When do investment banks use IPO price support?

• Published date: 01 June 2019
• Date: 01 June 2019
• DOI: http://doi.org/10.1111/eufm.12170

437Eur Financ Manag. 2019;25:437–461. wileyonlinelibrary.com/journal/eufm © 2018 John Wiley & Sons, Ltd.

DOI: 10.1111/eufm.12170

ORIGINAL ARTICLE

When do investment banks use IPO price support?

Sturla Lyngnes Fjesme

Oslo Business School, Oslo Metropolitan

University, Oslo, Norway

Email: sturla.fjesme@hioa.no

Funding information

American–Scandinavian Association, the

Center for Corporate Governance Research

(CCGR) at BI Norwegian Business School,

and the Central Bank of Norway

Abstract

Practitioners, regulators, and the financial media argue that

underwriters tie initial public offering (IPO) allocations to

investor post-listing buying of the issuer shares in a process

labelled price support. Arguably, this excess demand boosts

post-listing returns which underwriters trade quid pro

quo with investor stock-trading commission payments. In

this paper, I investigate unique data from the Oslo Stock

Exchange (OSE) including investor stock-trading commis-

sions, IPO allocations, and post-listing trading. I document

that investors who provide high returns to underwriters

before IPOs benefit from price support through increased

returns in IPOs. I conclude that price support is used when

investors share boosted returns with underwriters.

KEYWORDS

IPOs, price support, stock-trading commission

JEL CLASSIFICATION

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INTRODUCTION

Following recent financial scandals, regulators have investigated some of the leading international

initial public offering (IPO) underwriters for allegedly allocating underpriced shares in return for

I thank John Doukas (the Editor), two anonymous referees, François Derrien, Jaden Falcone, Neal Galpin, Lyndon Moore,

Øystein Strøm, and seminar participants at the Oslo and Akershus University College for helpful comments. I also thank

the Oslo Stock Exchange VPS for providing the data, the Financial Supervisory Authority of Norway (Finanstilsynet), and

the companies and investment banks that helped locate the listing prospectuses. I also thank the American–Scandinavian

Association, the Center for Corporate Governance Research (CCGR) at BI Norwegian Business School, and the Central

Bank of Norway for financial support. All errors are my own.

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FJESME

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additional rent-seeking services from investors. Arguably, underwriters tie allocations to stock-trading

commission payments, additional share purchases in the aftermarket to boost prices (a process referred

to as price support), and future corporate business (a process referred to as spinning).

1

Each of these

IPO scandals has since been investigated empirically one by one.

2

However, these allocation

mechanisms are more likely to be used in combination and thereby exacerbate the effects. Hao (2007)

shows theoretically how underwriters benefit by combining price support with allocations to high

stock-trading commission investors and thereby share in the boosted profits.

In this paper, I ask: Do underwriters tie IPO allocations to price support for some investors so that

other high ex ante stock-trading commission investors benefit through increased realized profits?

Obtaining data to investigate IPO practices has in the past proven difficult. The underwriter

generates the allocation data and many of the alleged practices are illegal.

3

The incentives for

investment banks to share data are therefore limited. To investigate the research question, I also need

data on investor stock-trading commissions as well as investor post-listing trades.

To overcome these data obstacles, I investigate IPOs on the Oslo Stock Exchange (OSE).

In Norway, all privately held companies must register shareholdings in the OSE VPS (the share

depositary) as part of the listing process. This data is continually updated with secondary trading. From

the OSE VPS I obtain IPO allocations for 188 companies as well as stock-trading commission and

secondary trading for all investors (not just IPO investors) in the period January 1993–September 2007.

I find a strong and robust relation between investor realized IPO profits and price support for high

stock-trading commission investors. I find that investors who increase abnormal stock-trading

commissions by US$1 million before the IPO are repaid US$2.34 million in realized profits from IPOs

with price support. Underwriters keep a large share of the IPO profits (US$1 million from abnormal

stock-trading commission) and the allocated investors receive the remainder IPO profits (US$1.34

million). I control for investors’portfolio values, past allocations between investors and underwriters

as well as other company-specific variables and fixed effects. Investors do not increase IPO realized

profits from having bigger portfolio values or prior dealings with the underwriter.

I also document that the increase in realized profits for high commission investors comes from three

sources. First, price support inflates returns in the immediate period after new listings. This allows

allocated investors to sell shares at higher prices. Price support is then related to negative returns in the

following months after the listing as price support investors offload their unwanted shares. Second,

allocations to high commission investors are increased when expected returns after the listings go up.

I measure expected returns using IPO overall subscription levels as well as with realized returns. I find

that underwriters who expect there will be inflated prices after the listing allocate more shares to high

commission investors (and thus further increases realized profits). Finally, when there is more price

support there is also more flipping by high commission investors. Increased flipping further indicates

that this is part of rent-seeking agreements as the high commission investors are aware that prices will

eventually fall and therefore flip their allocations. Price support is related to negative returns starting

1 month after new listings as price support investors start offloading shares. Any investor who has not

sold their allocations by this time will forgo the benefits from price support.

1

Tying IPO allocations to services has generated a massive interest from the financial media, practitioners, and regulators in

addition to academic research; see Farbrot (2011) for Norwegian evidence and Puliam and Smith (2001) for US evidence.

The US Securities and Exchange Commission (SEC) has also sued several global investment banks over allegedly tying

IPO allocations to price support; see the SEC (2003, 2005a, 2005b) litigation releases.

2

See Reuter (2006), Liu and Ritter (2010), and Griffin et al. (2007).

3

In Norway IPO price support when performed above the offering price is illegal under chapter 3 section 12 of the

Norwegian Securities Trading Act.

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