Extrapolation Errors in IPOs

Abstract

We demonstrate that relatively high revenue growth prior to an initial public offering (IPO) is associated with high IPO prices and poor returns. In particular, low‐growth IPO returns, −1% on a three‐year annualized basis compared to −12% (equal‐weighted) or −29% (value‐weighted) for high‐growth new issues. There is no evidence that the performance differentials reflect risk premia. Rather, low‐growth firms’ returns are more stable over time. Finally, while analysts’ forecasts are upwardly biased for all firms, the magnitude of this bias is greatest for firms with rapid pre‐IPO revenue growth. Overall, these results are consistent with the extrapolation errors model suggested by Lakonishok, Shleifer, and Vishny (1994).