Facebook’s initial public offering launched May 18 at $38 per share, and the social network’s stock ended the trading day up just 23 cents. But according to a blog post on Liberty Street Economics, Facebook’s underwriters were a major factor in keeping the stock from plummeting on its first day.
Liberty Street Economics is a blog hosted by the Federal Reserve Bank of New York website, and the post about day one of Facebook trading was written by: Thomas Eisenbach, an economist in the money and payment studies function of the research statistics group; David Lucca, an economist in the capital markets function; and Karen Shen, an undergraduate intern in the capital markets function.
Eisenbach, Lucca, and Shen examined the trading book for Facebook May 18, and used what they called a large integer-price bid identification assumption to determine which investors were bidding on the stock. They also mentioned the underwriters’ greenshoe option, which allows them to sell extra shares in order to stabilize the IPO stock’s price.
Among the findings by the three Federal Reserve Bank of New York staffers:
- Matt Levine wrote on the Dealbreaker blog May 18 that he found evidence of stabilizing trades in the form of some 43 million Facebook shares changing hands that day at exactly the $38 IPO price.
- Facebook shares shot up to $42.05 apiece at the start of trading May 18, then dropped to $38, before rising back to $41.05, all within the first hour. Later that day, after trading at around $41, the stock fell to $38 before closing at $38.23.
- There was a spike in bid size at around 11:50 a.m. ET, when the price first fell back to $38 per share, and again at around 2:40 p.m., when Facebook was hovering at around $40. But the largest spike occurred just before closing, when the price fell back to $38 again.
Eisenbach, Lucca, and Shen wrote:
This pattern suggests that there may be something special about the prices of $38 and $40. The two charts below show the distribution of ask sizes and bid sizes across prices by plotting for every price the maximum willingness to sell and maximum willingness to buy observed at that price during the day. The plots show that the depth of the buy book at $38 and at $40 is indeed significantly greater than at any other price (followed by additional spikes at the other integer prices of $39 and $41). By contrast, the distribution of the willingness to sell appears to be relatively evenly distributed across prices; there seems to be no difference between integer and non-integer prices, consistent with the idea that selling behavior was driven by small individual investors. We suggest that the large bids at the integer prices of $38 and $40 are likely stabilizing trades by the underwriters as they attempted to support the falling stock price at these points during the day. (Note that since our data do not identify individual investors, this identification is based only on indirect inference.)
What are the underwriters’ incentives to stabilize prices? Underwriters have conflicting objectives on the day of the IPO when the stock price appears at risk of falling below the issuing price. Their obligation to the firm — and their reputation — pushes them to support the stock, especially around the IPO price. However, this does not serve their short-run profit interests. Indeed, notice that because of the greenshoe option, which is equivalent to a short position on the stock and a call option at $38, the underwriters are effectively long a put option with a strike price of $38. (For simplicity, we ignore the fact that underwriters receive all shares, including the overallotment, at a small discount to the issuing price.) Such an option would become valuable were the price to drop below $38, and should therefore never be exercised above the strike price. In particular, in order to cover the short position created by the overallotment, underwriters should never buy at a price above $38 in the open market because they could instead exercise the greenshoe option. Contrary to this reasoning, we find that the greenshoe option was never exercised (based on the free-float level following the IPO of 421 million shares), but that there was significant buying activity at and above the strike price (specifically, at $38 and $40), which we interpret as being driven by underwriters’ stabilization attempts.
Readers: Why do you think the underwriters chose that strategy?
Nasdaq/Facebook image courtesy of Shutterstock. Charts courtesy of Liberty Street Economics.