Venture capital trusts and the expiration of IPO lock-up provisions

Abstract

Venture capital trusts (VCTs) were introduced to provide private equity capital for small expanding companies and to promote innovation. Investors in initial public offerings are rewarded with tax relief on the cost of lock-up provisions to stabilize the market. This paper examines the market reaction and trading activity around the expiration of lock-up provisions of 148 VCTs listed on the London Stock Exchange from 1995 to 2006. Downward-sloping demand curve theory suggests that an increased supply of VCT shares at the expiry date could shift their value to a new equilibrium at a lower price. Supporting this prediction, we document evidence of negative abnormal returns as well as permanent increases in the price discount relative to net asset value and trading volumes at and around the expiries of the required holding periods of VCTs. In addition, less negative abnormal returns, lower abnormal discounts and lower abnormal trading volumes are associated with VCTs that invest in AIM-listed companies due to lower information asymmetry, that experience lower prior performance due to a less pronounced disposition effect, and that are subject to a shorter lock-up horizon or are offering more generous tax benefits.

Keywords:

• IPO
• lock-up provisions
• income tax relief
• performance
• discount
• trading volume
• venture capital trusts

JEL Classifications:

• G14
• G24
• G28

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. As robustness checks to the multivariate analyses in Table 7, we also test abnormal returns, abnormal discounts and abnormal trading volumes during different time windows around the expiry date, such as trading day 0, trading days −5 to +5 and trading days +6 to +20, following the same models as the fomulas (13)–(15). The abnormal discounts, abnormal trading volumes and abnormal returns during the time window of trading days −20 to trading days −6 are not significantly different from zero. Therefore, the time window of [−20, −6] can not be used to make the robustness test. For the robustness tests of time windows [0], [−5,+5] and [+6, +20], we find that the results are qualitatively the same as those for the time window of [−1,+1] in Table 7. Specifically, we find that VCTs that invest in companies listed on the AIM market present less negative abnormal returns, with lower abnormal discounts and lower abnormal trading volumes than VCTs that invest in the shares of private companies. Better investment performance across the required holding period is associated with more negative abnormal returns, greater abnormal discounts and larger abnormal trading volumes displayed around the expiry date. VCTs requiring a three-year holding or offering 40% income tax relief have less negative abnormal returns, lower abnormal discounts and lower abnormal trading volumes than VCTs requiring a five-year holding or offering 20% income tax relief. Therefore, we only display the formulas and results for trading days −1 to +1 (three-day window), which time interval is typically used in the relevant event studies.

Additional information

Funding

This work was supported by the Beijing Municipal Commission of Education ‘Joint Construction Project’ and ‘Pilot Reform of Accounting Discipline Clustering’, and the Central University of Finance and Economics (CUFE) Innovative Research Team Project ‘Empirical Accounting and Auditing’.