This paper discusses policy options to reduce underpricing in initial public offerings (IPOs). It surveys recent theoretical insights into the causes and welfare implications of underpricing and reviews evidence on the signalling hypothesis, the winner’s curse model, the role of underwriters in assessing issuing firms’ future profitability and the genesis of speculative bubbles in IPO markets. The paper concludes that governments should curtail the abuse of market power in underwriting by prohibiting the allocation of shares to insiders and by reducing the incentives for investment banks to exploit underpriced share issues in order to cross-subsidise unrelated lines of business. Moreover, governments should seek to stabilize the IPO market by committing themselves to regular equal-sized issues of shares in government assets as part of a long-term privatisation programme.
Journal for Economic Policy is published on behalf of the Institute for Economic Policy at the University of Cologne. The Journal is open to publications from all areas of economics. Articles regarding current questions of German, European or international economic policy are preferred. At the center of each issue is the economic policy forum. It deals with topics, which are controversially discussed among the general public.