Nevertheless, Chiles rose 10.5 percent its first day of trading. Part of the reason investment banks earn large fees for underwriting IPOs is because of their expertise in measuring and maintaining demand in the market. In a typical deal, the underwriters take the risk of owning the stock if the issue is not fully purchased. To gauge demand in the market, investment banks engage in a book-building exercise, in which they discuss the merits of a new IPO with traditional institutional customers and privileged wealthy retail customers. They then ask for orders.
Weak demand lowers the price.
If demand is so weak that the price is unsatisfactory to the company raising the money, the issue is postponed or withdrawn, often quietly to avoid embarrassment. Even if the institutions are reluctant to buy, they put in orders anyway, because they don't want to be shut out when the market heats up,'' said Randall Roth, a senior analyst at Renaissance Capital, which manages the IPO Aftermarket Fund and provides IPO research to institutional clients. To make an IPO attractive, an underwriter may often price a new issue at a 15 percent to 25 percent discount to comparable listed companies in its sector. The result is frequently a short-term rise in the stock price during the first days of trading since the stock is perceived as cheaper than its peers. If that pop is more than 30 percent or 40 percent, the stock exceeds the value of its peers temporarily, and may go down, or its competitors' stocks may go up.