Directors' Dealing and Post‐IPO Performance

• DOI: http://doi.org/10.1111/j.1468-036X.2013.12013.x
• Date: 01 January 2015
• Published date: 01 January 2015
• Author: Meziane Lasfer,Hafiz Hoque

Directors’Dealing and Post‐IPO

Performance*

Hafiz Hoque

University of York

E-mail: hafiz.hoque@york.ac.uk

Meziane Lasfer

Cass Business School, City University London, 106 Bunhill Row, London EC1Y 8TZ, UK

E-mail: m.a.lasfer@city.ac.uk

Abstract

We use a unique mainly hand‐collected dataset to assess the impact of directors’

trades on IPOs’long‐term returns. We find that IPOs where directors are net sellers

are more likely to generate positive long‐run returns which occur mostly before the

sell trades, suggesting that directors sell when their IPOs reach their optimal

values. Conversely, IPOs where directors are net buyers underperform

significantly. Our results are not consistent with insider trading in seasoned

firms, partly because the valuation uncertainty of IPOs and the specific motivations

to trade weaken the precision of the trades’informativeness.

Keywords: long run IPO performance, insider trades, London Stock Exchange,

market timing

JEL classification: G12, G14, G24

1. Introduction

Previous studies show that IPOs generate no or negative excess returns in the long run,

despite their relatively high exposure to market risk and level of underpricing.

1

This

relatively low performance emanates from a combination of extreme differences of

We would like to thank Mark Leland from Directors Deals for supplying the data on insider

trading. We gratefully acknowledge comments from an anonymous referee, seminar

participants at Cass Business School, Manchester Business School and Nottingham Business

School. All remaining errors are our own responsibility. Correspondence: Meziane Lasfer.

1

Ritter and Welch (2002) find that the average beta of their IPOs in 1980‐2001 of 1.73. The

asymmetric models suggest that IPOs underprice on purpose to subsequently be able to sell

further shares at a higher price, and as a result, the long‐run returns should be high (e.g.,

Benveniste and Spindt, 1989; Jenkinson and Ljungqvist, 2001).

European Financial Management, Vol. 21, No. 1, 2015, 178–204

doi: 10.1111/j.1468-036X.2013.12013.x

© 2013 John Wiley & Sons Ltd

opinion among investors, costly short selling, and small public floats on many IPOs.

2

In

this paper, we contribute to this extensive literature by assessing whether the trading

behaviour of insiders, defined as board members, affects IPO long‐run performance. We

follow previous studies on insider trading (e.g., Seyhun, 1998; Lakonishok and

Lee, 2001) and expect directors to know better the true value of their IPO than outside

investors and their trades will be informative. Since IPOs underperform because of high

information asymmetries (Ritter and Welch, 2002), we test the hypothesis that directors’

trades increase the long‐run stock price accuracy and discovery by mitigating the

relatively significant information asymmetries inherent in IPOs, thus leading to a more

efficient long‐run pricing.

Huddart and Ke (2007) argue that, in the case of insider trading, both Grossman and

Stiglitz (1980) price‐taking model and Kyle (1985) imperfect competition model, predict

that higher information asymmetry leads to more positive (negative) abnormal returns

following buy (sell) trades, and, thus, higher returns to directors. Given the great

uncertainty about the value of their IPOs, directors are likely to benefit from their trades if

they hold perfect information, suggesting that their trades will only affect strongly stock

prices if their information is precise and credible, and if outsiders have lower information

about the value of the IPO. Therefore, in line with previous studies (e.g., Lakonishok and

Lee, 2001; Jenter, 2005), we expect directors to adopt contrarian strategies by buying

(selling) shares in under‐(over‐) performing IPOs and those where they are net buyers

(sellers) will generate positive (negative) long‐term returns. This post‐trade stock price

behaviour will also be consistent with the agency theory framework (Jensen and

Meckling, 1976) because directors’buy (sell) trades will lead to lower (higher) agency

conflicts, and, consequently, to higher (lower) long‐term returns. However, if they trade

for non‐private information reasons, such as liquidity and portfolio rebalancing

considerations, or if they sell because the lockup has expired, then we expect weak or

no relationship between insider trading and the long‐run returns of IPOs.

To test these hypotheses we construct a unique hand‐collected dataset of 830 UK IPOs

containing all information from prospectuses and insider trading events, and assess their

three‐year post‐IPO stock returns. We find contrasting results to our expectations as IPOs

where directors are net sellers (Net Sell) generate positive returns, while those where they

are net buyers (Net Buy) underperform substantially throughout the 36‐months post‐IPO

period. We find similar results using the style‐adjusted, equal and value‐weighted

cumulative abnormal returns, and the Fama and French (1993) three‐factor model. Our

regression results provide further support for these findings, as the coefficient of the net

purchase ratio, NPR,defined as directors’net purchases over total transactions, measured

in terms of trading value or volume, is negative and significant, suggesting that Net Sell

2

See Jenkinson and Ljungqvist (2001), Ritter and Welch (2002), Ritter (2003), and Eckbo et

al. (2007) for extensive reviews. Although the long‐run underperfromance is observed in

many countries including the US (e.g., Ritter and Welch, 2002; Brav and Gompers, 1997), UK

(Vismara et al., 2012; Levis, 2011; Espenlaub et al., 2000; Goergen et al., 2007), Greece

(Thomadakis et al., 2012), Switzerland (Kunz and Aggarwal, 1994), Finland

(Keloharju, 1993), and Australia (Finn and Higham, 1988), its significance may suffer

from econometrics misspecifications (Fama, 1998) and may be sample period dependent

(Carter et al., 2011).

© 2013 John Wiley & Sons Ltd

Directors’Dealing and Post‐IPO Performance 179