The Impact of Fundamentals and Signaling on IPO Valuation

Abstract

We investigate IPO valuation for a sample of 1,655 IPOs from three time-periods: 1986-1990, January 1997 through March 2000 (designated as the boom period), and April 2000 through December 2001 (designated as the crash period). We have four findings. * First, we find that firms with more negative earnings are valued more highly than are firms with less negative earnings and firms with more positive earnings are valued more highly than firms with less positive earnings. This V-shaped pattern to the relation between value and earnings suggests that inferences about IPO valuation based solely on firms with positive earnings are inaccurate, especially for the boom and crash periods. * Second, contrary to anecdotes in the financial press, we find that income of IPO firms is weighted more and sales is weighted less when valuing IPOs in the boom period compared to the late 1980's. * Third, we find that better fundamentals (lower discount rates, higher growth rates) increase the sensitivity of firm value to signaling through insider retention but not investment banker prestige. This suggests that insider retention serves a signaling role but investment banker prestige does not. * Fourth, we find that investment bankers and first-day investors assign different weights to post-IPO ownership and changes in ownership around the IPO of different classes of shareholders when pricing the IPO. Changes in the ownership retention of CEOs and VCs are more negatively associated with IPO values for tech, relative to non-tech firms. For internet firms, changes in VC ownership alone bear a significant relation with IPO values. Relative to non-tech firms, ownership retained by CEOs and VCs of both tech and internet firms is more positively associated with IPO values.