This module is part of the 2027 curriculum. You are following the 2026 curriculum, where it is not taught in this form. Switch if you are sitting the exam under the 2027 curriculum.
Lesson 3 of 8 · 12 min
Why IPOs are underpriced, and what secondary markets do
IPO underpricing persists because underwriters, favoured investors and even managers gain from it, while secondary markets, active in rising and falling markets alike, give investors liquidity and price discovery and give firms feedback that drives financing, buyback and pay decisions.
In short
- IPO underpricing is measured as the first-day return: closing price on the first trading day versus the offering price. It is positive on average, but some IPOs fall on day one (they were overpriced).
- Underwriters gain more from placing cheap shares with clients (who then accept their brokerage fees) than from a higher fee on a higher price.
- Managers tolerate it because their own shares jump in value, while the lower proceeds are a cost to the firm: a principal–agent problem.
- Primary issuance is most active when prices are rising; secondary trading matters in rising and falling markets alike.
- Secondary prices provide price discovery for investors and analysts and performance feedback for management, boards (e.g. RSU pay) and other stakeholders.
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