Valuation of IPOs with Negative Earnings

Abstract

IPO firms are new to the market and presumably more opaque than other public companies. Determining the value of these firms is challenging and even more difficult when earnings are negative. I value U.S. IPOs between 1994 and 2013 especially with negative earnings using a variety of different and novel techniques. The results suggest that IPOs with negative income are valued higher than other IPO firms. These higher valuations are in large part due to the increased marketing efforts of venture capitalists and underwriters. The findings show that venture capitalists and underwriters have market power to generate a high investor perception of IPOs and create investor demand, which boosts valuation. These high-valued IPOs tend to underperform in the long-run as valuation premia converge toward peer levels. Due to higher levels of uncertainty and overconfidence, IPOs with negative income seem to be different and more exposed to marketing hype than other IPOs.