Three essays on the effects of investor and manager behavioral biases on IPO pricing and market performance

This dissertation consists of three essays on the effect of investor and manager behavioral biases on the pricing and long-run market performance of initial public offerings. In the first essay, we apply an ex ante measure of heterogeneity in investor belief---excess industry volatility---to test the Miller (1977) prediction about IPO overvaluation in a sample of 7,212 IPOs from 1980 to 2003. Generally, IPOs in industries with high investor heterogeneity of beliefs have much higher initial returns and lower long-run returns in the following 2-3 years than IPOs in industries with low heterogeneity. The effect of investor heterogeneity on initial returns is about four times stronger during the tech bubble period than during other periods, and the extreme bubble-period initial returns are not reversed until about 5 years after the offer, consistent with the late 1990s' market being a market bubble fueled by investor euphoria. Excess industry volatility explains half of the annual time-series variation in aggregate initial returns. These findings support Miller's hypothesis that in markets with restricted short-selling, valuations tend to reflect the most optimistic investor's appraisal in the short-run, and revert to the average appraisal in the long-run.;Finally, the third essay looks at a sample of 340 venture capital-backed IPOs, where I find that IPOs with more optimistic managers underperform IPOs with less optimistic managers in the long-run. Moreover, the IPOs of the most optimistic managers underperform in the long-run when compared to a benchmark portfolio or even on a factor-adjusted basis, while the IPOs of the least optimistic manager do not. In terms of operating performance, firms with the most optimistic managers perform well at the time of the offer, thus justifying their high valuation relative to firms with the least optimistic managers. This operating performance advantage disappears over time however because optimistic managers invest too little in the years after the offer. Instead, optimistic managers choose to pay off their short and long-term debt, suggesting that their underperformance is driven by underinvestment.;The second essay examines whether investors overvalue initial public offerings (IPOs) more when there is a lack of accurate feedback about the firm's fundamentals. We hypothesize that greater information production by underwriting syndicates should lead to less investor behavioral biases, and hence less IPO overvaluation. Using syndicate size and underwriter reputation as measures of information production, we find that high information production predicts better long-run performance than low information production. Furthermore, information production has the greatest effect on IPOs with the most uncertainty, suggesting a new role for underwriting syndicates in mitigating the effect of firm uncertainty and improving IPO long-run performance.