Over-optimism when pricing IPOs

Purpose – The purpose of this paper is to contribute to the literature on the valuation of initial public offerings (IPOs). In particular, it tests the presence of over-optimism when pricing IPOs on the Italian Nuovo Mercato. Design/methodology/approach – The paper investigates whether the analysts make systematic errors when forecasting the performance of the firm undergoing the IPO by comparing analysts’ exante expectations to actual ex-post figures. Using a sample of pre-IPO analysts’ reports, the paper performs a regression analysis using the forecast errors (FE) of post-issue sales as dependent variable in order to find out the determinants of mis-valuation. Findings – It is found that theNuovoMercato has been essentially a ‘‘market for projects’’ inwhich young enterprises endowed with a few tangible assets sold their business plans to the market exploiting high-growth opportunities. In the aftermarket, stock and operating performances are found to be declining, falling short of initial expectations. The extent of the actual post-issue growth was lower than the ex-ante estimations by financial analysts, whose valuations were systematically upwardly biased. Affiliated analysts are found not to be more over-optimistic than the unaffiliated. FE appear to be primarily driven by the extent of forecasted growth, by market sentiment and (inversely) by the size of the firm. Originality/value – Fromthe perspective of investors, this study contributes to the understanding of the helpfulness and limits of the analysts’ forecasts in investment decisions and, more generally, of the determinants of over-optimism. This study addresses the issue of over-optimism and provides empirical evidence of it. This paper also contributes to the literature on the rise and fall of the new European stock markets