Do Underwriters Encourage Stock Flipping? A New Explanation for the Underpricing of Ipos

52 Pages Posted: 23 Jun 2000

See all articles by Raymond P.H. Fishe

Raymond P.H. Fishe

University of Richmond - E. Claiborne Robins School of Business

Ekkehart Boehmer

Singapore Management University - Lee Kong Chian School of Business

Date Written: May 8, 2000

Abstract

Disagreement persists about why IPOs are underpriced on average. In part because the more popular theories?based on asymmetric information, signaling, cascades, or investor feedback?are difficult to test, we do not know how much underpricing they can explain. We develop an alternative theory that provides a simple and testable explanation for underpricing. This theory is based on the need for liquidity in the after-market. The issuer gains little if the IPO is placed successfully, but there is no trading afterwards. We show that liquidity needs give rise to an offer price and allocation that encourages some flipping of the IPO. By placing shares with flippers and rationing demand to other investors, flippers have buyers waiting for their shares, which creates after-market trading. The underwriter accomplishes this by underpricing the issue to attract low-valuation investors, who flip shares to higher-valuation investors that are rationed. The underwriter gains trading profits from this arrangement by acting as the primary market maker in the IPO. We test this theory using proprietary data on stock flipping and find significant support for this explanation of underpricing.

Keywords: Initial public offerings, stock flipping, underpricing

JEL Classification: G12, G24

Suggested Citation

Fishe, Raymond P.H. and Boehmer, Ekkehart, Do Underwriters Encourage Stock Flipping? A New Explanation for the Underpricing of Ipos (May 8, 2000). Available at SSRN: https://ssrn.com/abstract=228434 or http://dx.doi.org/10.2139/ssrn.228434

Raymond P.H. Fishe

University of Richmond - E. Claiborne Robins School of Business ( email )

1 Gateway Road
Richmond, VA 23173
United States
804-289-8549 (Phone)

Ekkehart Boehmer (Contact Author)

Singapore Management University - Lee Kong Chian School of Business ( email )

Singapore

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