Historically, Initial Public Offerings (IPOs) of stocks have earned substantial positive return on the day of listing. This IPO underpricing is well know in finance literature and it is still a puzzle. If the stock is worth more then why do the firm’s management, existing shareholders, and IPO underwriters decide to sell it at a lower price? If they are doing it systematically, then there has to be some benefit which we cant observe. But what is that unobserved benefit?
Financial economists who believe in rational expectations cant explain why these people are behaving irrationally. Behavior economists, who think that human beings are not rational like robots, can’t solve this puzzle either.
Now there is a third view that is gaining more acceptance: corrupt human beings. It seems that IPO underwriters keep the offer prices low so that their premium clients can make plenty of money by selling the stocks. In return these clients give more business to the investment banks underwriting the IPO. There are other practices known to practioners which are called "laddering" and "spinning." Academicians in finance are now looking at all these possibilities.
So is this a third view? I think so. The markets are not fair or efficient as the financial economists would like us to believe. At the same time, the markets are not operated by Homer Simpsons of the world either. The corrupt managers are not rational because they are not looking at the big picture and the long term social costs of the corruption. Thus, they are not making value-maximizing decisions. But they are not irrational either…they precisely know how to game the markets and that’s not happening because they are using heuristics.