IPO Underpricing, Issue Mechanisms, and Size

This paper studies the pricing of IPOs in the Indian context. The paper also examines whether the introduction of Bookbuilding has an impact on IPO pricing. The results suggest that IPOs are underpriced. The results also suggest that bookbuilt IPOs show less underpricing than fixed price issues. A more detailed study suggests that this has to do more with the size of the issue than the issue process. A model describing the IPO process in the presence of asymmetric information and heterogenous beliefs is presented. This model suggests that IPO underpricing can be avoided in the presence of selectively informed investors. The model includes the choices on signaling cost, homogenous and heterogeneous beliefs among the investors, entrepreneur holding dilution and issue size that exist for a firm while coming for an IPO. The model suggests that a larger amount of money is left on the table if the entrepreneur holds a lesser amount with herself post IPO. Despite asymmetric information, the high value firm can place an issue without leaving money on the table. The model also suggests that IPO underpricing is unavoidable in a market with information asymmetry and homogenous beliefs among investors. The models predict that underpricing is more severe in the case of smaller issue sizes. This is consistent with the empirical findings.