Internet Stock Valuation: The Impact of Relational Value on Market Value of Equity

ABSTRACT This study focuses on the impact of accounting and nonfinancial information on the valuation of internet-related stocks during the years 1996-1999, at the inception of the internet industry. Only nonfinancial information is found to be consistently positively related to the market value of equity of internet companies, using both traditional and Ohlson residual income valuation approaches over this time period. The unaudited nonfinancial information, including number of customers, used in this study was self-identified by the internet firms for voluntary disclosure in their annual reports, and this type of nonfinancial information has not previously been studied in the context of the internet industry. Accounting information was not yet consistently positively related to market value of equity in this new industry during the years 1996-1999. Overall, nonfinancial information is found to be more value relevant than accounting information in the infancy (1996-1999) of the internet industry. These findings are of interest to both accounting researchers and investors in emerging industries. INTRODUCTION This study investigates the value relevance of accounting information and non-audited self-selected nonfinancial information found in the annual reports of internet companies. While other studies have investigated nonfinancial information in an emerging industry, the nonfinancial information in this study was self-selected by the companies as information that may be useful to investors and potential investors in a time period before accounting information becomes relevant. In addition, the nonfinancial information is unaudited and may allow the companies to signal their explanation of the reason for the growth in the firm's value. Both traditional and Ohlson (1995) valuation models are implemented for 82 firm-years from 1996-1999. The firms were selected from Internet stock indexes on the basis of the availability of additional nonfinancial measures in the annual report. The unaudited, self-selected nonfinancial information is found to be more value relevant than financial information during this time period. Intense investor interest in internet companies in the late 1990s was driven partially by the anticipated explosive growth of trade on the internet. In 1999, retail sales on the internet were expected to reach $86 billion by 2003. At the beginning of 2000, the internet industry made up ten percent of the US economy and was the fastest-growing sector (Van Slambrouck 2000). The investment hype surrounding internet stocks in general seemed to peak in March 2000, after which internet stock prices fell despite no significant changes in their underlying fundamentals. From March to April 2000 the technology-concentrated NASDAQ Composite Index lost a third of its value (Ip and Browning 2000). A combination of interest rate fears and a shift in investor psychology have been blamed for the sudden change in mood (Herman 2000). However, the internet industry continues to exist and change on a daily basis. The uncertainty inherent in the developing internet industry may be illustrated by the history of a more mature industry. For example, automobiles were first sold on the retail market in 1895. The traffic signal did not appear until 19 years later, followed shortly by windshield wipers, and for the first forty years there were no parking meters (Alger 1999). It is likely that many critical internet accessories and related products have yet to be developed, and as in the automobile industry, many products will not survive market competition in the long-term. While many investors were attracted to the growth opportunities that seemed obvious in dot-corn companies, older industries (such as electricity, cable television, and biotechnology) also experienced valuation bubbles at the outset that eventually deflated. According to most traditional valuation models, the internet firms were overvalued during the late 1990s, exhibiting small to negative net earnings and net operating cash flows. …