Although most IPOs are underpriced, the level of underpricing varies across IPOs with different issue characteristics, allocation mechanisms, underwriter reputation, and general financial market conditions. For example, the level of underpricing is reduced for larger IPOs, those underwritten by prestigious investment banks, firms with a longer operating history or more experienced insiders on the board, and those which intend to use the proceeds to repay debt. On the other hand, technology firms, firms backed by venture capital, firms with negative earnings prior to the IPO, or firms that went public during a bull market experience greater underpricing.
There is no a simple theoretical framework that could explain the factors that caused underpricing. Various theoretical models have been developed to explain the initial underpricing of stocks.
One of the most prominent explanation and also with the most empirical support is that IPO underpricing occurs due to the presence of asymmetric information between certain parties in an IPO transaction (explaining the short and long term IPO anomalies in US by RD). The issuing firm, the bank underwriting and marketing the deal, and the investors buying the stock are the key parties to an IPO transaction (Literature 2 pg13). There are two asymmetric models: Winner’s Curse & Principal-Agent Theory and Costly Monitoring.
Winner’s Curse Hypothesis
One of the asymmetric models of underpricing is the winner’s curse hypothesis developed by Rock (1986), which is an application of Akerlof’s (1970) lemons problem (Literature 2 pg13). Lemon problems:footnote. Underpricing arise due to the presence of asymmetric information between informed and uninformed investors. The informed investors can access...
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...tics such as the reputation of underwriters, choice of auditors, board of directors, company’s operating performance, international image of the company, and so on (underpricing in Mauritius).
Ownership Dispersion Hypothesis
Ownership dispersion hypothesis explains that underpricing is used to insure oversubscription of the shares issues. Booth and Chua (1996) and Brennan and Franks (1997) argue that firms have the incentive to underprice shares with the aim to create a diffuse ownership base and improve market liquidity of their shares. Thus ownership structure increases the difficulty for outsiders to challenge the board of management (Mai, T.L. 2011).
Underpriced IPOs generate excess demand and create a large number of small shareholders, this is important because high public participation in the company IPO create barriers on the challenge from outsiders.
Grand Metropolitan PLC is the world’s largest wine and spirits seller. It mainly operated in London, USA. In 1991, it beats market expectation with a 4.8% increase in pretax profits, and the company Chairman stated that company’s goal “to constantly improve on”. Despite the great performance in the world recession in 1991, the price of GrandMet shares was 10% below the average price/earnings ratio of the companies in the Standard & Poor’s 500 index. And more important, rumors had that GrandMet, valued at more than $14 billion in the stock market, maybe a takeover target. The management dilemma is to understand why the company’s stock is traded below of what considered being the right price and whether the company is truly being undervalued by the market or there are consistent issues with negative NPV projects and lines of businesses.
Dey, A. (2010). The Chilling Effect of Sarbanes-Oxley: A Discussion of Sarbanes-Oxley and Corporate Risk-Taking. Journal of Accounting And Economics, 49(1-2), 53-57. doi:http://proxy.ulib.csuohio.edu:2279/10.1016/j.jacceco.2009.06.003
The process of doing this cased the company to ask for help from other competitors about the exact price to offer in the market. Investors knew that the price might be among 22 to 24 per share. However, the JetBlue noticed that the IPO demand is anticipated to be more than 5.5 million. Thus, the management requested to increase its price to 25-26, this would make the management concerned to convince the shareholders that the higher price improve the company in the market. Furthermore, the company was scared if this strategy would hurt sales in future. They should decide if the higher price would improve company technique in stock
holds a large share and the action from each one may have a great affect on the
Is The Tyranny Of Shareholder Value Finally Ending? N.p., n.d. Web. The Web.
In contrast , the shareholder theory organisations or organisation's decision-makers only have the responsibility to their shareholders by increasing the organisation profits and should only make the decisions to increase as much as possib...
This separation between ownership and managerial control in this instance can be problematic as the principal and the agents have different interests and goals. In a large publicly traded corporation such as NOL/APL, shareholders (principals) lack direct control when the CEOs (agents) make decisions t...
Having a low P/E ratio with respect to the rest of the market, and the replacement cost of the firm being greater than its book value (argument 3), there is a good chance that the current stock price and the proposed offering price are too low. Although long-term debt is a better financing choice, a few of the drawbacks are pointed out. Debt holders claim profit before equity. holders, so the chances that profits may be lower than expected. increases risk to equity, may reduce or impede stock value. However, the snares are still a bit snare.
Investor psychology and security market under- and overreactions, Journal of Finance, 53, No. 1. 6, pp. 58-78. 1839 - 1885 - 1885. i.e. a. Burton G. Malkiel, 2003. The Efficient Market Hypothesis and Its Critics, Journal of Economic Perspectives, Vol.
Initial Public Offerings (IPOs) are common ways for small companies to grow and expand by increasing their availability of capital. The Initial Public Offering started seeing a strong increase in popularity in the late 1990's. As a result of the growing popularity resulting in the dot com explosion, the term "IPO" became a household name. In order to understand how IPOs work, its best to first know how IPOs are created.
Jensen, M.C and Meckling, W.H (1976). Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics, October, 1976, V. 3, No. 4, pp. 305-360. Available on: http://www.sfu.ca/~wainwrig/Econ400/jensen-meckling.pdf. [Accessed on 20th April 2014].
There is a sense of complexity today that has led many to believe the individual investor has little chance of competing with professional brokers and investment firms. However, Malkiel states this is a major misconception as he explains in his book “A Random Walk Down Wall Street”. What does a random walk mean? The random walk means in terms of the stock market that, “short term changes in stock prices cannot be predicted”. So how does a rational investor determine which stocks to purchase to maximize returns? Chapter 1 begins by defining and determining the difference in investing and speculating. Investing defined by Malkiel is the method of “purchasing assets to gain profit in the form of reasonably predictable income or appreciation over the long term”. Speculating in a sense is predicting, but without sufficient data to support any kind of conclusion. What is investing? Investing in its simplest form is the expectation to receive greater value in the future than you have today by saving income rather than spending. For example a savings account will earn a particular interest rate as will a corporate bond. Investment returns therefore depend on the allocation of funds and future events. Traditionally there have been two approaches used by the investment community to determine asset valuation: “the firm-foundation theory” and the “castle in the air theory”. The firm foundation theory argues that each investment instrument has something called intrinsic value, which can be determined analyzing securities present conditions and future growth. The basis of this theory is to buy securities when they are temporarily undervalued and sell them when they are temporarily overvalued in comparison to there intrinsic value One of the main variables used in this theory is dividend income. A stocks intrinsic value is said to be “equal to the present value of all its future dividends”. This is done using a method called discounting. Another variable to consider is the growth rate of the dividends. The greater the growth rate the more valuable the stock. However it is difficult to determine how long growth rates will last. Other factors are risk and interest rates, which will be discussed later. Warren Buffet, the great investor of our time, used this technique in making his fortune.
The essentials of IPOing in Japan are the same as they in the U.S. A company must select an underwriter to take charge of their IPO, that underwriter will then oversee the pricing, quantity, and actual sale of the stock. Once the sale is complete the proceeds will be transferred to the issuer. Stock listed on Japanese exchanges are divided into sections. The first two sections make up what are called the “Main Markets”, this is where the leading large and second tier Japanese and foreign companies are listed. The first of the two sections is especially view as top market for its size, liquidity, and the volume of foreign investors (Japan Exchange Group), while the second is for medium sized companies. The third section is called the Market of The High-growth and Emerging Stocks or (MOTHERS), a trading market for companies with high growth potential. What
There has been a drive towards corporate governance which has been driven by a greater need for shareholder protection. If investors feel well cushioned then there is a higher chance that t...
than we can assume that the financial position of the company is not sound. This also indicates that there is over trading.