Chapter 30 Initial public offerings

Abstract

Because initial public offerings (IPO) involve the sale of securities in closely-held firms in which some of the existing shareholders may possessnonpublic information, some of the classic problems caused by asymmetric information may be present. This chapter describes some of the mechanisms that are used in practice to overcome the problems created by information asymmetries. Evidence is presented in the chapter on three anomalies associated with IPOs: (i) new issue underpricing, (ii) cycles in the extent of underpricing, and (iii) long-run underperformance. These patterns have generated a large empirical literature.Various theories that have been advanced to explain these patterns are also discussed in the chapter. In some respects, the poor performance of IPOs in the long run makes the new issues underpricing phenomenon even more of a puzzle. Whether or not IPOs underperform in the long run, the question of why issuers set their IPO price at a level that is lower on average than the market price at the end of the first day has generated a large literature. While no one model can provide a definitive explanation of these anomalies, collectively the theories can account for many of the patterns that are observed.

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