The economics of IPO stabilization, syndicates and naked shorts
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 â€“ 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 regulatorsâ€™ 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 â€˜naked shortâ€™ 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.
When requesting a correction, please mention this item's handle: RePEc:sbs:wpsefe:2006fe14. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Maxine Collett)
If references are entirely missing, you can add them using this form.