An Examination of Large Sell Orders in Cold IPO Aftermarkets

Abstract

Investment bankers routinely take large naked short positions in low demand or cold IPOs, and flipping accounts for a relatively large proportion of trading volume in cold IPOs. We hypothesize that lead underwriters cover their short positions through selective buy-back of shares from institutions at the offer price during the stabilization period. The empirical implication is that the information content of these anticipated bulk trades will be small relative to other trades. Our results support this hypothesis and we offer the following explanation. Lead underwriters provide institutions with an escape mechanism if they do not wish to retain their initial share allocations because they are valuable buy-side clients involved in a repeated game. Such an escape mechanism entails the investment banker anticipating that some bulk flipped trades will occur that s/he will use to cover the short position in cold IPOs. Thus, there is no 'surprise' or information content in such bulk flipped trades. The idea that lead underwriters provide selective price support to institutions in the stabilization period is consistent with accounts in the popular press which indicate that restrictions on flipping are not uniformly applied and retail clients are specifically under duress not to flip their allocations.