Lock Up Period (Securities) - Explained
What is a Lock-Up Period in a Securities Issuance?
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Table of ContentsWhat is a Lock-Up Period?How does a Lock Up Period Work? Academic Research on Lock-up Period
What is a Lock-Up Period?
It is a period of time when the management and large shareholders of a publicly traded company are not allowed to sell their shares in the market. Usually following the initial public offering (IPO), the company management and investors are restricted to sell their shares. The same is also known as a lock-in, lock-out or locked up period.The lock-up period may also be applicable to the shareholders who acquire the stocks during the IPO. A lock-up period may stay for as long as 90 days to 180 days depending on the company. The companies specify a lock period to ensure that the market is not over flooded with the company's share at any given point of time. It is to prevent a dramatical price drop of the stocks of the company.
How does a Lock Up Period Work?
Private companies can go public by selling their stocks to the general public, this is known as the initial public offering. In order to be listed on an exchange, a company needs to go public with their stocks. It may be a newly formed company or an old company that wants to sell their stocks to the general public to raise capital. During the initial public offering a company can issue new shares to the public or the existing shareholders can sell their stocks to the general public. The lock-up period restricts the existing shareholders from liquidating their assets too quickly after the initial public offering. Large shareholders selling their stocks can also be perceived as a lack of confidence in the company and that may lead to panic sell. Lockup period may apply to someone who has acquired a company's shares in an initial public offering or to the early investors and employee of the company who hold the companys shares. Usually, the early investors and employees prefer a shorter lock-up period and underwriting banks want a longer one.In earlier days, lockup periods were usually 180 days for everyone but now the rules have become increasingly complex. The lock-up period for hedge funds depends on the underlying investments of each fund. It is usually a 90 days period for the funds invested in liquid stocks. The hedge funds invested in securities like loans or other debts may have a longer lock-up period. There may be no lock-up period for certain other hedge funds based on its nature of the investment.When the lock-up gets over, the shareholders are allowed to sell their shares according to the rule. Generally, they need to notify the fund manager 30 to 90 days prior to the redemption so that the manager can arrange the payments of the investors.The lock-up period allows the hedge manager to utilize the funds in a more efficient manner. During the lock-up period, the manager does not require to worry about share redemption and he/she may invest in securities according to the need. In this way, the manager is able to invest in assets and maximize potential gains without keeping much cash in hand. If there was no lock-up period, the hedge manager would have to be ready all the time with a large amount of cash or cash equivalents to pay the investors. It that case the manager could invest less amount of money with a lower return. As the lock-up period depends on the investors personal investment date, a huge liquidation does not occur for a fund at once. It allows the company to stabilize its funds effectively. After a company enters the market it needs some time to stabilize its stock price. The lock-up period allows that time, without a lock-up period in place if the shareholders start liquidating their stocks too fast that would negatively affect the company's stock prices.
Academic Research on Lock-up Period
- The IPO lock-up period: Implications for market efficiency and downward sloping demand curves, Ofek, E. (2000). This paper examines the volume and price patterns of the stocks around the time when the lock-up period gets over. It documents, although the event of expiration of the lock-up period is an anticipated event still it leads to 1% to 3% drop in the stock price and 40% increase in the volume. The paper attempts to find an explanation for this and suggests a new anomalous fact against market efficiency. However, it is evident that this inefficiency is not exploitable. Besides, the paper provides evidence of downward sloping demand curve for stocks and considers it to be the most likely explanation of a permanent and long-term effect.
- Price Elasticity of Demand for Common Stock in A-share Market: An Empirical Study on Full-circulation IPO Lock-up Period Expiration [J]. Xinjiang, Z. Z. C. J. W. (2010). Journal of Financial Research, 4, 012. The paper studies the price volume effect of the lock period expiration of IPO after a full-circulation offering of A-share. 432 samples of 265 companies are studied in the research to determine the effect and finds notable impact before and after the day of expiration. A modified model that contains a liquidity effect variable to amend the traditional single-variable model is proposed in the paper and it is proved that the data support this new model.
- The 180-day lock-up period and insiders' equity selling. Ayayi, A. (2005). Journal of Economics and Finance, 29(1), 32-45. The article analyzes the insider's control over determining the proportion of common stocks to be sold during an initial public offering. It shows a significant portion of the equity stake is held by the high-value investee's insiders after the IPO as compared to the low-value investee's insiders. This result supports the argument for the need of lock-up period and is consistent with the argument of signaling of the insider trader reputation.
- Earnings Quality and the Selling Behavior of Institutional Investors after the Lock-up Period of Private Equity Placement, XUE, S., & ZHENG, Q. (2010). Journal of Finance and Economics, 11, 008. The paper analyzes how the earnings quality affects the investment decision of institutional investors following the lock-up period of private equity placement. The results establish a correlation between the earnings quality and investment decision of institutional investors. It shows the institutional investors who take part in private equity placement, sell their shares after the lock-up period according to earnings quality of firms. If the earning quality of the firm is higher, the selling-out magnitude of the institutional investors shall be lower.
- Lock-Up Period. Kaiser, D. G. (2008). Encyclopedia of Alternative Investments, 55, 274. The author explains the lock-up period and discusses the positive correlation that exists between the length of the time the capital is invested and the hedge fund performance. The note explores the causes of such correlation between the two.
- The influence of IPO underpricing and lock-up period coverage on buy and hold return, Wu, C. P. (2003). The paper argues the initial public offerings are underpriced because the insiders want to maximize their personal wealth by using this strategy. It studies the relationship among underpricing, media coverage and returns. The study result shows the stock deposit and the age of a company are positively correlated with underpricing. It argues, during the lock-up expiration the stock price attract the media attention and that leads to a rise in stock price and establishes this with evidence. The result shows the electronic-related companies are much more noticeable than underpricing to lead to more coverage.
- Price inversion and post lock-up period returns on private investments in public equity in China: An interest transfer perspective, Lin, J., An, Y., Yang, J., & Liang, Y. (2019). Journal of Corporate Finance, 54, 47-84. This paper studies an anomaly in privately placed stock returns in China by using a sample of private investments in public equity (PIPEs) where the lock-up periods ended between 2007 and 2015. The study finds when the price after the lock-up period is lower than the issuing price, the short term returns during the post lock-up period are higher than other stocks. The short-term return is directly proportionate to the price inversion. The paper explains the unique PIPEs regulations of China obligates the issuing companies to transfer the interests to participating investors via means including aggressive earnings management and dividend increase and that leads to this anomaly.
- Empirical analysis of the effect of IPO lock-up period expiration, Zi-bing, Z., Xin-jiang, W., & Yu-jie, Z. (2010). Insurance Studies, 1, 012. The paper studies 432 samples of lock-up period expiration of 265 initial public offerings after their full-circulation offerings of A-share. The result shows significant price-volume effect before and after the day of expiration. From the of T_ -8 to T_ +2 , the average cumulated abnormal return is -2.3% and it doesnt reverse in the next two months. The data shows 163.2% of abnormal trading volume on the date of expiration and it rapidly falls to 33.2% of permanent abnormal trading volume shortly after that. This effect is more noticeable for samples composed by inquiry objects. The analysis of subsamples also shows in the bull market and bear market the lock-up period expiration impacts the price-volume differently.
- RETENTION RATIO, LOCK-UP PERIOD AND PRESTIGE SIGNALS AND THEIR RELATIONSHIP WITH INITIAL PUBLIC OFFERING (IPO) RETURN , Albada, A., Yong, O., Hassan, M. E. M., & Abdul-Rahim, R. (2018). The study examines the signaling variables to explain the initial return in the Malaysian initial public offering market. The variables which are studied in this paper are - lock-up period, shareholder retention ratio, underwriter reputation, auditor reputation, and board reputation are investigated this study to estimate their impact on the initial return. It also uses the stepwise regression to determine the order of contribution of these variables to the overall model. The analysis finds three of these variables have a significant impact in the initial return and the order is shareholder retention followed by auditor reputation and board reputation.
- Information content of lock-up provisions in initial public offerings, Mohan, N. J., & Chen, C. R. (2001). International Review of Economics & Finance, 10(1), 41-59. The study analyzes 729 initial public offerings between January 1990 and December 1992. It finds that the lock-up period signals the issuers riskiness and the usual lock-up period is of 180 days. The study shows that any departure from this 180-day lock-up period norm indicates to a more uncertain value of the firm and that leads to deeper IPO underpricing and larger underwriter spread. It also finds that the market prefers the thin-trading activity shortly after the lock-up expiration and perceives it as good news, but heavy trading is considered as bad news.
- Insider trading subsequent to initial public offerings: Evidence from expirations of lock-up provisions, Brav, A., & Gompers, P. (2000). The paper studies 1,948 initial public offering and the result supports the argument that lock-ups work as commitment mechanisms during the IPO. The study finds that the insiders lock-up their stocks for a longer period. It also finds that the firms who lock-up their stocks for a longer period have higher underpricing. Same is with the firms, who lock-up a larger portion of their stocks. The data establish that the price drop does not occur according to the rational expectation of the investors. The study concludes that the earnings forecasts are more optimistic around lock-up expiration.