Trading Restrictions and Stock Prices

I examine a series of stock splits in Japan in which firms restrict the ability of their investors to sell their shares for a period of approximately 2 months. By removing potential sellers from the market, the restrictions have the effect of increasing the impact of trading on prices. The greater the desire of investors to trade, and the greater the restrictions, the larger the impact of the restrictions. In the data, particularly severe restrictions are associated with returns of over 30 % around the ex-date, most of which are reversed when investors are allowed to sell again. Firms are more likely to issue equity or redeem convertible debt during the restricted period, suggesting strong incentives for manipulation. (JEL G12, G14) Can firms increase their stock price by constraining the ability of investors to sell? A growing literature in finance suggests that when there are limits to arbitrage, prices may deviate from fundamentals, often for sustained periods. These papers argue that among other things, noise trader risk (De Long et al., 1990), short-sale constraints (D’Avolio, 2002; and Jones and Lamont, 2002), investor withdrawals (Shleifer and Vishny, 1997), or systematic psychological biases (Barberis and Thaler, 2004) can make investors unwilling or unable to trade against mispricing.1 As long as there are benefits to having a high stock price, firms have strong incentives to further constrain investors from selling shares, thus bringing prices back to fundamentals. The idea that restricting trade can affect stock prices applies in a variety of settings, but is most obvious in initial public offerings (IPOs), where differences of opinion about the prospects of the firm are high. At IPO, many firms choose to offer only a small fraction of the total shares outstanding to the public, releasing a part of the float after a lockup period during which employees and some other investors are not allowed to sell. When the restrictions are lifted, prices fall (e.g., Field and Hanka, 2001; Bradle