when unattractive priced IPOs are offered and the uninformed investors will receive all the IPOs they buy for. In the case of oversubscription, the market is crowd out by informed investors, as a result, the return of IPO shares that the uninformed investors receive from allocation is below the average returns. Thus, the uninformed are unwilling to buy IPOs and withdraw from IPO market. Rock (1986) suggests that the IPO market needs the uninformed demand when the informed demand is not enough to response all shares on offer. The positive expected return is an important condition to attract the uninformed investors to participate the IPO market. This leads to the IPO underpricing. (Ljungqvist,…show more content…
Firstly, age, asset, and the industry of company are examples of the company characteristics, Ritter (1991) claims that the older firms have the lower level of underpricing than the younger firms because age can indicate the performance and success of the company. The uncertainty in the future of firms with several year operating will reduce and induce the lower underpricing. Furthermore, firms with high age have sufficient historical data and provide that company information to public, which reduce the information asymmetry. In addition to this, the firm asset is a popular proxy for the uncertainty of the company. As well as the firm age, the firm asset can imply the potential company in terms of production, investment, finance and profitability in the future. These factors allow companies to reduce the uncertainty in the future (Finkle, 1998). The potential investors can assess the IPO of large firms to reduce their risk. Prior studies report that the company with larger assets has the lower level of IPO underpricing (Megginson and Weiss, 1991, Ibbotson et al.,
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