Conventional wisdom says that the price reduction stocks experience at expiration of the initial public offering (IPO) lockup period is due to relaxation of selling constraints. Findings from more recent literature question this explanation. The purpose of this paper is to examine a different cause for this price drop, IPO overvaluation.
Using the IPO overvaluation measures of Purnanandam and Swaminathan (2004), the authors examine IPO lockup period stock return differences between stocks in the highest and lowest overvaluation quintiles.
The authors show that the IPO lockup period price reduction is strongly related to overvaluation. Zero-investment portfolios long in the lowest overvaluation quintile and short in the highest overvaluation quintile of IPO firms have positive significant returns.
IPO investors can use the technique to identify firms likely to underperform in the IPO lockup period, potentially avoiding bad investments.
This is the first study to link IPO lockup period stock returns to IPO overvaluation, providing evidence on the impact of both overvaluation and short-selling constraints on stock returns in the IPO lockup period.
