New issue underpricing

This week, one of the topics we have been looking at IPO stock issuance and the associated costs. Firms going to public markets through stock issuance incur a variety of costs, some are clear cut, such as direct fees paid for legal and accounting fees. There are also indirect internal costs such as the allocation of costs for management time spent on the “deal”. There are direct costs for underwriter fees (this is the “spread”, the difference in the initial IPO price and the price paid to the firm by the underwriters for the stock). An indirect cost that is a little harder to understand is “underpricing”. That is the difference between what the stock rises to on the first day (or the first bit of trading) and the initial listing price.

Attached is an article from late 1999 that provides a pretty good explanation of the underpricing and why it is a factor in IPOs. While this article is from 20 years ago, the practice is still in effect and is a real part of the IPO market.

Do you agree with the viewpoints expressed in the article? Do you have experience with IPOs  (either personally or from news reports) that are in line with this viewpoint? Research news and/or academic articles that may provide additional support for explaining changes in a stock’s price during the first trading day. These articles may either support or disagree with the viewpoint expressed in the article. You may want to find articles that describe specific IPOs in the past few years and the changes in price during the first day(s) of trading. If you are looking for academic articles, the researchers cited in the WSJ article (Loughran and Ritter) are certainly experts in this field.

Questions (minimum of 250 words per question)