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

Authors

  • Nilabhra Bhattacharya,

    1. The first author is from Cox School of Business, Southern Methodist University, Dallas, USA. The second author is from the Accounting and Control Area, INSEAD, France. The third author is from the Department of Accountancy, Tilburg University, The Netherlands, and fellow of TIASNimbas Business School, The Netherlands. They thank Baruch Lev for helpful discussions during the development stage of this study, and Jennifer Francis, Norman Strong (associate editor), and an anonymous referee for comments on an earlier version of the paper. Thomas Adelaar, Hemang Desai, Brian Rountree, Clara Vega, and workshop and conference participants at Maastricht University, the 2006 American Accounting Association Annual Meeting in Washington DC, and the 2007 European Accounting Association meeting in Lisbon also provided valuable comments and suggestions. All remaining errors are the responsibility of the authors.
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  • Elizabeth Demers,

    1. The first author is from Cox School of Business, Southern Methodist University, Dallas, USA. The second author is from the Accounting and Control Area, INSEAD, France. The third author is from the Department of Accountancy, Tilburg University, The Netherlands, and fellow of TIASNimbas Business School, The Netherlands. They thank Baruch Lev for helpful discussions during the development stage of this study, and Jennifer Francis, Norman Strong (associate editor), and an anonymous referee for comments on an earlier version of the paper. Thomas Adelaar, Hemang Desai, Brian Rountree, Clara Vega, and workshop and conference participants at Maastricht University, the 2006 American Accounting Association Annual Meeting in Washington DC, and the 2007 European Accounting Association meeting in Lisbon also provided valuable comments and suggestions. All remaining errors are the responsibility of the authors.
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  • Philip Joos

    Corresponding author
    1. The first author is from Cox School of Business, Southern Methodist University, Dallas, USA. The second author is from the Accounting and Control Area, INSEAD, France. The third author is from the Department of Accountancy, Tilburg University, The Netherlands, and fellow of TIASNimbas Business School, The Netherlands. They thank Baruch Lev for helpful discussions during the development stage of this study, and Jennifer Francis, Norman Strong (associate editor), and an anonymous referee for comments on an earlier version of the paper. Thomas Adelaar, Hemang Desai, Brian Rountree, Clara Vega, and workshop and conference participants at Maastricht University, the 2006 American Accounting Association Annual Meeting in Washington DC, and the 2007 European Accounting Association meeting in Lisbon also provided valuable comments and suggestions. All remaining errors are the responsibility of the authors.
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Address for correspondence: Elizabeth Demers, Accounting & Control Area, INSEAD, Boulevard de Constance, 77305 Fontainebleau Cedex, France.
e-mail: liz.demers@insead.edu

Abstract

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.

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