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Assignment I

- Advanced Corporate Finance –

Done by:
Nada Lahrech
Assya Chraibi
Naima Fakir

February, 21st 2011

The initial under pricing of the IPO is the difference between the price obtained by the shares at the close of the first trading day and the price of the offer. behavioral finance offers several possible explanations for the under- pricing phenomenon. and each has gained some empirical support. The IPO price is agreed upon and it may or may not reflect the actual worth of the company. This intentional under-pricing will reduce the chances that the issue will be undersubscribed. expand operations. However. This is also known as the initial under pricing practice of investment bankers. younger companies seeking the capital to expand. but can also be done by large privately owned companies looking to become publicly traded. just to start up their business. or in many cases. The pricing of a company’s stock in the IPO is greatly dependent on which of these entities possess perfect information about the issuing firm. The latter must rely on signaling to infer the true value of a stock and must give the more informed entities incentive to provided accurate data about the firm’s true value. dictated by supply and demand. IPOs are often issued by smaller. If the offering is undersubscribed. and which entities must rely on the others to report the information to them. Without the ability to hedge the risk of holding the issuing firm’s stock. then the large gain reflects the fact that the IPO issuing price agreed upon by the underwriter and the firm making the offer is under the actual value of the firm. One of the best ways that newer and less established companies have found to raise quick capital is to make a stock offering. there is clear and unambiguous evidence that investment bankers systematically under price IPOs in order to raise capital and attract a significant number of investors. If we assume that the market price of the stock. Aversion to loss may influence the pricing behavior of IPOs by the underwriting firm. Several theoretical models have been developed. underwriters (investment bankers) are risk averse. adjusting for the market return in that same period. Usually. is representative of the company’s value. it is . Perhaps the most obvious reason that underwriters choose to systematically under-price new stock is to make it easier for them to market the issue.All firms need to raise capital at one time or another to finance new projects. On the other hand. resulting in capital loss to the underwriters. the underwriter may be forced to reduce his inventory of shares.

Therefore. they are not disturbed by the IPO under pricing since their gain from the sale of their shares when going public is significantly high relative to the losses from the under pricing. Issuers irrationally aggregate the two producing an increase in their wealth.difficult to shift the risk to another party through derivatives. In the same optic. . even if issuers are loss averse. there is strong incentive for the underwriter to under price the IPO.

Han. References Adams.(December 2004). 4.(April 2008). B. .Prospects theory and its application in finance. B. M. Journal of Business and Economics Research . and Thornton.(6). and Hsu J. IPO Pricing Phenomena: Empirical Evidence Of Behavioral Biases.