The stock price performance of initial public offerings (IPOs) has long been a puzzle and researchers are still trying to understand the price behavior of these offerings. On average, IPOs jump up in price considerably on the first day of trading and provide excess returns to investors who are able to buy at the initial offer price and sell immediately in the secondary market. Recent literature examines the activities of underwriters in the aftermarket. These activities are generally referred to as stabilization activities because they provide price support for weak offerings that tend to trade at or below their offer price. Stabalization activities include exercise of the overallotment option, short covering in the aftermarket, and the use of penalty bids to restrict flipping.
This paper integrates the literature on underpricing of IPOs and aftermarket activities. The initial stock price performance of IPOs partly depends on how shares are priced, how they are allocated, and what investors do with these shares. Investment banks have the discretion to allocate IPO shares, and investors have the option to hold onto their allocated shares or to sell them immediately in the aftermarket. Investors who sell their shares in the first few days after trading begins are referred to as flippers and investment banks have implemented schemes to discourage flipping because this activity puts downward pressure on the stock price. Flipping is the term used when shares are sold in the immediate aftermarket by investors who receive an initial allocation at the offer price and does not include purchases in the aftermarket. The lead underwriter does not disclose the proportion of shares allocated to institutions versus individuals, and the public does not know who has flipped shares. However, the lead underwriter and each syndicate member maintain a detailed account of initial allocations and each customer’s flipping activity.
A recent article in the Wall Street Journal reported, “Traditionally, individuals get between 10% and 20% of IPO shares at the offer price” (Wall Street Journal, February 28, 2000, p. C21). Another article reported that 60% of the IPO of AT&T Wireless Group was allocated to institutions and 40% was allocated to retail customers (including a large allocation to employees):
- Trading volume was high: More than 137.4 million shares changed hands on the Big Board, making it the most active stock on the exchange. That indicates that many institutional investors who received shares on the offering were immediately “flipping” them to cash in. (Wall Street Journal, April 28, 2000, p. C19)
In the case of the Goldman Sachs IPO in May 1999, the shares reportedly were placed “with a group of institutional investors and rich individuals who Goldman believed would remain loyal, long-term holders and not flip the stock after its offering” (Wall Street Journal, May 5, 1999, p.C19). Even then trading volume was heavy on the first day, and the financial press concluded that this was due to trading by individuals.
I use a unique data set that permits a comprehensive empirical analysis of the flipping activities of investors after adjusting for allocations made to institutional and retail customers. The perception that heavy trading volume during the first few days of trading in an IPO is due to flippers is not found to be true. I conclude that during the first few trading days, even though trading volume as a percentage of shares offered is high (mean of 81.97% and median of 74.10%), high trading volume is not just due to flipping. On average, flipping accounts for 18.95% (median of 16.67%) of trading volume and 15.00% (median of 7.34%) of shares offered in the IPO. Therefore, the high trading volume is partly a result of other factors, such as buying and selling by investors who are not necessarily original buyers of the IPO, and partly a result of trading activity between market makers. Aggarwal and Conroy (2000) and Ellis, Michaely, and O’Hara (2000) document the important role of market makers, particularly wholesalers, who are dealers/market makers for Nasdaq IPOs and receive payment for order flow. These wholesalers are not original investors in IPOs but are major intraday traders who might conduct several transactions (including taking short positions) in order to satisfy each customer’s order and thereby add to trading volume. Geczy, Musto, and Reed (2002) discuss in detail the equity lending market in IPOs and document significant short selling activities in the first few days of trading.
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Allocation of initial public offerings and flipping activitys
