Stocks are usually offered in initial public offerings (IPOs) at a discount, leading to large first-day IPO returns. When there is a risk of a negative initial return, underwriters are known to actively support the aftermarket price of a stock through buying activities. In this post, we look at the trading book for Facebook stock on May 18, 2012, the day of its highly anticipated IPO. Using what we call a “large integer–price bid” identification assumption to indirectly infer which investors are bidding, we find evidence of significant trading by underwriters seeking to stabilize the stock’s price. This evidence suggests that underwriters incurred significant costs as a result of these activities.HT to DealBreaker who writes:
In an IPO, a company sells its shares to the public on a securities exchange for the first time. IPOs are generally conducted with the assistance of one or more investment banks acting as underwriters. The underwriters play three roles in the IPO process: They provide the company with procedural and financial advice, they buy the issue from the company, and they resell it to the public. A major task of the underwriters is setting the IPO price. The finance literature finds that IPOs are generally underpriced in the short run and overpriced in the long run. To date, there is no consensus on the drivers of these patterns (Ritter and Welch 2002).
The underwriters in an IPO try to get the price of its shares “right” by gauging demand in roadshows and conducting their own analysis. In addition, however, the issuing firm may offer underwriters a way of reducing initial market price volatility that is known as the over-allotment or “greenshoe” option. Under this option, which is sanctioned by the Securities and Exchange Commission, the underwriters sell to the public a certain number of extra shares, usually 15 percent of the issuance, in addition to the original offering that they purchased from the issuing firm. If demand for the stock is unexpectedly high, the extra shares reduce upward price pressure and are issued to the underwriters retroactively at the IPO price. However, if demand for the stock is unexpectedly low, the underwriters buy back the extra shares in the marketplace, thus helping to stabilize the price. In economic terms, the “greenshoe” option lends some elasticity to the supply of shares so that the price impact of demand fluctuations is dampened. As explained by Aggarwal (2000) and Lewellen (2006), this over-allotment option is the main mechanism used by underwriters to stabilize the price. In the case of Facebook, the underwriters were given the right to sell slightly more than 63 million additional shares, 15 percent of the issuance of about 421 million shares.
Writing about the Facebook IPO in a post on the blog Dealbreaker, Matt Levine found evidence of stabilizing trades by dealers in the fact that about 43 million Facebook shares were exchanged exactly at the IPO price of $38 on the IPO day. Is there any additional support for this interpretation or evidence of other such trades during the day?...MORE
How Hard Did Morgan Stanley Try To Lose Money On The Facebook IPO?
Let’s disclose some conflicts of interest. I want to be all “go read this post from the NY Fed’s Liberty Street blog about the Facebook IPO greenshoe, it’s good, you’ll like it,” but I have this nagging sense that I’m mostly saying that because the New York Fed cited Dealbreaker, and what are the odds of that, so I want you to see it with your own eyes. But the post is fun, if you like this sort of thing, so, now you’ve got the recommendation and the disclosure, make your own call.1
Anyway the Fed researchers look at the Facebook IPO and the underwriters’ price stabilizing activity on its first trading day, Friday May 18. And they note, as I did, that there was a whole lot of buying at the IPO price of $38, which was probably largely due to the underwriters and which kept the stock above $38 going into the weekend before it cratered Monday morning. But they also note that there was a whole lot of buying at $40, which kept the stock above $40 for … 15 minutes....MUCH MORE
