IPO Underpricing and Long-Run Drift

Two separate patterns show up again and again in studies of newly public companies, and they point in opposite directions. IPO underpricing is the well-documented tendency for shares to jump sharply on their first day of trading — the offer price is set below what the market is willing to pay, so investors who receive an allocation typically see an immediate gain. Averaged across decades and markets, first-day pops of 10–20% are common, and some periods (like the dot-com boom) saw far larger jumps.

Long-run drift is the separate, less intuitive finding that once you look past that first-day pop, IPOs as a group tend to underperform the broader market over the following one to three years. A stock that looked like a hot deal on day one often quietly lags behind non-IPO peers of similar size and industry for years afterward. Explanations offered for this combination include underwriters deliberately leaving money on the table to reward favored clients and ensure oversubscription (explaining underpricing), while overly optimistic initial investor sentiment about growth prospects fades over time (explaining the subsequent drift).

Worked example. A company prices its IPO at $20 and closes its first trading day at $24, a 20% pop — a clear case of underpricing benefiting day-one allocation holders. Three years later, despite that strong start, the stock trades at $22, having underperformed a basket of comparable non-IPO stocks that returned 35% cumulatively over the same period — the long-run drift showing up despite the strong opening.