Stock Underpricing: Causes, Strategies, and Market Efficiency
This paper examines stock underpricing as a deliberate strategy employed by underwriters during initial public offerings (IPOs). It surveys several explanations for underpricing, including legal risk reduction, competition among informed and uninformed investors, and uncertainty about liquidity and demand. Drawing on the contrasting IPO outcomes of Facebook and Twitter, the paper illustrates how underpricing and overpricing affect an organization's short- and long-term prospects. It also analyzes research by Krigman and Jeffus (2016) demonstrating that underpricing can serve as compensation for key institutional clients rather than as a purely market-driven phenomenon, raising questions about market efficiency and the role of client-provider relationships in IPO pricing decisions.
- Introduction to Stock Underpricing: Definitions and core reasons for IPO underpricing
- Underpricing as Strategy and Risk Management: Underpricing in competitive markets and monetary policy context
- Organizational Impact and IPO Outcomes: Facebook and Twitter: How underpricing affects organizations using real IPO examples
- Client Relationships and the Limits of Market Efficiency: Underpricing used to compensate institutional clients post-Facebook
- Conclusion: Summary of underpricing rationales and market efficiency implications
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What makes this paper effective
- Uses concrete, well-known case studies (Facebook and Twitter IPOs) to ground abstract financial concepts in recognizable real-world outcomes.
- Integrates multiple peer-reviewed sources to support each distinct rationale for underpricing, giving the argument layered, credible support.
- Moves logically from broad theoretical explanations to a specific empirical finding (Krigman and Jeffus, 2016), building toward a nuanced conclusion about the limits of financial theory.
Key academic technique demonstrated
The paper demonstrates effective use of comparative analysis: by contrasting the Facebook and Twitter IPOs, the author makes abstract pricing concepts concrete and evaluable. This technique allows the reader to see the direct consequences of underpricing versus overpricing without requiring technical financial knowledge, making the argument accessible while remaining analytically sound.
Structure breakdown
The paper opens with a multi-cause overview of underpricing, then contextualizes it within modern monetary policy conditions. The central section applies theory to the Facebook and Twitter cases, followed by a focused examination of the Krigman and Jeffus (2016) study on client-driven underpricing post-Facebook. A brief conclusion synthesizes the main rationales and their implications for market efficiency and organizational performance.
Underpricing can and does occur for numerous reasons. It can act as a type of insurance on the part of the underwriter: when a stock is overpriced at its initial public offering (IPO), legal suits may follow, as investors who end up holding heavily overpriced issues may have an incentive to sue the underwriter and/or the company directors for publishing misleading or incomplete information in the prospectus (Saunders, 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 — that is, better to be safe and leave a little money on the table than to overprice and face the consequences. This paper examines the uses of underpricing, 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 as an underwriter. However, market efficiency in today's environment — where markets are influenced 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 buyer of assets," underwriters might be more inclined to reconsider the likelihood of demand for the IPO when they price the underlying security (Joyce, Lasaosa, Stevens, & Tong, 2011).
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