Size of Issue (in millions)

Source: Ritter

The third cost is any underpricing on the issue, which provides a windfall to the investors who get the stock at the offering price and sell it at the much higher market price. Thus, for Netscape, whose offering price was $29 and whose stock opened at $50, the difference of $21 per share on the shares offered, is an implicit cost to the issuing firm. While precise estimates vary from year to year, the average initial public offering seems to be underpriced by 10-15%. Ibbotson, Sindelar, and Ritter (1993), in a study of the determinants of underpricing, estimate its extent as a function of the size of the issue. Figure 7.7 summarizes the underpricing as a percent of the price by size of issue.

Figure 7.7: Underpricing as percent of Price - By Issue Size

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Lessons From The Intelligent Investor

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