Dotcom Bubble and Underpricing: Conjecture and Evidence

We provide conjectures for what caused the high underpricing and how it fed the price spiral and visa-versa. Accordingly, the underpricing was consequence of the emergence of the Dotcom industry and its large cohort of firms racing for market leadership. For such firms, the continued use of capital markets was a need, forcing them to distribute their IPOs at near fundamentals’ value which, in face of market overvaluation, translated into high underpricing. The frenzy of such flow of highly underpriced IPOs fed the pricing spiral, which in turn forced underpricing and so on. We show that the Dotcom IPO firms had no inferior quality and better stock tradability conditions than previous IPO firms; high underpricing was associated to firm quality; top underwriters and analysts became more selective in the face of abnormally high demand for their services; and the prevailing high underpricing can be fully explained by firms’ characteristics and strategic goals. Contrary to conflict of interest conjectures, abnormal underpricing was not related to underwriting. Finally, we show that returns on NASDAQ composite index can be explained by the flow of highly underpriced IPOs.