Asymmetric information is an important reason for why underpricing exists in the IPO process

Question

BlackTom AI · Accepted Answer

The statement being evaluated is about the role of asymmetric information in the IPO underpricing phenomenon.
Consider how information gaps manifest in IPOs: issuers and underwriters typically have more information about the true value and risk of the offering than new investors. This informational gap increases the risk that some investors will demand a discount to participate, or that the price set in the market won't clear as desired.
One way to mitigate adverse selection and attract sufficient demand is to set the initial offer price below the eventual market-clearing price, i.e., underprice the issue. By doing so, underwriters reduce the risk of a failed issue and reward investors for bearing the uncertainty, thus helping to ensure a successful first-day trading.
In addition, underpricing can serve as a signaling mechanism in the presence of information asymmetry: firms and managers may use a lower offer price to signal quality in some contexts, though the primary rationale often cited is that underpricing compensates investors for information risk and the adverse selection problem they face.
From a broader perspective, this explanation aligns with standard explanations in corporate finance and IPO literature, where information asymmetry between insiders (issuers, underwriters) and outsiders (new investors) is cited as a fundamental driver of underpricing.
Therefore, the statement attributes a central cause of underpricing to asymmetric information, which is consistent with widely taught theories in IPO economics.

SP25-BL-BUS-F402-4299 Raising Capital and IPOs

Asymmetric information is an important reason for why underpricing exists in the IPO process

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Asymmetric information is an important reason for why underpricing exists in the IPO process

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