Do risk factors matter in the IPO valuation?

Abstract

PurposeThe purpose of this paper is to investigate whether all of the risk factors were priced during the internet bubble period.Design/methodology/approachA unique hand collected dataset was used from public prospectuses for companies that issued an initial public offering during the internet bubble period. Three hypotheses were proposed: the risk factors mentioned in the prospectus are important for IPO trading and therefore affect IPO underpricing; risk factors affect the IPO deal attributes; and the number of risk factors cited by the issuing firm is affected by direct participants such as venture capitalists and investment bankers.FindingsIt was found that hi‐tech dummy played a significant role during the bubble period. Moreover, not all risk factors are regarded important, some of them are not significant at all as predicted by first hypothesis. The most striking observation is the negative economic significance of the risk factor no prior market for the traded stock. This reveals that, traders are selective in valuing risks and may value some factors as opportunities and not as risk factors. In addition, the results reveal that risk factors do affect the deal attributes as predicted by our second hypothesis. Also, the pricing of these risk factors are not different between retail and hi‐tech companies. Regarding the participants, it was found that venture capitalists and investment bankers have a significant statistical and economic effect on the number of risk factors reported in the prospectus.Originality/valueThe paper contributes to the literature by investigating the IPO underpricing phenomenon in the internet bubble period.