Underpricing in IPOs

This report explores the concept of underpricing in initial public offerings (IPOs), providing a definition, examining various theories, and analyzing the IPOs of Aston Martin and Mind Gym. It also discusses the IPO process, its advantages and disadvantages, and the significance of IPOs in the financial markets.

Underpricing in initial
public offerings

Table of Contents
INTRODUCTION...........................................................................................................................1
TASK .............................................................................................................................................1
Definitions of Under pricing in context of IPOs:........................................................................1
Different theories around underpricing:......................................................................................1
Initial public offerings (IPO) process..........................................................................................3
CONCLUSION ...............................................................................................................................5
REFERENCES................................................................................................................................6
.........................................................................................................................................................7

INTRODUCTION
Initial public offerings (IPOs) come out when entities decide to enter into the equity
market to get funds for its business activities. In this process, companies offers its shares to
genearl public and public can apply to aquire the shares by taking prospectus of the company.
Generally, it is seen that IPOs are subjected to different anomalies such as underpricing and so
on. This report includes various aspects realting to underpricing in context of initial public
offerings (IPO) such as clear understanding of word underpricing, different theories relating to
underpricing etc. In this report, there are two companies is given which are Aston Martin and
Mind Gym and there is requiremnt to analysis the IPOs of these two company in context of
various explanations & theories by comparing the price changing from initial offer to the end of
first day of trading (Hanley and Hoberg, 2012).
TASK
Definitions of Under pricing in context of IPOs:
It means listing or issue of shares of a company by an initial public offering (IPO) at a
price which is less than its market price. In other hand, if the price offered to the general public is
less than its price at the time of first trade, then it shall be called as a underpricing. Generally, at
the time of IPOs, price happens to be under-priced for short time (temporary basis) but it shall
eventually increases as time passes (Aussenegg, 2015).
Different theories around underpricing:
There are various theories available in the field of IPO in context of short term
underpricing, these are discussed as under:
 As per winner's curse of Rock (1986), information asymmetry is main reason for
underpricing of initial public offerings (IPO). According to this theory,there are two types
of investors in the market; informed and uninformed investors and informed investors has
knowledge about the company's prospectus, fair value of its shares and other related
information. Accordingly, informed investors purchase this shares in a case when offer
price is low but in case of uninformed investors, they often acquire IPOs when there is
unfavourable condition exist (Hahn, Ligon and Rhodes, 2013).
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 As per model of Rock (1986), underpricing in Initial public offerings is due to ex ante
uncertainty. In such condition, investors has no knowledge about the value of company
and its performance in future and for this they can pay more to get information (Jain and
Padmavathi, 2012). This theory describes that there is positive relationship between
degree of uncertainty on share value and its underpricing i.e. if there is high degree of
uncertainty then value of share shall be under priced as high as degree of uncertainty.
 Allen and Faulhaber (1989) theory states that the issuer of the prospectus has a deep
knowledge about the market conditions and accordingly they issue company's prospectus
in favorable market condition and also issuer issue prospectus at a price which is less
than the fair market value. This is because, they think that due to underpricing of shares,
investors shall consider that company has enoygh fund to bear the cost of underpricing.
Therefore, usually prices of the initial public issue is under-priced (Khurshed and et. al.,
2014).
 According to Welch (1989), Underpn analysing the 2018 IPOs of Aston Martin and
Mind Gym? you should provide a clear definition of under-pricing and a clear
explanation of the reasons ricing is a good signal for the company to attract the investors
beacause according to this, investors like initial public offerings that has a price at less
than its fair value. Therefore, IPOs are genrally issued at under-priced (Bastı, Kuzey and
Delen, 2015).
 The model of Chemmanur (1993) tells that indiders of the company know verything
about the company. These insiders uses this information to ovecome the problem of
information asymmetric. Due to this, the insiders will be compensated by offering initial
public issues at a price which is less than fair valu (i.e. underpricing of IPOs). According
to this model, if funds has costly projects to do then it uses the underpricing to get funds
quickly to applied them in the projects and recover underpricing cost from these capital
projects. Thus, there is underpricing of IPOs to provide funding to profitable capiatl
projects (Katti and Phani, 2016).
 According to model of Aggarwal (2002), managers of company who create an
information momentum for IPOs shall analysis conduct research for creating information
momentum. These managers often start selling their stocks due to having knowledge of
company's internal knowledge. This model shows a positive relation between insiders
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retention of shares at the IPO and underpricing. The model predicts a positive
relationship between research coverage and IPO underpricing. This mean that after doing
research, managers conclude that if compny issue the IPO at a price less than fair value
then it should be beneficial for the general public to aquire these asset if company has a
stong future and this can be observed throuh reading about the company from various
sources such as information provided by the internet facilty and other sources
(Grammenos and Papapostolou, 2012).
Initial public offerings (IPO) process
 Have a trusted and reliable management team: - Organisation need to prepare proper
management team who can communicate with investors and their queries. Company need
to present clear organisation's vision and plans.
 Be ready with financial reporting system: - In the initial public offers, investors
required the disclosure of financial statements. Company need to ready with their
financial information so public can excess the data whenever they want. These financial
reports included balance sheet which the true position of the organisation. Income
statement help the investors to check company's profitability (Cornanic and Novak,
2013).
 Choose any investment banker: - Investor banker's also know by underwriter which
plays very important role in the IPO process. They provide assurance to the company and
find out the potential investors. They are like sales person for the company who sell their
shares to the public. There are some known underwriters such as Credit Suisse, Goldman
Sachs and Morgan.
 Write company's story: - Company need to their story with the objective of the
organisation which attract the public. Company present their vision, mission and goal of
the organisation (Jiang and et. al., 2014).
 Register with SEC: - After writing company's story, prospectus is ready to review.
Initial prospectus contain the all information regarding shares except offer price and date.
 Start your road show: - When company has compiled with SEC's comments and
recommendations after that company has to continued to meeting with prospective
investors. Company has to travelled and attend many more meetings, press conferences
and visits to city and particular areas for advertising of company but it will happen
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according to budget and there is provided merits of investments in their company. It is
also applied in marketing for attract more customers (Vakrman and Kristoufek, 2015).
 Price of IPO: -After completing the review process then produce a list of possible IPO
investors, the underwriters and board of directors of company to agree on a particular
value which is set by company for price per share of stock.
 Now, get ready to be publicly owned company: - Nothing is more exciting than going
public. After set price of stock IPO is closing on 4th day of business because the issuer
and selling stockholders will issue of the shares to their underwriters. These shares are
purchased by underwriters on 7% discount more or less. The issuer will still undergo
SEC quiet period that is 25 days and it will give broker deals time to approach and
deliver IPO sales materials to investors (Boone, Floros and Johnson, 2016).
Advantages of IPOs:
The essential advantage of opening IPO is the capacity to raise capital rapidly by
achieving an expansive number of financial specialists. An organization would then be able to
utilize that money to advance the business, be it as research, foundation, or extension. Also, by
issuing shares, more current, lesser-realized organizations can produce attention, in this manner
expanding their business openings. There's additionally the renown of being recorded on a
noteworthy stock trade to consider, which is a help for a few organizations that go the IPO
course. At long last, IPOs can enable developing organizations to draw in new ability by offering
advantages like investment opportunities.
Disadvantages of IPOs:
One noteworthy disadvantage of opening up to the world utilizing an IPO is the time and
cost of experiencing the procedure. It's normal for an IPO to take somewhere in the range of six
to nine months or more. Amid this time, the organization's supervisory crew is probably going to
be centred around that IPO, which could make different regions of the business endure.
Furthermore, it costs cash to proceed with an IPO, from budgetary administration and endorsing
expenses to documenting charges. Furthermore, when an organization opens up to the world, it
ends up subject to a large group of extra detailing and revelation necessities, all of which
likewise cost cash (Lowry, Michaely and Volkova, 2017).
Significance of IPO:
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The quantity of IPOs being issued is generally an indication of money markets' and
economy's well-being. Amid a retreat, IPOs drop since they do not merit the issue when share
costs are discouraged. At the point when the quantity of IPOs increment, it more often than not
implies the economy is returning once again to financial sanity (Miloud, 2014).
Overview of Aston Martin:
Aston Martin is a world famous luxury motor car brand and having approx 105 years of
business experience. By issuing IPO company wants to be the first British auto maker in London
Stock Exchange since 1980. IPO of company was approx £5.1bn. Company is objective was to
sell between 56,305,622 and 57,380,300 shares, 25% of the existing shares on offer, at a
marketed price range between £17.50-£22.5 per share giving a valuation range between £4.0bn
to £5.1bn but it had priced its shares at 19 pounds in its eagerly anticipated London stock market
debut, giving the luxury car maker a valuation of 4.33 billion pounds ($5.63 billion). Company
had not raised additional capital or issued any new shares, and the proceeds of the IPO has been
paid to existing shareholders. Aston Martin’s largest shareholders are Kuwaiti sovereign wealth
fund The Investment Dar (TID) and Italy’s Investindustrial, who own close to 40% of the
company (Zattoni and Judge, 2012).
CONCLUSION
From the above report it is concluded that investors like to acquire those companies
which shares has under-priced. Also further concluded that companies often issue their initial
public offerings at a price less than its fair value. There are various theories available which
supports the underpricing of the shares in company's benefits in long run and also beneficial to
provide funds to verious profitable capital projects. The certain information is provided by the
company to overcome the problem of infomartion asymmetric in case of issuing shares in genral
public through prospectus.
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REFERENCES
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Aussenegg, W., 2015. Privatization versus private sector initial public offerings in Poland.
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Katti, S. and Phani, B.V., 2016. Underpricing of initial public offerings: a literature review.
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Cornanic, A. and Novak, J., 2013. Signaling by underpricing the initial public offerings of
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