The Role of Lock-ups in Initial Public Offerings

This paper explores the role of investment banks and lock-up provisions in the market for new equity issues. In a sample of 2,794 IPOs, we test three potential explanations for the existence of lock-ups: (i) lock-ups serve as a signal of firm quality; (ii) lock-ups are a commitment device to alleviate moral hazard problems; and (iii) lock-ups serve as a mechanism for underwriters to extract additional compensation from the issuing firm. Our results support the commitment hypothesis. Insiders of firms that are associated with greater potential for moral hazard in the aftermarket lock-up their shares for a longer period of time. We also find that insiders of firms that have experienced larger excess returns, that are backed by venture capitalists, or that go public with high quality underwriters, are more likely to be released from the lock-up restrictions. In addition, we find that the average abnormal return at lock-up expiration is -2%. The price drop associated with this expiration is substantially higher for firms that are venture-backed.