General Evidence To Ipo Under-Pricing

During the 1980s, the market expected an average of 11% returns on the initial public offerings (IPOs) within the first week of opening, which subsequently almost reached up to 21% during the period of 1991-1999. During the magical period of 1999 – 2000, the returns were almost 66%.  These effects can be largely credited to the amendments in the composition of a number of listed companies appearing as public.

What is the most prominent reason behind the harsh under pricing of initial public offerings where the returns have been unexpectedly higher?

According to the statistics, the IPO under pricing had almost doubled from 7% to 16% from the 1980’s to the late 1990’s. In general, the increase in the under pricing can be pointed towards the previously concealed group troubles between underwriters and issuing firms.
Stating in other words, the problems between the two, that were initially not present on the main scene became of overriding importance during the 1999 – 2000. These two propositions are often referred to as the varying composition theory and the agency theory.
The first theory of varying composition is supported by the postulation that dicey and unsafe IPO’s will be obviously underpriced by more than less dicey IPO’s. If the percentage of IPOs that correspond to unsafe stocks swells up, then the average under pricing ought to increase (Ritter (1983)).
As a note, the number of IPO’s from the Information technology sector has risen up with time. Another significant point to note was that, there exists no proof about the companies which were appearing as public during the late eighties was actually older than those who went into the public sector during the nineties.
The average age of an issuing company was around 7 years during the 1980s and 8 years during the 1990s, before it came down to 5 years during 1999-2000 (“the internet bubble or the magical period”). An analogous outline holds for sales structure, that there was no secular inclination in the average sales of public companies.
In contrast to the late 1980’s, the IPOs which were administered by high profile investment banks / underwriters in the 1990’s, were more highly underpriced than IPO’s which were linked to inferior status under writers or investment institutions.
This phenomenon was explained as- since the underwriting in the IPO business became more profitable due to the augmented enthusiasm of firms to put down more money on the table. (Money on the table is defined as – the first-day price change (offer price to close) times the number of shares issued).
As a result the underwriters / investment institutions made more profit from the money that was left on the table with the help of a rent-seeking action of buy-side investors. Moreover the market investors are prepared to give higher rates to the underwriters in order to receive IPO allocations.
At the same time, the issuing companies are also ready to accept higher under pricing from high profile underwriters because of augmentation in the apparent significance of market analyst reporting and superior capital levels.
One more reason that has come into light about the causes of IPO under pricing is that the under writers actually want to under price the issue in spite of the gross spread profits that they sacrifice.
At the same the issuing firms most of the times do not try to bargain for a higher offer price when they are sure that the demand for the issue will be high enough. A number of firms went public which resulted in an obvious under pricing of IPO’s.
According to Lungqist and Wilhelm (2003) as stated in a paper, that the increase in the IPO under pricing during the period of 1996 to 2000, was mainly due to the increased sharing programs like – the friends and family share allotment programs.
Even more the number of shares that were owned by the company seniors like managers, CEO and venture capitalists had decreased by a significant amount, which offered fewer profits to them to stay away from harsh under pricing.
Lungqist and Wilhelm further advocate that ruthless under pricing of IPO’s is also a consequence of a blend of premeditated under pricing by the issuing firms, who often assume to observe it as a way of drawing market awareness, and essential under pricing in order to pull out information from probable investors about demand for the IPO.
In the year 2005, the European market had heaved up more money with the help of the initial public offerings (IPOs) and were able to create a center of attention for a large number of international IPOs as compared to the US exchanges.
This increase was due to the increment in the business activities at the London Stock Exchange and in particular to the AIM, which were accountable for more than 53% of the total IPO’s in the year 2005.
The London stock exchange has been the most active of the IPO world markets and as figures suggest, the IPO activity at the LSE is much higher than all the US markets. This paper makes an attempt to further study the under pricing in the London Stock Exchange (LSE) Main market and the AIM.
As the study suggests, the cost of raising IPO in the LSE is quite cheaper than on the US markets and there are some reasons that are evidence to this fact. London’s position in terms of measurable costs is similar to that of Euronext and Deutsche Boerse.
UNDER PRICING OF IPO – LONDON STOCK EXCHANGE
The capital trading markets all over the world are experiencing a new level of global integration as obstacles to the flow of international funds are being removed slowly. As a result, firms now possess high amounts of flexibility while listing and raising capital.
There are locations / markets that can actually prove to be quite cheaper for raising capital. This has given an opportunity to the companies as to select their own choice of trading market around the world keeping in mind, cost of raising capital, equity, debt and market advantages.
The decision of the firms to select a particular market depends upon varied issues like the market size, directness, level of expertise accessible in its financial centre, and the listing procedure involved.
Also, there exist several ways to float a company – the choices of which are highly affected by the size of the company, the risk involved, and the authoritarian planning and procedures in each country.  The most common of all the methods in the London Stock Exchange or the LSE are: offer for subscription, an open issue and a stock exchange opening.
The under pricing of IPO’s in the market refers to the extensive inspection that regardless of the scheme of entering into the market, the IPO’s be inclined to give considerable returns within days or weeks after the issue has been opened. Rilter (1985), Welch (1987), Ibotsen et al.
(1995), Dimson (1979), Buckland et al. (1981), Jenkins and Meyer (1988) point toward the average first day gains at the UK main market which varies from 9 % to 17%. According to Levis and Thomas (1995), during the period from 1985 to 1992, the LSE market had an average first day gains of 1.87% for a total of 106 IPO’s that was issues during the period.