Introduction
IPO underpricing is the recurring pattern where IPOs trade above their offering prices on day one, producing a "first-day pop" that compensates IPO investors for participating in the offering. Underpricing is structurally related to the IPO discount but operates at a different stage: the discount is set deliberately by the bank and issuer at pricing; the underpricing is what the market produces afterward in the first few hours of trading. Both reflect the IPO's supply-absorption dynamics, but the underpricing has been the subject of decades of academic literature (Loughran and Ritter's research being the most cited body of work) examining why issuers persistently accept the foregone proceeds and what role banker conflicts play in the outcomes. Figma popped 250 percent on day one and gave back most of it by year-end; CoreWeave printed flat and rallied 42 percent in three days; Klarna popped 15 percent and traded down 26 percent from offer by December. The 2025 cohort is the standing illustration that "first-day pop" and "well-received IPO" are not the same metric, and that the academic literature on underpricing (Rock, Welch, Loughran-Ritter, Hanley) all keeps showing up in interview questions for a reason.
The Underpricing Pattern
Average first-day IPO returns have followed a recognizable pattern across cycles.
Historical Levels
Average first-day returns ran approximately 7 percent in the 1980s, 15 percent through the 1990s pre-bubble period, and 65 percent during the 1999-2000 internet bubble. The post-bubble normalization brought returns back to the 10 to 20 percent range that has been the standard in the post-2002 era, with cyclical variation around that anchor. The structural drivers of underpricing have not changed materially over time, with the principal variation being demand-supply dynamics in specific market windows rather than fundamental shifts in the underlying economics.
What Drives Cross-Sectional Variation
Across IPOs in any given period, first-day returns vary based on issuer-specific factors: the underlying issuer's growth profile, sector positioning, valuation discipline, the strength of the bookrunner syndicate, depth of demand at the offering price, and the prevailing market environment. Premium issuers in receptive sectors typically pop 20 percent or more on day one; standard issuers in normal markets pop 10 to 15 percent; weaker-fundamentals issuers pop less or break issue.
2025 Examples
2025 averaged 22 percent first-day pops (median 13 percent), with the 20 largest IPOs averaging 36 percent. Specific deals: Figma priced at $33 and closed first day at $115.50 (250 percent pop), then fell 73+ percent from intraday highs to about $54 by year-end. Klarna priced at $40 in September, popped 30 percent intraday, closed first day at $45.82 (15 percent pop), then declined 26 percent from IPO price by year-end. Circle Internet priced at $31, closed first day at $83.23 (168 percent pop). Bullish priced at $37, opened at $102 (175 percent), closed at $68 (84 percent first-day pop), subsequently lost 52 percent. CoreWeave priced at $40 (below indicated $47-$55 range), closed flat at $40 day one but rallied to $52.57 within three trading days (about 31 percent above offer, including a 42 percent surge on day three). Across the 2025 cohort, 11 of the 20 largest IPOs plunged 40+ percent from intraday highs by year-end (4 including Figma fell 73+ percent from peak), reflecting the recurring "bloodletting after the pop" pattern as cornerstone lockups expired and momentum holders rotated out.
The Loughran and Ritter Framework
The most influential academic work on IPO underpricing comes from Tim Loughran (Notre Dame) and Jay Ritter (University of Florida), whose research over multiple decades has systematically documented the underpricing patterns and proposed competing explanations.
Money Left on the Table
Money left on the table is calculated as the gap between what the issuer received and what the issuer would have received at the first-day closing price:
The average IPO leaves approximately $9 million on the table (the gap between offering proceeds and what the issuer would have raised at the first-day closing price), which is roughly twice the typical underwriting fee. The "money left on the table" represents a substantial indirect cost to the issuer beyond the explicit underwriting fees. During the 1999-2000 bubble, the average amount of money left on the table reached $79 million per IPO, totaling approximately $63 billion in foregone proceeds across the bubble cohort.
- Money Left on the Table
The dollar value of foregone IPO proceeds calculated as the difference between the offering price and the first-day closing price multiplied by the number of shares offered. The average IPO leaves approximately $9 million on the table, roughly twice the typical underwriting fee, and the bubble-era 1999-2000 cohort left an average of $79 million per IPO. The metric is the principal academic measure of IPO underpricing's economic cost to issuing firms and is the central focus of Loughran and Ritter's research framework.
The Prospect Theory Explanation
Loughran and Ritter's prospect-theory explanation argues that issuers do not get upset about money left on the table because the IPO produces a sudden increase in wealth (the value of the issuer's retained shares jumps on the first-day pop), and the gain frames the foregone proceeds as a manageable cost. The behavioral framing is what allows underwriters to set offering prices below fully-distributed levels without facing the issuer pushback that the dollar amounts would otherwise warrant.
The Quid-Pro-Quo Explanation
A more controversial Loughran-Ritter contribution argues that underwriters set up personal brokerage accounts for venture capitalists and executives of issuing firms in order to allocate hot IPOs to them, a practice known as "spinning" that became commonplace through the 1990s. The side payments are intended to influence the issuer's choice of lead underwriter, meaning the issuer's decision-makers may be co-opted into accepting wider underpricing than would be in the issuing firm's interests. Spinning has been the subject of regulatory action and is more constrained today than it was during the bubble era, but the underlying agency problem still influences allocation decisions.
- Spinning
A practice where underwriters allocate shares of hot IPOs to personal brokerage accounts of venture capitalists, sponsor partners, and executives of potential issuing firms, in order to influence the issuers' choice of lead underwriter on subsequent IPO mandates. The practice became commonplace during the 1990s bubble era and was the subject of subsequent regulatory action under post-bubble securities reforms. Spinning is more constrained today than during the bubble era but the underlying agency problem (banker side benefits affecting issuer decision-making) remains a feature of the IPO allocation process.
Competing Theoretical Explanations
The academic literature on IPO underpricing has produced multiple competing explanations beyond Loughran and Ritter's frameworks.
Information Asymmetry, Signaling, Partial Adjustment, and Sentiment
The Rock (1986) model proposes uninformed investors face adverse selection (full allocations of poor IPOs, rationed allocations of good IPOs); underpricing compensates them. Welch (1989) signaling argues strong-fundamentals issuers underprice deliberately to signal quality. Hanley (1993) "partial adjustment" shows when bookbuilds reveal strong demand, underwriters adjust offerings up but not enough to fully reflect demand. Behavioral explanations argue retail and uninformed institutional investors overbid IPO shares due to over-optimism; the "exuberance hypothesis" predicts elevated underpricing in bullish windows and compression in stressed windows, broadly consistent with cyclical patterns.
| Theory | Key claim | Predicted pattern |
|---|---|---|
| Information Asymmetry (Rock) | Compensates uninformed investors for adverse selection | Persistent underpricing across cycles |
| Signaling (Welch) | Strong issuers underprice to signal quality | Premium issuers underprice more |
| Prospect Theory (Loughran-Ritter) | Issuers don't object due to wealth gain framing | Persistence even with high foregone proceeds |
| Quid-Pro-Quo (Loughran-Ritter) | Banker side payments to issuer decision-makers | Concentrated at biggest IPOs with hot demand |
| Partial Adjustment (Hanley) | Underwriters adjust offering up partially when demand is strong | Underpricing scales with demand strength |
| Exuberance/Sentiment | Retail over-optimism drives bidding | Cyclical, peaks in bull markets |
Underpricing on a Live Bookbuild
Beyond the academic framing, the underpricing dynamics manifest in specific patterns ECM bankers manage carefully.
Indicative Range Filed
Bank's syndicate desk files the prospectus with an indicative price range that builds in the underpricing target.
Wall-Cross Demand Builds
Anchor investors and large institutional accounts indicate participation at indicative prices, informing the bank's read on demand depth.
Public Roadshow
Management meetings with the broader institutional universe build the public order book; pricing-call insights emerge through the bookbuild.
Pricing Call Decision
Bank's senior bankers and issuer's CFO finalize the offering price, balancing underwriter recommendations with issuer's preferences on proceeds vs first-day support.
Allocation Process
Bookrunner allocates shares across the institutional and retail buyer base, with discretion driving the distribution pattern.
First-Day Trading
Stock opens and trades; first-day return measures the underpricing the market has produced relative to the offering price.
Post-IPO Aftermarket
Trading patterns over the subsequent days and weeks reveal whether the underpricing was sustained, exceeded, or reversed.
Allocation, Cornerstones, and Track-Record Effects
Underwriters have substantial allocation discretion, distributing underpricing's value across long-only accounts (larger allocations, long-term holding signals), cornerstone/anchor investors (defined allocations at offering price, tighter pricing for guaranteed access), and fast-money accounts (smaller allocations). Strong post-IPO trading establishes capital-markets credibility that supports later follow-on, convertible, and ATM access, partially justifying underpricing's persistence.
The IPO underpricing framework above completes the IPO valuation discussion. The next article walks through dilution analysis, where follow-on offerings' impact on earnings per share is examined using the treasury stock method and related analytical frameworks.
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