Initial Public Offering Essay Example

the pre-selling period, which can be used to help price the issue. The bandwagon hypothesis suggests that the IPO market may be subject to a bandwagon effect, whereby potential investors not only consider their own information about a new issue but also the actions of other investors. Therefore, if an investor sees that no one else wants to buy, they may decide not to buy despite favorable information.

The reason for underpricing an issue may be to encourage initial investors and create a cascade effect for subsequent investors to buy regardless of their personal knowledge. This is a prevention technique to deter law suits. Ritter (1998) explains that underpricing an IPO helps to reduce future lawsuits due to the Securities Act of 1933 which holds all signing prospectus participants accountable for material omissions. Essentially, underpricing may be a costly measure in avoiding potential lawsuits.

The phenomenon of underpricing in IPOs can be explained by two main theories. The first is the ownership dispersion hypothesis, which suggests that issuers intentionally underprice their shares to increase demand and attract a larger number of small shareholders. This not only increases market liquidity but also makes it harder for external parties to challenge management. The second theory is the Prospect theory, which argues that issuers are not overly concerned with underpricing if they are pleasantly surprised by the amount they can raise in the IPO, leading to the existence of underpricing. Additionally, Ritter (1998) has identified three theories that attempt to explain the underperformance of IPOs.

The theory of the Divergence of Opinion hypothesis posits that in cases of uncertain value regarding an IPO, investors with the highest levels of optimism will

be the purchasers. In this instance, the valuations of these optimistic investors will exceed those of their counterparts who hold more pessimistic attitudes. However, over time, as more information emerges, the gap in opinion between the two groups will lessen, ultimately leading to a drop in market price.

The Impresario hypothesis suggests that investment bankers, dubbed "impresarios," artificially create excess demand for IPOs to make them appear as events, similar to concert promoters. As a result, the IPO market is prone to fades, and underpricing of IPOs is common. This hypothesis also predicts that companies with initially high returns would eventually have low subsequent returns, although momentum effects reign in the first six months. The Windows of Opportunity hypothesis, on the other hand, posits that fluctuations in the volume of IPOs are typical due to cyclical business activity.

The windows of opportunity hypothesis posits that firms which go public during high volume periods are more likely to be overvalued in comparison to other IPOs. It is believed that these high-volume periods will ultimately result in the lowest returns. A comprehensive assessment of a company's decision-making process by financial planners is necessary to determine the optimal approach for raising long-term funds, given that both private placements and IPOs are components of a company's financial planning strategy.

To ensure effective operations, it is crucial to choose a competent investment banker who can assist in obtaining necessary funding. Decision criteria should be based on established standards to identify the most qualified banker. Inexperienced companies new to the stock market often require professional support from investment institutions like banks. To protect against under-subscription risks, organizations typically sell shares to

financial institutions and place offers under their control. Such intermediary organizations bear associated gains or losses.

Initial Public Offering is used by business organizations to obtain capital from the public via the stock market for the first time, whereas Private Placement enables the government to transfer ownership of public enterprises to private firms while still retaining ownership.

One way to improve the management of public enterprises and minimize wastage is through private placement. This method involves engaging another organization for investors to purchase shares in the company, acting as a safeguard for the initial public offering (IPO). Private placement is commonly used by large-scale organizations, including public enterprises, to attract investment from private investors.

Private placement and Initial Public Offering (IPO) are very distinct. Private placement refers to private organizations with weaker capitalization seeking additional investment from private individuals, while IPO publicly offers shares for the first time through the stock market, soliciting public investment. Private placement is not open to the public at large, and their shares are not quoted in the stock market. In some cases, a private organization may use private placement before going public by contacting prominent private individuals to invest in their business operations.

Private placement is a method used by many private firms to raise shares before going public through a Initial Public Offering (IPO), since the offer is not quoted in the stock market and certain restrictions limit the volume of funds that can be raised. Nonetheless, the authorized capital of a quoted company is set at a particular figure, which can be adjusted and increased periodically.