Yung and Zender 2010 IPO Lockups: Standard questions in the literature concern the motivation for the lockup period, the determination of the length of the lockup period, price reaction at the expiration of the lockup, and the causes and implications of early release of the lockup. The literature has focused on moral hazard or adverse selection as the motivation for and the determination of the length of the lockup period. The two prominent articles in the area reach contrasting conclusions. This paper seeks to reconcile the conflict.

Yung and Zender 2010 IPO Lockups: The starting point of our analysis is the presumption that all IPO firms suffer from both moral hazard and adverse selection problems. A model we had to discard showed that in the choice of the length of a lockup period the entrepreneur’s constraint on the provision of effort in enhancing firm value could (for different parameter values) either be binding or slack. If slack at the optimum, the length of the lockup would be chosen to solve the adverse selection problem inherent in the sale of shares. If binding at the optimum, the length of the lockup would be chosen to solve the moral hazard problem associated with the provision of effort. Thus for some firms, the lockup period is used to solve an adverse selection problem and for others it is chosen to solve a moral hazard problem.

Yung and Zender 2010 IPO Lockups: We require an identification strategy by which firms may be sorted into a group for which moral hazard is likely to be the dominant factor in determining the lockup length and a group for which adverse selection is the dominant factor. Firm size – as a firm grows it tends to become more transparent and easier to value (Beatty and Ritter 1986). Underwriter reputation – high reputation underwriters may reduce (Carter and Manaster 1990) the severity of the asymmetric information. Transparency and certification help identify value, however neither will help control managerial behavior. Certified firms should be more likely to see the lockup period set to control a moral hazard problem.

Here we use the standard deviation of market reactions to the expiration of the lockup as a check on our identification strategy. Note that IPOs of large firms and those with high reputation underwriters have significantly smaller variation in reactions to the expiration. In an environment of symmetric information trades are uninformative and have little price impact. With asym info management’s trades can be more or less aggressive than expected and so will partially reveal management’s information. Kyle and Milgrom and Stokey show that the greater the level of expected asym info the greater will be the price impact of trades, leading to a greater dispersion in market reactions. Std Dev can proxy for asym info.

Yung and Zender 2010 Empirical Hypotheses: Controlling for other determinants of lockup length, in the asymmetric information subsample lockup period and underpricing should positively co-vary. Controlling for other determinants of lockup length, in the moral hazard subsample lockup period and underpricing should be uncorrelated. For all firms, the level of asymmetric information should be a determinant of underpricing. Asymmetric information should be a determinant of the lockup period only in the asymmetric information subsample. Think about the asymmetric information subsample. Shock asymmetric information both underpricing and lockup length should change. Shock moral hazard, neither should change. Thus in the cross-section of the subsample we should see the positive correlation. In the moral hazard subsample, if we shock asym info, underpricing changes but not lockup length. If we shock moral hazard lockup length changes but not underpricing. Thus the lack of a correlation in the cross-section of firms in the subsample. The third hypothesis is developed by looking at the economic mechanism lying behind the first two and so represents a more stringent test of the relations between lockup length and firm characteristics. A challenge in the data will be the increasing standardization on 180 days for the lockup period length. The nature of our hypotheses will make it likely that we reject them given the standardization.

Yung and Zender 2010 Empirical Hypotheses: In the moral hazard subsample, controlling for other factors explaining lockup length, there should be a negative correlation between lockup length and the amount of equity retained by managers. In the asymmetric information subsample, controlling for other factors explaining lockup length, there should be a nonnegative correlation between lockup length and the amount of equity retained by managers. In the moral hazard subsample the lockup length is set trading off the benefits of controlling the problem against the cost to the managers of underdiversification. For a given level of control of the problem (i.e. at the optimum), increasing the proportion of the equity retained by the manager allows the length of the lockup to decline – hence the negative correlation in the cross-section. For adverse selection firms, there is no direct effect on the nature of the asymmetric information problem as the equity stake of the manager falls and no direct effect on the length of the lockup. A possible second order effect is that as the equity stake of the manager falls, bad firms have less of an incentive to mimic good firms, allowing a reduction in the length of the lockup to achieve the separation resulting in a positive correlation between equity stake and lockup length for the asym info firms.

Note the correlations and the partial correlations support the positive correlation between lockup and underpricing for asymmetric information firms and no correlation for moral hazard firms plus the negative and significant correlation for moral hazard firms between lockup and insider holdings. Finally in panel b note that in the full sample the correlation between lockup and underpricing supports asymmetric information as the motivation for the lockup while the correlation between insider holdings and lockup supports moral hazard as the motivation drawing attention to the need to separate the samples.

Gao, Ritter, Zhu From 1980 – 2000 an average of 310 companies when public every year. Since 2000 the average has been only 99 IPOs per year. Some have pointed to the 2002 SOX act and an apparent reduction in analyst coverage for the decline. The authors provide an alternative hypothesis: economies of scope/scale. This is troubling not only because Jay Ritter may not have anything to write about soon but for the potential economic implications. Point to lots of things affecting analyst coverage – 2003 Global Settlement of investment banks Decimalization and drop in bid – ask spreads that began in 1994 and the decline in incentives to cover small firms. SEC’s regulation FD in 2000 – Jegadeesh and Kim 2010 report that both the number of firms covered and the number of sell-side analysts peaked in 2002 and then declined.

One thing to point out is that there is significant time series variation in the number of IPOs per year.

Gao, Ritter, Zhu Economies of Scope Hypothesis On-going change in the economy that has reduced the profitability of small companies, both public and private. Small firms can create greater operating profits by selling out in a “trade sale” (merger or acquisition) to a firm in the same or a related industry rather than operating as a stand alone firm relying on organic growth. Larger firms can realize economies of scope and bring new technology to market faster. The authors suggest that the importance of getting big fast has increased over time due to the speed of technological innovation in may industries. Opportunities are lost if not quickly seized.

One of the key things the authors point to is that the number of small IPO firms that are profitable has declined.

Panel B summarizes their point small firms are increasingly likely to be acquired after an IPO. Most are acquired by publicly traded companies. Delisting small firms are not going private to avoid SOX costs. It appears that the attractiveness of being a small independent firm has noticeably declined. Also cite evidence that it is not the case that SOX costs have caused US firms to go public in foreign markets.

Results show no decline in analyst coverage post IPO patterns are inconsistent with the argument that the “drop” in coverage on small firms has contributed to the near disappearance of small company IPOs.

Furthermore… JOBS act of 2012 Increases the number of shareholders a company may have before being required to register its common stock with the SEC and become public from 500 shareholders of record to 2,000 total shareholders. Second Market is becoming more liquid. Raising the limit for simplified regulation A securities offerings from $5 Million to $50 Million. Allows the use of internet “funding portals” or “crowd funding” for amounts up to $1 Million. Requiring only review or auditing of financial statements. Second market provides for the trading of unregistered shares. How do we design such markets? How can we provide for the certification and information gathering necessary in these markets without the repeated player that the investment banker is? Or do they simply remains pools of bad securities?