(TIỂU LUẬN) title the impact of IPO underpricing and its connection with information asymmetry

BAFI3182
FINANCIAL MARKETS
Title: The Impact of IPO Underpricing and Its Connection with
Information Asymmetry

Lecturer

Nguyen Thi My Linh

Student Name

Student ID

Part A: 1901 words

Word Count
Part B: 502 words

Date of Submission

16 September 2021

I declare that in submitting all work for this assessment I have read, understood and agree to
the content and expectations of the Assessment declaration.
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TABLE OF CONTENTS
PART A: RESEARCH PAPER ......................................................................................................................3
I.
II.

III.
1.
2.
3.
IV.
V.

ABSTRACT......................................................................................................................................3
INTRODUCTION..............................................................................................................................3
LITERATURE REVIEWS.....................................................................................................................4
IPO BACKGROUND...............................................................................................................................4
IPO UNDERPRICING.............................................................................................................................5
INFORMATION ASYMMETRIC..............................................................................................................5
LIMITATIONS..................................................................................................................................7
CONCLUSION.................................................................................................................................8

PART B: REFLECTION ON THE INDUSTRY TALK .........................................................................................9
REFERENCE LIST: ...................................................................................................................................11

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PART A: RESEARCH PAPER
I.

ABSTRACT

This paper conducts a general review of Initial Public Offerings (IPO), including its strengths and
disadvantages. Aside from that, a thorough study of the factor causing underpricing in IPO
which is the asymmetrical in information, has been carried out based on the foundation of

numerous researches and theoretical findings. Furthermore, some of the advantages that have
emerged from underpricing behavior have been identified with an effort to assist in the issue
clarification.

II.

INTRODUCTION

The implementation of the Initial Public Offering (IPO) method of raising capital or acquiring
investment is a breakthrough step in the evolution of any growing firm. When the company
requires large amount of fund to maintain in the emerging market, the founders' contributions
might not be adequate, also they could not be able to acquire loans with such a valid assurance
of paying a reasonable interest rate (Bruton, Chahine & Filatotchev 2009). To circumvent this,
the most preferable method is to obtain public equity funding. For instance, the self-PR
campaign is a gem in the business's hat, and the consequent attention may result in indirect
benefits including increased recruiting capabilities of skilled worker and leaders, and boosted
company's reputation, etc. (Agoraki, Gounopoulos & Kouretas 2021). The company's shares are
later valued based on a variety of factors, both related and uncorrelated, that can impact the
market demand and supply trend on the trading floor.
Based on research conduct by Judge et al. (2015), underpricing in IPO is widely regarded to be a
widespread problem across the globe. This approach entails a negative gap between the bid and
the first listing day's closing price, as well as the estimated initial return rate (Filatotchev &
Bishop 2002). For many years, underpricing of initial public offerings has been a fascinating
research topic for economists. Thus, many theories have been established to explain this
behavior, including theories of information asymmetry, business ownership and manage,
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institutional variables, and behavioral finance (Lee, Taylor & Walter 1999). This paper would
provide an overview of Initial Public Offering; as well as identify, analyze and evaluate IPO

factors and variables that highlighted the impact of underpricing on business, and connect it to
the information asymmetry factor using the foundation of numerous researches and theoretical
findings.

III.

LITERATURE REVIEWS

1. IPO BACKGROUND
According to Mrzygłod and Nowak (2013), the Initial Public Offering is a process through which
shares of the company are offered in the marketplace through the trading floor of stock
exchange. The most suitable approach is to collect funds via public equity. For instance, Venture
Capitalists (VC) was given the opportunity to increase their funds raising and obtain financial
gains via this method (Wang & Wan 2013). Based on research conducted by Arend, Patel and
Park (2014), there are many reasons for a business to choose IPO approach. Ultimately, the goal
is to acquire additional funds in order to ensure the continued growth of the company, the
operations expansion, investment project execution, company development and innovation,
market expansion, and an increase in the overall value of the company over time. Additionally,
the IPO improves a company's image, which also increases its chances of receiving funds from
financial institutions, and allows additional income in the event of adverse outcomes (Morricone
et al. 2017).
Apart from these advantages, there are also disadvantages to an IPO approach. One of these
disadvantages is the need to provide financial information not only at the initial listing, but also
on a regular basis during the time that the organization’s shares is publicly traded on the
stock exchange trading floor (Yan et al. 2019). Moreover, the selling of a company's shares may
negatively impact a founder's authority (Chahine, Filatotchev & Zahra 2011). As part of the
preparation for the business to operate as a public corporation, a good amount of operational
expenses is needed, including for an increased in marketing expenses and a continuous
expenditure of preparation (Duong et al. 2021). After examining a great amount of initial public
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offering on multination’s stock exchange floor, the perks of this capital acquisition path exceed
any drawbacks, which leaves only one urgent issues being the price to set for the first
proposition (Bruton et al. 2010).
2. IPO UNDERPRICING
Companies that issued their shares on the stock trading floor could entice and encourage new
stakeholder. Likewise, in order to attract investors, it is common for companies to offer shares at
a price that are cheaper than the actual value. Such tactic is known as underpricing. An Initial
Public Offering (IPO) may be purposefully underpriced in order to increase demand and
persuade investors to take a chance on a new business. It's possible that the stock was
underpriced by mistake as a result of the underwriters' underestimation of the demand for the
firm's stock in the market (Zou et al. 2020). The initial stock launch mirrors the value of the
company’s stock in the marketplace which the business is unable to obtain when the shares are
first made available for purchase. Therefore, the IPO underpricing is a matter of serious concern
for just about any entrepreneurial company, as well as the entrepreneur (Judge et al. 2015).
Underpricing was described as “money left on the table by the business” (Goergen,
Gounopoulos and Koutroumpis 2021), resulting in a reduction in the financial obtains from the
initial public offering. Additionally, underpricing is viewed as an opportunity loss for businesses,
because the investments that the business received are governed by the bid price of the
issuance. The greater the offer, the more money received for a given number of issued shares.
However, it is predicted that businesses with a larger degree of IPO underpricing would attain
higher growth rates (Filatotchev & Bishop 2002).
3. ASYMMETRIC INFORMATION
Numerous studies support the above notion and argue that an IPO's price should be linked to
the asymmetric information surrounding the business. Based on research conducted by Cai,
Helwege and Warga (2007), a firm that experienced asymmetric of information would have had
a higher tendency to produce underpricing of IPO. It is a projection that has received substantial
empirical support since its publication. Various researchers also indicated that information
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asymmetry could compromised the precision of the pricing process (Hoque 2014; Fohlin 2010;
Duong et al. 2021). Furthermore, it would be difficult to evaluate the value of a business
accurately when it is characterized by significant information failure, because companies with a
greater level of uncertainty ought to have a greater level of initial return volatility (Officer, Lowry
& Schwert 2010).
According to Fohlin (2010), the asymmetric information theoretical key tenet implied
that participants to an initial public offering have multiple level of information asymmetry, with
the asymmetric information concept being positively correlated to the underpricing of IPO.
Additionally, the winner's curse theory indicated that issuers are unable to forecast their
aftermarket share price (Hendricks, Porter & Tan 2008). Not only that, Cai, He and He (2010)
found that the trade initiated by the institutional investor are better informed than by the
individual investment companies. Therefore, large financial organizations would only invest their
money in an offer that has a high return rate or profit on the investment, while individual would
make their investment decisions despite the quality or value of the shares. Moreover, the
business must issue shares at a discounted offer in order to attract the attention of investors
who are not well-informed. Funaoka and Nishimura (2019) argues that issuing businesses with
better performance are utilizing underpricing of IPO for the gathering of information in order to
compensate for the investors that experienced information asymmetry.
Correspondingly, asymmetric of information theory among businesses, investors, issuers, and
underwriters have been established based on the concept of asymmetric information (Sufi
2007). It is believed that there is an asymmetric information concerning the issuer and the
underwriter (Zou et al. 2020). Since the party or company with more experience and better
informed is responsible for organizing the IPO, it is preferable to estimate capital market
demand in order to accurately evaluate the worth of the issuer's shares. Overall, the final
decision for the price remain in the hand of the issuer, which implies that there is a solid
correlation between the issuer's concern and the potential demand for the offer (Su & Bangassa
2011).

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According to Liu et al. (2020), the uncertainty regarding the value of Initial public offerings
contributes to the underpricing of IPO because there is an asymmetry of information exist
among the issuer and the investor. In term of recognizing the value of IPO, the issuer is the one
knowing of the real worth of the company initial public offering and not the investors. As a
result, investors would rather choose to purchase stock with the company that offered lower
price to cover for the uncertainty caused by information asymmetry. As for the issuers part, in
order to attract those uninformed individuals’ investment, they should establish a lower price
than the real value of their share. Base on the above finding, a greater degree of uncertainty in
initial public offerings is expected to occur in greater underpricing (Boulton, Smart & Zutter
2010).
Correspondingly, investment banks or financial service companies also apply the concept of
underpricing to lower expenses, reduce risks, raise reputation and gain investors trust and favor
(Yu, Gul & Radhakrishnan 2014. Investors aim to avoid circumstances in which their
potential returns are adjusted or decreased. The offered share price is less than the anticipated
market value of the share, which is intentionally set by the issuers to guarantee investors a good
initial return. However, additional problems will inevitably arise and yield greater returns since
there were no specific conditions (Keefe & Gallagher 2014). In addition, due to the asymmetry
of information regarding start up businesses, Bansal and Khanna (2013) found that underpricing
would be widely adopted and pricing precision would be lowered; which indicate that their
anticipation would be higher and the dispersion of expected early returns would be larger than
the former businesses in the marketplace.

IV.

LIMITATIONS

The Initial Public Offering (IPO) is a watershed in the history of any business. IPO has become a

popular study subject for many academics and industry professionals alike (Derrien 2005;
Mumtaz & Yoshino 2021). When examining the relevant IPO underpricing driver, especially the
information asymmetry, I was undoubtedly constrained by the wide range of research articles
available. Since the underpricing phenomenon of initial public offerings (IPOs) and the
elements that influence it are indeed a broad subject, thus I was unable to cover all of the
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angles and factors in my paper. I was only able to highlighted one main cause which is
information asymmetry. Certain theories are based on objective judgements, and they may not
be entirely correct in some instances because of the presence of refute articles. There are
several additional factors that contribute to IPO underpricing that are not included in this study;
however, they were not included because of their lack of credibility and popularity, and the
emergence of many publications to invalidated them. Furthermore, since this study take into
account the international stock market, it may not be applicable to any situations that occur
infrequently, nor to nations that have distinct laws and policies governing the stock market.

V.

CONCLUSION

Entrepreneurs may benefit from their first significant access to cash from their resources and
effort invested in company via an initial public offering (IPO). It is proven that companies often
undervalue their first public offering. The research study has focused on IPO underpricing, with
the purpose of formulating the underlying cause of this phenomena which is information
asymmetry. Base on the various findings of prior studies on underpricing, the information
asymmetry between various participants in the listing process, including the IPO firms, financial
institutions, underwriters, and investors of the company, are considered. Additionally, certain
perspective of some parties regarding pricing behavior was revealed when they were offered
particular benefits.

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PART B: REFLECTION ON THE INDUSTRY TALK
The speech was delivered by our guess speaker, Mr. Thach. He went over an overview of
personal wealth management plan. The discussion of the talk was about the definition of
personal financial saving plan. It was answered through the definition of financial aspect,
security and wellness. Basically, in order to come up with a financial plan, people could have
done it through personal saving or investment. The term financial security and wellness is quite
similar, but financial security cared more about the requirement of money to support a personal
lifestyle; whereas, financial wellness tends to focus on how to manage a person financial and
economic life effectively. Afterward, Mr. Thach then go in more detail of how to come up with a
plan; in what timeline should people start to focus on financial plan; and the various options of
investment.
The thing that fascinated me most about his speech is how Mr. Thach was able to provide
various type of investments and a full detail of the stock market. First, he went over an overall
definition and few key details of the stock, gold, forex commodity, and real estate market. Those
terms are all familiar me since I have been learning about them in our Financial Market couse
which made it easier for me to follow his speech. From what I have learned, all the markets
come with benefits and risks that is unpredictable. Thus it is crucial that people must have an indept knowledge of the term before making any decision of investment. According to Mr. Thach,
the stock market is the one that can provide investor with the most benefits or lost. It is one of
the riskiest market to invest in. The P/E ratio that shown on the stock exchange floor is only a
reflection of a firm past behavior, and the price is what the investors expected of the firm’s
value to be in the future. Therefore, investors must be extremely conscious of those term and
avoid getting mixed up between them to prevent an extreme lost. Again, all markets come with
a risk and benefit, Mr. Thach recommended that investors should only invest when they have
enough knowledge, within a limit and do not go overboard with your financially set limit since it
could potentially ruin your life and financial saving plan.

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In conclusion, the speech has provided me with an incentive of how to manage my personal
financial saving, what are my options to expand my financial capacity to achieve a financial
wellness and enjoying my life to the fullness. I believe through the speech of Mr. Thach, and the
Financial Market course, I have the fundamental knowledge to manage my personal financial
plan and to make investment decision. However, I am currently interested in the cryptocurrency
market; and presently, it is an emerging industry on the marketplace. Thus it would have better
help me in the investment decision if Mr. Thach could have included that in his speech.

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Duong, HN, Goyal, A, Kallinterakis, V & Veeraraghavan, M 2021, ‘Market manipulation rules and
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