Facebook IPO and information cascades
Sources:
http://en.wikipedia.org/wiki/Facebook_IPO
http://www.forbes.com/sites/investor/2012/03/02/think-twice-before-jumping-on-facebooks-ipo-bandwagon/
http://money.cnn.com/2012/05/23/technology/facebook-ipo-what-went-wrong/index.htm
This year, Facebook went public. It held its IPO in May (one of the biggest IPOs ever), valued at around $16 billion. Shares of the company’s stock were sold to the general public for the first time, transforming it from a private company to a public one.
Just prior to opening, investment banks (underwriters) set the price to $38 per share. To put values in some context, Facebook was planning on aiming for a valuation around $30 per share around May. On opening day, May 18, trading was delayed due to computer glitches with the NASDAQ exchange: some traders complained of orders not processed, or shares at unexpected prices. While the vaulation momentarily shot up to as much as $45, the stock began to sink rapidly. In the aftermath, the stock lost a quarter of its value in the span of a month.
The “overpricing” of the stock can be understood given the incredible demand from retail investors. Facebook’s reputation as a social media giant led investors immediately to consider it a worthy investment. In the days leading up to the opening, analysts had mixed opinions on what the ideal valuation of Facebook’s stock should have been. Some recognized Facebook’s immediate potential, and suggested that its shares could jump up to “60 dollars” [wikipedia] and remarked that within the first few days, an value increase of less than 10-20% would be underwhelming. Still, some cautioned investors about jumping on the “Facebook IPO bandwagon”, calling it “overpriced” and out of control.
This is a prime example of information cascade. Investors began jumping on this “bandwagon” early, and when they did, other retail investors began doing the same, recognizing the increasing demand and potential for immediate benefit. This info-based information cascade escalates when people realize that the sheer number of investors flocking to a stock may suggest that others know something that they themselves do not know.
So what happened after the opening day? After NASDAQ’s glitches and the misplacement of trades worth millions of dollars, investors panicked and began selling. The fast downfall of the valuation can immediately be explained as another cascade: when the valuation did not meet people’s wildly positive predictions. The possibility of an inside job cannot be overruled, but it is important to note here that people behaved accordingly and similarly given limited information.