248 B.E. Eckbo et al.
Some issues are also allocated to friends and family of the issuer’s management and to
CEOs of companies the underwriter is cultivating for future business.^8
Public offer date activities. Underwriters confirm investor orders, allocate hot issues,
and may buy shares in the secondary market to meet some of their commitments as
a result of overselling the issue when the after-market price isn’t rising relative to the
offering price.
Analyst coverage commitment. Lead underwriters, co-managers and other syndicate
members often commit to produce analyst coverage for the stock for a period after
the offering. This is likely to enhance investor interest in the stock and improve the
stock’s liquidity. A survey of issuer managers finds that underwriter selection is strongly
influenced by whether an underwriter has reputable industry analysts.^9
Market making commitment. Lead underwriters generally commit to be active market
makers in the stock for a period of time after the offering. Existing evidence shows that
this market making is very important in the early seasoning of an issue, but typically
declines in importance over the first year following listing. This market making activity
is typically profitable for the lead underwriter.^10
Price support. Lead underwriters often place limit orders to buy shares immediately
after an offering without being subject to price manipulation restrictions. If an under-
writer oversells an offering, which afterwards drops in price, then the underwriter can
buy additional shares in the secondary market at a price at or below the offering price,
rather than exercise its over-allotment option to buy additional securities from the is-
suer. This has the effect of supporting the secondary market price and avoids adding
more shares into the secondary market. If the secondary market price rises relative to the
offering price, then no price support activity is necessary. Instead, the underwriter can
meet its commitments to customers of oversold issues by exercising its over-allotment
options to buy shares at the offer price net of the underwriter discount.^11
Lock-up agreements. Insiders and other large holders such as venture capitalists com-
mit not to sell their shares for a period of time after the offering. The typical lock-up
period is 180 days for IPOs. If the secondary market reception for the issue is very
strong, the agreements may be terminated early.^12
Insider trading regulation. U.S. SEC Rule 10b-5 prohibits a person in possession of
material non-public information from using it to buy or sell company securities or to tip
(^8) SeeCornelli and Goldreich (2001, 2003)andJenkinson and Jones (2004)for evidence on the book building
and share allocation process andLoughran and Ritter (2002)for evidence of spinning.
(^9) SeeKrigman, Shaw, and Womack (2001)andBrau and Fawcett (2006).
(^10) For an analysis of post-IPO market making by underwriters see (Ellis, Michaely, and O’Hara, 2004).
(^11) Price support or stabilization activity for IPOs is studied byAggarwal (2000), Boehmer and Fishe (2003)
andCotter, Chen, and Kao (2004)andLewellen (2006).
(^12) The lock-up process and its expiration effects are studied byBrav and Gompers (2003), Field and Hanka
(2001), Field, Cao, and Hanka (2004)andBrau, Lambson, and McQueen (2005).