Abstract
A major reason that issuers accept IPO underpricing is that they use options and stock grants to protect themselves from dilution to their existing shares. IPO underpricing decreases taxes paid by employees with options or can be used as currency to strengthen strategic alliances and customer loyalty. Option use is directly related to IPO underpricing and explains a substantial amount of its variation, but probably does not drive underpricing. Venture capital backing increases underpricing and options use. Nonfounder CEOs benefit more from the tax benefit than they lose in dilution, while founder CEOs are less likely to come out ahead.
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