What is a locking mechanism in an IPO?

A locking mechanism in an IPO refers to contracts that prevent certain shareholders from selling their shares for a specified period post-offering. This mechanism is particularly important because it helps stabilize the stock price after an IPO by limiting the immediate supply of shares in the market. When shareholders, such as company executives and insiders, are restricted from selling their shares for a certain time—often referred to as the lock-up period—this can instill confidence in new investors regarding the commitment of existing shareholders to the company's future. By reducing the risk of a sudden influx of shares that could lead to downward pressure on the stock price, a lock-up period can contribute to a smoother transition into public trading for a company. Thus, it plays a critical role in managing the initial trading volatility typically experienced after an IPO.