IPO Underpricing and Long-Run Performance: Theories and Evidence

Abstract

Initial public offerings (IPOs)—the first sale of a company’s shares to the public on a stock exchange—present one of corporate finance’s most studied and most robust empirical regularities: IPO underpricing. On average, IPO shares are priced approximately 15–20% below their first-day market close—leaving substantial ‘money on the table’ for initial buyers at the expense of issuing companies. Rock’s (1986) winner’s curse explanation, Benveniste and Spindt’s (1989) bookbuilding information extraction model, and signaling theories provide competing explanations for why rational issuers tolerate such large discounts. A second IPO regularity—long-run underperformance—was documented by Ritter (1991) in the Journal of Finance: IPO issuers significantly underperform comparable firms over the three to five years following issuance, raising questions about whether IPO markets efficiently price growth potential. This paper reviews IPO theories, evidence on underpricing and long-run performance, hot versus cold market dynamics, and the evolution of IPO mechanisms including direct listings and SPACs.