There is a misunderstanding, even among practitioners, that investment bankers intentionally underprice IPOs in order to please the investors who they work with. The main fact that supports this view is that “hot” IPOs often have prices that rise by large percentages within the first day of trading, representing significant capital that the firm going public could have demanded from investors. It was partially this dissatisfaction with the IPO that led to the brief SPAC bubble of the early 2020s and the ensuing destruction of shareholder value. Although the IPO is indeed full of conflicts of interest and can be significantly improved, it is also deeply misunderstood. In this post I examine the market structural as well as liquidity-related issues surrounding IPO mechanism, and offer some ideas for improvement. The first and last few sections of this post summarizes points provided in this a16z post.
Liquidity Is Multidimensional
Price, quantity, and speed are all facets of liquidity. Alex Rampell and Scott Kupor emphasize this in their defense of the IPO mechanism, which we reference multiple times in this post. When a private company raises $50 million at a $1 billion valuation, it doesn’t mean that every share will trade at that level—public markets may appear deep, but significant buyer–seller imbalances quickly expose their limits.
An IPO exemplifies such imbalances. Covenant lockup clauses typically restrict only 1–3 percent of a company’s stock from floating immediately after its listing. The price action observed in those first few days therefore reflects the natural interplay between severely constrained supply and prevailing demand, rather than a broad consensus on valuation.
We can see a similar effect in control premiums on corporate acquisitions. When Google announced its deal to acquire Fitbit, Fitbit shares traded around $4, yet the deal closed at $7.25 per share. Salesforce’s intent to buy Tableau sent Tableau’s stock up by roughly 50 percent. Bankers attribute these jumps to the “control premium”—the extra value an acquirer pays for a controlling stake—but that explanation is incomplete. Prices move at the margin: a large bid shifts aggregate demand and pushes up the price agreed upon by the marginal seller. Understanding liquidity’s multiple dimensions—especially supply constraints—completes the picture.
When you must persuade a majority of shareholders to sell, the last-traded price of a single share becomes far less relevant to the block’s value. Block traders understand that the inverse of a control premium is a block discount—a large, one-off supply shock shifts the aggregate supply curve and pushes block prices below the marginal retail price. For example, Twilio executed a $1.25 billion secondary offering at roughly a 5.2 percent discount to the prior close. This isn’t evidence of broker misconduct, but rather a reflection of the much greater market impact inherent in billion-dollar block trades versus ordinary retail orders.
The IPO Process
In a traditional IPO, a company sells stock primarily to institutional investors through a process much like a VC fundraise. The issuer prepares a slide deck and, in the pre-Zoom era, embarked on a road show to meet potential buyers who submitted limit or market orders. Investment bankers then hand-pick the IPO price—choosing a level at which firm supply and demand intersect (not all indications of interest are binding)—and allocate shares so that every buyer pays the same price.
When fortunate, issuers can select long-term, aligned investors (e.g., T. Rowe Price, Fidelity, Northern Trust). Others, however, participate as speculators hoping to “flip” shares on the first-day pop. Knowing supply is constrained, these traders often indicate orders several times larger than the quantity they actually intend to receive—sometimes 5× to 15× oversubscription. While IPO pops are common, they’re negatively skewed: if a speculator actually receives her entire oversized allocation, she may face significant adverse selection and steep losses in the opening auction. Thus, the frequency of profitable flips overstates the strategy’s true expected value.
On debut, liquidity remains thin because most pre-IPO holders are locked up. Lockup covenants mitigate information asymmetry between insiders and new investors. Only IPO subscribers can sell immediately, and those buyers are handpicked for long-term commitment. The resulting scarcity often drives the opening price higher as new entrants—gamblers and speculators—rush to acquire shares.
In addition to liquidity constraints, IPO participants shoulder significant fundamental risks. Nasdaq data show that the share of unprofitable IPOs has climbed from roughly 20 percent in the early 1980s to about 80 percent by 2020. Because these companies lack current earnings, their valuations rest almost entirely on projected future growth and cash flows, making them especially sensitive to shifts in market sentiment. The fact that most IPO cohorts underperform over the long term suggests that initial investors often overestimate these firms’ prospects and must recalibrate their expectations.
A handful of winners can more than offset the multitude of losers. Three years after their IPO, 64 percent of companies trail the market by over 10 percent. Although only about 29 percent of IPOs outperform, their gains are far more dramatic: the top decile of IPOs delivers an average market-adjusted return exceeding 300 percent, while the second and third deciles post roughly 75 percent and 25 percent, respectively.
The point is that, beyond supplying liquidity to both the issuing company and speculators chasing first‐day pops, IPO investors assume substantial risks—especially when unprofitable startups tap public markets for funding—and therefore deserve a commensurate risk premium.
IPO Inefficiencies
While part of the IPO pop occurs naturally—driven by the basic supply-and-demand imbalance rather than underwriters favoring certain investors—we recognize an inherent conflict of interest: investors want to buy cheaply, while issuers want to sell at the highest possible price. Unfortunately, there’s no simple fix for this tension.
It’s also clear that IPO participants capture expected “free” profits not only because they provide liquidity to large block trades but because they assume information-asymmetry risk and sell into a frenzy of price-sensitive speculators, especially in hot offerings. Yet it would be wrong to suggest that all these gains come at the issuer’s expense, and IPO flipping represents only a minority of aftermarket volume.
As Georgetown Professor Reena Aggarwal observes:
“There is general misperception that the large trading volume in initial public offerings (IPOs) in the aftermarket is mostly due to ‘flippers’ that are allocated shares in the offering and immediately resell them in the aftermarket when the stock starts trading. We find that on average flipping accounts for only 19 percent of trading volume (median of 17 percent) and 15 percent of shares offered (median of 7 percent) during the first two days of trading; institutions do more flipping than retail customers; and hot IPOs are flipped much more than cold IPOs.”
She goes on to note:
“It has been argued that institutions are strong hands that do not flip shares and are therefore allocated large proportions of an offering. However, we find that institutions consistently flip a larger proportion of their allocation than retail customers and that the hypothesis that institutions are smart investors that quickly flip cold IPOs while the underwriter is still providing price support is not true. Investment banks closely monitor flipping activity because excessive flipping can put downward pressure on the stock price, particularly of weak offerings. They have devised mechanisms, such as penalty bids, to restrict flipping activity.”
Underwriters indeed use tools like penalty bids to rein in excessive resale, recognizing that unchecked flipping can undermine a new issue’s performance.
What won’t fix IPOs
The main point is that an IPO pop doesn’t necessarily mean the offering was mispriced—a small fraction of shares trading at a higher level doesn’t imply every share could have sold at that price, just as one secondary‐market sale at a rich valuation doesn’t mean an entire private round could have closed at that level.
Removing lockups—which bar pre-IPO shareholders from selling for a typical six-month period—might dampen the first-day pop by boosting available supply, but it could also sap overall investor interest, especially from speculators seeking outsized early gains. That, in turn, could reduce the price a company can achieve in its IPO, undermining one of the primary benefits of going public.
Direct listings offer flexibility—allowing existing holders to sell without raising new capital—but they don’t solve the problem for unprofitable issuers (now roughly 80% of new listings) that need fresh funds. Moreover, direct listings lack the concentrated price-discovery mechanism of traditional IPOs, often leading to greater initial pricing uncertainty.
An institutional pre-placement followed by a direct listing might sound appealing, but basic economics suggests it aggregates less demand than a broad IPO and can result in a reference price that sits further from true market value—often below it. This route doesn’t materially reduce dilution versus a classic IPO, nor does it harness the broader retail enthusiasm that fuels price discovery and liquidity on debut.
Recent proposals from the NYSE, Nasdaq, and the SEC to combine direct listings with primary share sales grant early investors and founders more optionality, yet they carry significant fundraising risk: there’s no guarantee of securing needed proceeds, which could imperil a company’s stability.
Similarly, SPACs briefly captivated the market, but they provide almost no real price discovery. Their merger-process valuations are opaque, fee structures are typically higher, and the competitive tension that disciplines IPO pricing is largely absent—often resulting in less favorable terms for both the target and SPAC shareholders.
In short, while each alternative to the traditional IPO addresses specific pain points, none fully resolves the intertwined challenges of robust price discovery, reliable capital raising, and fair alignment among issuers, existing shareholders, and new investors. Despite its flaws, the classic IPO remains uniquely capable of aggregating broad demand and establishing a market-driven reference price at scale.
What may fix IPOs
To improve IPO price discovery and reduce post‐launch imbalances, companies should first broaden their investor base. Integrating with retail‐brokerage platforms and reaching out to a wider array of institutional investors and advisers—facilitated by electronic roadshows—can aggregate demand more effectively than the traditional, invitation‐only bookbuild. By drawing in more participants, issuers can set offering prices closer to true market value, minimize dilution, and dampen first‐day pops.
At the same time, narrowing the information gap between insiders and new investors will lessen the need for large IPO discounts. Regularly organized secondary‐market transactions in the months leading up to an IPO can supply up-to-date pricing data, align private and public valuations, and shift ownership toward long-term, research-oriented holders rather than speculators. Likewise, revisiting self-imposed constraints—such as lockups—by allowing pre-IPO shareholders and management to sell alongside new subscribers would modestly increase float and temper supply shocks.
On the regulatory front, modernizing the SEC’s S-1 amendment process would cut costly delays and paperwork. Instead of full re-filings days before pricing, a digital portal or API could permit incremental updates—reflecting today’s rapid information flow—and provide issuers with the flexibility to fine-tune terms without jeopardizing compliance.
Blockchain technology also offers powerful tools to supercharge these reforms. On-chain secondary markets—exemplified by Republic’s tokens acting as futures on private-company stock—enable continuous trading and transparent price discovery long before formal listing. Smart contracts can embed compliance directly into token logic, enforcing lockups, transfer restrictions, and KYC/AML checks automatically, slashing operational friction.
Tokenized capital-raises allow issuers to stagger funding tranches on-chain, dynamically matching supply to demand without repetitive regulatory filings. Finally, permissioned, decentralized auction modules can replicate roadshows and book-builds in real time: qualified bidders see order size, side, and broker identity, submit competitive bids, and receive uniform clearing prices—all enforced by code.
By migrating private-market rounds, lockups, investor outreach, and pricing mechanisms onto transparent, programmable rails, DeFi primitives reduce information asymmetries, eliminate procedural delays, and democratize access. Issuers benefit from broader demand and higher execution certainty, investors gain fairer pricing and smoother liquidity, and regulators obtain real-time oversight—aligning everyone around the shared goal of raising capital at the highest price the market will bear, with minimal dilution and friction.
Why this Matters?
The law of supply and demand tells us that rising prices should entice more issuers to bring new shares to market—but that isn’t what we’re seeing today. As The Economist recently noted, global equity indices have climbed roughly 14 percent over the past year even as net issuance—new equity less buy-backs—has plunged to –$120 billion, the lowest level since at least 1999.
Many of the most valuable companies—ByteDance, OpenAI, Stripe, SpaceX—remain private. In effect, demand is surging while supply is retracting, a dynamic that magnifies price moves and exacerbates the very liquidity constraints we see in IPOs and secondary blocks. Without fresh issuance, investors chasing growth are forced into ever narrower channels—secondary trades at steep premiums or tokenized futures on private shares—further disconnecting valuations from broad market reality. Understanding and addressing this supply squeeze—whether by encouraging incremental private‐round trading, loosening lockups, streamlining filings, or deploying blockchain‐based issuance platforms—will be critical if markets are to remain both deep and efficient in the years ahead.
This phenomenon suggests that either more demand for equity financing is being met outside the public markets (in which case the new equilibrium may indeed be Pareto efficient), or there are unnecessary frictions preventing companies from going public (making markets less efficient). Both factors play a role; we’ll begin by summarizing the latter. Jamie Dimon of J.P. Morgan Chase observes in his most recent shareholder letter:
“From their peak in 1996 at 7,300, U.S. public companies now total 4,300 — the total should have grown dramatically, not shrunk. Meanwhile, the number of private U.S. companies backed by private equity firms — which does not include the rising number of companies owned by sovereign wealth funds and family offices — has grown from 1,900 to 11,200 over the last two decades… Along with a frank assessment of the regulation landscape, we really need to consider: Is this the outcome we want?”
He goes on:
“I fear we may be driving companies from the public markets. The reasons are complex and may include factors such as intensified reporting requirements (including investors’ growing needs for environmental, social and governance information), higher litigation expenses, costly regulations, cookie-cutter board governance, shareholder activism, less compensation flexibility, less capital flexibility, heightened public scrutiny and the relentless pressure of quarterly earnings… The governance of major corporations is evolving away from guidance by governance principles that focus on a company’s relationship to long-term economic value toward a bureaucratic compliance exercise.”
Similarly, editors at The Economist cite René Stulz of Ohio State University:
“Requirements for disclosure of financial information and strategy favor companies with tangible assets, such as machinery and real estate. When a firm announces it owns a building, competitors can hardly steal the asset. When it comes to ideas, research and other intangibles, the less rival firms know, the better. If a company tries to withhold information when listing, it may be undervalued. Worse still, it may be breaking the law.”
Meanwhile, private-equity and private-credit assets have exploded: by mid-2023, private-equity funds managed $13 trillion—more than twice the 2018 total—offering firms ample alternatives to the public markets.
The shrinking size of public markets is a growing concern for founders, investors, regulators, and the general public. Public markets have traditionally offered benefits—high liquidity, transparency, and retail access—while providing companies a platform to raise substantial capital from a diverse investor base. They are also subject to stricter governance and potential investor activism, which, in theory, encourages better management over the long run under competitive pressure. As fewer companies choose to go public, these positive externalities are becoming less available.
Public companies must disclose detailed financial and operational information regularly, offering valuable insights into economic trends and corporate health. As more firms stay private, regulators monitoring financial stability and analysts assessing macroeconomic conditions face growing blind spots, making forecasting and risk assessment more challenging and potentially undermining overall stability.
The decline in public listings also affects wealth distribution and social equity. Publicly traded stocks have long been a cornerstone of many Americans’ portfolios, allowing broad participation in economic growth. As more value creation shifts to private markets—accessible mainly to the wealthy and institutions—wealth inequality may worsen. This trend risks eroding the social contract in liberal democracies, where free-enterprise gains are expected to be shared to some extent. If corporate profits become too disconnected from majority voters’ financial well-being, public support for business-friendly policies could erode, harming everyone over time.
Proposed solutions range from tighter regulation of large private companies—narrowing the public–private rule gap—to reducing disclosure burdens on IPO issuers. Imposing stricter requirements on private firms could level the playing field but might stifle innovation, especially in intangible‐asset–intensive sectors. Conversely, scaling back disclosure obligations—as the JOBS Act of 2012 did—initially boosted IPOs by 25 percent by 2015, but a 2022 study suggested it also encouraged low-quality offerings that underperformed the market. This mixed outcome underscores the complexity and potential unintended consequences of regulatory tweaks.
Given these challenges, the most sustainable impetus for revitalizing public markets may come from private-equity investors themselves. Public listings remain the most reliable exit for converting illiquid holdings into cash, and as end-investors increasingly seek liquidity, natural market forces could drive a resurgence in IPOs. Streamlining the IPO process—by broadening investor access, narrowing information asymmetries, and modernizing regulatory workflows—can help ensure that this pressure translates into more robust, efficient public markets.
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