Facebook shares fall again

Facebook shares fell further today to only just over half their initial price of $38. There are plenty of reasons for the fall, the drop today being due to the end of the lock-in period for early investors.

What is happening to Facebook shares is not unusual, although it is a bit more extreme than normal. It has been documented that stock prices increase an average of 15% on their first day of trading and then in the long-run they fall 15% below the offer price relative to similar firms.

Facebook shares increased 18% during their first day of trading before dropping back to the offer price by the end of the day. This is in line with the expected 15% increase but the rise and fall back all happened in one day.

Facebook has then followed the pattern of falling back but this has been a faster and bigger fall than the average.

What can explain these movements?

There are two groups that might be interested in buying the shares initially. Some buyers are well informed about the stock and will not overpay. Other buyers are less well informed and over-optimistic about the shares. This second group will end up getting most of the initial shares as they are willing to pay more.

In order to encourage these optimistic buyers into the market the shares need to be priced a little below what they would be willing to pay. This ensures that the offering is fully subscribed. This means that on the first day of trading there are still more optimistic buyers around who will push the price up to the price that they value the shares at.

It only takes a day or two (or a few hours in the case of Facebook) for all the optimistic buyers to have bought up the shares that they want. After that the decline sets in. More information gradually comes out about the company and the initially optimistic investors start to adjust their expectations down to the true value of the company so the share price falls.

Of course for any particular stock the price will be affected by many other factors but, on average, a new share will be pushed up by optimistic buyers initially before falling back in the long-run.

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