The Internet Downturn: Finding Valuation Factors in Spring 2000

Abstract

During the spring of 2000, the market values of internet companies declined 61% in 10 weeks. Using a sample of internet direct and support (infrastructure) firms, this paper investigates whether the stock market decline could be attributed to new disclosures over the period (buy/sell recommendations, analyst forecast revisions, and web traffic measures) or to information that caused a "reassessment" of the implications of pre-existing accounting information. In addition, we focus attention on the non-cash purchases of goods and services using equity instruments, such as stock warrants and options. We find little evidence that the spring 2000 decline was precipitated by new disclosures of web traffic statistics, earnings or earnings forecasts. In contrast, the valuation of internet firms, particularly support firms, declined sharply in relation to certain 1999 accounting measures. Firms that earned greater gross profit in 1999 experienced a relatively smaller stock price decline in spring 2000, while firms that spent more on research and development in 1999 experienced a relatively larger stock price decline. Valuations before and after the downturn reflected the speed with which firms consumed cash and marketable securities as well as the use of equity instruments to acquire facilities, goods and services. Finally, we find evidence that employee stock option grants are viewed positively by investors, most likely due to their effect on employee retention.

Keywords: Valuation, internet firms, stock options, earnings, cash flows

JEL Classification: G12, M41, C31, L86