Short Selling Before Initial Public Offerings

Abstract

This paper shows that the presence of security lending supply before an initial public offering (IPO) reduces the initial stock return following IPO and improves subsequent long-run performance. We use a sample of British firms that go public via a two-stage IPO procedure where a firm becomes publicly traded on the London Stock Exchange in the first stage, and offers new shares to the public in the second stage. Stocks are lendable before the new equity issuance which relaxes the short-sale constraints that investors typically face in a conventional IPO. We find that two-stage offerings with higher security lending supply before offering are associated with lower IPO underpricing and better long-run performance. Our results are consistent with the conjecture that short selling improves the pricing efficiency of the IPO market.