3. Problem at
hand
The purpose
of our
research
Brief
presentation
of our results
Our data Methodology
Explanation
of results
Conclusion
• The underlying paradigm behind economic theory :
• Tries to reproduce the advancements in natural sciences to explain the dynamics of
the financial markets
• Economists argue that the methodologies and criteria that apply to the study of
natural phenomena also apply to the study of events implying social events
• Financial Markets being the biggest such phenomena
• Big flaw with such an approach
• Natural science: studies a series of facts
• Social sciences: implies thinking participants
• When occurrences have thinking participants, such as those of the financial markets, the
subject matter is no longer confined to the facts only, but also the participants` perception of
those facts
Financial markets are affected by the participants’ interactions unlike natural events
4. Problem at
hand
The purpose
of our
research
Brief
presentation
of our results
Our data Methodology
Explanation
of results
Conclusion
• To what extent does the economic man control the outcome of a
situation before his bounded rationality takes over?
• This paper tries to account for the dichotomy between natural and
social sciences to :
• explain how the perceived “attractiveness” of an IPO affects price volatility over the
week that follows the offering
• Study its impact on stock performance over time
5. Problem at
hand
The purpose
of our
research
Brief
presentation
of our results
Our data Methodology
Explanation
of results
Conclusion
• Firms in the tech sector close their first day of trading with a CAR0 =
66.69% increase over their offering price
• CAR0 of 10.81% for the 172 companies operating in the industrials
sector
• initial buildup surrounding the IPO for tech companies is followed by six
straight days of negative CARs ranging from -0.8% to -.5.5% before
closing the week with a CAR7 of ~ 0%. VS Flat CARs for industrials
• 79% of studied tech companies filed for bankruptcy
• 53% of industrials filed for bankruptcy
6. Problem at
hand
The purpose
of our
research
Brief
presentation
of our results
Our data Methodology
Explanation
of results
Conclusion
• IPOs between 1998-2008 and their offering price : SDC
• Daily close to close stock prices & benchmark returns: CRSP
• Yearly stock prices and revenues: Bloomberg
• Sample of 702 companies:
• 530 tech companies
• 172 industrials
7. Problem at
hand
The purpose
of our
research
Brief
presentation
of our results
Our data Methodology
Explanation
of results
Conclusion
• Closing daily stock prices deflated by the respective benchmark’s
return for the seven days following the IPO
• Another set of daily CARs using asking prices
• We deemed them directly related to investor’s demand for a given stock
• The higher the ask-close spread; the higher the willingness to own the stock
• We decided to put a greater emphasis on Daniel Khaneman’s
prospect theory to explain our established outcomes
• provides the most well-established reference scheme to interpret our results
• while simultaneously challenging the status quo in financial theory; mainly the
expected utility theory.
8. Problem at
hand
The purpose
of our
research
Brief
presentation
of our results
Our data Methodology
Explanation
of results
Conclusion
• Cognitive dissonance:
• mental conflict that individuals experience when they are presented with new
evidence suggesting that their beliefs and assumptions are wrong
• an individual has a tendency to develop convoluted arguments that support his
outstanding belief or assumption (or screen out contrarian information that
diminishes the strength of his initial belief).
• Investors formulate a perception of the potential success of an IPO based on the
idea that companies that go public are the strong ones
• Reflexive feedback loophole:
• since going public implies a mean of attaining growth, then investors systematically
assume that any company going public is a solid company that is simply seeking
new sources of financing its well-established growth potential
• explains the first day price rally
• investors approach new tech IPOs with the idea that the company in question can be the
next Google or Microsoft, while simultaneously screening out information that may halter
such a belief
9. Problem at
hand
The purpose
of our
research
Brief
presentation
of our results
Our data Methodology
Explanation
of results
Conclusion
• Subjective probability weighing:
• individuals do not weigh the likelihood of the occurrence of an outcome by its
statistical probability
• individuals have a tendency to misrepresent the probabilities of the occurrence of
any given outcome based on the implied repercussions of that outcome on their well
being, and base their decisions on the perceived rather than statistical probability of
that outcome
• the weighing function derived by prospect theory stipulates that individuals have a
tendency to overweight unlikely extreme outcomes
• Partaking in an IPO implies a mental probability > 50% of investment being
profitable
• Underlying belief behind tech companies is that they partake in a get big fast scheme to
build a huge customer base
• Investors abandon traditional valuation methods and focus on eyeballs and total
approachable market in that case increase the implied probability of profitable
investment significantly higher than 50%
• Kaplan-Meir model suggest that 53% of tech companies shut down after 5 years of
their IPO and only 29% make it past their 10th year
10. Problem at
hand
The purpose
of our
research
Brief
presentation
of our results
Our data Methodology
Explanation
of results
Conclusion
• So how rational, or irrational, investors actually are?
• Comparing the aforementioned modified decision weight implying a probability
substantially higher than 50% that an investment in a tech IPO will yield a profit to
the objective statistics derived by Goldfarb, Kirsch and Miller, and which suggest
that only 29% of tech companies are profitable after their 10th year of operation
• We can conclude that investors’ bounded rationality yields a disillusioned
perception in regards of the reality of the tech IPO market
• When such a high divergence from reality is built into the aggregate
industry stock prices, it becomes obvious that when reality strikes, and
tech firms disclose their lackluster fundamentals, investors will react
negatively
• In that case, instead of the market going through a slight correction, it descends into
financial distress and ends up crashing (tech bubble of 1999). Similar dynamics
occurring in the current tech IPO market = tech bubble 2.0
