Stabilization Activities by Underwriters After Initial Public Offerings

Abstract

Although much attention has been paid to the price behavior of initial public offerings (IPOs), research related to the activities of underwriters in the aftermarket has been hampered by both lack of data and the limited transparency of industry practices. This paper uses a unique data set that allows us for the first time to find out how these activities take place and whether they are economically significant. We find that underwriters are actively engaged in aftermarket activities that help provide price support for weak offerings. Whereas prior research has assumed that underwriters post a “stabilizing bid” in the aftermarket, we find instead that the activities of underwriters are less transparent and include stimulating demand in the aftermarket through short covering, and restricting supply by penalizing the “flipping” of shares. There is a clear relationship between these aftermarket activities and initial IPO returns. In more than half the IPOs, a short position of an average 10.75 percent of shares offered is covered in 22 transactions over 16.6 trading days in the aftermarket, resulting in a loss of 3.61 percent of underwriter spread. Underwriters manage price support activities by using a combination of aftermarket short covering, penalty bids, and the selective use of the overallotment option.