Pricing and Operating Efficiency of Venture-Backed and Nonventure-Backed Internet IPOs

Abstract

ABSTRACT Initial Public Offerings (IPOs) were the most popular form to raise new capital in the united States during the last decade (1990-2000). Thousands of companies went public for the first time, particularly in the technology-heavy Nasdaq stock market. Along with the regular IPOs came the Internet IPOs backed by the venture-capitalists, who specialize in financing promising start-up companies and bringing them public. When we examine these Internet IPOs issued during 1996-2001, we find that the first-day returns of both the venture-backed and nonventure-backed IPOs were much higher than in other time periods, but they were slightly higher for the nonventure-backed IPOs than that of the venture-backed IPOs. Also, the former group performed better than the latter group regarding operating ratios and the growth of cash flows. The regression results show that the first-day closing price was significantly and negatively associated with the return variables, thus suggesting the underpricing of the Internet IPOs during 1996-2001 - the period covered by our study. INTRODUCTION Initial Public Offerings (IPOs) were the most popular form to raise new capital in the United States during the last decade (1990-2000). Thousands of companies went public for the first time, particularly in the technology-heavy Nasdaq stock market. Along with the regular IPOs came to Internet IPOs backed by the venture-capitalists, who specialize in financing promising start-up companies and bringing them public. More than half of the Internet IPOs were backed by the venture-capitalists during 1996-2001. For example, in 1998 venture-capitalists put $13.7 billion into 2,023 start-ups, up from $2.5 billion invested in 627 companies in 1994. In 1999 alone, Internet companies received nearly $20 billion in venture capital funding. As a matter of fact, hardly there was a successful Internet IPO in that year that did not receive funding from at least one big-name venture capitalist. It was the Internet stocks that fueled the IPO outburst in the late 1990s. In 1991 the World Wide Web (WWW) was born when the new HTML code let programmers combine words, pictures and sound on Web pages. When in 1993, Marc Andressen and fellow University of Illinois students developed Mossale to browse the Web effectively, the number of users grew by leaps and bound at year's end. Within a very short time, Web-based Internet browsing came into being and the Online business was launched. It was online trading, in turn, that helped give rise to the volatile first-day and after-market performances for the Internet IPOs. And the significance of the Internet in reshaping both the United States and the world economy was enormous. It has changed such businesses as the selling of airline tickets and the distribution of financial service products, among many others. It ushered in the information technology we know today. The Internet stocks took off when the first Web browser Netscape Communications (NSCP) came into being in 1995. It went public on August 1 ofthat year and its share prices soared 108% on its first day. In 1 996, Yahoo went public, and the stock market value of the company was nearly $1 billion within a year. Then in 1997, the first e-commerce company Amazon.com went public. In 1 998, during its first half, demand for the IPO stocks were so robust that on average 44 new issues a month were floated. Since then, the Internet stock had dominated the IPO market until March 2000, when the whole stock market in the United States took a nosedive, so to speak, until the recovery process got started in 2003. In this paper, we have addressed the question whether the venture-backed Internet IPOs performed better than the nonventure-backed Internet IPOs during 1996-2001. We have taken a sample of 117 Internet firms selected randomly, covering both the New York Stock Exchange and the Nasdaq stock market. Our objective here is to examine the pricing performance and operating efficiency of both the venture-backed and nonventure-backed Internet IPOs during the period covered by our study. …