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How underinvestment reduces underpricing

Author

Listed:
  • Marco Bade

    (ICN Business School, CEREFIGE - Centre Européen de Recherche en Economie Financière et Gestion des Entreprises - UL - Université de Lorraine)

  • Hans Hirth

    (TUB - Technical University of Berlin / Technische Universität Berlin)

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, 2024. "How underinvestment reduces underpricing," Post-Print hal-04578776, HAL.
    • Handle: RePEc:hal:journl:hal-04578776
    DOI: 10.1002/ijfe.2987
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