The Risk of Setting a Fixed-Offer Price and Underpricing from the Perspective of Book-Building Underwriters and Best-Efforts Issuers
Posted: 8 Mar 2011
Date Written: March 7, 2011
Initial uncertainty about the value of IPOs combined with costs of over and underpricing make it risky to set fixed-offer prices. Assuming issuers seek to maximize proceeds net of the spread, we show it is optimal for book-building underwriters and best-efforts issuers to set the fixed-offer price below the expected value of the new shares, yielding underpricing consistent with observed levels. The results provide a more comprehensive view of underpricing, reflecting the perspectives of underwriters and best-efforts issuers, along with straightforward explanations for why underpricing persists when investors expect price support and the observed correlation between IPO uncertainty and underpricing.
Keywords: initial public offering, IPO, underpricing
JEL Classification: G24
Suggested Citation: Suggested Citation