Flipping is the simplest method to make money through an IPO (by purchase of the new shares directly from the underwriter and then selling them immediately on the open market).
Particularly, flipping involves reselling of a hot IPO stock in the first few days (or day) of trading to make a quick profit. This task is not a simple one and difficult to perform, and investors are highly dissuaded by underwriters.
The logic is that underwriters prefer that long-term investors keep their stocks. There does not exist any laws that preclude flipping, but underwriters may blacklist “bad” investors from future offerings.
Fishe (2001) indicates that stock flippers are a massive problem for underwriters. They depress the market by immediately reselling their shares, creating a confusing environment for the remaining long-term oriented investors.
Underwriters’ main characteristic is to aggressively attempt to discourage flippers by various penalty schemes, such as threatened exclusion from future hot offerings. Consequently they should favor a lower offer price and overselling of the issue, which may lead the underwriter to assume a short position of the issue.
The short position should be covered ideally with aftermarket purchases. Through an estimation of the total demand and flipping, underwriters select an optimal offer price that produces a cold, weak, or hot IPO.
Krigman et al. (1999) empirically measure flipping. The authors report that flipping is responsible for 45% of trading volume on the first day of trading for cold IPOs (this is due to the decreased trading volume in weak IPOs and is a result of frequent flipping) and 22% for hot IPOs.
Recent indications favor the mainstream notion that institutions are intelligent investors and therefore flip a great deal more of the cold IPOs during the first few days, whereas the main investment bank provides price support.
Welch and Ritter (2002) state that penalty bids are rarely formed and “flipping may even be encouraged in order to keep market demand from pushing to unsustainable levels.” The authors also argue that in instances of elevated levels of unnecessary flipping, the lead underwriter collects the commission paid to syndicate members for selling shares.
Each syndicate obtains a selling concession based on the number of shares it issues. In the event that clients of a syndicate decide to flip their shares, the selling concession on those shares is credited back to the lead underwriter.