Will stock in Facebook, which recently filed for initial public offering (IPO), drop significantly following the end of its IPO lock-up period later this year? It might if the company follows recent trends, finds a new study by graduate students at Washington University in St. Louis.
Written by Borge Klungerbo, Sam Poteat and Jonathan Woo, students in Olin Business School’s masters of science in finance program, the new paper, “A Persistent Anomaly,” finds that negative abnormal returns follow the expiration of IPO share lock-up periods.
An IPO lock-up is a contractual caveat referring to a period of time after a company has initially gone public, usually between 90 to 180 days. During these initial days of trading, company insiders or those holding majority stakes in the company are forbidden to sell any of their shares.
Once Facebook’s lock-up period ends later this year most trading restrictions will be removed.
The lock-up is done to prevent the market from being flooded with too much supply of a company’s stock too quickly.
“In class we’re always taught markets are efficient and that anomalies, should they exist, disappear quickly,” Woo says. “Our research shows differently. More research needs to be performed to see if people can make money from the strategy because if not, then the anomaly would persist.”
The paper won first prize in the recent Indian Institute of Management–Ahmedabad student research competition. It can be found on page 114 of the school’s publication The Efficient Frontier.
The paper attempts to expand the extensive research surrounding the IPO lock-up anomaly and finds that companies that experience negative returns during the lock-up period experience greater negative abnormal returns following the lock-up period’s expiration.
In addition, the students find high beta companies experience a greater negative abnormal return than low beta stocks after the lock-up periods. Beta is a measure of a stock’s volatility.
“In November, we noticed LinkedIn’s IPO expiration period was coming up, and we joked we should short it because all the insiders were going to sell their shares,” Woo says. “As it turned out, on the expiration day LinkedIn’s share price dropped 2.8 percent.
“We were intrigued,” Woo says. “Borge (Klungerbo) gathered a small sample of data and ran some simple regressions and found there was a negative abnormal return. We decided to pursue it and see if the results held for a larger sample.”
While there are many academic studies on the subject, none has been able to pinpoint a singular cause of the abnormal returns, Woo says.
“We also learned in class that once a strategy to earn abnormal returns is made public it is usually arbitraged away by market participants fairly quickly,” he says. “We wanted to see if the abnormal returns persisted because the last major study was performed in 2001.”
“Once we found out the result still held true today, we wanted to expand the literature to see which companies were more likely to have greater negative abnormal returns.”
Poteat says he was amazed that this anomaly still persists even 11 years after a major study was conducted on the topic.
“I think the most important finding of our paper is that we were able to characterize what IPOs are most likely to return a higher negative alpha at expiry,” says Klungerbo. “From our results we saw that it might not be very significant to look at all IPOs like previous papers have done, but to look at IPOs that have experienced a significant negative return during the expiration period.”