Page 138 - Initial Public Offering - An Introduction to IPO on Wall Street

As one would imagine, during uncertain and risky times, most businesses tend not to IPO.
Researchers have noted that the volume of IPOs decreases dramatically during times when the
VIX is greater than 20.

On the flip side, the amount of monthly IPOs increases significantly when the VIX is less than
20 for prolonged periods, and the IPO window is deemed "open". For businesses that IPO
during these market windows, an additional advantage is that increased demand typically
results in more favorable pricing.

During periods of instability, the drop in IPOs is better understood when evaluating how the
following IPO stakeholders respond to risk and uncertainty

Institutional Investors

Institutional investors want to see a payout that provides them ‘enough’ for the risk they are
taking to invest in an IPO. Volatile market circumstances increase the risk for investors,
pushing up the necessary return, leading to a large discount on the stock of a company.

When the market is unpredictable, businesses can be unable to reduce the stock price to a level
that is reasonable to investors and therefore opt to wait for more steady conditions.

Underwriters

Other than having the same fears as institutional investors, the reputational risk that comes with
a failed IPO is often of interest to underwriters. Underwriters are trying to identify an offering
price that fits the institutional investors as well as the public business.

It can be hard to find mutually acceptable prices even in strong market conditions, but it is
extremely tough in times of high volatility. For instance, if the price range is set too high by
the underwriters and the stock price falls in preliminary trading, institutional investors will
suffer losses, undermining the credibility of the underwriters.

Underwriters are typically more cautious when the VIX is high to prevent these potential
problems. They may choose to wait until the above-described hazards are less widespread or
they may sell the shares at a less exorbitant discount.

The Company

The need for institutional investors and underwriters to shield themselves from reputational
and financial losses clashes with the business's need to collect the money they need without
unreasonable dilution of equity.

These conflicting interests will make it very hard for all the parties involved to reach an
agreement on offering price and business valuation. A business may either lower the price
range to drive up demand during difficult market conditions or postpone the IPO until volatility
decreased and there is an improvement in market conditions. Both strategies can have their
downsides.

The initial reduced share price is just one of the potential pitfalls when a business tries to move
ahead with an IPO under uncertain market conditions. Volatile market circumstances in the
months after the IPO can also contribute to rapid changes in the valuation of a business.

Large share price drops can harm the credibility of a business with investors and make it harder
for workers and founders to liquidate their holdings. In the months after the IPO, obtaining a

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