Over-Allotment Options in IPOs on Germany's Neuer Markt - An Empirical Investigation

Abstract

Abstract:Over-allotment arrangements are nowadays part of almost any initial public offering. The underwriting banks borrow stocks from the previous shareholders to issue more than the initially announced number of shares. This is combined with the option to cover this short position at the issue price. We present empirical evidence on the value of these arrangements to the underwriters of initial public offerings on the Neuer Markt. The over-allotment arrangement is regarded as a portfolio of a long call option and a short position in a forward contract on the stock, which is different from other approaches presented in the literature.Given the economically substantial values for these option-like claims we try to identify benefits to previous shareholders or new investors when the company is using this instrument in the process of going public. Although we carefully control for potential endoge neity problems, we find virtually no evidence for a reduction in underpricing for firms using over-allotment arrangements. Furthermore, we do not find evidence for more pronounced price stabilization activities or better aftermarket performance for firms granting an over-allotment arrangement to the underwriting banks. EFM Classification: 230, 410Keywords: Over-Allotment Option, Flotation Costs, Underwriter Fee, Neuer Markt * Center for Financial Studies, Taunusanlage 6, 60329 Frankfurt am Main, Germany. Phone: +49-69-242 941 16, Fax: +49-69-242 941 77, Email: franzke@ifk -cfs.de ♣ Faculty of Economics and Business Administration, Goethe University, Mertonstr. 17, 60054 Frankfurt am Main, Germany. Phone: +49-69-798-22674, Fax: +49-69-798-22788, Email: schlag@wiwi.uni-frankfurt Introduction and MotivationSince the mid nineties book building has increasingly replaced the fixed-price method as the standard procedure for setting the issue price in initial public offerings (IPOs) in Germany. Along with this change the instrument of the over-allotment option (also called "greenshoe" option 1 ) has gained considerable importance. An over-allotment arrangement (OAA) typically works as follows. To be able to meet potentially higher demand for an issue, i.e. to be able to place more than the initially announced number of shares, the underwriter borrows additional shares (the greenshoe (GS)) 2 from the company going public. This borrowing of the shares comes with the obligation for the underwriter to return the shares within a fixed period of time, usually one month. In case of a bullish market the underwriter might thus be forced to buy back the shares at a higher price, thereby incurring a loss. An OAA, including a GS option, however, allows the underwriting bank to buy the shares from the issuing firm at the issue price, and this agreement protects the underwriter against unfavorable price movements in the secondary market. On the other hand, a trading profit for the underwriting bank could arise if the stock trades below the issuing price sometime during the life of the OAA, since the underwriter could then buy the sha...

The Existence and Effectiveness of Price Support Activities in Germany - A Note

“…If on the other side demand is low and the stock price drops below the offer price the underwriter can, instead of using the greenshoe option, buy the stock in the secondary market and therefore support the performance of the IPO due to increased demand. Franzke and Schlag (2002) Before analyzing the usage of the greenshoe option for the first time we provide, following Ruud (1993), new evidence on underwriter price support by examining the distribution of first day returns. This analysis is supported by the study of the returns patterns during the first 30 trading days.…”