Stabilization Activities by Underwriters after Initial Public Offerings

Abstract

Prior research has assumed that underwriters post a stabilizing bid in the aftermarket. We find instead that aftermarket activities are less transparent and include stimulating demand through short covering and restricting supply by penalizing the f lipping of shares. In more than half of IPOs, a short position of an average 10.75 percent of shares offered is covered in 22 transactions over 16.6 days in the aftermarket, resulting in a loss of 3.61 percent of underwriting fees. Underwriters manage price support activities by using a combination of aftermarket short covering, penalty bids, and the selective use of the overallotment option.RESEARCHERS ARE STILL TRYING TO UNDERSTAND the price behavior of initial public offerings~IPOs!. 1 Short-run underpricing and long-run overpricing continue to be a puzzle. Underpricing refers to the initial trading of IPOs above the offer price in the immediate aftermarket, whereas overpricing refers to long-run underperformance. However, finance research has paid little attention to the specific activities of underwriters in the aftermarket that are likely to have an impact on IPO price performance. These interventions by underwriters are not well understood because of both lack of data and lack of transparency in industry practices. The unique data set used in this paper allows for the first time a comprehensive analysis of exactly how these aftermarket activities are conducted, the characteristics of IPOs in which un-* The McDonough School of Business, Georgetown University. The author thanks Bill Atkinson,

Short selling in initial public offerings☆

“…27 Although our findings are consistent with underwriters constraining short sales, possibly through the supply of lendable shares in order to provide price support, the literature has also provided mixed results on the potential profitability of shorting price supported IPOs (e.g., Aggarwal, 2000;Lewellen, 2006). Thus, we cannot determine whether short sellers are either unable (because of potential underwriter constraints on supply) or unwilling (due to profitability) to short price supported IPOs.…”

“…Underwriters typically oversell the number of shares in the IPO (Aggarwal, 2000;Jenkinson and Jones, 2007) and must cover this overallocation either with the exercise of the overallotment option or by purchases in the open market. Generally, the underwriter will cover its shares in the open market when the market trading price is near or less than the offer price in order to provide price support.…”

“…Generally, the underwriter will cover its shares in the open market when the market trading price is near or less than the offer price in order to provide price support. Aggarwal (2000) finds that underwriter purchases in the open market, in order to cover its overallocation, occur for 10-15 days after the IPO. In addition, she finds that underwriters may oversell the issue by more than the 15% overallotment option which would necessitate the purchase of shares in the open market.…”

“…This suggests that failures to deliver in price supported IPOs may arise from the mechanics of the offering process. Underwriters generally allocate more shares in an IPO than are offered (e.g., Hanley, Lee, and Seguin, 1996;Aggarwal, 2000). If the first-day return is positive, the underwriter covers this overallocation by exercising the overallotment option.…”

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

“…This was in 1924 when Greenshoe Manufactoring Co. went public. 2 For a better understanding we will differentiate between the phrase "over-allotment arrangement"…”