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This study analyzes 1,655 U.S. IPOs from 1986 to 2001 to examine the fundamental factors influencing IPO valuation. It investigates whether IPO valuation methods changed during the rise of the New Economy and which fundamental variables play a more significant role.

Key Findings: IPO Valuation and Market Trends

1. V-Shaped Pattern in Valuation and Returns

• Firms with negative earnings receive higher valuations than firms with low but positive earnings.

• This suggests that looking only at positive earnings can lead to misleading conclusions.

• The pattern is most prominent during booms and busts.

2. Growth Potential of Loss-Making Firms

• Firms with negative earnings often represent high-growth internet companies.

• Negative earnings are viewed as a signal of aggressive investment in future growth.

3. Ownership Structure and IPO Pricing

• Investment bankers and first-day investors weigh post-IPO ownership and ownership changes differently when pricing IPOs.

• The impact of ownership structure on IPO valuation varies depending on the stakeholders involved.

4. Fundamental Valuation Model

• Uses Abel & Eberly (2005) valuation model incorporating:

  • Tangible assets

  • Expected future cash flows

  • Growth options related to future technological upgrades

Detailed Analysis

1. Market Segmentation & IPO Trends

The study examines three periods:

• 1986–1990 (early IPO market)

• 1997–March 2000 (boom phase)

• April 2000–2001 (bust phase)

2. Valuation Patterns & Profitability

• Firms with negative earnings often receive higher valuations than firms with low positive earnings.

• This phenomenon is strongly tied to venture capital-backed tech and internet firms.

• Negative earnings serve as a proxy for high growth potential.

3. Ownership Structure & Investment Decisions

• Investment bankers and first-day investors assign different weights to post-IPO ownership changes.

• Insider ownership correlates positively with firm value.

• Investment banker reputation has a stronger impact on tech firm valuations.

4. Role of Fundamentals in IPO Pricing

• Abel & Eberly (2005) model guides the study’s valuation approach.

• Key factors influencing IPO valuations:

  • Tangible assets

  • Expected future earnings

  • Growth options from technological advancements

Conclusions & Implications

• IPO valuation evolves over time, with 1990s tech booms reshaping valuation approaches.

• Growth options play a dominant role in tech IPO pricing, outweighing traditional financial metrics.

• Ownership changes influence valuation, but differently for different investors.

This study suggests that IPO pricing is not purely driven by financials—market perception of growth potential and ownership structure significantly shapes valuation trends.

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