Short Selling and Failures to Deliver in Initial Public Offerings

Abstract

This paper documents that short selling is prevalent in early IPO aftermarkets in contrast to the assumption in the literature that IPOs are short sale constrained. We observe more short selling in IPOs where the divergence of opinion is highest, those with positive partial adjustment, large trading volume and high initial returns and fewer short sales in IPOs that are more likely to have short covering in the aftermarket. We examine whether short selling in IPOs is due to a failure to locate and borrow shares for delivery, i.e. short selling. Despite finding that settlement failures (failures to deliver) occur regularly in IPOs, our results do not support the conjecture that naked short selling is to blame. In fact, we show that failures to deliver are uncorrelated with short selling and for many IPOs, exceed the level of short selling. We conclude that IPOs are not as short sale constrained as suggested by the literature and failures to deliver are a byproduct underwriter short covering activities to support the trading price.