An examination of large sell orders in cold IPO aftermarkets

Abstract

It is well-known that investment banks routinely take large naked short positions for low demand IPOs, and for such cold IPOs, the immediate sale of initial allocations back to the market accounts for a relatively large proportion of total trading volume. In this paper, we investigate the relationship between investment banks and institutional investors during the stabilization period. Specifically, we hypothesize that lead underwriters cover their short positions through selective share buy-back from institutional investors at the offer price. Using trade data, we examine the trading patterns of large (institutional) and small (retail) trades during the stabilization period. We find that a large proportion of institutional sells take place at the offer price, while a large proportion of retail sells take place below the offer price in a cold IPO stabilization period. We then estimate the information content of all trades to determine whether seller-initiated trades from institutional investors are correctly anticipated by the investment bank in an effort to cover their short position. If they are anticipated, these trades would carry little to no new information. Indeed, we find that the information content of large sell orders in cold IPO aftermarkets is lower than the information content of small trades, and is the least compared to several control samples. The results are robust and survive controls for external factors such as volume, turnover, and volatility. These results suggest that lead underwriters allow their valuable buy-side clients to sell back cold IPO allocations at the offer price.