Determinants of IPO Pricing: A Review of Theories and Evidence

This literature review explores the role of information asymmetry in Initial Public Offering pricing, focusing on how companies impact their informational advantage over investors to underpricing shares. Information asymmetry creates an adverse selection problem, leading firms to underprice IPOs to attract institutional investors and reduce risks. Signaling theory suggests that underpricing can also signal a firms quality with high-quality firms absorbing short-term losses to gain long-term benefits. Empirical evidence, including studies by Jain and Kini (1994) and Rock (1986), demonstrate how underpricing compensates uninformed investors for higher risk. Additionally, the allocation process is influenced by market sentiment, firm size, and underwriter reputation, with institutional investors often receiving favorable allocations in high-demand IPOs, leading to better outcomes for them.