Abstract

Abstract

It is well established that initial public offerings (IPOs) tend to experience positive first-day returns followed by abnormally low subsequent returns, especially around the expiration of lockup agreements. Miller’s (1977) overvaluation theory offers a unified explanation of aftermarket IPO pricing based on divergence of investor opinion about fundamental value combined with short-sales constraints. While prior studies are inconclusive with respect to the importance of short-sales constraints in the IPO aftermarket, we find robust evidence consistent with Miller’s theory. Our research design employs detailed data from the securities lending market and ex ante identifies IPOs with high divergence of investor opinion and limited floating stock. We show that these IPOs drive prior evidence of overpricing in the aftermarket, as indicated by positive first-day returns followed by negative lockup returns, and that the supply of lendable shares is severely constrained for these IPOs, thereby limiting short sellers’ effectiveness to arbitrage overpricing.