392 Part Four Financing Decisions and Market Efficiency
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the cost of underpricing may be outweighed in shareholders’ minds by the happy surprise
of finding that they are wealthier than they thought. eBay’s largest shareholder was Pierre
Omidyar, the founder and chairman, who retained his entire holding of 15.2 million shares.
The initial jump in the stock price from $18 to $47.375 added $447 million to Mr. Omidyar’s
wealth. This may well have pushed the cost of underpricing to the back of his mind.^25Hot New-Issue Periods
Figure 15.4 shows that the degree of underpricing fluctuates sharply from year to year. In
1999, around the peak of the dot.com boom, new issues raised $65 billion and the average
first-day return on IPOs was 70%. Nearly $37 billion was left on the table that year.^26 But, as
the number of new issues slumped, so did the amount of underpricing. By 2014 the new issue
market had recovered with 157 offerings and an average first-day return of 15.5%.
Some observers believe that these hot new-issue periods arise because investors are prone
to periods of excessive optimism and would-be issuers time their IPOs to coincide with these
periods. Other observers stress the fact that a fall in the cost of capital or an improvement in the
economic outlook may mean that a number of new or dormant projects suddenly become prof-
itable. At such times, many entrepreneurs rush to raise new cash to invest in these projects.^27(^25) T. Loughran and J. Ritter, “Why Don’t Issuers Get Upset about Leaving Money on the Table in IPOs?” Review of Financial Studies
15 (2002), pp. 413–443.
(^26) The “money left on the table” is the difference between the value placed by investors on the stocks and the amount that investors
paid for the stocks.
(^27) For examples of these explanations, see A. P. Ljungqvist, V. Nanda, and R. Singh, “Hot Markets, Investor Sentiment, and IPO Pric-
ing,” Journal of Business 79 (July 2006), pp. 1667–1702; and L. Pastor and P. Veronesi, “Rational IPO Waves,” Journal of Finance
60 (2005), pp. 1713–1757.
◗ FIGURE 15.4
IPO proceeds in the
United States and
average first-day
returns, 1990–2013.
Source: J. R. Ritter, “Initial
Public Offerings: Updated
Statistics,” May 9, 2014, bear.
cba.ufl.edu/ritter.
0
10
20
30
40
50
60
70
80
199019911992199319941995199619971998199920002001200220032004200520062007200820092010201120122013
Return, %
Issue proceeds, $ billions
15-3 Alternative Issue Procedures for IPOs
Table 15.2 summarizes the main steps involved in making an initial public offering of stock
in the United States. You can see that Marvin’s new issue was a typical IPO in almost every
respect. In particular most IPOs in the United States use the bookbuilding method in which
the underwriter builds a book of likely orders and uses this information to set the issue price.