View metadata, citation and similar papers at core.ac.uk brought to you by CORE provided by Research Papers in Economics econstor www.econstor.eu Der Open-Access-Publikationsserver der ZBW – Leibniz-Informationszentrum Wirtschaft The Open Access Publication Server of the ZBW – Leibniz Information Centre for Economics Oehler, Andreas; Rummer, Marco; Smith, Peter N. Working Paper The Existence and Effectiveness of Price Support Activities in Germany: A Note Bank- und Finanzwirtschaftliche Forschung: Diskussionsbeiträge des Lehrstuhls für Betriebswirtschaftslehre, insbesondere Finanzwirtschaft, Universität Bamberg, No. 30 Provided in cooperation with: Otto-Friedrich-Universität Bamberg Suggested citation: Oehler, Andreas; Rummer, Marco; Smith, Peter N. (2004) : The Existence and Effectiveness of Price Support Activities in Germany: A Note, Bank- und Finanzwirtschaftliche Forschung: Diskussionsbeiträge des Lehrstuhls für Betriebswirtschaftslehre, insbesondere Finanzwirtschaft, Universität Bamberg, No. 30, http:// hdl.handle.net/10419/22505 Nutzungsbedingungen: Terms of use: Die ZBW räumt Ihnen als Nutzerin/Nutzer das unentgeltliche, The ZBW grants you, the user, the non-exclusive right to use räumlich unbeschränkte und zeitlich auf die Dauer des Schutzrechts the selected work free of charge, territorially unrestricted and beschränkte einfache Recht ein, das ausgewählte Werk im Rahmen within the time limit of the term of the property rights according der unter to the terms specified at → http://www.econstor.eu/dspace/Nutzungsbedingungen → http://www.econstor.eu/dspace/Nutzungsbedingungen nachzulesenden vollständigen Nutzungsbedingungen zu By the first use of the selected work the user agrees and vervielfältigen, mit denen die Nutzerin/der Nutzer sich durch die declares to comply with these terms of use. erste Nutzung einverstanden erklärt. Leibniz-Informationszentrum Wirtschaft zbw Leibniz Information Centre for Economics The Existence and Effectiveness of Price Support Activities in Germany – A Note* Andreas Oehlera / Marco Rummera / Peter N. Smithb aDepartment of Economics and Management, Bamberg University, Germany bDepartment of Economics and Related Studies, University of York, UK Revised Version, September 2004 Abstract The overallotment or greenshoe option has become very popular in the German IPO market since its introduction in 1995 and is nowadays an important tool to stabilize IPOs or to issue additional shares in the case of excess demand. Besides providing evidence for the prevalence of price support activities by the underwriter we show that the greenshoe option which seems to be used to support overpriced offerings in the secondary market is not very effective in propping up aftermarket prices. Additionally, the market seems to decide quite early which firms are ‘losers’ and which are ‘winners’ in terms of stock market performance. JEL Classification: G10, G12, G24, G32 Key Words: Initial Public Offerings (IPO), Price Support, Overallotment Option * Address correspondence to: Andreas Oehler, Marco Rummer, Bamberg University, Chair of Finance, Kirschaeckerstrasse 39, D-96045 Bamberg, phone: (+49) 951-863-2536, fax: (+49) 951-863-2538, e-mail: [email protected], internet: http://www.uni-bamberg.de/sowi/finanz. The paper benefited from discussions with Wolfgang Bühler, James Gill, Leslie Godfrey, John Hutton, Aydin Ozkan, Klaus Röder, Ray da Silva Rosa, Dirk Schiefer, Oliver Schwindler and Ben Werner. We also thank seminar participants at the Bambeg University and Freiburg University and participants at the workshop “economics meets psychology 2004” held by the Deutsche Bundesbank, the Portuguese Finance Network Conference 2004, SAM/IFSAM-Conference 2004, Money Macro and Finance Conference 2004 and European Investment Review Conference 2004. The usual disclaimer applies. 1 Introduction The analysis on initial public offerings (IPO, hereafter) has been a major stream of research in corporate finance for over 30 years. Most research focuses on the explanation of underpricing, hot-issue-markets and long-run underperformance (Loughran and Ritter, 1995). Recently, researchers have discovered another, due to lack of data and lack of transparency, less explored puzzle of underwriter activities in the secondary markets to support or stabilize IPOs and therefore influence the IPO price performance (Aggarwal, 2000). Aggarwal (2000) points out that a popular way of supporting IPOs during the first trading days is the combination of initially selling excess shares (e.g. 115%) and covering this short position using an overallotment option. This overallotment or greenshoe option, which has been named after the Greenshoe Manufacturing Company as this firm was the first to go public while using this type of a call option, allows the underwriter to buy additional shares (e.g. the 15% additionally sold) from the issuer at the issue price in order to meet excess demand. If on the other side demand is low and the stock price drops below the offer price the underwriter can, instead of using the greenshoe option, buy the stock in the secondary market and therefore support the performance of the IPO due to increased demand. Franzke and Schlag (2002) stress that greenshoe options have become very popular in Germany and are nowadays announced in nearly all initial offerings. As this tool for supporting IPOs dominates not only the Germany New Issue Market it is interesting to analyze its effectiveness in stabilizing newly issued stocks and, additionally, to analyze the impact on return patterns during the first weeks of trading. Before analyzing the usage of the greenshoe option for the first time we provide, following Ruud (1993), new evidence on underwriter price support by examining the distribution of first day returns. This analysis is supported by the study of the returns patterns during the first 30 trading days. In order to conduct this examination we group IPOs with an - 2 - initial return below 5% into different groups, as they are most likely supported by underwriter in the aftermarket ( Aggarwal, 2000). After providing some evidence for the presence of price support activities at the Frankfurt Stock Exchange we analyze the behavior of buy-and-hold returns of IPOs with initial returns during the first trading day between -5% and +5% and compare the results with IPOs with initial returns below -5%. In order to draw inference of the price impact of the overallotment we break down all IPOs into groups where the greenshoe option has been used, has not been used or has not been announced before the IPO. Summing up, we provide evidence, consistent with Aggarwal (2000), that the use of greenshoe options seems to be the tool to be used for stabilizing activities. Additionally, we provide evidence that overpriced IPOs decrease even more during the first 30 trading days and therefore support the idea of a negative cascade as discussed by Welch (1992). The reminder of this paper is organized as follows. Section 2 provides a short overview of prior research and the reason why underwriter are supporting IPOs in the secondary market. Section 3 describes the data set and provides the empirical analysis for the existence of price support activities in Germany and the effectiveness of the overallotment with regard to price support by the underwriter. Section 4 concludes the paper. 2 What do we know about aftermarket price support? Underwriters use price support to prop up aftermarket prices when the market price would decline without intervention (Schultz and Zaman, 1994). This argument is in line with the cascade theory discussed by Welch (1992), as potential buyers could change their mind in the absence of potential price support and therefore starting a negative cascade resulting in further price declines. - 3 - Aggarwal (2000) analyzes 114 IPOs between May to July 1997 and posses information on each short market transaction and whether penalty bids are part of the contracts and if they have been assessed. Due to this unique dataset this is the first comprehensive analysis of underwriter activities in the secondary market. Aggarwal (2000) discusses and analyses ‘pure’ stabilization, aftermarket short covering and penalty bids and finds that the first type is never performed by the intermediary, as theses transactions have to be identified due to SEC regulations, and that aftermarket short covering is the cardinal way to support newly issued stocks if they perform worse than expected. Contrary to Aggarwal (2000) most researchers have had to estimate which IPOs are supported in the aftermarket or use indirect measures to identify stabilizing activities due to a lack of data. Ruud (1993) bases her findings on the skewed distribution of the initial returns following the public offer. She discovers that instead of forming a symmetric curve centered over a positive mean, the distribution of one-day returns is found to peak rather steeply around a value close to zero and are heavily skewed to the right. We are therefore only able to observe the distribution of returns conditional on market stabilizations by underwriters, but not the unconditional return distribution, which means that relatively few IPOs sink much below their offering price immediately (Mihurko, 2000). Due to this, one could argue that the effect of such stabilizing activities is to reduce the number of negative initial returns from what would otherwise be observed. Ruud (1993) uses a sample of 463 IPOs occurring in 1982 and 1983 in her analysis. She found that one-fourth