Why Did so Many Poor-Performing Firms Come to Market in the Late 1990s?: Nasdaq Listing Standards and the Bubble

Abstract

This paper examines the impact of Nasdaq Listing Standards on the composition of new listings in the late 1990s. The Nasdaq has two types of listing standards: one based on profitability and the second based explicitly or implicitly on market capitalization. Specifically, unprofitable firms are allowed to list if either their pro-forma net tangible assets, which include the anticipated proceeds from their IPO, exceeds $18 million or their market capitalization exceeds $75 million. We show that as the market bubble accelerated in the late 1990s, a vast majority of firms entered under a market capitalization based standard, and these firms became a substantial portion of the Nasdaq. Subsequently, these firms performed the poorest both in terms of financial performance, stock return performance as well as involuntary delistings, while firms that listed under the profitability standard performed much better. In addition, firms that entered under market capitalization standards also exhibited the greatest return volatility. These results illustrate the importance of a profitability standard and the danger of a market capitalization based standard (explicit or implicit) in a market that is in, what ex-post turns out to be, a bubble.