“Raising Capital and the Pricing of New Issues” by Xianming ZHOU
University of Hong Kong
Selling a firm in an initial public offering (IPO) differs from selling other items in a significant aspect: IPOs typically raise equity capital and hence involve an invest decision. With decreasing returns to investment, the value of existing shareholders' ownership depends on the amount of new capital to be raised from selling primary shares. When the demand for the new issue is downward slopped, there is a trade-off between increasing the offer price for a better sale and decreasing the price to obtain enough funds. We present a model to characterize this tradeoff. The model produces rich implications to IPO underpricing and the firm's going public decision.