Internet Stock

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Summer Research Paper

Investigating the Role of Financial Analysts in the

Internet Bubble

Conducted by: Yao Tian

Supervised by: Pat O'Brien

Summer, 20041

1 I thank Pat O'Brien for her insight and research guidance and Sean Speers for his technical help.

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Table of Contents

Abstract ............................................................................................................................... 3

1. Introduction................................................................................................................... 4

2. Literature Review and Hypothesis Development....................................................... 7

2.1 Analysts' Forecast/Recommendation Optimism..................................................... 7

2.2 Internet Stock Overpricing ...................................................................................... 8

2.3 Hypothesis Development........................................................................................ 10

3. Research Design .......................................................................................................... 10

3.1 Sample Selection .................................................................................................... 10

3.2 Data Collection....................................................................................................... 12

4. The Logistic Regression - Tests for H1..................................................................... 12

4.1 The Logistic Model ................................................................................................ 12

4.2 The Yearly Analysis ............................................................................................... 20

5. The OLS analysis - Test for H2................................................................................. 22

6. Conclusion ................................................................................................................... 24

References....................................................................................................................... 26

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Investigating the Role of Financial Analysts in the

Internet Bubble

Abstract

This paper empirically investigates the role of financial analysts in the 1996-2000

Internet Bubble. It addresses the following two research questions: (1) were financial

analysts relatively more optimistic about Internet stocks than other stocks during the

Internet Bubble period and (2) did their relative optimism for the Internet stocks inflate

the prices of these stocks to create the Internet Bubble. Using a Logistic Regression of

recommendations on industry sectors, I investigate analysts' relative optimism for the

Internet stocks while controlling for their over-optimism for all stocks in general and

their relative optimism for IPO stocks in particular. The results suggest that during the

Internet Bubble period, financial analysts made relatively more optimistic

recommendations for the Internet stocks than for other stocks; this relative optimism is

specific to Internet stock and does not apply to other stocks in the high-tech sector. To

further investigate the impact of this relative optimism, I use an OLS regression to

examine whether analysts' recommendations for the Internet stocks drove the prices of

these stocks. The result suggests that analysts' recommendations have no significant

impact on the stocks' future prices. I thus conclude that although financial analysts were

relatively more optimistic for the Internet stocks, their relative optimism did not inflate

the prices of these stocks to create the Internet Bubble.

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1. Introduction

Internet stocks first went public in the early 1990s. With the success of the early

Internet initial public offerings (IPOs), such as Yahoo (1996), Amazon (1997), and eBay

(1998), an increasing number of Internet firms joined the market in the late 1990s. In

1999 and 2000 a total of 338 Internet companies went public, more than doubling the

number of existing Internet IPOs. Even more astounding than the growth of Internet

IPOs during those 2 years was the dramatic rise in share values for Internet stocks.

"During the two-year period 1998-1999, returns on an Internet index (INTDEX)

compiled by Pegasus Research International exceeded 125% while the NASDAQ and

S&P 500 indices grew at 85% and 19.5% respectively" (Liu and Song, 2001). However,

the remarkable rise of Internet stocks was eclipsed by their monumental failure. Ending

the year 2000 at 361.47 and 2470.53, the Internet and NASDAQ indices dropped by more

than 19% and 51% respectively (Hiriam, 2000). This represents the biggest decline in

stock indices since the