Networks

This article talks about the social network site Facebook’s IPO earlier this year. However, since then Facebook’s stock value has dropped from the initial $38 per share to about $20 per share on November 13, 2012. Its disappointing performance to investors could be partially explained by invoking the cascading model taught in class.

In the beginning, for investors, there are two states: Good (Facebook’s stock will continue to go up), and Bad (Facebook’s stock value will decline). The investor could choose not to own any of Facebook’s stock, and he will have a payoff of 0. On the other hand, if he buys Facebook’s stock, then his return will be positive if Facebook is indeed Good, and negative if it’s Bad. The more important part of this model is the private signal. Each player will receive some kind of signals regarding the future trend of Facebook’s stock, and he will likely to react based on this signal. For example, one player might work in Facebook and thinks the company is doing well, or another player bought advertisement on Facebook and realized it was very profitable, etc.

One of the reasons why Facebook’s performance was so disappointing was that too many players, especially the so-called insiders, sold its stock too early to create a cascading effect. This group of insiders included VC firms, bankers, and even Facebook’s own executive team. To ordinary investors, they do not know what signals this group of “insiders” have, and therefore they do not know the exact reason behind them selling Facebook’s stock. This creates a panicking atmosphere among ordinary investors, and is likely to have driven down Facebook’s price. For example, Mark Zuckerberg, the founder and CEO of Facebook, sold 1 billion’s worth of Facebook stock in order to cover his tax bill. However, the ordinary investors do not know this, all they see is that Mark Zuckerberg sold his stock, and they will likely to follow too.