Why Everyone Wants a Piece of Facebook’s IPO: Insights From Behavioral Economics

Photograph by Scott Eells/Bloomberg

Facebook’s IPO is one of the most anticipated stock offerings of the year—maybe the decade. Everyone, from the novice to professional investor, seems to want to own a piece of the company. Of course, some of this is driven by the desire to turn a quick profit—not unusual for a high-tech IPO. What makes this offering stand out is the unprecedented interest among individual investors, many of whom lack the expertise to evaluate Facebook’s true profit potential.

So what’s driving the Facebook IPO craze? A quick look at some of the key principles of behavioral economics suggests that the Facebook frenzy might stem, at least in part, from investors’ irrational thinking and behavior. In particular, the following five factors might nudge investors toward the forthcoming IPO:

• Familiarity. Behavioral research has shown that people tend to develop a preference for objects merely because they are familiar with them. This suggests that investors might prefer Facebook stock to that of lesser-known companies simply because of its top-of-mind awareness. Moreover, personal usage might be creating a false sense of familiarity with the company’s business model and instilling misplaced confidence in the potential performance of Facebook stock.

• Halo effect. The term “halo” dates back nearly 100 years to psychologist Edward Thorndike’s interesting observation that people tend to evaluate others in a way that highly correlates their individual traits—such as physical qualities, intelligence, and character. In other words, those who score high on one dimension, such as physical appearance, are also likely to be rated better on others, like intelligence or character. The same principle is likely to apply when investors think of Facebook, where their affinity for the brand can create a “halo” that casts a favorable glow over its stock.

• Self-expression. People express themselves every day through the kind of cars they drive, the brands they use, even the television shows they watch. In the same vein, many individual investors tend to display a preference for stocks whose image is consistent with their desired self-perception. Facebook has become such an omnipresent and hip brand that being a Facebook shareholder can become a means of self-expression for many investors. In fact, one can speculate that Facebook’s IPO might change investor demographics by bringing in new investors for whom Facebook is a “cool-to-own” brand.

• Scarcity. A plethora of behavioral research has documented that our desire for an item tends to be inversely related to its availability: We crave items in short supply. In the case of Facebook, investors are faced with two types of scarcity. First, unlike during the dot-com boom, when the market was flooded with “hot” companies, in today’s market Facebook is a standout among Internet IPOs. The demand for Facebook stock is further fueled by the limited access to its IPO—a very different approach from the one Google took in 2004 by providing broad access to its IPO for all investors.

• Loss aversion. The principle of loss aversion argues that losses loom larger in our minds than corresponding gains, such that our behavior is often guided by the desire not only to optimize gains but to avoid losses. In the case of Facebook, many investors may consider missing out on the “next Google”—rather than the potential decline in the value of the stock—to be the prospective loss. Thus, by anchoring on the market success of companies such as Google and Apple, investors’ loss aversion ironically might stir them toward riskier investments.

Rational or not, Facebook has become a must-have stock for many individual investors. It seems that Facebook’s eagerly awaited IPO may be remembered not only as one of the most important financial events of 2012, but also as one of the most “liked” IPOs in recent history.

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