When a new stock begins trading in an initial public offering (IPO), the expectation is often that the markets will celebrate the security's new status. Investors go to great lengths to participate in new issues in hopes of earning sizable returns, or profits. When there is a break issue, the new issue is not received by the public markets as expected. The market value of the IPO instead falls beneath the debut market price in a short amount of time. Subsequently, many investors are left with a loss in the stock.
The range in which a new stock is priced in the public markets is set by a team of investment bankers and corporate executives. Market value is typically in response to market conditions and the demand stemming from investors for the IPO. This information is often derived by traveling and speaking with investors before ultimately taking early orders for a new equity security. Depending on the terms of a deal, an investment bank often agrees to buy shares of a new stock and subsequently sell those holdings to public investors at a greater price. It is also not unusual for investment banks and other early and large investors to agree to hold a stock for a period of time before selling into the markets to prevent unusual trading to occur in the new issue.
Given all of the preparation and risk associated with IPOs, a break issue can be extremely costly. Although market participants might do everything possible to predict the ideal price for a new issue and investors might initially support the stock, trading in the stock market can be unpredictable. Subsequently, a break issue may be unpreventable in some cases.
In some cases, a break issue might occur because bankers and corporate executives miscalculated the support for a new stock. Despite the efforts made to make an early assessment on market reception, those perceptions could be misguided. If investors decide that the stock does not have the earning potential that it was marketed to have, they are likely to demonstrate that lack of confidence by selling shares.
Different scenarios can cause a new stock to become a break issue. The IPO could be released during challenging market conditions in which the stock did not have much of a chance to have immediate success. Some companies delay launching a new stock when the financial markets are experiencing a downturn or the economy is in turmoil. It can also be costly, however, to continue postponing an IPO and remain registered with a regulatory agency that governs stock market activity.
