Explain why IPOs are usually underpriced?

Explain why IPOs are usually underpriced? 

Ans. IPO underpricing is the increase in stock value from the initial offering price to the first-day closing price. IPOs are usually underpriced due to following reasons: 

(a) Many believe that underpriced IPOs leave money on the table for corporations, but some believe that underpricing is inevitable. 

(b) Investors state that underpricing signals high interest to the market which increases the demand. On the other hand, overpriced stocks will drop long-term as the price stabilizes so under pricing may keep the issuers safe from investor litigation. 

(c) It is believed that IPOs are often underpriced because of concerns relating to liquidity and uncertainty about the level at which the stock will trade. The less liquid and less predictable the shares are, the more underpriced they will have to be in order to compensate investors for the risk they are taking. 

(d) Because an IPO’s issuer tends to know more about the value of the shares than the investor, a company must under price its stock to encourage investors to participate in the IPO.