Stock Underpricing and Market Efficiency
Underpricing can and does occur for numerous reasons. It can act as a type of insurance on the part of the underwriter, as when a stock is overpriced at its IPO, legal suits may follow: investors who end up holding heavily overpriced issues may well have an incentive to sue the underwriter and/or the company directors for publishing misleading or incomplete information in the prospectus (Saudners, 1990, p. 7). There is also the theory that underpricing is a way to compete in the IPO market, where “some investors are viewed as informed while a larger group is viewed as uninformed” (Saunders, 1990, p. 7). Other explanations include uncertainty about liquidity and/or demand: underpricing is a way to hedge against this uncertainty—i.e., better to be safe (and leave a little money on the table) than sorry (and overprice). This paper will examine the uses of underpicing, its impact on organizations, and why underwriters might adopt it as a strategy.
Underpricing can be seen as a strategy in a competitive market; and it can also be seen as a way to safeguard oneself (if one is an underwriter). However, market efficiency in today’s day and age, where markets are impacted by unconventional monetary policy on the part of central governments, is not quite what it used to be. With central banks acting as “a significant...
However, if the demand is kept up, the organization could follow the IPO with another offering at a later point in the future. Few organizations are going to complain that their stock is too high in value: that value can always be leveraged in a number of ways to benefit the company and strengthen its operations. The IPO is but one step in the process of building a company’s future and underpricing certainly has much more appeal than overpricing. A stock that is overpriced and tanks upon its IPO may not ever recover. One can compare IPO’s if one likes: Twitter and Facebook, for example, serve as good illustrations of IPOs that are overpriced and underpriced. Twitter’s initial offering was at $26. It dipped and soared and dipped and soared again as investors struggled to find its real value in the months following the IPO. Finally it fell below its IPO price and today remains under $20. Facebook on the other hand…
