Short Selling in Initial Public Offerings

Abstract:     
Short sale constraints in the immediate aftermarket of IPOs are often used to explain short-term pricing anomalies that are subsequently reversed in the long-term. Using newly available data, this paper documents that short selling is an integral part of the immediate aftermarket trading of IPOs. Short selling is higher in firms with greater first day returns and revisions in offer price. We find no evidence that perceived restrictions on borrowing shares are circumvented by “naked” short selling. Failures to deliver are unrelated to short sales and are much larger than short sales in many cases. Instead, we show that failures to deliver are most likely related to price support. The level of short selling marginally predicts abnormal returns over the first three months of trading but the average short seller does not earn abnormal profits. An examination of potential market maker short sales indicates that our findings on the relation of short selling to initial returns and failures to deliver are not driven by market maker short selling activity. We conclude that short selling in IPOs is not as constrained as suggested by the literature implying that other factors may be responsible for high levels of underpricing.

Keywords: IPO, short selling, underpricing, price support, short covering, naked short sale, failures to deliver, price stabilization

JEL Classifications: G14, G24, G28, G32

Working Paper Series