The Relevance of Accounting Information in a Stock Market Bubble: Evidence from Internet IPOs

Abstract

Prior research shows that accounting information is relevant for stock valuation, failure prediction, performance evaluation, optimal contracting, and other decision-making contexts in relatively stable market settings. By contrast, accounting's role during stock market bubbles such as those involving a revolutionary emerging technology is the subject of considerable debate, and prominent market observers have alleged that outdated and flawed accounting practices contributed to the crash of the Internet-led high-tech bubble of the late 1990s. We address the issue of whether accounting data is informative in a stock market bubble by examining its failure prediction ability in the context of Internet IPOs, one of the most egregious and economically significant sectors of the high tech bubble. Our setting of young start-up firms is one in which there is relatively little room for managerial discretion with respect to accounting accruals; Internet firms' accounting earnings closely approximate operating cash flows. Yet in contrast to widespread criticisms of accounting and its alleged role in fueling the bubble, we find that accounting variables are highly informative for failure prediction; specifically, they are significant in explaining ex post realized Internet IPO failures. Using an existing IPO failure prediction methodology and two alternative definitions of innovative IPOs, we further show that ex ante, out-of-sample Internet IPO failure forecasts are associated with economically and statistically significant hedge returns. Our analyses suggest that the traditional financial reporting system could serve as an anchor during speculative bubbles.

Firm Valuation in Venture Capital Financing Rounds: The Role of Investor Bargaining Power

“…Lagged financial statement variables are also included, as financial accounting information is informative and relevant in investors’ valuation expectations, even in extreme settings, such as for Internet IPO firms during the high‐tech bubble (Bhattacharya et al, 2010). These variables are recorded in the year before the investment is made (Hand, 2005) and are taken from financial statements supplied by the National Bank of Belgium 1 .…”

IPO Survival in a Reputational Market

“…It measures the activity of the IPO market at the time of a sample IPO is conducted and is defined as the average of the initial returns of the IPOs issued in the three months prior to the month of a given IPO. This measure is similar to the one used by Bhattacharya et al (2010). Ln( Age ) is the natural logarithm of the number of years from incorporation of the IPO company until the IPO; Ln( Size ) is the natural logarithm of the market capitalization of the IPO company at the IPO price in £ million; Initial return is the difference between first day closing and offer prices as a percentage of the offer price; Public float is IPO proceeds as a percentage of market capitalization; Ln( Sales ) is the natural logarithm of the sales of the IPO company averaged over the year before the IPO and the year of the IPO; Insider ownership is the percentage of insider ownership at the time of the IPO; VC Backed is a dummy variable coded one if the IPO firm is backed by venture capital or more generally, private equity and zero otherwise.…”

Underpricing and Number of Risk Factors of Initial Public Offerings in Indonesia

“…For example, Hedge and Miller (1996), Lee et al (1996b), Efrata (2008), and Bhattacharya et al (2010) find negative relationship, whilst Keasey and Short (1992), Lee et al (1996a), Aggarwal et al (2002), Bradley and Jordan (2002), Loughran and Ritter (2004), Johnston and Roten (2015), and Dell' Acqua et al (2015) report significant positive relationship. Studies using Indonesian IPO relating to retained ownership have also been inconclusive.…”

“…Larger IPO is also associated with high quality IPO and thus less risky which will lead to a lower initial return. The issue size appears to be consistently and negatively related to the degree of underpricing (Hedge and Miller 1996, Buckland and Davis 1990, Bhattacharya et al 2010, Kayani and Amjad 2011, Sahoo and Rajib 2011, Francis 2017). Gumanti (2000) also finds a negative relationship on his study of Indonesia IPOs from 1989-1996.…”