Briefly summarize the evidence relating to IPO underpricing, and discuss possibl

Question

Briefly summarize the evidence relating to IPO underpricing, and discuss possible reasons for the phenomena.

You are the CFO of a non-dividend paying firm that currently has excess cash reserves. You are preparing for an internal management meeting where dividends are on the agenda. You know that the CEO favors the commencement of a dividend program. You, however, oppose any dividend plan at this time. Write up a memo incorporating as many arguments as you can think of in support of your position.

Explanation / Answer

The initial public offering is often placed below the market value so that the demand and supply will automatically take the stock to its intrinsic value. Also because of the liquidity and the uncertainty of the price at which stock will trade, the shares are often undervalued. Example: the under pricing of Facebook shares in its ipo in 2012

Part 2

The payment of dividends reduces the amount of retained earnings which helps in long term growth prospects of the company. This also helps in creating long term wealth for the shareholders. Historically several companies have never payed dividends. The most famous example is that of Berkshire Hathaway where Warren Buffet believes that payment of dividends reduces the growth opportunities for the company. Also by not paying dividends the company can save the dividend distribution tax (DDT). Therefore payment of dividends reduces future growth prospects and also has additional tax burden. In conclusion, I as the CFO do not recommend the payment of dividends.

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