How Investors React To IPO Lockups

Tuesday, December 28, 2004

Profs. James Brau, David Carter, Stephen Christophe, and Kimberly Key, Brigham Young (JB); Oklahoma State (DC); George Mason (SC); Auburn (KK), http://

Abstracted from: Market Reaction To The Expiration Of IPO Lockup Provisions
Managerial Finance - Vol. 30, No. 1, Pgs. 75-91

Scrutinizing insiders before the lockup expires.
Insiders’ stock ownership has long been the focus of intense scrutiny by investors seeking to glean insights from the activities of those with first-hand knowledge of a company. Professors James Brau, David Carter, Stephen Christophe, and Kimberly Key report that the circumstances surrounding an IPO lockup impact the stock price in the days immediately before and after the lockup expires. Corporate insiders under a lockup agree not to sell their shares for a specified time, usually around 180 days. The proportion of outstanding stock subject to these agreements can be quite large, making the potential level of sales upon expiration an important consideration for the public shareholders.

Driving a wedge between insiders and investors.
Previous research concluded that lockup agreements enhance share values because investors think any negative information will likely be divulged before expiration and insiders who continue to hold a large stake in the company will align their interests with those of other shareholders. Other studies have confirmed the positive relationship between high insider ownership at an IPO and firm value. Yet despite these observations, suggest the authors, investors generally recognize that the existence of a lockup agreement does not close the information gap between insiders and outsiders. Lockup periods are short, covering perhaps two quarters of earnings announcements, so insiders planning to sell shares upon expiration have ample incentive to withhold information, which will most likely be negative. This factor drives a wedge between the interests of the managers and the shareholders, prompting investors to become more anxious to sell as the expiration date approaches.

Negative impact on price.
The approach of a lockup date does not inevitably translate into a wholesale dumping of stock by investors. The authors found that IPO shares generally fare better in the days immediately before and after the lockup expiration when shareholders feel some certainty about insiders’ future actions. Nevertheless, companies with a very high percentage of locked-up stock face negative market reaction because the insiders have less opportunity to signal firm value and the investors worry about the insiders unloading large amounts of stock. A high percentage of ownership by venture capitalists, who are more likely to sell their shares than managers, also has a negative impact on price.

Continued ownership important.
By contrast, unit issues­in which the IPO issuer packages a share offer with stock warrants in a single unit­, fare comparatively well. The investors believe that the insiders have an incentive to continue their commitment to the firm (i.e., so they can later exercise their stock warrants). Larger firms fared better than smaller ones, because the investors had more information about them. Investors also felt more confident about management’s commitment to the company if the insiders retained a high degree of ownership after the offering.

Abstracted from Managerial Finance,
published by Emerald Group Publishing Ltd.,
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