Question

East Bay Semiconductor, Inc., currently a small private company, plans to go public via an initial public offering (IPO) and will issue 10 million shares of stock. It is hoping to sell the shares for an offer price of $25. It hires an investment bank, which suggests that the offer price for the stock should be $20 per share to ensure that all the shares can be easily sold. 5. What is the advantage of following the advice of the investment bankers? What is the disadvantage? Is the investment bank’s incentive to sell the shares aligned with the incentives of East Bay Semi? What trade-off does East Bay Semi face in this decision regarding the issue price? Briefly explain

Answer 1

What is the advantage of following the advice of the investment bankers? What is the disadvantage?

Whenever a small company decides to carry out an IPO, the risk of not selling all the stocks exists and it has happened many times before. East Bay's executives probably believe that their company is the next Apple or Microsoft, or any other super huge high tech corporation. But the reality is that it is not. If the IPO goes on and not all the stocks are sold, the stock price will plummet by the end of the trading day.

On the other hand, maybe East Bay in a couple of years will be worth more than Tesla, Amazon or any other top corporation, and pricing their stocks too low will only result in losing money.

Actually, no two analysts in the world ever agree on the exact intrinsic price of stocks. Even though math should be the same and they all use the same formulas, several factors are considered differently.