Understanding the Dynamics of IPO Underpricing and Its Effect on Bond Issuance Strategies

Important milestones in a company's life cycle, IPOs are often marked by underpricing. The equities of high-tech enterprises on the China Scientific and Technological Innovation Board (STAR Markets) are significantly underpriced during IPOs. In this paper, we use the Two-tier Stochastic Frontier Models to break IPO underpricing down into its component parts—the pricing effect of the primary market while the transaction effect of the secondary market—and then we examine how these two markets differ in their effects on IPO underpricing. We do this from an investor behavior perspective in order to understand why STAR Market has such high IPO underpricing. Furthermore, company size has little bearing on the IPO underpricing. As a result, the STAR Market's IPO underpricing has historically been mostly influenced by secondary market investor activity. To investigate this, we used Ordinary Least Squares regression modeling to look at how underpricing affected the long-term success of IPOs. In China's STAR market, underpriced IPOs were associated with better long-term success, according to the regression results. We provide an evolving framework of a market for IPOs, where companies seek investment funds by becoming public. In making decisions about going public, raising and investing funds, and pricing the IPO, the initial shareholders have access to confidential information about the quality of their company's investment prospects. There are two categories of outside investors: those who are privy to the original shareholders' hidden financial motivations and those who learn about the IPO market only from publicly available IPO market data.