Re examining the IPO unlock day anomaly, do market conditions and increased availability of information matter

... INING THE IPO UNLOCK DAY ANOMALY: DO MARKET CONDITIONS AND INCREASED AVAILABILITY OF INFORMATION MATTER? and subm itted in partial fu lfilm e n t o f the requirements for the degree o f MASTER OF. .. about the unlock This suggests that the prevalent m arket conditions at IPO and unlock affect the performance o f the offe ring about the unlock day The results pertaining to the unlock day event...Reproduced with permission of the copyright owner Further reproduction prohibited without permission Re- examining the IPO Unlock Day Anomaly: Do Market Conditions and Increased Availability

INFORMATION TO USERS

This manuscript has been reproduced from the microfilm master UMI films the text directly from the original or copy submitted Thus, some thesis and dissertation copies are in typewriter face, while others may be from any type of computer printer.

The quality of this reproduction is dependent upon the quality of the copy subm itted Broken or indistinct print, colored or poor quality illustrations and photographs, print bleedthrough, substandard margins, and improper alignment can adversely affect reproduction.

In the unlikely event that the author did not send UMI a complete manuscript and there are missing pages, these will be noted Also, if unauthorized copyright material had to be removed, a note will indicate the deletion.

Oversize materials (e.g., maps, drawings, charts) are reproduced by sectioning the original, beginning at the upper left-hand comer and continuing from left to right in equal sections with small overlaps.

Photographs included in the original manuscript have been reproduced xerographically in this copy Higher quality 6” x 9” black and white photographic prints are available for any photographs or illustrations appearing

in this copy for an additional charge Contact UMI directly to order.

ProQuest Information and Learning

300 North Zeeb Road, Ann Arbor, Ml 48106-1346 USA

800-521-0600

Re-examining the IPO Unlock Day Anomaly:

Do Market Conditions and Increased Availability of

Information Matter?

George J Gaspar

A Thesis Inthe John M olson School o f Business

Presented in Partial F u lfilm e n t o f the Requirements

fo r the Degree o f M aster o f Science in A d m in istra tio n at

Concordia U niversity

M ontreal, Quebec, Canada

A p ril 2002

©G eorge J Gaspar, 2002

1 + 1 of Canada National Library

Acquisitions and Bibliographic Services

395 Wellington Street Ottawa ON K1A0N4 Canada

Bibliotheque nationale

du Canada Acquisitions et services bibliographiques

395, rue Wellington Ottawa ON K1A0N4 Canada

YourUm Y ou * riM n n c* Our Ha Hotta raHranca

The author has granted a non­

exclusive licence allowing the National Library o f Canada to reproduce, loan, distribute or sell copies o f this thesis in microform, paper or electronic formats.

The author retains ownership o f the copyright in this thesis Neither the thesis nor substantial extracts from it may be printed or otherwise

reproduced without the author’s permission.

L’auteur a accorde une licence non exclusive permettant a la

Bibliotheque nationale du Canada de reproduire, preter, distribuer ou vendre des copies de cette these sous

la forme de microfiche/film, de reproduction sur papier ou sur format electronique.

L’auteur conserve la propriete du droit d’auteur qui protege cette these

Ni la these ni des extraits substantiels

de celle-ci ne doivent etre imprimes

ou autrement reproduits sans son autorisation.

0-612-68418-0

C O N C O R D IA U N IV E R S IT Y

School o f Graduate Studies

This is to c e rtify that the thesis prepared

ANOMALY: DO MARKET CONDITIONS AND INCREASED AVAILABILITY OF INFORMATION MATTER?

and subm itted in partial fu lfilm e n t o f the requirements fo r the degree o f

MASTER OF SCIENCE IN ADMINISTRATION

com plies w ith the regulations o f this U n ive rsity and meets the accepted standards

w ith respect to o rig in a lity and quality

Signed b y the fin a l exam ining com mittee:

A B S T R A C T

R e-E xam ining the IPO U n lo ck Day A n om a ly: Do M arket C onditions and Increased

A v a ila b ility o fln fo rm a tio n Matter?

George J Gaspar

The lockup agreement prohibits insiders and pre IPO shareholders from selling any o f

their stake in the company p rio r to the unlock date Field and Hanka (2001) find that the

unlock day is associated w ith sig nifica nt abnormal returns D uring the period o f the Field

and Hanka (2001) study the p ub lic was alm ost never reminded o f the unlock date, other

than the unlock date being available in the com pany's prospectus However, as o f

October 1999 reminders o f the unlock date have been w id e ly available via internet

sources This study investigates i f the greater degree o f public inform ation/scrutiny

pertaining to the unlock day results in the e lim in a tio n o f the unlock day abnormal returns

Abnorm al returns are found to be confined to firm s having venture capital backing

Observed price adjustments tend to begin much earlier and declines appear more severe

than previously reported The study considers i f the nature o f the actual response

observed at unlock is tied to the overall market sentiment at the tim e o f IPO and unlock

fin d in g that firm s m aking IPOs in cold markets are less affected at unlock than those

firm s m aking IPOs in hot markets Further, many o f the factors surrounding the IPO o f a

security act to lessen the in form ationa l asy m m etries persisting at the tim e o f the o ffe rin g :

the study confirm s the relation o f these IPO sig nallin g factors as drivers o f unlock day

selling pressure Furthermore, in the exam ination o f the unlock day effect, consideration

was also given to afterm arket price support and industry effects

Table o f Contents

1 In tro d u c tio n

2 Literature R e vie w

2.1 V C B a c k in g

2.2 S ta b iliz a tio n

2.3 H ot and C old M a rk e ts

2.4 A B r ie f O verview o f the M arke t C o nditions during the Study P e rio d

3 Data and M e th o d o lo g y

3.1 D a ta

3.2 M e th o d o lo g y

3.2.1 A b norm a l Returns C o m p u ta tio n

3.2.2 A b norm a l V o lum e C o m putation

3.2.3 S ta b iliz a tio n

4 H ypotheses

4.1 In fo rm a tio n H y p o th e s is

4.2 S ig n a llin g H ypotheses

4.3 M arke t C onditions H y p o th e s is

4.4 Industry Effects H yp oth esis

4.5 S tabilization/P rice Support H y p o th e s is

5 R esults

5.1 A b n o rm a l Returns about the U n lo ck D a te

5.2 In fo rm a tio n S ig n a llin g

5.3 M arke t C o nditions at IPO and U n lo c k

5.4 Industry E ffe c ts

5.5 Price S u p p o rt

5.6 A b norm a l V o lu m e

6 Summary and C o n c lu s io n

T a b le s

Table 1 a) A b norm a l Return Regression I

Table 1 b) A b n o rm a l Return Regression I

Table 2 a) A b norm a l Return Regression I I

Table 2 b) A b norm a l Return Regression I I

Table 3 A b norm a l Return Regression I I I

Table 4 a) A b n o rm a l Return Regression I V

Table 4 b) A b n o rm a l Return Regression I V

Table 5 A b n o rm a l V o lum e Regression I

Table 6 Regression: A bnorm al U n lo ck Day V o lum e as a d riv e r o f A bnorm al I nlock Day R e tu rn s

fa b le 7 a) Venture C apitalist Backing and SIC Code C la ssifica tio n s

Table 7 b) Venture C a pitalist Backing and SIC Code C la ssifications

Table 8 a) M arke t C onditions at IPO and U n lo c k

fa b le 8 b) M arke t C onditions at IPO and U n lo c k

1

6

6

8

10 12 15 15 10 10 21 21

24 28 31 32

A

3 3 34 36 38 40 41

42

46 46 47 48 40 50 51 52

53

54

55 55

56 56

Table 9 Hypothesis T e s tin g 57

T able 10 Hypothesis T e s tin g 57

Figures 58

F igure la ) M arke t M odel: O verall P e rio d 58

Figure lb ) M arke t A djusted Return: O verall P e rio d 59

Figure 2a) M arke t M odel: O verall Period V C Backed F irm s 60

Figure 2b) M arke t Adjusted Return: O vera ll Period V C Backed F irm s 61

Figure 3a) M arke t M odel: O verall Period Non V C Backed F irm s 62

Figure 3b) M a rke t A djusted Return: O vera ll Period Non VC Backed F irm s 63

Figure 4a) M arke t M odel: H o t/H o t M a rk e t 64

Figure 4b) M arke t A djusted Return: Hot/Plot M a rk e t 65

Figure 5a) M arke t M odel: H ot/C old M a rk e t 66

Figure 5b) M arke t A djusted Return: H o t/C o ld M a rk e t 67

Figure 6a) M arke t M odel: C o ld/C o ld M a rke t 68

Figure 6b) M arke t A djusted Return: C o ld /C o ld M a rke t 69

Figure 7a) M a rke t M o d e l: H o t/H o t M arket V C Backed F irm s 70

Figure 7b) M arke t Adjusted Return: H o t/H o t M arket V C Backed F irm s 71

Figure 8a) M arke t M odel: H o t/C old M arket V C Backed F irm s 72

Figure 8b) M arke t Adjusted Return: H ot/C old M arket VC Backed F irm s 73

Figure 9a) M arke t M odel: C o ld/C o ld M arket, V C Backed F irm s 74

Figure 9b) M arke t A djusted Return: C o ld /C o ld M arket V C Backed F irm s 75

Figure 10a) M arket M odel: H o t/H ot M arket N o n V C Backed F irm s 76

Figure 10b) M arket Adjusted Return: H o t/H o t M arket Non VC Backed F irm s 77

Figure 1 la ) M arke t M odel: H ot/C old M arket Non V C Backed F irm s 78

Figure 1 lb ) M arke t Adjusted Return: H o t/C o ld M arket Non VC Backed F irm s 79

Figure 12a) M arke t M odel: C o ld 'C o ld M arket Non V C Backed F irm s 80

Figure 12b) M arke t Adjusted Return: C o ld /C o ld M arket Non VC Backed F irm s 81

Figure 13a) M arket M odel: SIC Code 3 5 0 0 82

Figure 13b) M arke t A djusted Return: SIC Code 3 5 0 0 83

Figure 14a) M arket M odel: SIC Code 3 6 0 0 84

Figure 14b) M arket Adjusted Return: SIC Code 3 6 0 0 85

Figure 15a) M arke t M odel: SIC Code 3 8 0 0 86

Figure 15b) M arke t Adjusted Return: SIC Code 3 8 0 0 87

Figure 16a) M arke t M odel: SIC Code 4 8 0 0 88

Figure 16b) M arke t Adjusted Return: SIC Code 4 8 0 0 89

Figure 17a) M arket M odel: SIC Code 5 9 0 0 90

Figure 17b) M arke t Adjusted Return: SIC Code 5 9 0 0 91

Figure 18a) M arke t M odel: SIC Code 7 3 0 0 92

Figure 18b) M arke t Adjusted Return: SIC Code 7 3 0 0 93

Figure 19a) M arke t M odel: SIC Code 8 7 0 0 94

Figure 19b) M arke t Adjusted Return: SIC Code 8 7 0 0 95

Figure 20a) M arke t M odel: VC Backed Firm s SIC Code 7 3 0 0 96

Figure 20b) M arke t Adjusted Return: V C Backed Firms SIC Code 7 3 0 0 97

Figure 21a) M arket M odel: Non V C Backed Firm s SIC Code 7300 98

Figure 21a) M arke t Adjusted Return: Non V C Backed Firm s SIC Code 7300 99

Figure 22a) M arke t M odel: V C Backed Firm s Non SIC Code 7300 100

Figure 22b) M arket Adjusted Return: VC Backed Firm s Non SIC Code 7 3 0 0 101

Figure 23a) M arket M odel: Non VC Backed Firm s Non SIC Code 7300 102

Figure 23b) M arket Adjusted Return: Non V C Backed Firms Non SIC Code 7300 103

Figure 24 A bnorm al V olum e: O verall P e rio d 104

Figure 25 A bnorm al V olum e: V C Backed F irm s 105

Figure 26 A bnorm al Volum e: Non VC Backed F irm s 106

Figure 27 Abnorm al Volum e: H ot/ Hot M a rk e t 107

Figure 28 A bnorm al Volum e: H o t/C old M a rk e t 108

Figure 29 A bnorm al Volum e: C o ld/C o ld M a rk e t 109

Figure 30 Abnorm al Volum e: H o t/H ot M arket V C Backed F irm s 110

Figure 31 A bnorm al Volum e: H ot/C old M arket VC Backed Firm s 1 11 Figure 32 A bnorm al V olum e: C o ld/C o ld M arket V C Backed F irm s 112

Figure 33 A bnorm al Volum e: H o t/H o t M arket Non VC Backed F irm s 113

Figure 34 A bnorm al Volum e: H ot/C old M arket Non VC Backed F irm s I 14 Figure 35 Abnorm al Volum e: C’o ld /C o ld M arket Non V C Backed F irm s 1 I 5 Figure 36 A bnorm al Volum e: Com parison o f V C and Non VC Backed F irm s 116 Figure 37 Proportion o f Firms Trading B e low O ffe r P ric e 1 1 7 Figure 38 Proportion o f Firms Trading Below O ffe r Price IPO H o t 1 1 7 Figure 39 Proportion o f Firms Trading B elow O ffe r Price IPO C o ld 1 1 <S Figure 40 Proportion o f Shares Locked U p 119

Figure 41 SIC Code D is trib u tio n 119

References 120

1 Introduction

When a company undertakes an in itia l public o ffe rin g (IP O ) most insiders are

subject to a lockup agreement The lockup agreement prohibits insiders and pre IPO

shareholders from selling any o f th e ir stake in the company p rio r to the unlock date The

lo ckup agreement is a legally enforceable contract imposed on the insiders b \ the

u n d e rw rite r o f the issue H ow ever insiders may be released from the agreement by the

decree o f the underwriter T y p ic a lly 3/4 o f the com panies' shares are locked under the

agreement Once the lockup expires the insiders are no longer p ro h ibited from selling

th e ir shares However they are s till restricted by other rules and lim ita tio n s , w h ich appl\

to sales by insiders These rules encompass com pany imposed restrictions and blackout

periods as w e ll as SEC regulations S p e cifica lly, under rule 144 lim ita tio n s as to sales b\

insiders are put forward S till the unlock day signifies a potentially m ajor increase in the

p u b lic float o f the com panies' stock

The t>pical length o f the lockup period is 180 days, f o r the firm s in this stud>

96% o f the firm s have a lockup period o f exactly 180 days The in fo rm a tio n pertaining

to the length o f the lockup period is contained in the IPO prospectus, f urther, the lockup

day and the number o f shares locked up is know n and printed in the prospectus in

advance o f both the in itia l public o ffe rin g date and w ell before the unlock day itself

Thus the unlock day represents a com pletely predictable event Field and Hanka (2001 )

fin d that the unlock day signifies a statistically sig nifica nt three-day abnormal return o f -

1.5°b O fek and Richardson (2000) fin d that there is a s im ila r 1% - 3°<> drop in stock

price around the unlock day S im ila r unlock day returns are reported by B ra\ and

Ciompers (1999) as w ell as Bradley et ai (2001) This price reaction is quite surprising

since there is no in form ation asym metry about the unlock date and goes against the

notion o f m arket e fficie n cy as the unlock date is public inform ation K n o w in g the unlock

day in advance o f the IPO it w o u ld seem that in an e ffic ie n t m arket investors would

incorporate the expected effects o f the unlock day p rio r to the event day The price o f the

stock should adjust, at least over the period from IPO until the unlock day itse lf, to the

expected increase in the pub lic float Investors should, on average, anticipate the extent

to w h ich the additional shares w ill generate an over supply and make appropriate

adjustments to take this into account p rio r to the unlock itself Thus, in an efficien t

m arket, no price reaction to the event should be observed However, even though fie ld

and Hanka (2001) find abnormal returns about the unlock they also fin d that "the

abnormal returns around the unlock day are not large enough to provide short term pro tits

fo r traders that must transact at the bid ask spread.” These results are further supported

by O fek and Richardson (2000) who also contend that at the unlock date this inefticiencv

is not exploitable

Since insiders are no longer prohibited from selling th e ir positions, the unlock

date results in a permanent increase in the number o f shares that must be held b\ the

public I f the demand curve fo r securities is dow nw ard sloping O fek and Richardson1

take this as their prim ary explanation, then the increase in the supply o f shares needed to

be held by the public fo llo w in g unlock w ill result in a reduction o f the stock price, fie ld

and Hanka's study looks at data for the period beginning in 1988 and ending in 1997

They note that durin g this period the p u b lic was almost never reminded o f the unlock

date, other than the unlock date being available in the com pany's prospectus However,

as o f October 1999 reminders o f the unlock date have been widely available

' F ie ld and H an ka ( 2 0 0 1 ) also cite the d o w n w a rd sloping demand curve as a partial explanatio n o l'th e

u nlo ck dav effect.

IPO Lockup.com was the first website that tracked the tim in g o f lockup expirations o f all

U.S IPOs and contains data on all IPOs having unlocks October 1 1999 and onwards

This in form ation is also w id e ly available from many other Internet sources such as

w w w u n lo ckd a te s.co m w xvw ip o p ro s.co m w w w ip o.co m and vvwvv.ipoexpress.com to

name a few

Thus, it is the intention o f this study to ascertain i f the greater degree o f public

in form a tio n /scru tin y pertaining to the unlock day results in the e lim in a tio n o f the unlock

day abnormal returns found by Field and Hanka (2001) or i f th e ir reported results have

dim inished appreciably That is i f one believes that the unlock day was not really widely

available public in form ation and thus not incorporated into a stock's price, does the

resulting w ide spread public a v a ila b ility o f an IPO 's unlock date result in the e lim ina tion

o f the unlock day anomaly? I f this is not the case, are there alternative influences

concurrently a ffe cting the returns at unlock'? As far as 1 am aware, this is the first study

to consider the unlock under increased scrutiny It is expected that the additional shares

becoming available at unlock w ill result in a temporary over supply resulting in

dow nw ard pressure on the stock price Since the unlock day event is know n in advance,

it is expected that this intluence w ill be priced into the stock price in the days p rio r to the

unlock expiration day w ith possible liq u id ity and in fo rm a tio n based adjustments

occuring on the unlock day itself It is expected that due to the easy and widespread

accessibility o f unlock date in form ation through Internet sources, that the abnormal

returns around the unlock reported by Field and Hanka (2001) w ill no longer be

statistically d ifferent from zero However, it is expected that the volum e effect w ill be

consistent w ith the findings o f Field and Hanka (2001) and others as the increase in

tradable shares on the unlock date w ill continue to persist

M any o f the factors surrounding the IPO o f a security are by design, a means o f

sig n a llin g and a lle via tin g , to some extent, the in form ationa l asymmetries w hich persist at

the tim e o f IPO itself Factors such as: the propo rtion o f shares locked up the le \e l o f

venture capitalist backing and the reputation o f the lead und erw riter may all assist in the

alle via tio n o f in form ationa l asymmetries at the tim e o f IPO H ow ever it is expected that

the amount o f sellin g on the unlock day w ill also be a ffilia te d w ith these IPO signalling

factors The propo rtion o f shares locked up the backing o f venture capitalists and

underw riter reputation w ill all in turn contribute to increased selling pressure at the lim e

o f unlock since a ll o f these variables proxy to some extent the degree to w hich selling

about the unlock date w ill take place." Field and Hanka demonstrate that the negati\e

unlock day returns are clearly more severe fo r VC backed firm s

This study also considers i f the actual response observed at the unlock date is tied

to the overall market sentiment at the tim e o f IPO and unlock, the latter, w hich is mu

measurable at the tim e o f IPO but should have a substantial influence as to the market

reaction on the unlock day As far as 1 am aware, this is the first stud> to look at this

aspect w ith respect to the unlock day anomaly In a deteriorating market it is the

expectation that market participants react more severely to the underlying proposed

unlock day's selling variables.' A d d itio n a lly , the study investigates the unlock unomalx

' Brav and G om pers (1 9 9 9 ) find that these variables are associated w ith increased selling pressures.

[o ther due tim e varx ing RRA o r tim e van ing risk p rem ia ( K outoulas and K rx /a n o w s k i ( 1996))

Essentiallv in o rd er to prov ide the same level o f liquidity at unlock it is expected that insiders w ou ld he required to p rovide greater price concessions in return.

in terms o f industry influences to gauge i f the V C effect reported by f ie ld and Hanka

(2001) is in part due to the industries that VCs tend to invest in

V C backed firm s are associated w ith higher q u a lity underwriters, who in turn are

k now n to provide stabiliza tion o f issues in terms o f afterm arket price support as noted in

studies by Hanley K u m ar and Seguin (1993) and Prabhula and Puri (1998) f o r the

duratio n o f the lockup VCs have every incentive to control the v o la tility o f the issue or

fo r that m atter movements below the o ffe r price Thus it is expected that during the

lo ckup period V C backed firm s w ill experience a lesser degree o f v a ria b ility below their

o ffe r price than those firm s lacking VC support H ow ever post unlock it is expected that

the p ropo rtion o f IPOs w ith prices below the o ffe r price experienced by V C backed firm s

w ill increase since any stabilization activ ity provided due to the presence o f VC backing

is expected to stop w ith expiration o f the lockup agreement, fu rth e rm o re , the expiration

o f the lockup may be viewed as an expiration o f pul options4 (Prabhula and Puri 1998)

and thus mav contribute to price deterioration in firm s hav ing VC backing

The remainder o f the paper is organized as fo llo w s: Section 2 provides b rie f

background in fo rm a tio n as to: the role o f venture capitalists, stabilization, market

cond ition s in the IPO process as w ell as an overv iew o f m arket conditions during the tim e

o f the study Section 3 outlines the process used in c o m p ilin g data and also discusses the

m ethodology employed in the study In Section 4 the hypotheses are set forth and

discussed In Section 5 the results and findings o f the study are presented, fin a llv

Section 6 concludes the paper

1 Prabhulab and Puri ( 1 9 9 8 ) note that the u nderw riter's co m m itm en t to p ro vide price support is in essence,

a put option.

2 Literature Review

2.1 VC Backing

Venture capitalists provide capital finan cing to companies VC s generally

p ro vid e finan cing fo r firm s; in expansion (usually p rio r to IPO), turn arounds and for

LB O s and they most com m only specialize by industry or stage o f development

(W S c h ilit 1996) As a result o f the degree o f V C 's specialization, a V C s return is a

fu n ctio n o f the V C ’ s; experience, the industry' that the fund invests in as w e ll as

geographical concentration Barry (1990) finds that venture capitalists prim arily

concentrate th e ir investments in young h ig h -risk private firm s where the VCs goal is to

take these firm s public, as they derive most o f th e ir p ro fit from such activities Thus VC

investm ents are typ ica lly highly illiq u id u n til such a tim e the firm is taken pub lic and

V C s are able to exit their investments

M ost o f the tim e VC investments are organized as lim ite d partnerships Through

the partnership, the venture capitalist has the role o f general partner and manages the

fund The investors are lim ited partners A large portion o f investors in such VC funds

are in stitu tio n a l Generally, these partnerships have predetermined li\e s typically o f 10

years in length In most cases when a firm is taken p u b lic the VC w ill distribute shares to

the general partners A fte r such a d istrib u tio n , the general partners are free to sell their

shares w ith in the SEC set guidelines F o llo w in g an IPO d istribu tion, the investors in the

fund generally liquidate their position im m e d ia te ly

Gompers (1995) examines VC investments and the control mechanisms

associated w ith VC financing The study documents that VCs tend to invest in early stage

com panies, as w e ll as high tech companies where the level o f inform ational asymmetry is

lik e ly to be the most pronounced The paper focuses on staging o f capital finan cing as a

control mechanism, which allow s fo r m o n ito rin g by the V C o f their investments Staging

o f finan cing also provides the V C w ith an abandonment option w ith respect to their

investm ents and acts as a mechanism to ensure that investor and entrepreneur interests

coincide Venture capitalists are able to provide m onitorin g through the duration o f

fu n d in g they provide as w ell as by the frequency w ith w hich they provide such funds

(G om pers (1995)) The m onitorin g provided by VCs is especially o f value considering

that these V C partnerships typ ica lly concentrate th e ir investments in voung high tech

com panies where inform ational asymmetries are most severe Furthermore Barn, et al

(1990) report that VCs typ ica lly hold one th ird o f the shares and Board seats in the

com panies they invest in Thus venture capitalists are active participants in the firm s that

they invest in p rovid ing both financing and m onitoring

M egginson & Weiss (1991) consider the im pact o f VCs p ro vid in g c e rtifica tio n in

the IPO process C e rtificatio n is o f value in any instance where there is an opportunitv to

alleviate asymmetry o f inform ation T his is especially true o f IPOs where the prospects o f

a fle d g lin g firm are not fu lly know n by the market and insiders have the m otive to

conceal adverse inform ation Rational investors understand the insider m o tive to conceal

and thus w ill price this into the issue The authors find that VCs are able to certifv the

value o f the firm to investors by reducing inform ational asymmetries and thereby

reducing the level o f underpricing, hence reducing costs to the firm The VCs are able to

provide increased c re d ib ility by rem aining shareholders post IPG and in fact in most

cases V C s do not cash out any o f their holdings at the tim e o f IPO Further Field and

Hanka (2001) document that venture capitalists continue to hold a sig n ifica n t proportion

o f th e ir o rig in a l holding in the year fo llo w in g the in itia l public o ffe rin g M egginson &

W eiss (1991) also fin d that V C backed issuers are able to attract more prestigious

auditors and underwriters VC s are know n to establish continual relationships w ith

specific underwriters and are able to attract higher quality underwriters by lo w e rin g the

level o f due diligence perform ed by the underw riter A d d itio n a lly VC backed lin n s

generate more interest from in stitu tio n a l investors and are thus able to bring their

o ffe rin g s to market earlier

2.2 Stabilization

W hen considering underperformance o f new issues Loughran and R itte r (1995)

fin d that IPOs e xh ib it no tendency to under perform in the first six months fo llo w in g the

o ffe rin g H ow ever these firm s under perform matching firm s by 4 5 °o over the next six

m onths Thus it seems that the first six months o f an IPO trading are quite d iffe re n t from

the fo llo w in g six C oincidentally, it is further interesting to note that most lockup

agreements have a duration o f 6 months Field and Hanka (2001 > find that the length o f

the lockup period has over tim e become standardized Indeed in this study nearly 96"» o f

firm s had lockup agreements w h ich were in effect for exactly 180 days Thus it seems

possible that the difference in perform ance in the first h a lf o f the year and the second h a lf

o f the year fo llo w in g the o ffe rin g is related to the lockup agreement itself

The difference in the perform ance o f new issues as documented by Loughran and

R itte r (1995) i f related to the lockup agreement, may be attributable to both a rtific ia l

price support taking place as w e ll as insiders guarding negative sentiments as to firm

prospects d urin g the lockup period I f private sentiment is being revealed on the unlock

day it w o uld be expected that the greatest portion o f private in fo rm a tio n w ill be revealed

on this day also M arket participants w ill be able to in fe r the trading a c tiv ity o f insiders

from the volum e o f selling and price changes at unlock

Field and Hanka (2001) demonstrate that the abnormal returns about the unlock

date are more severe for firm s having V C backing The difference between the

perform ance around the unlock day between V C and Non VC backed firm s suggests that

perhaps VC s who have been documented to be associated w ith higher qual it\

underw riters (M egginson and Weiss 1991) are possibly ben efiting from a rtific ia l

u n d erw riter price support

Chow dhrv & Nanda (1996) argue that underpricing, as a means o f compensating

the uninform ed investors as proposed by Rock (1986) is sub optim al I'n d e rp ric in g

rewards both inform ed and uninform ed investors but price support rewards mainly

uninform ed investors since inform ed investors vs ill inv est on av erage in those issues

w h ich they expect to appreciate Thus price support is put forw ard as a superior means o f

rew arding uninform ed investors Further, only reputable underwriters w ould he able to

convince investors that such support w o uld be provided since they possess the capability

o f p u ttin g th e ir c re d ib ility at stake T y p ic a lly larger investment bankers are in a position

to generate such a signal Such investm ent banks may be able to control th e ir losses from

an afterm arket price support arrangement since they are more able to disperse th e ir losses

amongst other syndicate members, especially under the threat o f exclusion from further

o ffe rin g s fo r non compliance Chowdhrv and Nanda's model predicts that larger issues

should be associated w ith more underpricing due to the lim ite d loss capacity o f any

syndicate Further, during hot markets i f there is larger demand fo r u n d e rw ritin g services

then there should be a greater deal o f underpricing and less afterm arket price support

A d d itio n a lly , during periods o f increased v o la tility , stabilization costs increase and it

becomes less lik e ly that underwriters participate in the stabilization process Prabhala &

Puri (1998) put forward the argument that price support offered bv the und erw riter is in

fact a put option U n derpricin g o f issues effe ctively m inim izes the value o f this put

optio n offered by the underwriter

2.3 Hot and Cold Markets

There is much evidence po in tin g to the fact that investors are ove rly o p tim istic

Barber & Odean (1999) demonstrate that investors e xh ib it overconfidence in both the

precision o f in form ation that they possess as w ell as in their ability to interpret it Barber

and Odean looked at the trading behaviour o f investors in order to ascertain i f they trade

excessively Excessive trading was defined as the level at w hich the costs associated

w ith trading a ctivity was in excess o f the profits generated by investors uetivelv adjusting

th e ir p o rtfo lio positions Rational inform ed traders are expected to trade in order to

increase th e ir returns on average Traders should at least expect to cover the cost o f their

trading activity However Barber & Odean (1999) find that the market adjusted returns o f

stocks sold outperform ed the market-adjusted returns o f those purchased The results o f

the study may be confounded by psychological factors relating to investors being more

lik e ly to sell w inning investments and holding on to their losing ones.' Further, not onlv

are average investors overly op tim istic, professionals m aking recom mendations as to

' N B a rb e ris points out that ind ividu als arc not onlv loss averse but that the degree o f loss aversion is conditional For exam ple: people that w on substantial rnonev on ea rlier bets w ere less averse o f future losses Thus, when the m arket advances, investors associate less risk w ith future prospects, consequentlv

d riv in g the m arket higher.

m arket o u tlo o k also display systematic biases in overestim ating prospects Rajan &

Servaes (1997) investigate analysts* fo llo w in g o f in itia l p u b lic o ffe rin g s and specifically

how this relates to a hot issues markets The authors fin d that analysts are over o p tim istic

o f the prospects o f hot issue IPO firm s as evident through th e ir excessive earnings

estimates Further, as the tenure o f the forecast increases, so does the extent o f the

forecast error, in d ica tin g that analysts are even more o p tim is tic as to lo ng term prospects

fo r these firm s The authors report that there exists a positive relationship between the

magnitude o f forecast error and the num ber o f new issues being brought to market Thus,

as the op tim ism o f analysts increases, so does the num ber o f IPOs com ing to market as to

capture the opp ortun ity to raise funds in the face o f o p tim is tic sentiments Chung and

Kryzano w ski (2000) report s im ila r findings when lo o kin g at recom mendations o f both

analysts and strategists They find that the degree to w h ich overly optim istic

recommendations are biased is positive ly related to the num ber o f bu ll m arket months for

the period under investigation

The decision to issue equity may be d ire ctly related to market sentiment I f markets

are overly o p tim istic to future prospects, firm s may seize this o p p o rtu n ity to raise funds

by conducting a public o ffe rin g This reasoning is in line w ith M yers and M a jlu f (19X4)

who argue that managers, having better in fo rm a tio n o f the fir m ’ s prospects than the

market, w ill want to issue equity when it is overvalued Fvidenee to this effect is

provided by Loughran and R itte r (1995) who demonstrate that the extent to w hich IPO

firm s under perform is d ire c tly related to the issues m arket at hand They find that

underperformance is most severe when firm s go p ub lic d u rin g hot issue markets, under

perform in g by 60 basis points per m onth As fo r the sub sample o f firm s that underwent

issues d u rin g cold issue periods, they displayed re lative ly m in im a l underperform ance in

the m agnitude o f 17 basis points per m onth Further R itter (1984) finds that hot markets

are characterized by sm aller, earlier stage speculative firm s com ing to market Loughran

and R itte r's (1995) results indicate that sm aller firm s experience worse perform ance than

larger issuing firm s Thus in conjunction w ith R itte r (1984) it seems that these more

speculative firm s are com ing to m arket as to take advantage o f m arket sentiment and

issuing equity when it is overvalued Lerner (1994) studying venture capita list backed

firm s in the biotechnology sector, provides further support fo r the opp ortun istic tim in g o f

equity issues in that the volum e o f IPOs com ing to m arket is a consequence o f the ability

to cash in on investor sentiment.b Biotechnology firm s are studied since these firm s

mature s lo w ly and do not require large up front costs, m ostly rem aining in the R & D

phase w e ll after going public Thus venture capitalists in these types o f industries have

opportunity as to the lim in g o f equity issues, as compared to other industries where the

nature o f funding needed at certain stages may not lend its e lf to market lim in g As Lerner

(1994) finds, venture capitalists tim e IPOs and increase the lik e lih o o d to take companies

public at peak valuations

2.4 A Brief Overview of the Market Conditions during the Study Period

The general market sentiment as to the overall market, as w e ll as the IPO market,

was hig h ly o p tim is tic fo r 1999 and the beginning o f 2000 R eferring to IPO market

conditions in 1999 and at the beginning o f the first quarter 2000 O m ar Sacriby o f The

IPO Reporter notes that, venture capitalists "w ith their pipelines bulging and investors

b itin g at v irtu a lly anything" were "flo a tin g some questionable deals kn o w in g that they

” Barrv et al ( 1 4 9 0 ) report that V C s take th eir com panies public vs hen m arket valuations are high.

w o u ld be carried by sheer m om entum " The end o f the First Quarter o f 2000 was

fo llo w e d by a general fallout in both the overall m arket and the IPO markets as investors

began to reassess record equity valuations.7 Readjustment o f investor sentiment began to

take hold as o f M arch 10 2000 fo llo w in g the N A S D A Q reaching an all tim e peak level

o f 5048 C N N m one y8 reports that the bear market began in the first Q uarter o f 2000

when the performance o f Blue Chips began to deteriorate However many com puter

related industries continued unabated long after the general m arket's decline was w ell

under way The inevitable adjustment that did occur when technology stocks gave wav

nearly 6 months later was attributed to investors rev ising their overly o p tim is tic sentiment

o f the market C N N m oney explains that the tech hold out was a consequence o f investors

" c u lt-lik e b e lie f in technology" Referring to the hot market o f 1999 w hich continued

through the firs t quarter o f 2000 and its subsequent fallout Richard Frisbie founder o f

Battery Ventures said in The IPO Reporter "W e have been in a plavground fo r VCs and

investors We knew it wasn't real life and it w o u ld n 't last, but as long as it did we were

happy to participate It created easy w in d fa ll o f gains for us." The Venture Capital

Journal (Feb 2001) noted that 2000 was a year marred w ith continuous deterioration in

the venture capital industry This point was further exem plified by the fact that five o f the

venture capital companies that went p ub lic in 2000 were also delisted in that year

H ow ever the IPO market in 2000 s till remained receptive to technology, com m unications

as w e ll as biotechnology equity issues, at least up until the third quarter The IPO market

o f 2000 saw companies issued that year fin ish the year trading dow n -2 0 2 8 "n w ith onlv

32°d fin ish in g the year up in stark contrast when compared to the returns o f those firm s

The IP O R eporter August 7 2000: O m a r Sacirbv

s C N N F N (S ep t 2 0 0 1 ) " B e a r o f a D iffe re n t C o lo r W hen D id die B ear M arket Begin? '

that lPOed in 1999 who finished th e ir IPO year up 188% w ith 72% fin is h in g in positive

te rrito ry 9 H ow ever 2001 was an especially weak year for the IPO m arket marked b> few

p u b lic offerings In total o n ly 110 IPOs came to market The Venture Capital Journal

(Jan 7 2002) attributes the poor performance o f the IPO m arket in 2001 to the dow nturn

experienced by internet stocks as w e ll as the record number o f private companies that

were being taken public in both 1999 and the first Quarter o f 2000 Kathleen Sm ith,

manager o f the Renaissance IPO Plus A fterm arket Fund said o f the IPO market

adjustm ent "T h is is a healthy thing w e 've been in a very, very strong IPO market that's

been w illin g to accept all kinds o f companies and put high valuations on those

com panies— even the risky one s"10

The com m on b e lie f o f practitioners and observers was that the m arket adjustment

w h ich had occurred in 2000 w ith respect to the market fo r equities, as w e ll as that for

new issues, was a result o f investors' overconfidence resulting in unsustainable market

valuations w hich adjusted as investors began more c ritic a lly assessing m arket valuations

and prospects Furthermore it is evident from the comments and actions o f VCs and the

com m entary o f those that fo llo w the activ ity o f v enture capitalists that VCs do in fact trv

to tim e IPOs in order to take advantage o f excessive market valuations fo r issues IPO

analysts frequently reported to the media as to the cyclical nature o f the IPO market

"s h u ttin g d o w n after a glut o f companies file and go public and investor demand

wanes" Scott Sipperelle o f M id to w n Research.11

1 Figures obtained from T he IP O Reporter January 7.2U O I: O m a r Sacirbx "2 0 0 1 : A I'ale o f f u o M arke ts"

T he Associated Press: Dustin Prial " IP O M a rk e t Expected to S u ffer at Hands o f lechn olo gv Crash"

" T h e Associated Press: Dustin Prial " IP O M a rk e t Expected to S u ffer at Hands o f lech n o lo g v C rash”

3 Data and Methodology

3.1 Data

The sample o f firm s m aking IPOs was obtained from w w \v ipolo ckup.com The

web site w w w ip olocku p.co m in itia lly started posting data w ith respect to firm s

undergoing unlock expiration as o f O ctober 1999 and onward T h is study takes into

consideration all those firm s that had unlock dates from the tim e this in fo rm a tio n became

p u b lic ly available via the web and encompasses the tw o year tim e frame fo llo w in g That

is the sample includes the set o f firm s undergoing lockup expiration fo r the tim e period

in clu sive o f October 1999 to the end o f September 2001 on either the New Y o rk Stock

Exchange or the N A S D A Q Exchange The entire sample o f lockup expirations durin g

the study periods was 812 O f the entire sample 44 firm s had m u ltip le unlock dates, w ith

the respective number o f distin ct unlocks ranging from 2 to 6 Thus, the in itia l sample o f

firm s was reduced by only taking into consideration the firs t unlock date for these firm s

that had m u ltip le unlock dates, reducing the sample s i/e to 753 observations, fu rth e r,

there were another 38 firm s for w hich no trading in form ation was asailable and had to be

elim ina ted from any analysis Thus, the final sample consists o f 715 IPOs that had

unlocks during the period October 1999 to September 2001

Data fo r the study was gathered from m u ltip le sources Data pertaining to the

companies under going IPO lockup expirations, as mentioned before, was gathered from

w w w ip o lo c k u p c o n i A d d itio n a lly from this source, data pertaining to the length o f the

lo ckup period, number o f shares offered fo r the IPO issue, unlock dale, trading volum e

around the unlock day and stock returns around the unlock day was obtained D a il\

price, adjusted price, and volum e data fo r ever> stock in the data set was obtained from

w w w silico n in ve sto r.co m The data fo r each company in the sample, regarding price,

adjusted price, and volum e was collected from the tim e o f IPO to 60 trading days

fo llo w in g the unlock date M arket performance data, that is index level data for the

Nasdaq and S&P 500 was gathered from wAvxv.nasdaq.com H ow ever onlv results

em p lo yin g the Nasdaq Com posite index are reported in the study since this was deemed

to be the more appropriate benchmark considering 94% o f the sample was listed on the

Nasdaq exchange.12 Further wAVAv.alert-ipo.com was used to gather the fo llo w in g stock

in fo rm a tio n : o ffe r price, exchange listing, lead underwriter, o ffe rin g amount, shares

offered by company, post-offering shares, over-allotm ent, and SIC code To find missing

data pertaining to company SIC codes the web site ww w.edgarpro.com was emploved

S im ila rly , the website vvAvw.freeEdgar.com was used to complete the other missing

in fo rm a tio n in the data set

Prospectuses were looked at in order to ascertain whether a companv was VC

backed o r not The total sample o f firm s is greater than the sum o f tlm is in the VC and

Non V C categories since it was not possible to locate 22 lin n prospectuses In order to

be classified as VC backed one o f the top 10 inv estors listed in the prospectus needed to

have either o f the words Venture Capitalist, or Lim ited Partnership a ffilia te d w ith the

inv esting groups name Under this method 76% o f all firm s were classified as hav ing VC

backing Further, the V C classifications used in the study were crosschecked w ith the

data set com piled by Van X ie at Concordia U niversity In his data set 543 o f the firm s

overlap w ith firm s in my study sample Yan X ie also collected data as to the proportion

W hen the S & P was used as the benchm ark the results w ere consistent with those obtained when the Nasdaq was the point o f reference H o w e v e r, the S & P benchm ark vielded more severe abnorm al returns.

o f V C backing O f the 543 corresponding firm s in our tw o data sets Yan X ie 's reports

446 firm s as having some level o f V C backing at the tim e o f IPO

Furthermore, tw o sets o f u n d e rw ritin g rankings were com piled fo r the sludv The

first set was obtained from w w w live d g a r.co m from the '33 A c t Deals Database

Rankings w h ich is based on quarterly rankings o f underw riters w ith respect to the dollar

value as to total net proceeds o f offe rings brought to m arket by the u n d erw riter during the

particular quarter Rankings were obtained for the second quarter 1999 to the first quarter

2001 The set o f offe rings consists o f all deals registered w ith the SEX' and have

prospectus dates that fall w ith in the specified tim e period In order to come up w ith a set

o f und erw riter rankings the in d ivid u a l quarterly rankings were each given equal 1 S'1'

w eighting The second set o f underw riter rankings fo r this study em ployed were the

http:, /bear.cba.ufl.edu/ritter/R an k.E lT M The rankings were as o f 2001 The tw o sets o f

rankings are h ighly correlated (0 7 8 )1'’ as w ould be expected and yielded statisticall>

indistinguishable results when employed in the regressions

F inally, all data other than the daily returns fo r in d ivid u a l stocks and the markets

was cross-referenced at least w ith one alternate Internet source For exam ple both

w w w ip o lo cku p co m and wwvv.alert-ipo.com have in fo rm a tio n pertaining to o ffe ring

am ount, o ffe rin g price, total shares offered, p o st-o ffe rin g shares, lis tin g exchange, lead

underw riter and the length o f lockup period When data discrepancies were discovered,

fo r the most part in less than 10% o f cases, an alternate source fo r the in fo rm a tio n was

located and the more frequently reported figure was employed I f the in fo rm a tio n could

1 Hav inu p-value 0 0 0 0 1

not be ve rifie d , it was om itted In addition to the in fo rm a tio n sources already mentioned

the fo llo w in g sites were also employed as cross references fo r the data com piled:

w w w edgarscan.pw cglobal.com w w w secinfo.com w w w edgarpro.com

w w w depts.washington.edu and w w w e q u ityw e b co m The variable categories w ith most

frequent discrepancies and their corresponding frequency o f m ism atch were as fo llo w s:

SIC code classification (5% ) O ffe rin g A m o u n t (2.6% ) O ffe r Price (6.5% ) and market

capita lization (12.3% ) A lth ough there existed a m ism atch in market capitalization in

12.3% o f the cases 61% o f these discrepancies were o f order less than 5% these were

classified as being identical and thus the in itia l observation was employed

The classification as to " H o t" or "C o ld " markets was chosen to coincide w ith the

peak o f the N A S D A Q Composite Index The N A S D A Q reached its all tim e high o f 5048

on M arch 10 2000 F o llo w in g the peak the market was in steady decline M any financial

w riters in the months fo llo w in g this peak reported M arch 2000 as the beginning o f a bear

market Thus fo r classification, as to market conditions and sentiment, the period prior to

M arch 2000 was classified as a hot market and event dates in M arch 2000 and onwards

were classified as occurring in a cold market O f course i f the number o f IPOs com ing to

m arket is influenced by market sentiment as reported by Lem er (1904) and further i f

there generally exists a 3-6 month lag tim e between the in itia tio n o f the IPO process and

taking the firm p u b lic 14, then the slow dow n in IPO o ffe rin g s w ill be preceded b\ that o f

the market slow dow n itself The sample o f firm s undergoing lockup expirations was

partitioned into groups, based on the market cond ition s at the tim e o f both the IPO and

unlock Due to the market conditions during the period under investigation, three groups

arise The first group deals w ith those firm s m aking IPOs and unlocking in a hot market

The second group consists o f those w hich made IPOs in a hot market but unlocked in a

cold m arket and the th ird group is composed o f those both m aking IPOs and unlocking in

a cold market We refer to these classifications as H o t/H o t H ot/C old and C o ld/C o ld

respectively The paper classifies market conditions w ith respect to the overall market,

how ever classifications as to market cond ition s may be more accurate i f the\ w ould

account fo r specific industry conditions as one sector may be in decline w h ile another

may at the same tim e be experiencing grow th

3.2 Methodology

3.2.1 A bnorm al Returns Computation

Abnorm al returns were calculated using three alternative methods These are <i)

the M arket Adjusted Return method, ( ii) the Field and Hanka (2001) M arket Adjusted

Return method, and ( iii) the M arket M odel method The d istinction between the two

M arket Adjusted Return Models is that Field and Hanka use the m u ltip lic a ti\e

fo rm u la tio n as opposed to the additive nature o f the original M arket Adjusted Return

M odel A ll three methods produced s im ila r results although the magnitude o f the results

varied somewhat W hen classifications based on m arket conditions at the tim e o f IPO and

unlock were undertaken, the three calculations again yielded s im ila r results for the

classification H ot/C old and C o ld/C o ld H ow ever this was not the ease fo r the Hot Hot

market In the case o f the H o t/H ot market, the results are more se\ere w ith continued

deterioration when the M arket M odel was used as compared to when the other models

were employed Pan o f the problem may be attributable to the short e \e n t window used

“ l \ o W e lc h IP O -T h e In itia l Public offerings ( I P O ) Resource Page u u u ip o ro M H irc c ' o re ipopage mini

to estimate the regressions These may all be reasons as to why studies by Field and

Hanka (2001) O fek and Richardson (2000) as w ell as others em ploy the M arket Adjusted

Return M odel when lo okin g at the IPO unlock day effect For this reason I w ill report all

results using both the M arket A djusted Return M odel as carried out in the Field and

Hanka study, as w e ll as the M arke t M odel method Throughout the rem ainder o f the

paper first the M arket M odel m ethod results w ill be reported follow ed by results from the

M arket Adjusted method in parentheses and their corresponding tables w ill be indexed

w ith an a) and b) s u ffix respectively The M arket M odel method is out lined below , the

M arket Adjusted method fo llo w s in the same manner w ith alpha set to zero and beta set

to one fo r all firms

A b norm a l returns were calculated using the M arket M odel m ethod tw ice, once

using the N A S D A Q returns as the proxy fo r market return and next using the S& P 500 as

the proxy The abnormal return was calculated fo r company /' by adjusting the da>s

return on company /' R, b y the corresponding return on the particular m arket R,„,

Next, fo r each day the residuals were averaged across the firm s to produce the average

residual for that day

The cum ulative average return (C A R ), was calculated, for example for the (-1 1) w indow

as fo llo w s

( I )

( 2 )

(3)

The corresponding test statistic fo r the cu m u la tive abnormal return fo r the 715 firm s over

w here T j is the trading volum e fo r firm / on day T

The three-day abnormal volum e fo r firm i is calculated as the arithm etic average o f

equation (6) over day -1 to 1 The m ethodology em ployed to calculate abnormal volum e

was carried out in the same manner as presented in Field and Hanka (2001)

3.2.3 Stabilization

In order to detect i f any price stabiliza tion was taking place w ith respect to VC -

backed firm s p rio r to the unlock the fo llo w in g method was emploved First a ll firm s

having unlocks o f 180 days were considered For these firm s each dav's stock price,

from IPO to 20 days fo llo w in g the u nlock expira tion was divide d bv the firm 's o ffe r

price N ext, the firm s were d ivid e d in to tw o groups categorized by VC -baeking For each

day the proportion o f firm s whose price had fallen below th e ir o ffe rin g price was

calculated and plotted fo r each category (V C and Non V C ) The graphs were then

exam ined as indicators o f whether sta b iliza tio n a c tivity existed Further the charts were

also exam ined in terms o f market conditions at the tim e o f the IPO since any arrangement

to provid e stabilization o f the stock price after the o ffe rin g w ould be agreed to at the tim e

o f IPO

4 Hypotheses

4.1 Information Hypothesis

Since the study by Field and Hanka (2001) was published, in fo rm a tio n on the IPO

unlock date has become w idely available, appearing on many websites such as:

ipopros.com and ipoexpress.com and most notably on ipolockup.com I f the results

found by Field and Hanka (2001) were a consequence o f in form ationa l asymmetry

am ong investors as to the unlock day itself, this is clearly no longer the ease Hence it is

proposed that the unlock day effect should not persist in the manner reported by the Field

and Flanka (2001) study fo r firm s having unlocks between October I Odd and September

2001 The abnormal returns about the unlock date, i f any should not be percei\ed as

being driven by inform ational asymmetry Rather it is the contention o f this study that

any abnormal returns about the unlock are a result o f temporary price pressure Price

pressure here refers to the increase in selling pressures due to insiders liq u id a tin g and

d iv e rs ify in g their positions to various extents at unlock and thus tem porarily reducing the

price o f the issue in order fo r the market to provide liq u id ity I f the price pressure

argum ent is to hold, then there should be a reversal in the unlock day effect shortly

fo llo w in g the event itself I f a reversal occurs, but is o n ly partial, then it may be that price

pressure is only one component as to the unlock day anomaly Observation o f a

tem porary price pressure effect may be confounded by a rtific ia l price m anipulation prior

to unlock or as a result o f private in fo rm a tio n becoming public once insiders are allow ed

to trade

I f the v o la tility o f stock returns pre and post unlock day are d iffe re n t this may

indicate that the unlock day effect is not merely driven by a dow nw ard sloping demand

curve and temporary price pressures but that there is in fact valuable in fo rm a tio n that is

c om ing to market from the observation o f the trading behaviour o f insiders I f private

in fo rm a tio n , as to the value and future prospects o f the firm , is com ing out at lockup

e xpira tion, one w o uld expect the in fo rm a tio n , on average, to adversely affect the stock

price Prior to the unlock day insiders have an incentive to conceal negative inform ation

A t the same lim e, post quiet p e rio d 1', they have an incentive to reveal positive

expectations Both actions coincide w ith insider's m axim ization o f expected returns at

unlock Thus at the tim e o f unlock there may be both price pressure at piav as w ell as the

effect o f private inform ation becom ing public fo llo w in g the unlock, suggesting that onlv

a partial price adjustment w ill occur post unlock A d d itio n a lly , post-unlock, it is

expected that the incorporation o f insider in form ation and increased trading w ill lead to

an increase in the actual return v o la tilitie s If as Rubinstein (2001) points out that price

and volum e activities reveal in fo rm a tio n as to the beliefs and preferences o f other

T he quiet period for new issues lasts 25 days fo llo w in g the o fferin g date D u rin g this tim e the companv and its insiders are restricted from m akin g any com m ents w ith respect to the o fferin g , f o llo w in g the expiration o f the quiet period generallv analysts begin m aking recom m endation regarding the issue M ost

o f the coverage being positive buy recom m endations Scott S ip p re lle o f M id to w n Research notes "M o s t o f the smart monev knows that 25 davs out you tvpically get a g lo w in g reco m m en datio n ” F heStreet.com M

F albo A Lockup U p d ate Dec 10.200 1.

investors, then m arket v o la tility may increase as a consequence o f investors in fe rrin g

from m arket a c tiv ity changes in the demand curv es o f other investo rs.Ih

4.2 Signalling Hypotheses

The p ro b a b ility that the price o f an IPO w ill fa ll below the o ffe r price is reduced

as the amount o f underpricing increases Since insiders are prohibited from selling their

shares p rio r to the unlock date, insiders may be interested in und erpricing as a means to

ensure that there is a greater lik e lih o o d that they w ill receive com pensation above the

o ffe r price for th e ir shares upon the unlock day especially i f greater underpricing is

p ositive ly associated w ith the returns investors experience from IPO u n til unlock

The sale o f securities at IPO is m otivated by d ifferent factors compared to the

selling that takes place at unlock A t IPO very often much o f the sales o f securities are

carried out to raise funds to aid in the grow th o f the firm In add ition , insiders also sell for

various reasons, liq u id ity , d iv e rs ific a tio n etc However the unlock se lling is entirelv

driven by the sales o f insiders Thus the two events are characterized bv different

m otivations The firs t is concerned w ith firm value m a xim iza tio n as w e ll as personal

wealth m a x im iz a tio n 1 The latter case is concerned e xclusive ly w ith in d iv id u a l wealth

m axim iza tion in that the proceeds do not contribute to the firm value in any wav

U nderpricing must be closely related w ith the proportion o f insiders locked in I f insiders

do not lock in at a ll that is insiders liquidate there entire position at IPO then it is

French and R oll (1 9 8 6 1 suggest that trading introduces noise into stock returns especially i f investors arc inferrin g inform ation from the trading activity o f others.

W e should also expect an increase in v o latilities i f artific ia l price m anipulation gives wav at the unlock day

as w ell.

1 In the sense that the w ealth o f the insider is linked to the value o f the firm as w e ll as the proceeds gathered at IP O bv any sale o f insider’ s holdings.

o p tim a l fo r them to ensure that there is no und erpricing associated w ith the issue, l or

in d ivid u a ls o f this sort, the IPO is the only o p p o rtu n ity to sell and thus they w ill he highly

concerned w ith wealth m a xim iza tio n and thereby m in im iz a tio n o f underpricing o f the

securities issue

However, i f the level o f underpricing as w e ll as the propo rtion o f shares locked in

by insiders generates a m om entum effect, then it may be logical to underprice to a greater

extent when o ffe rin g up only a small proportion o f shares to the m arket A higher lev el o f

und erpricing w ill be associated w ith a greater am ount o f positive coverage and market

fo llo w in g , as suggested by Meggison and W eiss (1991) and reported bv Rajan and

Servaes (1997) w h ich in turn, it is expected, w ill result in the increase in market demand

and a greater lik e lih o o d o f value appreciation by the tim e o f unlock Thus price

appreciation occurs in part, as a consequence o f these tw o factors Thus as the proportion

o f shares locked up increases so does the incentive fo r insiders to underprice to a greater

extent

The proportion o f shares locked in signals the fact that the in side r's wealth w ill

continue to be tied to the fortunes o f the com pany and the interests o f the new

shareholders fo r at least the tim e o f the lockup period Thus, fo r the duration o f the

lockup period, the lockup agreement assures that the interests o f the o ld shareholders and

management is aligned w ith that o f the new shareholders and as the propo rtion o f insiders

locked in increases so does the c re d ib ility o f the signal sent w ith respect to the v alue and

prospects o f the firm

Further, it is expected that those firm s associated w ith a greater extent o f

underpricing w ill perform better in the IPO to unlock w in d o w , in terms o f returns to

investor Further it is expected they w ill also experience a greater decline upon unlock

day due to the expectation that those firm s w ith a greater price appreciation are more

lik e ly to have increased p ro fit ta k in g 18 thus co n trib u tin g to an increase in selling and

price pressure about the unlock day

M any o f the factors around the IPO o f a security are by design, a means o f

sig n a llin g and a lleviating to some extent the in form ationa l asymmetries which persist at

the tim e o f IPO itself The greater the uncertainty for new investors as to firm value and

prospect, the stronger the signal that is required to overcome the asymmetry o f

in fo rm a tio n That is such factors as the proportion o f shares locked up the level o f

underpricing, the level o f venture capitalist backing and the reputation o f the lead

u nd erw riter may all assist in the a lle via tio n o f in form ationa l asymmetries

S p e cifica lly, as a means o f a lle via tin g some o f the asymmetry , the insiders (pre

IPO shareholders) have incentive to lock in their shares, thereby alig n in g the interests o f

the existing shareholders and new investors for at least the duration o f the lockup period

Thus the greater proportion o f insiders locked in the more credible the signal that is sent

as to the firm 's outlook Howev er, it is also expected that the proportion o f shares locked

in w ill be p o sitively related to the degree o f underpricing as argued previously I hal is

those issues w ith greater proportion o f shares locked up w ill be underpriced to a greater

extent

Further, venture capitalists are able to ce rtify inform ation as to the value o f a firm

by putting th e ir reputational capital at stake and lo cking in their holdings for the length o f

I s

It can also be argued that those tlrm s w hich under perform the market durin g the hold in g period m a \ also be exposed to more dram atically negative C A R since for these it is likely to be m ore d iffic u lt to act investors to hold additional share, thus resulting in m agn ified negative abnorm al returns about the unlock.

the IPO lo ckup p erio d.14 Since venture capitalists, through their endorsement o f an issue

and by themselves lo cking in already provide some ce rtifica tio n as to the value o f an

o ffe rin g and as a consequence lessening the asym metry o f inform ation, a lesser degree o f

und erpricing should be associated w ith those firm s having V C backing It has been

documented by Meggison & Weiss (1991) and Brav Gompers (1997) that new issues

having V C backing are underpriced to lesser extent than those not having VC' backing

Further the VCs are able to attract higher q u a lity underwriters since they are able

to alleviate some o f the asymmetry in the valuation o f the firm for the u n d e rw ritin g

parties, and thus decreasing the level o f research needed to be undertaken by the

underwriters The lead underw riter associated w ith the o ffe rin g in turn provides

in fo rm a tio n to the market participants The underw riter sim ilarly puts at stake their

reputational capital when the price is set and the issue is brought to market, and as

documented by Chowdry and Nanda (1996) and M eggison and Weiss (1 9 9 ]) are also

prov iders o f price support

M ore severe price pressure is expected in relation to IPOs w ith V C -b ackin g as

opposed to those lacking VC participation Many VCs distribute shares in IPO firm s to

in stitu tio n a l investors who then typically sell at first possible opportunity, the unlock day

as reported by Gompers and Lem er (1998) It is com monly noted that VCs distribute

th e ir holdings to partners who then liquidate more aggressively'1", or that VCs w ill desire

to liquidate their positions quicker post unlock as to realize their return on investment in

V C put th e ir reputational capital at stake w ith respect to the underwriters they em ploy to bring issues to

m arket and w ith the institutional investors they partner w ith furtherm ore they must be able to bring i s s u e s

to m arket repeatedly and thus also must protect th eir cred ib ility w ith investors ( M eugison and \V e i s s

I W )

‘ ' Institu tion al investors may liquidate th e ir positions im m ediately as a consequence o f restrictions p o rtfo lio

m anagers may have in regards to holding illiq u id stocks.

order to em ploy these funds and repeat their investm ent cycle In order to ascertain i f

VC s do in fact sell more aggressively at unlock, abnormal volum e about unlock is

exam ined It is thus expected that the more aggressive selling should be associated w ith

IPOs having VC backing and thus in conjunction w ith a dow nw ard slo pin g demand

curve, w o u ld result in a more severe decline for unlock day abnorm al returns as

documented in Field and Hanka (2001)

C onsidering the unlock day it is expected that the findings w ill be consistent w ith

a dow nw ard sloping demand curve for securities Thus, greater price declines at unlock

should be associated w ith those variables p roxyin g the like lih o o d o f greater volum e o f

se lling by insiders since a price pressure effect is expected even w ith widespread

in fo rm a tio n ava ila b ility The expectation as to the am ount o f selling upon the unlock day

should be a ffilia te d w ith the signalling factors at IPO i.e the proportion o f shares locked

up the backing o f venture capitalists, and underw riter reputation as thev are all proxies

fo r the v olum e o f trading upon unlock Further, holding period returns are expected to be

associated w ith increased p ro fit taking and price pressure on the unlock date

It seems reasonable to take into account firm size since for sm aller issues one

w o u ld expect that there w ould be more d iffic u ltv getting insiders to continue to hold on

to shares in illiq u id firms Thus, it is expected that these sm aller issues w ill be associated

w ith greater price pressure around the unlock date

4.3 Market Conditions Hypothesis

As noted prev iously, much o f the circumstances surrounding the IPO da> have to

do w ith asymmetry o f inform ation and signalling w ith regard to the value o f the firm

The p ro p o rtio n o f shares locked in presence o f VC backing, und erw riter ranking and

level o f underpricing are a ll to some extent sig nallin g the value o f the firm to the market

It is this paper's contention that the unlock day anomaly is a result o f liq u id ity effects

w h ich are further confounded by m arket conditions both at the tim e o f IPO and unlock

The abnorm al returns reported in the study by Field and Hanka (2001) about the unlock

day are expected to be priced in p rio r to the unlock day when we consider the aggregate

sample o f firm s The sig n a llin g variables as w ell as the other lin n characteristics,

contribute to expectations as to the increase in supply o f the asset fo llo w in g unlock Thus

in the context o f a dow nw ard sloping demand curve all are drivers o f price pressure

around unlock However, the reaction to the increase in float around unlock is inevitably

related to the psyche o f the market

Further confounding the nature o f the actual response observed at unlock is tied to

the overall market sentiment at the tim e o f unlock, w hich is o f course not gaugeable at

the tim e o f IPO its e lf but w hich should have a substantial influence on the market

reaction on the unlock day In a deteriorating market, it is expected that participants w ill

react more negatively to the underlying proposed variables proxxing for unlock dax

selling: V C backing, underw riter ranking, level o f underpricing and firm s i/ e '1 A t the

same tim e during worsening markets, the demand curve may in fact sh ift or become

steeper Further investors may in fe r in form ation from the trading behaviour o f other

investors (French and R o ll 1986) Thus any unexpected sales by insiders about the

unlock may result in a positive feedback response d riv in g the returns even lo w er as

■' Due to e ith er change in m arket s e n tim e n t risk aversion or the m arket required rates o f return.

negative in form ation is derived by other participants."' Since the unlock day effect is

p rim a rily proposed to be a liq u id ity effect, in a stable market (that is either H o t'H o t or

C o ld /C o ld ) w ith wide spread in form ationa l a va ila b ility as to the unlock day and the

aforem entioned variables, we w o u ld expect rational behaviour to prevail and that

investors w ill on the w hole properly ascertain the amount o f selling at unlock and thus no

permanent abnormal return is expected to result from this com pletely predictable event

However, i f market conditions change fo r the worse from the tim e o f IPO to unlock, a

greater response is expected since it is lik e ly that the investor sentiment in terms o f

expectation has changed or alternatively that the m arket’ s required risk prem ium has

changed

In the H o t/H ot sample it is expected that there w ould be less unlock price pressure

when compared w ith the H o t/C old group However, the selling pressure about unlock

may in fact be greater in the H o t/H o t as opposed to the C o ld/C o ld market, fo r in Hot IPO

markets a greater va ria b ility as to the qu a lity o f firm s approaching the market exists and

thus there may be more price pressure due to this marginal element at unlock (hot issues

m a rk e t)." Lem er (1994) finds that issuers take advantage o f the opportunity to come to

the market when optim ism persists Insiders are also inclined to take advantage o f

m arket optim ism at unlock and cash out at inflated valuations Thus, in fact selling

pressure in hot markets may be most severe due to the level o f selling However, it is

expected that the price reaction w ould be most severe fo r the H o t/C o ld market D uring

the C o ld /C o ld scenario it w ould be anticipated that the C A R about the unlock should not

“ F ie ld and H an ka (2 0 0 1 ) argue that the unlock d a \ effect is at least partK a consequence o f worse then expected sales bv insiders and a d ow n w ard sloping dem and curve.

be worse than observed d urin g the H o t/H o t market due to the fact that no counter

adjustm ent as to market conditions had taken place from the tim e o f IPO to unlock

Further the firm s that make IPOs d urin g a cold m arket are expected to be the higher

q u a lity firm s, on average, and insiders o f such firm s w o uld also be less in clined to sell at

the unlock

In the H o t/C old sample it is expected that abnormal returns about the unlock w ill

be the most pronounced Further, adverse market sentiment at the tim e o f unlock would

result in greater price deterioration since in order to absorb the new shares the market

w o u ld require more incentive to provide liq u id ity to insiders C o nfo unding this matter is

that d urin g hot markets firm s o f all qualities IPO M any firm s make IPOs ju s t to take

advantage o f the p re vailing m arket optim ism Thus, when a hot m arket sours these lower

q u a lity firm s w ill be most drastically affected and further im p a ir the performance o f the

overall sample

4.4 Industry Effects Hypothesis

Lem er (1993) shows that for the biotechnology sector VC s have the ability to

tim e the m arket as to industry conditions It may be the case that fo r particular industries

there is in essence, no unlock day anomaly but in other industries it does persist as a

result o f firm s taking advantage o f market optim ism Furtherm ore i f an industry is

experiencing adverse market conditions any additional pressure about unlock may result

in more severe reaction to the increase in float This, coupled w ith the effect o f private

' Further d urin g hot markets V C s have greater influx o f funds w ith more lirm x to invest in the m arginal quality o f firm s may decrease as w e ll T he m o n ito rin g provided by the V C may also be d im inished in such instances.