The initial valuation of a stock of a company is critical to the success of an IPO. These initial valuations serve as the primary signals for the first investors. An overpriced initial valuation may turn off many preliminary investors, subsequently causing any future investors to ignore their own private signals and align themselves with the herd mentality, thus driving an IPO into a fiery heap of failure. Due to this potential information cascade of rejections, it is not uncommon to have IPOs with undervalued shares. A business man uneducated on the consequences of information cascades would be irritated that his company was valued under what it should be, but the savvy business man knows that the undervaluation of his stock sends a positive signal to investors, ultimately benefiting his company. These positive signals lure the initial investors to support the fledgling company, and thus induce an information cascade of acceptance causing future investors to also flock to the company. As you can see, the outcomes of initial share valuations is highly polar–ending either in loads of success of complete failure–and is one oft he reasons why Investment Banking and financial advising is highly valued in the financial industry.
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