Does Investor Heterogeneity Lead to IPO Overvaluation?

We apply an ex ante measure of heterogeneity in investor beliefs - 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