Short Selling in
Initial Public Offerings
By
Amy K. Edwards
and
Kathleen Weiss Hanley
U.S. Securities and Exchange Commission
For Presentation at the
University of Waterloo
Disclaimer
The U.S. Securities and Exchange
Commission disclaims responsibility for
any private publication or statement of
any SEC employee or Commissioner.
This study expresses the authors’ views
and does not necessarily reflect those of
the Commission, the Commissioners, or
other members of the staff.
2
“.. short-selling is impossible during…
the first days of trading.”
-Hanley, Lee and Seguin (1996)
3
Short sale constraints and
IPO pricing
Previous studies suggest that short sale
constraints can lead to overvaluation and/or
underpricing
– Miller (1977), Derrien (2006) and Ljungqvist, Nanda,
and Singh
Constraints include:
– Limits on underwriter lending shares during first
month of trading: Houge, Loughran, Suchanek and
Yan (2001)
– Restricted supply of shares due to lock-ups: Ofek and
Richardson (2000)
– Level of rebate rates: Ljundqvist, Nanda and Singh
(2006), Geczy, Musto and Reed (2002)
4
Motivation
Recent research questions the importance
of short sale constraints in IPOs.
– Rebate rates: D’Avolio (2002) and Geczy,
Musto and Reed (2002)
– Grey markets: Dorn (2003), Ausseness, Pichler
and Stomper (2003), Cornelli Goldreich and
Ljungqvist (2006)
Short sale transactions data publicly
unavailable prior to January 2005
Examination of short selling at IPO
provides natural experiment to examine
effect of short sales (or lack thereof)
5
Empirical findings
Short selling occurs early in the aftermarket
Short sales are positively related to the change in
offer price and level of first day returns
– Consistent with overvaluation due to either investor
sentiment or divergence of opinion
No evidence that investors are systematically
circumventing constraints or rules on borrowing
shares by engaging in “naked” short selling
Short selling only marginally related to
subsequent price returns
Findings not due to market maker activity
6
Outline
Short selling institutional details
Data and summary statistics
Evidence on short selling
Determinants of short selling
Constraints on short selling
Effect of and profitability of short selling
Market makers
Conclusion
7
Timing
T=0
– Offer date
– First possible short selling date
T+3
– First settlement date
– IPO closing date
– First possible fail to deliver date
8
Mechanics of a short sale
Short sellers must borrow stock for delivery
on T+3
Brokers must locate shares before executing a
short sale
Locate occurs when the broker, not the
investor, determines whether the stock can be
borrowed
– Market makers exempt from locate if shorting
for their own account
9
Cost of borrowing
To borrow stock, the short seller must post
(proceeds of sale) collateral of about 102-105% of
the stock value
A short seller is usually also required to post
margin
– Margin calls can be very costly if the short seller has
limited capital
The lender rebates interest on the collateral to
the short seller
– Rebate rate= Fed funds rate – stock loan fee
– Depends on lending difficulty
– Can be negative
10
Data
IPOs from SDC issued from January 1, 2005
through December 31, 2006 .
– Final sample is 388 IPOs
– No unusual characteristics except one IPO
Estimate market variables using TAQ and CRSP
Short selling data
– Publicly available transaction-level data from:
Amex, Aracex, Boston, Chicago, NASD, NASDAQ, National,
NYSE, Phlx
– Aggregated to daily short selling volume
11
Additional variables
First day returns (CRSP)
–
–
–
From offer to open
From open to close
From offer to close
Change in Offer Price = (Pipo-Pmid)/Pmid (SDC)
VolumeT+0/shares offered (CRSP)
Price supported IPO dummy
–
IR=0 OR IPO is in the bottom quartile of % OAO exercised
(Bloomberg) OR top quartile for % percent trades, using TAQ,
executed at the Pipo on offer day
Float= shares offer/shares outstanding (CRSP)
Ability to execute
–
Percentage of the trading day when the rule allows short sales
to execute (TAQ)
NASDAQ dummy
12
Offering statistics
Table 1
Mean
Median
Offer Price
$14.82
$14.50
Offer Amount (in mils)
$188.53
$114.23
Change in Offer Price
-4.18%
0.00%
Panel A: Offering Statistics
Panel B: Offer Day Trading Statistics
First Day Return from Offer Price to Open
9.07%
2.84%
First Day Return from Open to Close
0.62%
0.00%
First Day Return
9.58%
4.17%
13
Does short selling exist?
Table 1
Mean
Median
Short SalesT+0 /Shares Offered
7.26%
5.56%
Short SalesT+0/ Trading Volume T+0
12.02%
10.36%
Trading Volume/Shares Offered
58.94%
53.80%
Short SalesT+0/Shares Outstanding
3.02%
1.94%
14
Distribution of first day short sales
50%
45%
Percent of Sample
40%
35%
30%
25%
20%
15%
10%
5%
0%
0%
>0-5%
>5-10%
>10-15% >15-20% >20-25%
First Day Short Selling/Shares Offered
>25%
15
Daily short sales
11%
54%
49%
9%
44%
Short Sales
Volume
Returns
8%
7%
39%
34%
6%
29%
5%
24%
4%
19%
3%
2%
14%
1%
9%
0%
4%
-1%
1
3
5
7
9
11
13
15
Trading Day
17
19
21
23
25
27
-1%
Volume/Shares Offered
Short Sales /Shares Offered and Returns
10%
16
Intraday short sales
60%
Nasdaq Short Sales/Total Nasdaq Short Sales T+0
50%
Percent of Total on T+0
Nasdaq Trades/Total Nasdaq Trades T+0
NYSE & Amex Short Sales/Total NYSE & Amex Short Sales T+0
40%
NYSE & Amex Trades/Total NYSE & Amex Trades T+0
30%
20%
10%
5
3:
30
-3
:4
5
3:
00
-3
:1
5
2:
30
-2
:4
5
2:
00
-2
:1
5
1:
30
-1
:4
5
1:
00
-1
:1
5
0:
30
-0
:4
0:
00
-0
:1
5
0%
Time Relative to Open in 15 Minute Increments
17
Short selling in other studies
Diether, Lee and Werner (2006): Short
sales comprise
– 24% of daily trading volume in NYSE
– 32% of daily trading volume in Nasdaq
– Daily short selling volume is much lower than
short interest.
Trading volume initially much higher in
IPOs than in individual stocks
18
Comparison to other studies
30%
70%
Short Sales/Volume
50%
20%
40%
15%
30%
10%
5%
All IPOs
Nasdaq IPOs
20%
Nyse IPOs
Volume/Offer
10%
0%
Volume/Shares Offered
60%
25%
0%
1
3
5
7
9
11
13
15
17
19
21
23
25
27
19
Day
Is short selling related to
divergence of opinion?
Miller (1977) argues that
“the prices of new issues… are set not by
the appraisal of the typical investor, but by
the small minority who think highly
enough of the investment merits of the
new issue to include it in their portfolio.
The divergence of opinion about a new
issue [is] greatest when the stock is
issued.”
20
Statistics by quartiles of
first day return
Table 2
Lowest
Q1
Q2
Highest
85
109
97
97
First Day Return from
Offer Price to Close
-4.78%
1.11%
9.72%
31.54%
Volume T+0/Shares Offered
48.49%
46.56%
60.41%
80.53%
Change in Offer Price
-12.55%
-13.51%
0.08%
9.38%
Short SalesT+0 /Shares Offered
5.48%
5.20%
7.37%
11.00%
Short SalesT+0/
Trading Volume T+0
11.47%
10.17%
13.50%
13.12%
Cumulative Short SalesT+0 to T+21
/Shares Offered
12.83%
13.27%
18.94%
33.38%
Number of IPOs
21
Determinants of short sales
Table 3: Dep Var=Short sales/Shares offered
Model 1
Model 2
Intercept
0.056
(4.70)***
0.073
(6.41)***
Return from Offer to Open
0.188
(8.88)***
0.173
(9.90)***
Change in Offer Price
Price Supported IPO
0.008
(1.17)
0.004
(0.55)
Float
-0.005
(-1.37)
-0.008
(-2.30)**
Ability to Execute T+0
-0.029
(-1.84)*
-0.022
(-1.43)
NASDAQ
0.022
(3.57)***
0.033
(5.41)***
0.23
0.25
Adj. R2
22
Short sale constraints
Ability to execute
Uptick Rule and Nasdaq Bid Test
Greater ability to execute, lower (not higher) is
short selling
Ability to borrow shares
– Float
Proxy for supply of lendable shares
> Lower the float, higher (not lower) is short selling
– “Naked” short selling
Cost of borrowing shares
– Rebate rates
23
Ability to borrow shares
Settlement and clearing process
– From trade date (T) to settlement date (T+3), the
clearing house (NSCC) aggregates buys and sells at
clearing broker (not investor or level
Called “Continuous Net Settlement” or CNS
– If a net seller does not have enough shares on account
DTC records a “failure to deliver” (FTD) in that
clearing broker’s account and assigns a “failure to
receive” (FTR) to account of clearing broker who was
a net buyer
Fails to deliver as a proxy for “naked” short
selling
– Daily fails collected from CNS
Only aggregate fails of 10,000 shares or more
Balance variable not flow
24
Summary statistics on
fails to deliver
Table 4
Mean
Median
Panel A: All IPOs First Settlement Day (T+3)
Fails to Deliver/Shares Offered
Fails to Deliver/Short SalesT+0
4.23%
2.29%
1,083.37%
30.32%
Panel B: 210 IPOs with First Fail on First Settlement Day (T+3)
First Day Return
9.14%
3.67%
Fails to Deliver/Shares Offered
6.92%
5.73%
1,779.50%
99.70%
Fails to Deliver/Short SalesT+0
Panel C: 77 IPOs with First Fail Later Than First Settlement Day (T+4 to T+29)
First Day Return
10.88%
5.44%
First Fails to Deliver/Shares Offered
0.86%
0.46%
First Fails to Deliver/Short SalesT+0
31.47%
7.99%
6.14
5.00
Day of First Fails to Deliver
25
Fails and Short Sales As Percent of Shares Offered
Daily fails to deliver
8.00%
7.00%
Fails to Deliver
6.00%
Short Sales
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
0 1
2 3
4
5 6
7 8
9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
Trading Day
26
Determinants of fails to deliver (T+3)
Tobit analysis
Table 5: Dep Var=FTD/Shares offered
Model 1
Model 2
Intercept
0.056
(3.40)***
0.056
(3.44)***
Short SalesT+0/Shares Offered
0.39
(0.62)
0.029
(1.06)
First Day Return
0.038
(4.53)***
0.040
(4.55)***
-0.008
(-0.81)
-0.008
(-0.85)
Ability to Execute T+0
-0.043
(-2.05)**
-0.045
(-2.11)**
NASDAQ
-0.038
(-4.40)***
-0.037
(-4.41)***
169.58
169.95
Price Supported IPO
Float
Log Likelihood
27
Threshold list
Longer lived fails
– Max of 10,000 shares or 0.5% of shares
outstanding for five consecutive days
T+7 is first day for inclusion on threshold
list
– Threshold list information from NYSE, Amex,
and Nasdaq
155 IPOs are on threshold list at some
point during the first 30 days with 113 or
29% on list at T+7
– Only 2% of non-IPO stocks on list in May 200628
Threshold list
Probit analysis
Table 5: Dep Var=Dummy Threshold
Model 1
Model 2
Intercept
-0. 405
(2.16)
-0.322
(1.43)
Short SalesT+0/Shares Offered
0.430
(0.15)
-0.495
(0.92)
First Day Return
0.571
(15.39)***
0.483
(8.58)***
Float
0.038
(0.20)
0.035
(0.17)
Ability to Execute T+0
-0.240
(0.43)
-0.214
(0.34)
-0.483
(10.65)***
-0.463
(10.11)***
221.11
220.73
Price Supported IPO
NASDAQ
Log Likelihood
29
Could fails to deliver be related to
underwriter price support activities?
Only offering amount plus exercise of the
overallotment option (OAO) settles at DTC
Any shares allocated in excess of the number of
shares offered but not covered by the exercise of
OAO at time of closing are considered
“uncovered”
– Must either be purchased in open market or through
OAO
– Will result in fail to deliver if investor sells shares
prior to covering by underwriter
30
Cost of borrowing shares
Rebate rate data from anonymous vender
– Includes 259 IPOs or 67% of sample
– More likely to be in data
Greater is the short selling on first day and over first month
IPO listed on NYSE/Amex
Loan fee=Fed funds rate-rebate rate
Average loan fee over first month of trading
– Monthly: 0.15%
– Annual: 1.88%
– Compare to Geczy, et.al. (2002)
First day: 2.95%
End of first month: 1.47%
31
Determinants of the
cost of borrowing
Other independent variables not shown and are
insignificant (N=259)
Table 6: Dep Var=Avg weighted loan fee
(T+3 to T+24)
Model 3
Model 4
Model 5
Intercept
0.014
(2.49)***
0.013
(2.73)***
0.019
(3.13)***
Short SalesT+0/Shares Offered
0.120
(5.59)***
Cumulative Short SalesT+0 to T+21 /
Shares Offered
0.049
(10.65)***
0.068
(2.14)**
Fails to Deliver T+3/Shares Offered
R2
0.10
0.30
.01
32
Short selling and returns
Short selling negatively related to
subsequent returns
– Diether, Lee and Werner (2007a)
– Boehmer, Jones and Zhang (2008)
Use buy-and-hold returns adjusted for
Nasdaq Composite Index
Adjust standard errors for clustering by
month of IPO
33
Return predictability
Panel B
One Month Return
From First Day
Close
Panel C
Three Month Return
From First Day
Close
Panel D
Three Month Return
With Loan Fees
(N=259)
Table 8
Model 2
Model 3
Model 4
Model 5
Model 6
Model 7
Intercept
0.083
(3.43)***
0.057
(2.99)***
0.119
(2.51)**
0.087
(2.21)**
0.108
(2.33)**
0.076
(1.87)*
Short SalesT+0 /
Shares Offered
-0.215
(-1.35)
Cumulative
Short SalesT+0 to T+21/
Shares Offered
Price Supported
IPO
Adj. R2
-0. 500
(-1.67)
0.050
(1.33)
-0.491
-(1.67)
-0.031
(-0.60)
-0.027
(-0.69)
-0.079
(-5.63)***
-0.070
(-4.78)***
-0.099
(-3.34)***
-0.091
(-3.10)***
-0.107
(-2.97)***
-0.099
(-2.78)***
0.09
0.09
0.04
0.03
0.05
0.03
34
Profitability
Three month Nasdaq adjusted return
Variable
Lowest
Q2
Q3
Highest
Annual Weighted Loan Fee
From T+3 to T+24
2.19%
1.35%
1.88%
2.05%
Month Weighted Loan Fee
From T+3 to T+24
0.17%
0.11%
0.15%
0.17%
First Day Return
8.08%
6.92%
13.02%
10.31%
Short SalesT+0/Shares Offered
8.38%
7.06%
7.05%
6.53%
Cumulative Short SalesT+0 to T+21/
Shares Offered
19.98%
18.25%
20.92%
19.34%
Three Month Nasdaq Adjusted
Return
-26.34%
-6.71%
-7.43%
36.30%
Three Month Profit
23.09%
6.30%
-7.78%
-37.64%
35
Potential market maker activity
Market makers important in aftermarket trading
– Krigman, Shaw and Womack (1999), Ellis, Michaely
and O’Hara (2000) and Ellis (2006)
Exempt from locate requirement and some
execution rules
Use “exempt” indicator for trading on Nasdaq
for Nasdaq IPOs as proxy for market maker
activity
– 40% of first day short sales in Nasdaq IPOs are
marked exempt
36
Market maker effect on
short selling
Panel A
Short Selling
Table 9
Exempt
Other Short Sales
Intercept
0.054
(7.03)***
0.050
(3.75)***
First Day Return from
Offer to Open
0.059
(4.99)***
0.106
(5.14)***
Price Supported IPO
-0.00002
(-0.01)
-0.005
(-0.72)
-0.001
(-0.78)
-0.003
(-1.13)
-0.049
(-3.87)***
-0.012
(-0.52)
0.12
0.11
Float
Ability to ExecuteT+0
Adj. R2
37
Market maker effect on
fails to deliver
Panel B
Fails to Deliver
Table 9
Exempt
Other Short Sales
Intercept
0.055
(2.31)**
0.069
(2.99)**
0.214
(1.30)
-0.040
(-0.43)
Price Supported IPO
0.029
(2.86)***
0.027
(2.64)***
Float
-0.048
(-2.23)**
-0.046
(-2.15)**
Ability to ExecuteT+0
-0.081
(-2.35)***
-0.090
(-2.64)***
99.87
99.12
Short SalesT+0/Shares Offered
Log Likelihood
38
Market maker effect on return
predictability
Panel C
One Month Return
From First Day Close
Panel D
Three Month Return
From First Day Close
Table 9
Exempt
Other Short
Sales
Intercept
0.134
(3.42)***
0.148
(3.90)***
0.234
(3.94)***
0.228
(4.43)***
-0.257
(-0.74)
-0.399
(1.97)*
-0. 897
(-1.32)
-0.766
(-2.17)**
-0.079
(-4.17)***
-0.084
(-4.88)***
-0.098
(-2.74)***
-0.1.05
(-3.05)***
0.0042
(2.08)**
0.003
(1.74)*
-0.005
(1.30)
0.004
(1.00)
-0.178
(-3.11)***
-0.170
(-3.35)***
-0.263
(-3.66)***
-0.226
(-2.72)**
0.09
0.11
0.04
0.05
Short SalesT+0 /
Shares Offered
Price Supported IPO
Float
Ability to ExecuteT+0
Adj. R2
Exempt
Other Short
Sales
39
Conclusion
Short selling is prevalent in early trading of IPOs
Constraints on short selling do not appear
binding
– No evidence that short sellers fail to borrow shares
Fails to deliver may be due to underwriter price support
– Loan fees positively related to amount of short selling
Short selling is negatively related to short term
returns but do not appear to mitigate
underpricing
Results not due to market making activity
Unlikely that short sale constraints are
responsible for high underpricing
40