Why would an issuer underprice its shares in an IPO?  

Companies going public often seem to leave money on the table. When IPO shares start trading, the market price is often higher than the IPO price by 10%, 20%, or even more. This “IPO pop” suggests that companies could have sold their shares for more money. So why don’t they?

In this note, I summarize some of the potential reasons why companies appear to underprice their IPO shares:

For detailed surveys of the academic literature on IPO (under)pricing, see Ritter and Welch (2002), Ljungqvist (2007), and Lowry, Michaely, and Volkova (2017).

Several explanations for IPO underpricing are based on a situation where different IPO participants possess different information; underpricing acts as compensation for IPO investors in response to these information differences. In Rock’s (1986) model of the IPO market, underpricing pays for the participation of uninformed investors, whose money is needed to fully sell the IPO shares. In the model, some potential IPO investors know more than others about the value of the IPO shares. These “informed” investors will avoid IPOs where the shares are priced too high relative to their true value, leaving the remaining “uninformed” investors to buy all the shares for a price that is too high. The uninformed investors face a winner's curse: they get more shares precisely in the bad deals that informed investors avoided. On average, underpricing makes up for this winner’s curse so that uninformed investors still want to participate in the IPO market.

Alternatively, underpricing may be the price of getting investors to reveal what they know. In Benveniste and Spindt’s (1989) model of IPO pricing and allocations, investors know things about the issuer’s value that the underwriter does not. To set the IPO price, the underwriter needs honest feedback from investors about what the IPO stock is worth, but investors want to keep the IPO price low. The underwriter essentially buys the honest feedback of investors by discounting the price when investors reveal their high valuations. Despite the underpriced IPO, the issuer still benefits because honest feedback leads to a higher IPO price than if investors had hidden their positive information.

Relatedly, underpricing may pay for investors’ cost of evaluating an issuer (i.e., due diligence). Sherman and Titman (2002) assume that collecting information about the IPO issuer is costly; investors will only spend time, effort, and money on due diligence if they can profit from underpriced IPO shares. More investors doing due diligence means better pricing and more money for the issuer, but it also requires more underpricing to compensate all of them. These information-based theories—Rock (1986), Benveniste and Spindt (1989), and Sherman and Titman (2002)—all suggest that underpricing is a necessary cost of the IPO process, not a mistake or market failure.

Underpricing may also reflect the cost of the issuer choosing its preferred shareholders rather than those willing to pay the most. Companies might want long-term investors who share management’s vision (Greifeld and Levine, 2025), or conversely, many small shareholders who won’t challenge management’s decisions (Brennan and Franks, 1997). By excluding investors willing to pay higher prices, issuers essentially pay for their ideal shareholder base through underpricing. For example, Coupang Inc. shares opened for trading 81% above the IPO price after the company allocated 80% of its IPO shares to a “handpicked” group of 25 investors (Tse, 2021). Similarly, Figma Inc. lowered its IPO price to attract certain long-term institutional shareholders, after which the stock popped by a massive 250% (Hughes, 2025).

Issuers may also underprice their IPO shares to reduce the risk of large stock price declines in the future. By setting a lower IPO price, the company creates a buffer to help keep the market price above the IPO price. While underpricing is costly, keeping the market price above the IPO price has at least two benefits. First, it reduces both the probability and potential damages from IPO-related shareholder lawsuits (Lowry and Shu, 2002). Second, as one venture capital partner noted, large stock price drops have a huge negative impact on employee morale, and CEOs want to avoid that. In both cases, underpricing acts as insurance; companies accept lower IPO proceeds to avoid other future costs.

According to some market observers with a contrarian perspective, the IPO pop may look like substantial underpricing when substantial underpricing does not exist. When comparing the IPO price to the initial market price, there is an important factor that is often overlooked: share quantity. The market price is initially based on the trading of only 10% of the IPO shares, on average (Henry and O’Brien, 2025). However, the issuer wants to sell 100% of the IPO shares, all at once, for a single price. Because of the larger share quantity in the IPO, the price needs to be lower in order to attract enough willing buyers for all the shares. Consider concert tickets as an analogy, and imagine all seats have the same view. If the price is high, then only a few people will want to buy, the “superfans.” If the price is low, then you can sell more seats to a broader audience. If only a small fraction of the venue’s seats are available to buy at market pricing, then the price ends up being determined by the demand of the most enthusiastic buyers. But suppose you wanted to sell all the venue’s seats at once. In that case, the price would need to be lower to entice a broad enough audience. The same logic applies to IPOs when comparing the initial market price to the IPO price. As Rampell and Kupor (2020), Levine (2021), and Henry and O’Brien (2025) argue, the IPO pop occurs in large part due to these supply-and-demand factors rather than deliberately setting an IPO price below investors’ willingness to pay.

These various theories, along with many others that were not mentioned here, show that IPO underpricing is a complex phenomenon with multiple potential causes. Rather than representing a simple market inefficiency, underpricing may serve one or more important economic functions in the IPO process, although the relative importance of each explanation continues to be debated. The appearance of billions of dollars of money left on the table and the variety of potential explanations explain why IPO pops are such a hot topic in the financial press and in academic research.


REFERENCES

 

Benveniste, L. M., & Spindt, P. A. (1989). How investment bankers determine the offer price and allocation of new issues. Journal of Financial Economics, 24(2), 343-361.

 

Brennan, M. J., & Franks, J. (1997). Underpricing, ownership and control in initial public offerings of equity securities in the UK. Journal of Financial Economics, 45(3), 391-413.

 

Greifeld, K. and Levine, M. (2025, Aug. 15). Money Stuff Podcast: Dinosaur Bone Treasury Company: A Mailbag Episode. https://www.bloomberg.com/news/audio/2025-08-15/money-stuff-podcast-dinosaur-bone-treasury-company-a-mailbag.

 

Henry, Joseph J. and O'Brien, Terrence M., How much money is really left on the table? Reassessing the measurement of IPO underpricing (August 08, 2025). Available at SSRN: https://ssrn.com/abstract=5384467 or http://dx.doi.org/10.2139/ssrn.5384467

 

Hughes, A. (2025, Aug. 4). Figma’s Pursuit of Long-Term Backers Kept IPO Price in Check. https://www.bloomberg.com/news/articles/2025-08-04/figma-s-pursuit-of-long-term-backers-kept-ipo-price-in-check.

 

Levine, M. (2021, Jan. 14). IPOs Keep Going Up. https://www.bloomberg.com/opinion/articles/2021-01-14/ipos-keep-going-up.

 

Levine, M. (2021, March 11). Companies Can Pick Their Investors. https://www.bloomberg.com/opinion/articles/2021-03-11/roblox-and-coupang-chose-their-initial-investors.

 

Ljungqvist, A. (2007). IPO underpricing. Handbook of Empirical Corporate Finance, 375-422.

 

Lowry, M., Michaely, R., & Volkova, E. (2017). Initial public offerings: A synthesis of the literature and directions for future research. Foundations and Trends in Finance, 11(3-4), 154-320. Available at SSRN: https://ssrn.com/abstract=2912354 or http://dx.doi.org/10.2139/ssrn.2912354

 

Lowry, M., & Shu, S. (2002). Litigation risk and IPO underpricing. Journal of Financial Economics, 65(3), 309-335.

 

Rampell, A., and Kupor, S. (2020, Aug. 28). In Defense of the IPO, and How to Improve It. https://a16z.com/in-defense-of-the-ipo-and-how-to-improve-it/.

 

Ritter, J. R., & Welch, I. (2002). A review of IPO activity, pricing, and allocations. The Journal of Finance, 57(4), 1795-1828.

 

Rock, K. (1986). Why new issues are underpriced. Journal of Financial Economics, 15(1-2), 187-212.

 

Sherman, A. E., & Titman, S. (2002). Building the IPO order book: underpricing and participation limits with costly information. Journal of Financial Economics, 65(1), 3-29.

 

Tse, C. (2021, March 11). Coupang Handpicked Few Investors to Buy Into Mega IPO. https://www.bloomberg.com/news/articles/2021-03-11/coupang-is-said-to-handpick-few-investors-to-buy-into-mega-ipo.