Product Market Advertising, IPO Valuation, and Long-Run Stock Returns

We study the impact of product market advertising on IPO valuation and long-run post-IPO stock returns. We find that a firm going public with a greater extent of advertising in its IPO year is valued higher both in the IPO as well as in the immediate market, and experiences lower long-run post-IPO stock returns. Such an IPO firm is also characterized by a greater upward price revision from the mid-point of its filing range during its book-building period. We conjecture that the above results are due to the effect of advertising on the heterogeneity in IPO market investor beliefs about the prospects of the firm going public: advertising may make retail investor investors more optimistic about the firm (leaving institutional investors unaffected), thus increasing the heterogeneity in beliefs among investors as a whole. This, in turn, increases both IPO valuation and immediate aftermarket valuation, and lowers long-run stock returns. We test this "heterogeneous beliefs hypothesis" using the dispersion in analysts' earnings forecasts and the stock turnover in the IPO aftermarket as proxies for the degree of heterogeneity in investor beliefs. We document three important findings consistent with the heterogeneous beliefs hypothesis. First, product market advertising increases both analyst forecast dispersion about the firm going public and stock turnover in the IPO aftermarket. Second, a greater extent of product market advertising is associated with a smaller fraction of equity holdings in the IPO firm's stock by institutional investors. Third, the higher IPO valuation and long run post-IPO stock returns induced by product market advertising are related to the higher analyst forecast dispersion, the higher stock turnover, and the lower institutional investor holdings experienced by the IPO firm.