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

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Re-examining the IPO Unlock Day Anomaly:
Do Market Conditions and Increased Availability of
Information Matter?

George J. Gaspar

A Thesis
In
the 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 dm inistra tion at
Concordia University

M ontreal, Quebec, Canada

A p ril 2002

©George J. Gaspar, 2002

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C O N C O R D IA U N IV E R S IT Y
School o f Graduate Studies

This is to ce rtify that the thesis prepared
By:

GEORGE J. GASPAR

Entitled:

RE-EXAM 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 SCIENCE IN ADMINISTRATION

com plies w ith the regulations o f this U niversity and meets the accepted standards
w ith respect to o rig in a lity and quality.
Signed by the fin a l exam ining committee:

Chair

ner

Examiner

Thesis Supervisor

Approved by
ha ir o f Departm ent or Graduate Program D ire ctor

ApriV ft 20 c>2_
Dean o f Faculty

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ABSTRACT

R e-Exam ining the IPO U nlock Day Anom aly: Do M arket Conditions 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 significant abnormal returns. D uring the period o f the Field
and Hanka (2001) study the public 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 w idely 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 elim ina tion 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 time o f IPO and unlock
finding 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 inform ational asy mmetries persisting at the tim e o f the offering:
the study confirm s the relation o f these IPO signalling 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

iii

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effects.


Table of Contents
1. In tro d u c tio n ...............................................................................................................................

.

1

2. Literature R e view ....................................................................................................................
2.1 V C B a ckin g ...................................................................................................................

2.2 S ta b iliz a tio n ..................................................................................................................
2.3 H ot and C old M a rke ts.................................................................................................
2.4 A B r ie f O verview o f the M arket C onditions during the Study P e rio d ............

.

6

.

6

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 bnorm al Returns C o m p u ta tio n ...........................................................................
3.2.2 A bnorm al V olum e C om putation...........................................................................
3.2.3 S ta b iliz a tio n ...............................................................................................................

15
15
10

4. Hypotheses.................................................................................................................................
4.1 Info rm ation H yp o th e sis...............................................................................................
4.2 S igna lling H ypotheses................................................................................................
4.3 M arket C onditions H yp o th e sis.................................................................................
4.4 Industry Effects H ypothesis.......................................................................................
4.5 Stabilization/P rice Support H yp o th e sis ..................................................................

5. Results.........................................................................................................................................
5.1 A bnorm al Returns about the U nlock D a te..............................................................
5.2 Inform ation S ig n a llin g ................................................................................................
5.3 M arket C onditions at IPO and U n lo c k ....................................................................
5.4 Industry E ffe cts ............................................................................................................
5.5 Price S upport.................................................................................................................
5.6 A bnorm al V o lu m e ......................................................................................................

.8

10
12

10
21

21

24
28

31
32

A
33
34
36
38
40

41

6. Summary and C o n clu sio n ......................................................................................................

42

T ab les............................................................................................................................................. .
Table 1 a) A bnorm al Return Regression I .............................................................................
Table 1 b) A bnorm al Return Regression I .............................................................................
Table 2 a) A bnorm al Return Regression I I ............................................................................
Table 2 b) A bnorm al Return Regression I I ............................................................................
Table 3 A bnorm al Return Regression I I I ...............................................................................
Table 4 a) A bnorm al Return Regression I V ..........................................................................
Table 4 b) A bnorm al Return Regression I V ..........................................................................
Table 5 A bnorm al V olum e Regression I ...............................................................................
Table 6 Regression: Abnorm al U nlock Day Volum e as a d rive r o f Abnorm al I nlock
Day R e tu rn s ..................................................................................................................................
fa b le 7 a) Venture C apitalist Backing and SIC Code C lassifications............................
Table 7 b) Venture C apitalist Backing and SIC Code C lassifications............................
Table 8 a) M arket Conditions at IPO and U n lo c k ................................................................
fa b le 8 b) M arket Conditions at IPO and U n lo c k ...............................................................

46

iv

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46
47

48
40
50
51
52

53
54

55
55
56
56


Table 9 Hypothesis T e s tin g .......................................................................................................... 57
Table 10 Hypothesis T e s tin g ......................................................................................................... 57
Figures................................................................................................................................................. 58
Figure la ) M arket M odel: O verall P e rio d ..................................................................................58
Figure lb ) M arket Adjusted Return: O verall P e rio d .............................................................. 59
Figure 2a) M arket M odel: O verall Period. V C Backed Firm s............................................... 60
Figure 2b) M arket Adjusted Return: O verall Period. V C Backed F irm s ............................61
Figure 3a) M arket M odel: O verall Period. Non V C Backed F irm s...................................... 62
Figure 3b) M arket Adjusted Return: O verall Period. Non VC Backed Firm s....................63
Figure 4a) M arket M odel: H ot/H ot M a rk e t............................................................................... 64
Figure 4b) M arket Adjusted Return: Hot/Plot M a rk e t.............................................................65
Figure 5a) M arket M odel: H ot/C old M a rk e t.............................................................................66
Figure 5b) M arket Adjusted Return: H ot/C old M a rk e t.......................................................... 67
Figure 6a) M arket M odel: C old/C old M arke t............................................................................68

Figure 6b) M arket Adjusted Return: C o ld/C o ld M arket......................................................... 69
Figure 7a) M arket M odel: H ot/H ot M arket. V C Backed F irm s ............................................70
Figure 7b) M arket Adjusted Return: H o t/H o t M arket. V C Backed F irm s ..........................71
Figure 8a) M arket M odel: H ot/C old M arket. V C Backed Firm s...........................................72
Figure 8b) M arket Adjusted Return: H ot/C old M arket. VC Backed F irm s ....................... 73
Figure 9a) M arket M odel: C old/C old M arket, V C Backed F irm s........................................ 74
Figure 9b) M arket Adjusted Return: C old/C o ld M arket. V C Backed F irm s...................... 75
Figure 10a) M arket M odel: H ot/H ot M arket. N on V C Backed F irm s .................................76
Figure 10b) M arket Adjusted Return: H ot/H ot M arket. Non VC Backed F irm s .............. 77
Figure 1 la ) M arket M odel: H ot/C old M arket. Non V C Backed Firm s............................... 78
Figure 1 lb ) M arket Adjusted Return: H ot/C old M arket. Non VC Backed Firm s............. 79
Figure 12a) M arket M odel: C o ld'C old M arket. Non V C Backed F irm s ............................. 80
Figure 12b) M arket 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 arket Adjusted 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 arket M odel: SIC Code 3 8 0 0 ............................................................................ 86
Figure 15b) M arket Adjusted Return: SIC Code 3 8 0 0 .......................................................... 87
Figure 16a) M arket M odel: SIC Code 4 8 0 0 ............................................................................. 88
Figure 16b) M arket 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 arket Adjusted Return: SIC Code 5 9 0 0 ........................................................... 91
Figure 18a) M arket M odel: SIC Code 7 3 0 0 ............................................................................ 92
Figure 18b) M arket Adjusted Return: SIC Code 7 3 0 0 .......................................................... 93
Figure 19a) M arket M odel: SIC Code 8 7 0 0 ............................................................................ 94
Figure 19b) M arket Adjusted Return: SIC Code 8 7 0 0 ........................................................... 95
Figure 20a) M arket M odel: VC Backed Firm s. SIC Code 7 3 0 0 ......................................... 96
Figure 20b) M arket 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 arket Adjusted Return: Non V C Backed Firms. SIC Code 7300............... 99
Figure 22a) M arket M odel: V C Backed Firm s. Non SIC Code 7300 .............................. 100

v

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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 Abnorm al V olum e: O verall P e rio d ....................................................................... 104
Figure 25 Abnorm al V olum e: V C Backed F irm s ...................................................................105
Figure 26 Abnorm al Volum e: Non VC Backed F irm s ..........................................................106
Figure 27 Abnorm al Volum e: Hot/ Hot M a rk e t.................................................................... 107
Figure 28 Abnorm al Volum e: H ot/C old M a rk e t................................................................... 108
Figure 29 Abnorm al Volum e: C old/C old M a rke t.................................................................. 109
Figure 30 Abnorm al Volum e: H ot/H ot M arket. V C Backed F irm s ..................................110
Figure 31 Abnorm al Volum e: H ot/C old M arket. VC Backed Firm s............................... 1 11
Figure 32 Abnorm al V olum e: C old/C old M arket. V C Backed F irm s.............................. 112
Figure 33 Abnorm al Volum e: H ot/H ot M arket. Non VC Backed F irm s .......................113
Figure 34
Abnorm al Volum e: H ot/C old M arket. Non VC Backed Firm s
I 14
Figure 35
Abnorm al Volum e: C’old/C old M arket. Non V C Backed F irm s
1I 5
Figure 36 Abnorm al Volum e: Comparison o f V C and Non VC Backed F irm s
116
Figure 37 Proportion o f Firms Trading B elow O ffe r P ric e ................................................ 1 17

Figure 38
Proportion o f Firms Trading Below O ffe r Price. IPO H o t
117
Figure 39
Proportion o f Firms Trading Below O ffe r Price. IPO C o ld
11Figure 40 Proportion o f Shares Locked U p ........................................................................... 119
Figure 41 SIC Code D is trib u tio n ............................................................................................. 119
References..................................................................................................................................... 120

VI

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1. Introduction
When a company undertakes an in itia l public offe ring (IP O ) most insiders are
subject to a lockup agreement.

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. The
lockup agreement is a legally enforceable contract imposed on the insiders b\ the
underw riter 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 companies' shares are locked under the
agreement.

Once the lockup expires the insiders are no longer prohibited from selling

their shares. However they are s till restricted by other rules and lim ita tio n s, w hich appl\

to sales by insiders. These rules encompass company imposed restrictions and blackout
periods as w ell as SEC regulations. S pecifica 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 ub lic float o f the companies' 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 form ation 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 )
find that the unlock day signifies a statistically significant three-day abnormal return o f 1.5°b.

O fek and Richardson (2000) fin d that there is a sim ilar 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 well as Bradley et ai (2001).

This price reaction is quite surprising

since there is no inform ation asymmetry about the unlock date and goes against the

I

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notion o f market efficien 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 uld seem that in an e fficie n t market 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 itself, to the
expected increase in the public float. Investors should, on average, anticipate the extent
to w hich 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 efficient

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 find that "the
abnormal returns around the unlock day are not large enough to provide short term pro tits
for 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 their 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 downward 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 during this period the public 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

available.

1999. reminders o f the unlock date have been widely

' Field and H anka (2 0 0 1 ) also cite the d ow n w ard sloping demand curve as a partial explanatio n o l'th e
u nlock dav effect.

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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 idely available from many other Internet sources such as
w w w .unlockdates.com .w xvw .ipopros.com . w w w .ipo.com 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
inform ation/scrutiny 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 their 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 wide spread public a va ila b ility o f an IPO 's unlock date result in the elim ination
o f the unlock day anomaly?

I f this is not the case, are there alternative influences

concurrently affecting 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 inform ation

occuring on the unlock day itself.

based adjustments

It is expected that due to the easy and widespread

accessibility o f unlock date inform ation through Internet sources, that the abnormal
returns around the unlock reported by Field and Hanka (2001) w ill no longer be
statistically different from zero.

However, it is expected that the volum e effect w ill be

"V

j

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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
signalling and alleviating, to some extent, the inform ational asymmetries w hich persist at
the tim e o f IPO itself. Factors such as: the proportion o f shares locked up. the le \e l o f
venture capitalist backing and the reputation o f the lead underw riter may all assist in the
alleviation o f in form ational asymmetries at the tim e o f IPO. H owever it is expected that
the amount o f selling on the unlock day w ill also be a ffilia te d w ith these IPO signalling
factors. The proportion 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 all 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 for VC backed firms.
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 Gom pers (1 9 9 9 ) find that these variables are associated w ith increased selling pressures.
[other due tim e varx ing RRA or tim e van. ing risk prem ia ( Koutoulas and K rx /a n o w s k i ( 1996)).
Essentiallv in ord er to prov ide the same level o f liquidity at unlock it is expected that insiders w ould he
required to provide greater price concessions in return.

4

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in terms o f industry influences to gauge i f the V C effect reported by fie 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
know n to provide stabilization o f issues in terms o f afterm arket price support as noted in
studies by Hanley. K um ar and Seguin (1993) and Prabhula and Puri (1998). f o r the
duration o f the lockup. VCs have every incentive to control the v o la tility o f the issue or
fo r that matter movements below the offe r price. Thus it is expected that during the
lockup period. V C backed firm s w ill experience a lesser degree o f va ria b ility below their
o ffe r price than those firm s lacking VC support. However post unlock it is expected that
the proportion 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, furtherm ore , 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 follow s: Section 2 provides b rie f
background inform ation as to: the role o f venture capitalists, stabilization, market
conditions in the IPO process as w ell as an overv iew o f market conditions during the time
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 underw riter's com m itm ent to provide price support is. in essence,
a put option.

5

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2. Literature Review
2.1 VC Backing
Venture capitalists provide capital financing to companies.

VC s generally

provide financing 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
function o f the V C ’ s; experience, the industry' that the fund invests in as w ell as
geographical

concentration.

Barry

(1990)

finds

that

venture

capitalists

prim arily

concentrate th e ir investments in young high-risk private firm s where the VCs goal is to
take these firm s public, as they derive most o f their p ro fit from such activities. Thus VC
investm ents are typically highly illiq u id u n til such a tim e the firm is taken public 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 institutio nal. Generally, these partnerships have predetermined li\e s . typically o f 10
years in length. In most cases when a firm is taken public the VC w ill distribute shares to
the general partners. A fte r such a d istribu tion, the general partners are free to sell their
shares w ith in the SEC set guidelines. F o llo w in g an IPO distribution, the investors in the

fund generally liquidate their position im m ediately.
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
companies, as w ell as high tech companies where the level o f inform ational asymmetry is

6

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lik e ly to be the most pronounced. The paper focuses on staging o f capital financing as a
control mechanism, which allow s for m onitorin g by the V C o f their investments. Staging
o f financing 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 onitoring

through the duration o f

funding they provide as well as by the frequency w ith which they provide such funds
(Gom pers (1995)). The m onitoring provided by VCs is especially o f value considering
that these V C partnerships typically concentrate their investments in voung high tech
companies where inform ational asymmetries are most severe.

Furthermore. Barn, et al

(1990) report that VCs typically hold one third o f the shares and Board seats in the
companies they invest in. Thus venture capitalists are active participants in the firm s that
they invest in. providing both financing and m onitoring.
Megginson & Weiss (1991) consider the impact o f VCs providing ce rtification in
the IPO process. C ertification 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 known by the market and insiders have the m otive to
conceal adverse inform ation. Rational investors understand the insider m otive 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 cre 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 time o f IPO.

Further. Field and

Hanka (2001) document that venture capitalists continue to hold a sig nifica nt proportion

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o f th e ir o rig in a l holding in the year fo llo w in g the in itia l public offering.

M egginson &.

W eiss (1991) also find 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 erin g the
level o f due diligence performed by the underwriter. A d d itio n a lly. VC backed lin n s
generate more interest from institutio nal investors and are thus able to bring their
o ffe rings to market earlier.

2.2 Stabilization
W hen considering underperformance o f new issues. Loughran and R itter (1995)
fin d that IPOs exhibit no tendency to under perform in the first six months fo llo w in g the
o ffe rin g . However 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 different 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 hich were in effect for exactly 180 days. Thus it seems
possible that the difference in performance 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 performance o f new issues as documented by Loughran and
R itter (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 during the lockup period. I f private sentiment is being revealed on the unlock

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day it w ould be expected that the greatest portion o f private inform ation w ill be revealed
on this day also. M arket participants w ill be able to infer the trading a ctivity 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

underw riters (M egginson and Weiss.

to be associated

w ith

higher qual it\

1991). are possibly benefiting from

a rtificia l

underw 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 ricin 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 hich they expect to appreciate. Thus price support is put forward 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 ould be provided since they possess the capability
o f putting their cre d ib ility at stake. T yp ica lly larger investment bankers are in a position
to generate such a signal. Such investm ent banks may be able to control their losses from
an afterm arket price support arrangement since they are more able to disperse their losses
amongst other syndicate members, especially under the threat o f exclusion from further
offe rings for 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 for u n d erw riting services

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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 vo 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 underw riter is in
fact a put option.

U nderpricing o f issues effectively m inim izes the value o f this put

option offered by the underwriter.

2.3 Hot and Cold Markets
There is much evidence pointing to the fact that investors are overly optim istic.
Barber & Odean (1999) demonstrate that investors exhibit overconfidence in both the
precision o f inform 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
their p o rtfo lio positions. Rational inform ed traders are expected to trade in order to
increase their 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
like ly to sell w inning investments and holding on to their losing ones.' Further, not onlv
are average investors overly optim istic, professionals m aking recommendations as to

' N .B a rb eris points out that individuals 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 earlier 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 rivin g the market higher.

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m arket ou 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 pub lic offe rin g s and specifically
how this relates to a hot issues markets. The authors find that analysts are over optim istic
o f the prospects o f hot issue IPO firm s as evident through their excessive earnings
estimates. Further, as the tenure o f the forecast increases, so does the extent o f the
forecast error, indicating that analysts are even more o p tim istic as to long term prospects
for 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 optim ism o f analysts increases, so does the num ber o f IPOs com ing to market as to
capture the opportunity to raise funds in the face o f o p tim istic sentiments.

Chung and

Kryzanow ski (2000) report sim ila r findings when lookin g at recommendations o f both
analysts and strategists.

They

find

that

the degree

to

w hich

overly

optim istic

recommendations are biased is positively related to the num ber o f bull market months for
the period under investigation.
The decision to issue equity may be directly related to market sentiment. I f markets
are overly o p tim istic to future prospects, firm s may seize this opportunity 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 form ation o f the firm ’ 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 itter (1995) who demonstrate that the extent to w hich IPO
firm s under perform is d ire ctly related to the issues market at hand. They find that
underperformance is most severe when firm s go public during hot issue markets, under
perform ing by 60 basis points per m onth. As for the sub sample o f firm s that underwent

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issues during cold issue periods, they displayed relatively m inim al underperformance in
the m agnitude o f 17 basis points per month. Further R itter (1984) finds that hot markets
are characterized by smaller, 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 performance than
larger issuing firm s.

Thus in conjunction w ith R itter (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 capitalist backed
firm s in the biotechnology sector, provides further support for the opportunistic tim in g o f
equity issues in that the volum e o f IPOs com ing to market 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 like 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 highly o p tim istic for 1999 and the beginning o f 2000. Referring 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

bitin g at v irtu a lly anything" were "flo a tin g some questionable deals know in g that they

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

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w ould 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 oney8 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 istic sentiment
o f the market. CN 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 first 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 for 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 public 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 finish the year trading down -2 0 .2 8 "n w ith onlv
32° d finishin g the year up. in stark contrast when compared to the returns o f those firm s

The IP O Reporter August 7. 2000: O m a r Sacirbv
s C N N F N (Sept 2 0 0 1 ) " B e a r o f a D ifferen t C o lo r W hen D id die B ear M arket Begin? '

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that lPOed in 1999 who finished their IPO year up 188% w ith 72% fin ish in g in positive
te rrito ry.9 H ow ever 2001 was an especially weak year for the IPO market marked b> few
pub lic offerings.

In total only 110 IPOs came to market. The Venture Capital Journal

(Jan 7. 2002) attributes the poor performance o f the IPO market 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 ones"10
The com m on b e lie f o f practitioners and observers was that the m arket adjustment

w hich had occurred in 2000 w ith respect to the market for equities, as w ell 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 market valuations
and prospects. Furthermore it is evident from the comments and actions o f VCs and the
com mentary o f those that follow 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
"sh 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 The 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 arkets"
The Associated Press: Dustin Prial " IP O M arke t Expected to S u ffer at Hands o f lechnologv Crash"
" T h e Associated Press: Dustin Prial " IP O M a rk e t Expected to S u ffer at Hands o f lechn olo gv Crash”

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3. Data and Methodology
3.1 Data
The sample o f firm s m aking IPOs was obtained from w w \v .ipolockup.com .
web site w w w .ipolockup.com

in itia lly

started posting data w ith

respect to

The
firm s

undergoing unlock expiration as o f O ctober 1999 and onward. This study takes into
consideration all those firm s that had unlock dates from the time this in form ation 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 for the tim e period
inclusive 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 during

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 distinct unlocks ranging from 2 to 6. Thus, the in itia l sample o f
firm s was reduced by only taking into consideration the first unlock date for these firm s
that had m ultiple unlock dates, reducing the sample si/e to 753 observations,

fu rth e r,

there were another 38 firm s for w hich no trading inform ation was asailable and had to be
elim inated from any analysis. Thus, the final sample consists o f 715 IPOs that had
unlocks during the period October 1999 to September 2001.
Data for the study was gathered from m ultiple sources. Data pertaining to the
companies under going IPO lockup expirations, as mentioned before, was gathered from
w w w .ip o lo cku p .co n i. A d d itio n a lly from this source, data pertaining to the length o f the
lockup 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

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w w w .silicon inve stor.co m . The data for 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 owever onlv

results

em ploying 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 form ation: 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 www.edgarpro.com was emploved.
S im ila rly, the website vvAvw.freeEdgar.com was used to complete the other missing
inform ation 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 ffiliate 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 eve r, the S & P benchm ark vielded more severe abnorm al returns.

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