Strategic IPO Underpricing, Information Momentum, and Lockup Expiration Selling

Abstract

Managers of firms going public usually do not sell their own shares at the initial public offering. Instead, they often sell a portion of their shares at the end of the lockup period. We develop a model in which the manager strategically underprices the IPO in order to maximize his wealth from selling shares at lockup expiration. First-day underpricing creates information momentum, i.e., it generates incremental comments and recommendations by research analysts, especially by non-lead underwriter analysts. This increased research coverage shifts the demand curve for the stock outwards, allowing the manager to sell shares at the lockup expiration at prices higher than he would otherwise be able to obtain. We test the model on a sample IPOs in the 1990s. We find that managerial share and option holdings are positively correlated with first-day underpricing and that higher first-day underpricing leads to more analyst research coverage. We also find that research coverage is positively correlated with stock price performance through the lockup expiration and with insider selling at the expiration of the lockup. Overall, the empirical results are consistent with the model.

Keywords: IPO, lockup expiration, insider selling, underpricing

JEL Classification: G24, G10, G30