Question

From 1999 to 2017, the average IPO rose by 19.2% in its first day of trading. In 2000, 115 deals doubled in price on the first day. What factors might contribute to the huge 1^st-day returns on IPOs? Some critics of the current IPO system claim that underwriters may knowingly underprice an issue. Why might they do this? Why might issuing companies accept lower IPO prices? What impact do institutional investors have on IPO pricing?

Answer 1

1.Ans:-1.significant amount of hype that surrounds new issues and underpricing by underwriters. ("tech bubble")
2. underwriters may intentionally underprice issues.

2.Ans:-to increase their own profits and make shares easier to sell.

3.Ans:-1. if it draws attention to their firm which may make it easier raise funds through add additional share offerings at a later date.

2. only way for a young firm to raise the capital needed for growth.

4.Ans:-Institutional investors tend to receive most of the shares of IPOs that are in demand ('good IPOs'.) Their concern about overpaying for shares may contribute to underpricing.

Answer 2

The huge first-day returns on IPOs can be influenced by several factors:

1. Investor Enthusiasm: In some cases, there is high investor enthusiasm and demand for the IPO, leading to a surge in the stock price on the first day of trading. This can be driven by positive market sentiment, expectations of future growth, and the desire to participate in the early stages of a potentially successful company.

2. Limited Supply: IPOs typically offer a limited number of shares to the public, which can create scarcity and drive up demand, leading to higher prices on the first day of trading.

3. Underpricing: Underpricing is a deliberate strategy where the IPO is priced below its actual value. This encourages investors to buy shares, as they expect immediate gains. Underpricing can attract more investors and create a positive image for the issuing company.

4. Hype and Media Attention: Companies that receive significant media attention and hype leading up to their IPO may experience a higher demand for their shares, contributing to higher first-day returns.

Regarding underpricing by underwriters and why issuing companies might accept lower IPO prices:

1. Underwriters' Incentives: Underwriters, who are responsible for selling the IPO shares to investors, may have incentives to underprice the offering. Higher demand for the IPO shares means more commission for the underwriters, which motivates them to set a lower initial price.

2. Attracting Investors: Underpricing can attract more investors, including institutional investors, who prefer to invest in IPOs with strong initial returns. This can result in a more successful IPO and a positive reputation for the underwriters.

3. Building Positive Market Sentiment: Issuing companies may accept lower IPO prices to create positive market sentiment and generate excitement among investors. A successful IPO can lead to increased interest from investors in the company's future growth prospects.

The impact of institutional investors on IPO pricing:

1. Influence on Demand: Institutional investors, such as mutual funds and pension funds, often have significant capital to invest. Their participation in an IPO can increase overall demand for shares, which may contribute to higher first-day returns.

2. Reputation: Companies often seek investment from reputable institutional investors. A successful IPO with support from institutional investors can signal the company's strength and potential for growth, enhancing its reputation in the market.

3. Long-Term Holders: Institutional investors typically take a long-term approach to investing. Their presence in an IPO can provide stability to the company's shareholder base, reducing the risk of excessive volatility in the stock price.

In conclusion, factors such as investor enthusiasm, limited supply, underpricing, and media attention can contribute to the significant first-day returns on IPOs. Underwriters may underprice IPOs to attract more investors and generate higher demand, while issuing companies may accept lower IPO prices to build positive market sentiment and attract reputable institutional investors. The participation of institutional investors can also impact IPO pricing, both in terms of demand and long-term stability.

Answer 3

The huge first-day returns on IPOs, such as the average rise of 19.2% and 115 deals doubling in price in 2000, can be attributed to various factors:

1. Investor Enthusiasm: Investors often show excitement and enthusiasm for newly listed companies, especially if the company is perceived as having strong growth potential or is in a high-demand industry.

2. Limited Supply: IPOs usually have limited shares available for public trading, and if the demand from investors exceeds the supply, it can drive up the price.

3. Information Asymmetry: Prior to the IPO, information about the company might be limited, making it challenging for investors to accurately assess the company's value. This uncertainty can lead to higher volatility and potentially higher first-day returns.

4. Irrational Exuberance: Investor behavior can sometimes be influenced by emotions and speculative tendencies, leading to inflated prices in the initial excitement of the IPO.

Regarding underpricing by underwriters and the acceptance of lower IPO prices by issuing companies:

1. Underpricing by Underwriters: Underwriters may knowingly underprice an IPO to create a positive impression and attract demand from investors. This strategy can help ensure a successful IPO and generate positive buzz for future offerings. Underpricing can also lead to a "pop" on the first day, making investors feel they made a good investment.

2. Issuing Companies Accepting Lower IPO Prices: Companies might accept lower IPO prices to ensure a successful launch and to attract a broader investor base. A lower IPO price can create immediate demand and encourage more investors to buy into the offering.

Institutional investors also play a significant role in IPO pricing:

1. Demand from Institutional Investors: Institutional investors, such as mutual funds, pension funds, and hedge funds, often participate in IPOs due to the large sums of money they manage. Their demand for shares can drive up the IPO price.

2. Stabilization Efforts: Underwriters and institutional investors might engage in stabilization efforts during the initial trading days to support the stock price if it starts to decline. This can help maintain investor confidence and reduce extreme volatility.

3. Book Building Process: Institutional investors often participate in the book-building process, where they indicate their willingness to buy shares at different price levels. The book-building process helps determine the IPO price by gauging investor interest.

Overall, the combination of investor enthusiasm, limited supply, information asymmetry, and irrational exuberance can lead to substantial first-day returns on IPOs. Underpricing by underwriters and the acceptance of lower IPO prices by issuing companies are strategies to ensure a successful offering, while institutional investors play a significant role in influencing IPO pricing through their demand and participation in the process.