Product Market Advertising and IPO Overvaluation

Abstract

This paper studies the impact of product market advertising on the overvaluation of IPO price relative to intrinsic value. We find that an IPO firm with more product market advertising in its IPO year sets a higher offer price for its upcoming IPO. Such an IPO firm is also more overpriced by investors in the aftermarket. Our results are robust to various measures of IPO valuation, such as long run stock return and the ratio of price to intrinsic value. We further study the impact of product market advertising on investors and financial analysts in the aftermarket. Our results show that product market advertising increases both the dispersion in analysts' earnings forecasts and the trading volume in the aftermarket, and decreases the stock holding by institutional investors. We also provide evidence that these changes in forecast revisions, trading volume, and institutional investor holding are related to IPO overvaluation. Overall, our results suggest that the positive impact of product market advertising on IPO valuation could be explained by the sentiment explanation. Product market advertising could increase the divergence of opinion among retail investors and induce investors with more optimistic sentiment to buy the IPO stock in the aftermarket. This optimism induced by advertising allows the IPO firm to overprice its IPO to a larger degree.