Insider Trading Following Lockup Expiration and the

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Insider Trading Following Lockup Expiration and
the Long-Run Stock Performance of Initial Public
Offerings
Hsuan-Chi Chen Anderson School of
Management University of New Mexico
Sheng-Syan Chen Department of Finance National
Taiwan University
Chia-Wei Huang Department of Finance National
Taiwan University
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Research Purpose

• On their IPO prospectuses IPO firms specify share
  lockup agreements, which restrict insiders and
  other pre-IPO shareholders from selling their
  shares before a certain date, ranging from
  several days to several years with a mode of 180
  days.
• Regarding insider selling following IPO lockup,
  the corporate insiders of IPO firms usually state
  that they sell their shares to diversify their
  portfolios or meet their liquidity needs.

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Research Purpose (conti.)

• Some investment gurus or investors express their
  concerns with the message sent by corporate
  insiders because of weak commitment or
  information asymmetry existing between insiders
  and outsiders.
• Our paper makes a study of IPO lockups and
  insider trading following the lockup expiration,
  and examines the relationship between post-lockup
  insider trading and the long-run performance of
  IPOs.

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Literature Review

• Field and Hanka (2001) examine the short-run
  abnormal return and trading volume around IPO
  lockup expiration.
• Bradley, Jordan, Roten, and Yi (2001) examine the
  stock price behavior in the period surrounding
  lockup expiration of venture-backed and
  non-venture-backed IPOs over 1988 to 1997.
• Aggarwal, Krigman, and Womack (2002) develop and
  test a model that investigates the interaction
  among strategic IPO underpricing, information
  momentum, and insider selling around lockup
  expiration.

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Literature Review (conti.)

• Brav and Gompers (2003) test three potential
  explanations for the existence of IPO lockups.
• Cao, Field, and Hanka (2004) test the hypothesis
  that insider trading impairs market liquidity, by
  analyzing intraday trades and quotes around IPO
  lockup expirations in the period 1995-1999.
• Complementing these studies on IPO lockup, we
  examine the trading behavior of corporate
  insiders following IPO lockup expiration and
  investigate whether their trading activities are
  an indication for subsequent long-run stock
  performance.

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Hypotheses I

• The diversification hypothesis
• This hypothesis argues that corporate
  insiders simply desire to diversify their
  portfolios no matter what the prospects of IPO
  firms are and then they sell their IPO shares
  when they are allowed to do so. If portfolio
  diversification is the main reason for insider
  selling following the lockup expiration, insider
  selling will not have predictive power for the
  subsequent long-run performance of IPOs.
• ? Corporate insiders can sell their shares at
  the stage of initial public offering. However,
  IPOs are usually underpriced and selling a large
  amount of secondary shares at IPOs sends an
  unfavorable signal to potential investors (Leland
  and Pyle (1977)) and may lead to the failure of
  an IPO. Thus, large insider sales at IPO do not
  maximize the returns of corporate insiders.

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Hypotheses II

• The disposition effect hypothesis
• The disposition effect is one implication
  extended from the prospect theory (Kahneman and
  Tverskys (1979)) and labeled by Shefrin and
  Statman (1985). The disposition effect
  illustrates that investors have the tendency to
  realize their winning investments too quickly and
  hold losing investments for a longer time. Thus,
  if IPOs experience run-up before the lockup
  expiration, corporate insiders may sell their IPO
  shares because of the disposition effect. On the
  other hand, if IPOs experience negative returns
  before the expiration date, insiders would hold
  onto their IPO shares. If the disposition effect
  is the major reason for insider selling, insider
  selling will not have predictive power for the
  subsequent long-run performance of IPOs.

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Hypotheses III

• The informative selling hypothesis
• Corporate insiders have some information
  about their IPO firms prospects or current
  overvaluation around lockup expiration and sell
  their shares knowingly to reduce their exposure
  to the individual IPO firm. If this is the case,
  insider selling will convey bad news and have
  predictive power for the poor long-run
  performance of IPOs following IPO lockups.
• Tests of long-run performance would
  differentiate the informative selling hypothesis
  from the last two hypotheses about insider
  selling. If the strong-insider-selling IPOs do
  perform worse than the other IPOs in the long
  run, it is more likely that the corporate
  insiders, who have access to the information
  about the firms true value, time the market and
  sell knowingly to cash out their overvalued
  shares.
• Insider selling from senior corporate
  insiders can help further test the informative
  selling hypothesis because they have better
  information than junior insiders.

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Data and Methodology

• IPO sample are recorded in the Thomson Reuters
  SDC Global New Issues database for the period
  1988-2003.
• To remain in the final sample, an IPO firm must
  satisfy the following criteria

(1) The common stock is listed on the NYSE, AMEX,
or Nasdaq and has security returns available from
the CRSP tape. (2) The offer price must be at
least 5. (3) The security is not a REITs, ADRs,
closed-end fund, non-US stocks, reverse LBOs,
spin-offs, limited partnerships, shares of
beneficial interests, and unit offering. (4) The
firms lockup period information is available
from SDC. (5) The firm must have financial
information available from Compustat. (6) The
firm must have accounting information available
to calculate discretionary current accruals
(DCA).
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Data and Methodology (conti.)

• We obtain insider trading data from Thomson
  Reuters Insider Filing database, which contains
  the trading activities of the officers and
  directors of publicly traded companies.
• We use all transactions by executives, officers,
  directors, and controlling persons of the IPO
  firms but exclude those transactions that are
  duplicate, amended, inconsistent, and fewer than
  100 shares as in Seyhun (1986), Lee, Mikkelson,
  and Partch (1992), Lee (1997), and Clarke,
  Dunbar, and Kahle (2001).
• Top executives include presidents, vice
  presidents, chief executive officers, board
  chairs, officer-directors, chief financial
  officers, and controlling persons. Other insiders
  include those insiders that are not top
  executives.

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Data and Methodology (conti.)

• We trace the insider trading for two quarters
  (126 trading days) after the lockup expiration.
• ?Using different insider trading periods
  (i.e., three-month, nine-month, and one-year
  periods) does not result in any material change
  in our conclusion.

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Data and Methodology (conti.)

• We use three-year buy-and-hold returns (BHRs) to
  measure the long-run stock performance of IPO
  firms because they represent a feasible
  investment strategy to investors.
• The three-year BHRs of IPO firms are calculated
  starting with two quarters following the lockup
  expiration and ending on the three-year
  anniversary (756 trading days) after IPO lockup
  or on the delisting date of the IPO firm.
• We use size and book-to-market adjusted matching
  firms in our analysis.

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Data and Methodology (conti.)

• The size and book-to-market adjusted matching
  firms are neither IPO firms nor SEO firms during
  the four-year period prior to two quarters
  following the lockup expiration of their IPO
  counterparts.
• To select matching firms for each IPO firm, we
  first choose the Compustat-CRSP listed firms with
  the same book-to-market quintile and size decile
  as that of the IPO firm. We then sort those
  selected firms by their market capitalization.
  The market capitalization of matching firms is
  calculated on the lockup expiration day for each
  IPO firm. Finally, we select the matching firm
  with the closest market capitalization to the IPO
  firm.

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Sample Distribution
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Sample Distribution (conti.)
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Firm Characteristics
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Insider Trading Following Lockup Expiration
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Insider Trading Following Lockup Expiration
(conti.)
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The Number of Trading Days Between IPO Lockup
Expiration and the First Insider Trading
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The Number of Trading Days Between IPO Lockup
Expiration and the First Insider Trading (conti.)
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Long-Run Stock Performance
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Cross-Sectional Regression
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Cross-Sectional Regression (conti.)
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Abnormal Insider Trading Patterns of IPO Firms
Following Lockup Expiration
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Long-Run Stock Performance of IPO Firms by
Abnormal Insider Trading Following Lockup
Expiration
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Regressions of Abnormal Insider Trading on the
Long-Run Stock Performance of IPO Firms
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Cross-Sectional Regression Analysis of Abnormal
Insider Trading of IPO Firms Following Lockup
Expiration
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Conclusion

• We find that pure insider sale IPO firms and IPO
  firms with aggressive insider selling within two
  quarters after lockup expiration exhibit poor
  three-year stock returns following IPO lockup
  expiration.
• Further investigation into different groups of
  insider sales shows that aggressive sales from
  senior corporate insiders, such as CEOs and top
  executives, do convey a negative signal for the
  long-run IPO stock performance following the
  lockup expiration.
• Overall, the findings are consistent with the
  informative selling hypothesis that high rank
  corporate insiders have some information about
  their IPO firms prospects or current valuation
  and sell their shares knowingly to reduce their
  exposure to the individual IPO firms.

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Thank you for your attention !