Decimalization, IPO aftermath, and liquidity

Abstract

We investigate the effect of decimalization on the aftermarket trading of NYSE-listed IPOs. We find that the relation between bid-ask spread and underpricing becomes negative post-decimalization, suggesting that benefits from the increased price competition accrue more to hot IPOs. The quoted depth is generally smaller post-decimalization due to a higher probability of front running, which aggravates the cost of adverse selection and limit order submission. We show that underwriters continue to provide price support but are only willing to cover the initial short position, if profitable to do so. Decimal pricing does not affect the flipping strategy of institutions for cold IPOs as they are likely bound by the underwriter's price support and their share allocation. Institutions, however, tend to flip more hot IPOs during the post-than in the pre-decimalization period, suggesting that the cost of flipping is lower for shares with a substantial price runup during aftermarket trading.

Long-Term Effect of IPO Underpricing on Aftermarket Liquidity

“…Findings from Ljungqvist (2007) and Charoenwong et al (2016) show that when newly listed companies offer underpriced shares at IPO, they tend to have their share price increase substantially on the first day of trading, resulting in a liquid aftermarket. Underpricing of shares at IPO is characterized by a positive return for investors who decided to sell their shares on the first day.…”