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How underinvestment reduces underpricing

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  • Marco Bade
  • Hans Hirth

Abstract

We develop an economic model demonstrating that firms can benefit from committing to underinvestment. The model considers a firm's IPO, secondary‐market trading and subsequent investment decision. We analyse the conditions under which underinvestment can paradoxically be advantageous despite reducing the fundamental value of the firm. The benefit of committing to underinvest post‐IPO is expressed in reduced underpricing and thus a higher valuation during the IPO. We furthermore show that the firm may commit to an inefficient investment policy by appointing a manager with biased expectations or risk aversion. Our findings imply that, under certain conditions, firms are better off relying on biased managers when their initial outlook is poor, but risk‐averse managers when their initial outlook is good.

Suggested Citation

  • Marco Bade & Hans Hirth, 2025. "How underinvestment reduces underpricing," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 30(2), pages 1689-1706, April.
    • Handle: RePEc:wly:ijfiec:v:30:y:2025:i:2:p:1689-1706
    DOI: 10.1002/ijfe.2987
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