What is the major reason that underwriters tend to offer stocks in an IPO at a price that is below that which the market will pay?

Question

BlackTom AI · Accepted Answer

When evaluating why underwriters price an IPO below the market, consider the incentives and mechanics of the underwriting process.
Option 1: 'to gain from the rise in value of any stocks they hold after the IPO' This is not the primary motive for pricing below market; underwriters do not rely on holding shares to profit from a post-IPO rise, and doing so could create a conflict of interest with selling new shares to the public.
Option 2: 'to benefit from greenshoe provisions' Greenshoe (overallotment) provisions are about stabilizing the price after the offering, not about why the initial price is set below market. They are a separate mechanism used after pricing, so this choice misplaces the timing and purpose.
Option 3: 'to reduce their exposure to losses from unsold stock' This is the core reason: pricing below the expected market price creates demand, helps ensure the full allotment is sold, and minimizes the risk of leaving shares unsold, which could leave underwriters with inventory losses.
Option 4: 'to increase their spread' While pricing can affect underwriting spreads, the primary policy motivation for a below-market IPO price is not simply expanding the spread; it is about ensuring demand and mitigating the risk of unsold shares, so this option misstates the main objective.
Overall, the key concept is that a below-market offer price lowers the risk to underwriters of not selling all issued shares, aligning with their goal of a successful and fully subscribed offering.

What is the major reason that underwriters tend to offer stocks in an IPO at a price that is below that which the market will pay?

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