Skip to main content
SpringerLink
Log in

Decimalization, IPO aftermath, and liquidity

  • Original Research
  • Published:
Review of Quantitative Finance and Accounting Aims and scope Submit manuscript

Abstract

We investigate the effect of decimalization on the aftermarket trading of NYSE-listed IPOs. We find that the relation between bid–ask spread and underpricing becomes negative post-decimalization, suggesting that benefits from the increased price competition accrue more to hot IPOs. The quoted depth is generally smaller post-decimalization due to a higher probability of front running, which aggravates the cost of adverse selection and limit order submission. We show that underwriters continue to provide price support but are only willing to cover the initial short position, if profitable to do so. Decimal pricing does not affect the flipping strategy of institutions for cold IPOs as they are likely bound by the underwriter’s price support and their share allocation. Institutions, however, tend to flip more hot IPOs during the post- than in the pre-decimalization period, suggesting that the cost of flipping is lower for shares with a substantial price run-up during aftermarket trading.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1
Fig. 2
Fig. 3

Similar content being viewed by others

Notes

  1. NYSE and AMEX implemented decimal pricing initially with a small number of stocks on August 28, September 25, and December 4, 2000, and finally with the remaining stocks on January 29, 2001. NASDAQ, however, experimented with decimal pricing in March 2001 and went to full implementation in April 9, 2001.

  2. We refer aftermarket trading as the first-day trading of post-IPO throughout this study. All NYSE-listed IPOs in our sample switched to decimal pricing in 2001.

  3. Amihud and Mendelson (1986) and Brennan and Subrahmanyam (1996) provide a detailed discussion on the relation between liquidity and stock returns. Butler et al. (2005) find that investment banks charge lower fees to seasoned equity offering firms with more liquid stocks.

  4. The start of IPOs aftermarket trading is unique, important, and is a period of extremely high trading activity [e.g., Corwin et al. (2004), Ellis et al. (2000, 2002), and Ellis (2006)]. Price stabilization and flipping are important activities, especially during the IPOs’ first day of trading.

  5. Flipping refers to the activity of selling shares immediately after an IPO begins trading in the aftermarket.

  6. Corwin and Harris (2001) find that smaller and riskier firms tend to list on NASDAQ to avoid the higher listing fees on the NYSE. The aggregating demand feature of the NYSE suggests that their IPOs have lower underpricing and narrower spreads than IPOs that trade on NASDAQ [see Bennouri et al. (2012)]. Importantly, the underwriter typically becomes the market maker of NASDAQ-listed IPOs, but NYSE Rule 98 requires an organizational separation between the underwriter and the specialist.

  7. Using the Standard and Poors Global Industry Classification Standard (GICS) code at the ten-industry sector level, about 28 % of the firms are classified in the information technology industry on the NASDAQ, whereas only 7 % of the firms are in this industry on the NYSE.

  8. Ritter and Welch (2002) document that the percentage of technology IPOs dropped from 72 % (803 IPOs) during the internet bubble in 1999–2000 to 29 % (80 IPOs) in 2001.

  9. We conduct an analysis on the impact of tick size reduction from $1/8 to $1/16 on the spreads of NYSE-listed IPOs from January 1, 1996 to December 31, 1998. Our results (not reported but available upon request) show that the spreads decline significantly for hot, warm, and cold IPOs after the reduction. However, we do not find any evidence that suggests a relation between spreads and underpricing for tick size changes on June 24, 1997. We thank the referee for suggesting the test for the tick size reduction for NYSE-listed IPOs on June 24, 1997.

  10. Overallotment options are also known as Green Shoe options. Normally, the issuer allows the underwriter to offer shares up to 115 % with an over-allotment options agreement which allows the underwriter to buy additional shares from the issuer within 30-days. In our sample, 226 out of 230 NYSE-listed IPOs have the overallotment options agreement with underwriters.

  11. Chen and Ritter (2000) document a seven percent rule of the underwriter spread. Thus, it is obvious that short-covering from a market purchase is profitable if the share price drops more than seven percent below the offering price, regardless of pre- or post-decimalization.

  12. Krigman et al. (1999) and Aggarwal (2003) document that institutional investors flip more than retail investors in the aftermarket. Also, institutional investors tend to consume liquidity rather than provide liquidity.

  13. We also use other classifications for hot, warm, and cold IPOs employed by previous studies for our robustness checks. Overall, the results do not change materially.

  14. Consistent with the argument of underwriter price stabilization in cold IPOs, 25 out of the 29 and 22 out of the 28 cold IPOs open at exactly the offering price in the pre- and post-decimalization periods, respectively.

  15. IPOs are assigned the Global Industry Classification Standard (GICS) code at the ten-industry sector level.

  16. Assigning trades completed at prices above (below) the prevailing quote midpoint as customer buys (sells). Trades executed at the quote midpoint are assigned by the “tick test”, in which trades at a higher (lower) price as compared to the most recent trade at a different price are classified as buys (sells).

  17. The Wilcoxon signed ranks tests (not reported but available upon request) show that the medians of both quoted dollar spread and effective dollar spread for hot IPOs are higher than cold IPOs, and statistically significant at 1 % in pre-decimalization. However, the medians are not significantly different between hot and cold IPOs in post-decimalization. This result supports our findings later that hot IPOs receive greater spread reductions after decimalization.

  18. For added robustness, we perform a similar analysis on the median depths and spreads. The results are qualitatively similar but not reported.

  19. Underwriters usually provide price support for cold IPOs by short-covering in aftermarket trading (see Aggarwal (2000) and Boehmer and Fishe (2004a, b).

  20. Boehmer and Fishe (2004b) document that the underwriter generally submits passive buy orders to provide liquidity.

  21. Campbell et al. (2004) note that institutions might break trades into extremely small sizes when they are stealth trading, or institutions are likely to engage in scrum trades to round off an extremely small equity position, and institutions may put in tiny iceberg trades to test the waters before trading in a larger size. Aggarwal (2003) documents that institutions split their orders into smaller sizes in order to reduce the price impact.

  22. Krigman et al. (1999) find that institutional flipping accounts for 45 and 22 % of the total dollar volume of cold and hot IPOs, respectively.

  23. To investigate the selling pressure of cold IPOs post-decimalization, we collect the overallotment options (green shoe options) data for cold IPOs from the SDC database, and find that overallotment shares increase in price post-decimalization but the results are not statistically significant. However, the overallotment shares remain relatively the same for both hot and warm IPOs, pre- and post-decimalization. The results are not reported but available upon request. Ellis et al. (2000, 2002) document that the quality of overallotment exercise data provided by the SDC is a concern. Thus, we are unable to examine whether the overallotment options are exercised more for hot, warm or cold IPOs. However, in general, underwriters receive about 22 % (20 %) of green shoe options for hot (cold) IPOs in both the pre- and post-decimalization periods. We thank the referee for pointing out this issue.

  24. The mean and median of the first day total trading volume for hot (cold) IPOs are 12.64 (9.65) and 8.60 (7.18) million, respectively, in our sample.

  25. The mean values of shares traded as a proportion of total shares offered on the first trading day are 62.07 and 64.77 % in the pre- and post-decimalization periods, respectively. Aggarwal (2003) reports that the mean of the shares traded as a proportion of total shares offered in the first two days is 81.97 %. Thus, we eliminate outliers which are defined as shares traded on the first day that are more than 100 % of the total shares offered. 5 (8 %) and 4 (7 %) IPOs are deleted in pre- and post-decimalization, respectively, from the sample.

  26. To control for the possible effect from the quoting environment (e.g., different tick size) on the underpricing, we adjust the underpricing by regressing the underpricing variable on the a variable of decimalization for hot, warm, and cold IPOs. The results remain unchanged for all models.

  27. Control firms are selected based on (1) non-IPO firms; (2) NYSE; (3) same 2-digit SIC; and (4) similar market capitalization, closing price times shares outstanding, prior to IPO listing day to IPO opening price times shares outstanding. Thus, 230 seasoned stocks are selected as control firms.

References

  • Aggarwal R (2000) Stabilization activities by underwriters after initial public offerings. J Finance 55:1075–1104

    Article  Google Scholar 

  • Aggarwal R (2003) Allocation of initial public offerings and flipping activity. J Financ Econ 68:111–135

    Article  Google Scholar 

  • Aggarwal R, Conroy P (2000) Price discovery in initial public offerings and the role of the lead underwriter. J Finance 55:2903–2922

    Article  Google Scholar 

  • Amihud Y, Mendelson H (1986) Asset pricing and the bid–ask spread. J Financ Econ 17:223–249

    Article  Google Scholar 

  • Bacidore J, Battalio R, Jennings R, Farkas S (2001) Changes in order characteristics, displayed liquidity, and execution quality on the New York Stock Exchange around the switch to decimal pricing. New York Stock Exchange, Working Paper No. 2001-02

  • Bacidore J, Battalio R, Jennings R (2003) Order submission strategies, liquidity supply, and trading in pennies on the New York Stock Exchange. J Financ Mark 6:337–362

    Article  Google Scholar 

  • Barry CB, Jennings RH (1992) The opening price performance of initial public offerings of common stock. Financ Manag 22:54–63

    Article  Google Scholar 

  • Bennouri M, Falconieri S, Weaver D (2012) Trading mechanism, ex-post uncertainty and IPO underpricing. Working paper, City University of London

  • Benveniste LM, Busaba WY, Wilhelm WJ Jr (1996) Price stabilization as a bonding mechanism in new equity issues. J Financ Econ 42:223–255

    Article  Google Scholar 

  • Bessembinder H (2003) Issues in assessing trade execution costs. J Financ Mark 6:233–257

    Article  Google Scholar 

  • Blume ME, Goldstein MA (1997) Quotes, order flow, and price discovery. J Finance 52:221–244

    Article  Google Scholar 

  • Boehmer E, Fishe RPH (2004a) Price support by underwriters in initial and seasoned public offerings. Working paper, EDHEC Business School

  • Boehmer E, Fishe RPH (2004b) Underwriter short covering in the IPO aftermarket: a clinical study. J Corp Finance 10:575–594

    Article  Google Scholar 

  • Boehmer E, Saar G, Lei Y (2005) Lifting the veil: an analysis of pre-trade transparency at the NYSE. J Finance 60:783–815

    Article  Google Scholar 

  • Bollen NPB, Whaley RE (1998) Are “teenies” better? J Portf Manag 25:10–24

    Article  Google Scholar 

  • Brennan MJ, Subrahmanyam A (1996) Market microstructure and asset pricing: on the compensation for illiquidity in stock returns. J Financ Econ 41:441–464

    Article  Google Scholar 

  • Butler AW, Grullon G, Weston JP (2005) Stock market liquidity and the cost of issuing capital. J Financ Quant Anal 40:331–348

    Article  Google Scholar 

  • Campbell JY, Vuolteenaho T, Ramadorai T (2004) Caught on tape: predicting institutional ownership with order flow. Harvard Institute of Economic Research Discussion Paper No. 2046

  • Campbell JY, Ramadorai T, Schwartz A (2009) Caught on Tape: institutional trading, stock returns, and earnings announcements. J Financ Econ 92:66–91

    Article  Google Scholar 

  • Chakravarty S, Harris S, Wood R (2001a) Decimal trading and market impact. Working paper, University of Utah

  • Chakravarty S, Harris S, Wood R (2001b) Decimal trading and market impact: the NASDAQ experience. Working paper, University of Memphis

  • Chakravarty S, Wood RA, Van Ness RA (2004) Decimals and liquidity: a study of the NYSE. J Financ Res 27:75–94

    Article  Google Scholar 

  • Chen HC, Ritter JR (2000) The seven percent solution. J Finance 55:1105–1132

    Article  Google Scholar 

  • Chou RK, Lee WC, Chen SS (2005) The market reaction around ex-dates of stock splits before and after decimalization. Rev Pacific Basin Financ Mark Policies 8:201–216

    Article  Google Scholar 

  • Chowdhry B, Nanda V (1996) Stabilization, syndication, and pricing of IPOs. J Financ Quant Anal 31:25–42

    Article  Google Scholar 

  • Chung KH, Chuwonganant C (2002) Tick size and quote revisions on the NYSE. J Financ Mark 5:391–410

    Article  Google Scholar 

  • Chung KH, Van Ness B, Van Ness R (2003) Trading costs and quote clustering on the NYSE and NASDAQ after decimalization. J Financ Res 27:309–328

    Article  Google Scholar 

  • Chung KH, Charoenwong C, Ding DK (2004) Penny pricing and the components of spread and depth changes. J Bank Finance 28:2981–3007

    Article  Google Scholar 

  • Corwin SA, Harris JH (2001) The initial listing decisions of firms that go public. Financ Manag 30:35–55

    Article  Google Scholar 

  • Corwin SA, Harris JH, Lipson ML (2004) The development of secondary market liquidity for NYSE-listed IPOs. J Finance 59:2339–2374

    Article  Google Scholar 

  • Ellis K (2006) Who trades IPOs? A close look at first days of trading. J Finance 79:339–363

    Google Scholar 

  • Ellis K, Michaely R, O’Hara M (2000) When the underwriter is the market maker: an examination of trading in the IPO aftermarket. J Finance 55:1039–1074

    Article  Google Scholar 

  • Ellis K, Michaely R, O’Hara M (2002) The making of a dealer market: from entry to equilibrium in the trading of NASDAQ stocks. J Finance 57:2289–2316

    Article  Google Scholar 

  • Fishe RPH (2002) How stock flippers affect IPO pricing and stabilization. J Financ Quant Anal 37:319–340

    Article  Google Scholar 

  • Goldstein MA, Kavajecz KA (2000) Eighths, sixteenths, and market depth: changes in tick size and liquidity provision on the NYSE. J Financ Econ 56:125–149

    Article  Google Scholar 

  • Greene JT (1997) The impact of limit order executions on trading costs in NYSE stocks: an empirical examination. Working paper, Georgia State University

  • Hanley KW, Kumar AA, Seguin PJ (1993) Price stabilization in the market for new issues. J Financ Econ 34:177–197

    Article  Google Scholar 

  • Harris L (1994) Minimum price variations, discrete bid–ask spreads, and quotation sizes. Rev Financ Stud 7:149–178

    Article  Google Scholar 

  • Hegde S, Miller R (1989) Market-making in initial public offerings: an empirical analysis. J Financ Quant Anal 24:75–90

    Article  Google Scholar 

  • Jones C, Lipson M (2001) Sixteenths: direct evidence on institutional trading costs. J Financ Econ 59:253–278

    Article  Google Scholar 

  • Krigman L, Shaw WH, Womack KL (1999) The persistence of IPO mispricing and the predictive power of flipping. J Finance 54:1015–1044

    Article  Google Scholar 

  • Krishnan CNV, Singh AK, Zebedee AA (2006) An examination of large sell orders in cold IPOs aftermarkets. J Financ Mark 9:119–143

    Article  Google Scholar 

  • Lee CMC, Radhakrishna B (2000) Inferring investor behavior: evidence from TORQ data. J Financ Mark 3(2):83–111

    Article  Google Scholar 

  • Lee CMC, Ready MJ (1991) Inferring trade direction from intraday data. J Finance 46:733–746

    Article  Google Scholar 

  • Lee CMC, Mucklow B, Ready MJ (1993) Spreads, depths, and the impact of earnings information: an intraday analysis. Rev Financ Stud 6:345–374

    Article  Google Scholar 

  • Lewellen K (2006) Risk, reputation, and the price support of IPOs. J Finance 61:613–654

    Article  Google Scholar 

  • Miller R, Reilly F (1987) An examination of mispricing, returns, and uncertainty for initial public offerings. Financ Manag 16:33–38

    Article  Google Scholar 

  • New York Stock Exchange (2001a) Comparing bid–ask spreads on the New York Stock Exchange and NASDAQ immediately following NASDAQ decimalization. Manuscript prepared by NYSE Research, July 26, 2001

  • New York Stock Exchange (2001b) Decimalization of trading on the New York Stock Exchange: a report to the securities and Exchange Commission. Manuscript prepared by Research Division of the New York Stock Exchange, Inc., September 7, 2001

  • Ritter JR (1998) Initial public offerings. In: Logue D, Steward J (eds) Handbook of modern finance. Warren, Gorham, and Lamont, Boston and New York

    Google Scholar 

  • Ritter JR, Welch I (2002) A review of IPO activity, pricing, and allocation. J Finance 57:1795–1828

    Article  Google Scholar 

  • Ruud JS (1993) Underwriter price support and the IPO underpricing puzzle. J Financ Econ 34:135–152

    Article  Google Scholar 

  • Schultz PH, Zaman MA (1994) Aftermarket support and underpricing of initial public offerings. J Financ Econ 35:199–219

    Article  Google Scholar 

  • Van Ness R, Van Ness B, Pruitt S (2000) The impact of the reduction in tick increments in major US markets on spreads, depth, and volatility. Rev Quant Finance Acc 15:153–167

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations

  1. Nanyang Business School, Nanyang Technological University, Singapore, 639798, Singapore

    Charlie Charoenwong

  2. School of Economics and Finance, Massey University, Auckland, New Zealand

    David K. Ding

  3. Lee Kong Chian School of Business, Singapore Management University, Singapore, 178899, Singapore

    David K. Ding

  4. James Cook University Australia, Singapore, 387380, Singapore

    Tiong Yang Thong

Authors
  1. Charlie Charoenwong
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. David K. Ding
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Tiong Yang Thong
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to David K. Ding.

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Charoenwong, C., Ding, D.K. & Thong, T.Y. Decimalization, IPO aftermath, and liquidity. Rev Quant Finan Acc 47, 1303–1344 (2016). https://doi.org/10.1007/s11156-015-0539-8

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11156-015-0539-8

Keywords

JEL Classification

Search

Navigation