Because the terms of a lockup agreement are reported in the IPO prospectus, investors are well informed about the possible increase in supply on and after the unlock date. Ofek and Richardson (2000) suggest that the impacts of lockup expiration should already be reflected in both the offer price and price movement shortly following the IPO. If the market is efficient, no abnormal return should be found around the unlock date. However, Bradley, Jordon, Roten, and Yi (2001), Brav and Gompers (2003), and Field and Hanka (2001) provide evidence of abnormal returns around the unlock date for industrial IPOs.
Considering the characteristics of REITs, we expect the market reaction to lockup expiration for REIT IPOs will be different from those of industrial IPOs. Specifically, we hypothesize that there will be no significant abnormal returns around the unlock date.
Our hypothesis is based on the following characteristics of REITs: First, REITs are less volatile and more transparent due to their stable and predictable rental incomes. As REITs are less information asymmetric than industrial firms, outsider demand for REITs does not drop substantially around the unlock date. Second, REITs are generally held by investors with long-term investment horizon, such as pension fund and insurance companies, to capture
dividends. These institutional investors are less sensitive to additional supply of shares, if any, when IPO lockup expires. Third, REITs are not backed by venture capitalists who aim to earn high returns in a relatively short-term period. Without aggressive selling by venture capitalist around the unlock date, the selling pressure for REITs following the lockup is relatively small.
Fourth, Ofek and Richardson (2000) suggest that aggressive selling of unlocked shares is mainly driven by the desire of pre-IPO shareholders for diversification. Compared to industrial stocks, REITs provide a larger diversification benefit. A study by Ibbotson Associates show that the correlation between REIT and other asset classes have been declining, and adding REITs to a portfolio can improve return and reduce risk. For example, for the period 1972-2003, the average return and standard deviation of a portfolio with 10% Treasury bill, 50% stocks, and 40% bonds are 10.9% and 10.6% respectively. Replacing 10% stocks and 10% bonds by REITs (i.e., 10%
Treasury bill, 40% stocks, 30% bonds, and 20% REIT), the average return and standard deviation become 11.6% and 10.1% respectively. In addition, Corcoran (2009).show that U.S. REITs are better investment vehicles for diversification than 95 percent of global stock market indexes. The diversification benefit of REITs reduces the incentive of pre-IPO shareholders to sell when the lockup expires. These reasons potentially explain the insignificant market reaction to lockup expiration of REIT IPOs.
In addition to examine the abnormal returns around the unlock date, we are also interested in finding the determining factors of the cross sectional differences in the market reaction for REIT IPOs. We measure abnormal returns using the event study methodology.
Abnormal return and abnormal trading volume
Following Field and Hanka (2001), we define CAR as
⎥⎥
where Rit equals the daily return for the ith REIT t days from the unlock date; Rmt equals the daily return for the market portfolio, proxied by the CRSP value-weighted index return, on day t from the unlock date; and T and N represent the starting and ending day in the event window period, respectively.
We also examine the change in trading volume around the unlock date. Shefrin and Statman (1985), Makhija, Haugen, and Ferris (1998) and Odean (1998) suggest that an increasing stock price is an important indicator of abnormal trading volume, because investors tend to realize profit when the stock price is high and rising. In addition, Field and Hanka (2001) find a 40% permanent increase in average trading volume and a statistically significant three-day abnormal return of –1.5% on lockup expiration. They show that aggressive sales by venture capitalists are the major reason behind this observation. Determining whether venture capitalists cause abnormal trading volumes might be clarified by further examining REITs, given that they are not backed by venture capitalists mostly.
We measure abnormal trading volume (ATV) with respect to the average trading volume over a 45-day period, beginning 70 days prior and ending 26 days prior to the unlock date:
1 prior to the unlock date.
Determining factors of the market reaction to lockup expiration
We use the following cross-sectional model to examine the determinants of market reaction to lockup expiration.
CARi = α + β1LNPROCEEDS + β2INSTITUTION + β3SELF_MGT +
β4ATV + β5INSIDER + β6RETAIL + β7RESIDENTAL + (2) β8OFFICE_INDUSTRIAL + β9LODGING_RESORTS +
β10UNDERWRITER_RANK
where CARi is the CAR for event window i, INSTITUTION is the percentage of institutional ownership one quarter prior to the lockup expiration, and INSIDER is the insider ownership.
Given that a major motivation for lockup agreements is to reduce the level of asymmetric information and mitigate the moral hazard problem, negative abnormal returns around the unlock date are more likely to appear for firms with more severe asymmetric information and/or moral hazard problems.
As defined above, LNPROEEDS is a proxy for firm size. The larger the firm size, the less is the information asymmetry, but more severe the moral hazard problem. According to the signaling hypothesis, we expect a positive relation between IPO proceeds and abnormal returns around the unlock date. Larger firms are more liquid and have more coverage by financial analysts, lockup is less important as a signal and have a less negative impact on price movement when lockups expire. On the other hand, if the unlock agreement is a commitment device to mitigate the moral hazard problem, we expect a negative relation between LNPROCEEDS and abnormal returns. As a lockup expires, the fear of the potential agency problem is likely to reduce demand or encourage more aggressive sales by investors.
Since 1993, investments in REITs by institutional investors have increased rapidly. In particular, pension funds have become major investors. As shown in Panel B of Table 3, institutional investors own more than 50% of REIT shares on average. In general, institutional investors are well informed investors with professional knowledge and respond quickly to new information. Moreover, institutional investors are expected to play a better monitoring role than individual investors. Institutional ownership may substitute lockup as a mean to control the moral hazard problem. Therefore, REITs with more institutional investors are less likely to have negative abnormal returns around the unlock date than REITs owned mainly by individual investors.
As management structure is likely to affect the nature of the moral hazard problem, it might also be a determinant of the market reaction to lockup expiration. Our Tobit analysis suggests that lockups are more relevant to self-managed REITs than to externally managed REITs as a commitment device. Moral hazard problems could be more severe after the unlock date for internally managed REITs because their managers are more likely to hold REIT shares.
Therefore, we expect that investors will respond more negatively to the lockup expirations of self-managed REITs than to those of externally managed REITs.
A reputable underwriter provides positive signals about issuer quality because underwriter reputation is at stake. Pre-IPO shareholders of REIT IPOs underwritten by prestigious underwriters have a greater incentive to hold their shares around the unlock date.
Therefore, REIT IPOs with prestigious underwriters are less likely to exhibit negative abnormal returns around the unlock date.
We also use abnormal trading volume before the unlock date to examine the relation between transaction frequency and stock price movement. Insider ownership one quarter before
the lockup expiration is used to examine how the level of insiders’ commitment affects the market response. The larger the insider ownership, the larger is the chance of a significant supply shock on or immediately following the unlock date. Therefore, we expect a negative relation between insider ownership and abnormal returns. However, if insiders have strong incentives to retain shares for diversification benefits, insider ownership will have little impact on market reaction to lockup expiration.
Empirical results
We first calculate the abnormal returns for the full sample within an 11-day event window (–5, +5). To examine the impact of institutional ownership, insider ownership, and management structure, we divide our sample into the following categories: high versus low institutional ownership groups, high versus low insider ownership groups, and self-managed versus externally managed groups. For each category, we compare their abnormal returns and then use Equation (2) to estimate the impacts of the selected determining factors.
Table 5 reports the results of abnormal returns for the full sample around the unlock date.
The results are in sharp contrast to those reported in the current literature (e.g., see Bradley, Jordan, Roten and Yi, 2001; Field and Hanka, 2001). The mean abnormal returns for Day –5 up to Day 0 are all negative, while the abnormal returns for Day 1 up to Day 4 are positive.
However, none of the abnormal returns for individual days or any of the CARs for the four selected event windows—(–5, +5), (–5, –1), (–1, +1) and (0, +5)—are significantly different from zero at the conventional levels. The results for the median abnormal returns and CARs are similar, except that the CAR for the pre-expiration period (–5, –1) is –0.55%, which is significant at the 5% level. Figure 1 illustrates the cumulative abnormal returns for the full sample from day
-25 to day 25.
[TABLE 5 ABOUT HERE]
[FIGURE 1 ABOUT HERE]
Unlike previous studies, we find no strong evidence of significant negative abnormal returns around the unlock date, indicating no sudden shifts in supply or drastic decreases in demand around lockup expirations, or both. Field and Hanka (2001) have tested the following hypothesis in explaining their finding of significant abnormal returns: i) increase in proportion of trades at the bid, ii) temporary price pressure, iii) increasing trading cost, iv) downward-sloping demand curves, and iv) worse than expected insider sales. As we find no significant abnormal return around the unlock date for REIT IPOs, the testing hypotheses suggested by Field and Hanka are not applicable to our study.
However, our finding is consistent with the results of previous studies for industrial IPOs in that abnormal returns are limited to IPOs with venture capital backing. As REITs are not backed by venture capitalists, the absence of aggressive selling by venture capitalists after the unlock data may explain the insignificant market responses for our sample.
Another possible reason for our finding is that insiders do not have the incentive to sell their holdings when lockups expire. To verify this argument, we examine insider trading behavior 10 days before and after the unlock date. We compare the abnormal returns for those REITs with and without insider trading around the unlock date. The information on insider transaction are available from the U.S. Insiders Data of Thomson Reuters for 76 REITs, of which, 24 REITs have insiders traded during the (-10, +10) period. Unexpectedly, there are only 3 REITs have
insiders selling shares during this event window. This finding reveals that almost all insiders of REITs commit to hold their shares when the lockup restriction is lifted. Table 6 shows that the cumulative abnormal returns for those REITs with insider transactions are not significantly different from zero for three event windows: (-5, +5), (-1, +1), and (0, +1). Similar results are obtained for those REITs without insider trading. For those REITs with insiders selling shares, abnormal returns are also insignificant. Overall, these results indicate that insiders do not intend to cash out immediately following lockup expiration. The diversification benefit of REITs may provide an incentive to pre-IPO shareholders for retaining their shares.
[TABLE 6 ABOUT HERE]
To examine the impact of institutional holdings, insider ownership, and management types on the market response to lockup expiration, we estimate abnormal returns for various subgroups classified by these characteristics. Panel A of Table 7 shows no significant abnormal returns on the unlock date for REITs with high levels of institutional ownership. The CARs for the four selected event windows are also not significantly different from zero. For the subsample with low levels of institutional ownership, the evidence is more aligned with that reported in the literature. The abnormal return on the event day is –0.49%, which is significant at the 5% level.
The CAR for the (0, +5) window is significantly below zero at the 10% level. The results for the low institutional ownership subsample implies that without intense monitoring from institutional investors, investors are uncertain about the future of the company following lockup expiration and thus react negatively around the unlock date.
[TABLE 7 ABOUT HERE]
As shown in Panel B, the market responses similarly to lockup expiration for firms with high and low levels of insider ownership. For the high insider ownership group, a significant negative abnormal return of –0.39% is observed on the event day. However, the negative abnormal returns seem to be temporary only. None of the abnormal returns for Day +1 up to Day +5 is significantly different from zero, and the CARs for the four selected windows are insignificant. A similar pattern of market reaction exists for the low insider ownership group.
Overall, this pair-wise comparison indicates that insider ownership has no significant impact on abnormal returns around the unlock date. This result is consistent with our finding that insiders do not aggressively sell their holdings when lockups expire.
Panel C presents the results for self-managed and externally managed REITs. These results are compatible with those from the Tobit analysis. For externally managed REITs, no significant abnormal returns are found on the unlock date and for any of the selected event windows. On the other hand, the results for self-managed REITs are aligned with those of previous studies. The cumulative abnormal returns are significantly below zero for three event windows, (–5, +5), (–5,–1) and (–1, +1). As a lockup expires, the bonding imposed on inside managers is no longer in effect. Investors may sell their shares in the midst of uncertainty or due to the fear of managers’ self-serving behavior following lockup expiration. However, due to different compensation structures and their lack of investments in their own trusts, the bonding function of a lockup is less relevant to external managers. As a result, lockup expiration does not generate significant negative abnormal returns around the unlock date for externally managed REITs.
Analysis of abnormal trading volume
Table 8 presents the abnormal trading volume for the full sample within a 51-day event window (–25, +25). Figure 2 provides a graphical representation of the data. The full sample shows an insignificant decline (–12.57%) in trading volume on the unlock date. In contrast to previous studies, we find no permanent increase in trading volume within the 51-day event window. There is only one significant positive abnormal trading volume, which appears one day after the unlock date. While there are some positive big jumps in abnormal trading volume such as days +11, +16 and +22, none of them is significantly different from zero. Field and Hanka (2001) find that unlocking shares result in a 40% permanent increase in trading volume, our result for equity REITs does not indicate any permanent change. As shown in Figure 2, throughout the event window, abnormal trading volume wanders around zero. For the big jumps after the unlock date, trading volume is quickly reverting to zero. The findings for abnormal trading volume are consistent with the results shown in Table 5 in that no significant abnormal returns appear around the unlock date
[TABLE 8 ABOUT HERE]
[FIGURE 2 ABOUT HERE]
Regression analysis
We analyze the cross-sectional difference in market reaction to lockup expiration using CARs for the event windows (–5, +5) and (–1, +1) and the abnormal return on the event date.
The results are shown in Table 9. For the event window (–5, +5), the coefficient of institutional ownership is significantly positive at the 5% level. REITs with high levels of institutional
ownership have higher CARs than REITs with low levels of institutional ownership for the 11-day window. This result is consistent with the finding in Table 7 that REITs with low levels of institutional ownership show significant and negative returns on the event date and in the event window (0, +5). In contrast to Brav and Gompers (2003), we find no significant relation between trading volume and abnormal returns. Offer size, property type, management style, and insider ownership are also not significantly related to the CAR for the 11-day event window.
For the event window (–1, +1), institutional ownership is no longer significant. We find a significant negative relation between self-management style and abnormal returns. In addition, the higher the level of insider ownership, the higher the abnormal return. REITs with assets in lodging and resorts show negative and significant abnormal returns, which may be caused by a lower level of commitment due to the shorter lockup periods used than in other types of REITs.
The last column of Table 9 shows that none of the explanatory variables can explain the variation in abnormal returns on the event date. In Table 5, abnormal returns on the unlock date, AR(0), are not significantly different from zero.
None of the coefficients on LNPROCEEDS and UNDERWRITER_RANK are significantly different from zero, indicating that the signaling hypothesis cannot explain the cross sectional difference in market reaction to lockup expiration. While the regression results are not very robust, the significant results for INSITUTION and SELF_MGT pinpoint the importance of the moral hazard problem for REIT IPOs. More monitoring effort is implied by a larger institutional ownership, and thus, investors are less likely to liquidate their holdings upon lockup expiration. Nevertheless, our results can partially be attributed to the fact that no significant abnormal returns are found for our sample as a whole.
[TABLE 9 ABOUT HERE]