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The economics of IPO stabilization, syndicates and naked shorts

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  • Tim Jenkinson

    ()

  • Howard Jones

    ()

Abstract

Stabilization is the bidding for and purchase of securities by an underwriter immediately after an offering for the purpose of preventing or retarding a fall in price. Stabilization is price manipulation, but regulators allow it within strict limits – notably that stabilization may not occur above the offer price. For legislators and market authorities, a false market is a price worth paying for an orderly market. This paper compares the rational for regulators’ allowing IPO stabilization with its effects. It finds that stabilization does have the intended effects, but that underwriters also seem to have other motives to stabilize, including favouring certain aftermarket sellers and enhancing their own reputation and profits. A puzzling aspect of stabilization is why underwriters create ‘naked short’ positions which are loss-making to cover when, as is usual, the aftermarket price rises to a premium. We set up a model to show that the lead underwriter may profit from a naked short at the expense of the rest of the syndicate given the way commissions are apportioned between them. We argue that a naked short mitigates the misalignment of interests which stabilization causes between issuer and lead underwriter, although it does so at the expense of the non-lead underwriters.

Suggested Citation

  • Tim Jenkinson & Howard Jones, 2006. "The economics of IPO stabilization, syndicates and naked shorts," OFRC Working Papers Series 2006fe14, Oxford Financial Research Centre.
  • Handle: RePEc:sbs:wpsefe:2006fe14
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    File URL: http://www.finance.ox.ac.uk/file_links/finecon_papers/2006fe14.pdf
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    Cited by:

    1. Antonio Acconcia & Alfredo Del Monte & Luca Pennacchio, 2011. "Underpricing and Firm’s Distance from Financial Centre: Evidence from three European Countries," CSEF Working Papers 295, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    2. Mei-Hua Liao & Chien-Chih Lin & Yinrou Wang, 2011. "The Effects of Removing Price Limits: Evidence from Taiwan IPO Stocks," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 47(0), pages 40-52, November.
    3. Mei-Hua Liao & Chien-Chih Lin & Yinrou Wang, 2011. "The Effects of Removing Price Limits: Evidence from Taiwan IPO Stocks," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 47(0), pages 40-52, November.
    4. Khelifa Mazouz & Sam Agyei-Ampomah & Brahim Saadouni & Shuxing Yin, 2013. "Stabilization and the aftermarket prices of initial public offerings," Review of Quantitative Finance and Accounting, Springer, vol. 41(3), pages 417-439, October.
    5. Edwards, Amy K. & Hanley, Kathleen Weiss, 2010. "Short selling in initial public offerings," Journal of Financial Economics, Elsevier, vol. 98(1), pages 21-39, October.
    6. Jeon, Jin Q. & Lee, Cheolwoo, 2015. "A new measure for heated negotiation in the IPO syndicate," The North American Journal of Economics and Finance, Elsevier, vol. 33(C), pages 278-304.

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    Keywords

    IPO; stabilization; syndicates;

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