Search and uncertainty: Determinants of the degree of underpricing of initial public offerings
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This paper reexamines the issue of IPO underpricing. The behavior of each of the three decision makers involved with an IPO, the original shareholders (the firm), the underwriter, and the prospective shareholders, is modeled explicitly. Using basic maximizing behavior in the present of uncertainty, it is shown that the institutional constraint that prevents the underwriter from adjusting the going-public price in the face of under or over subscription results in expected underpricing. In addition, the analysis identifies the factors that determine the degree of underpricing. Thus, it provides a unified framework within which existing empirical results are easily and continuously interpreted.
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