Ch. 7: IPO Underpricing 381
Within the available space, it is impossible to do justice to all theoretical and em-
pirical contributions. Therefore, I have focused my discussion on the main “milestone”
papers that have shaped the way I think about this literature. Inevitably, this reflects my
tastes. Notable surveys embodying somewhat different tastes includeRitter and Welch
(2002)andRitter (2003).
- Evidence of underpricing
Underpricing is estimated as the percentage difference between the price at which the
IPO shares were sold to investors (the offer price) and the price at which the shares
subsequently trade in the market. In well-developed capital markets and in the absence
of restrictions on how much prices are allowed to fluctuated by from day to day, the
full extent of underpricing is evident fairly quickly, certainly by the end of the first day
of trading, and so most studies use the first-day closing price when computing initial
underpricing returns. Using later prices, say at the end of the first week of trading,
typically makes little difference.
In less developed capital markets, or in the presence of ‘daily volatility limits’ restrict-
ing price fluctuations, aftermarket prices may take some time before they equilibrate
supply and demand. The Athens Stock Exchange, for instance, specified daily volatility
limits of plus or minus eight percent during the 1990s. Thus for many underpriced IPOs,
the first-day return would equal 8% by force of regulation. In such cases, it makes more
sense to measure underpricing over a longer window.
In the U.S. and increasingly in Europe, the offer price is set just days (or even more
typically, hours) before trading on the stock market begins. This means that market
movements between pricing and trading are negligible and so usually ignored. But in
some countries (for instance, Taiwan and Finland), there are substantial delays between
pricing and trading, and so it makes sense to adjust the estimate of underpricing for
interim market movements.
As an alternative to computing percentage initial returns, underpricing can also be
measured as the (dollar) amount of ‘money left on the table’. This is defined as the
difference between the aftermarket trading price and the offer price, multiplied by the
number of shares sold at the IPO. The implicit assumption in this calculation is that
shares sold at the offer price could have been sold at the aftermarket trading price
instead—that is, that aftermarket demand is price-inelastic.
Figures 1–3provide evidence of underpricing in a range of countries. The U.S. prob-
ably has the most active IPO market in the world, by number of companies going public
and by the aggregate amount of capital raised. Over long periods of time, underpric-
ing in the U.S. averages between 10 and 20 percent, but asFigure 1shows, there
is a substantial degree of variation over time. There are occasional periods when the
average IPO isoverpriced, and there are (more frequent) periods when waves of com-
panies go public at quite substantial discounts to their aftermarket trading value. In