DotComMania:The Rise and Fall of Internet Stock Prices

This paper explores a model based on agents with heterogenous beliefs facing short sales restrictions, and its explanation for the rise, persistence, and eventual fall of Internet stock prices. First, we document substantial short sale restrictions for Internet stocks. Second, using data on Internet holdings and block trades, we show a link between heterogeneity and price e¡ects for Internet stocks.Third, arguing that lockup expirations are a loosening of the short sale constraint, we document average, long-run excess returns as low as 33 percent for Internet stocks postlockup.We link the Internet bubble burst to the unprecedented level of lockup expirations and insider selling. IN THETWO-YEAR PERIOD from early 1998 through February 2000, the Internet sector earned over 1000 percent returns on its public equity. In fact, by this date, the Internet sector equaled 6 percent of the market capitalization of all U.S. public companies and 20 percent of all publicly traded equity volume. As is well documented, however, these returns had completely disappeared by the end of 2000. What can explain this rise, persistence, and then subsequent fall of Internet stock prices? This paper provides empirical support for one potential explanation that has garnered recent attention in the literature. In particular, there is a considerable and growing literature that looks at the impact of short sales restrictions on stock prices in a setting with heterogenous investors (see, e.g., Lintner (1969), Miller (1977), Figlewski (1981), Jarrow (1981), Diether, Malloy, and Scherbina (2002), Ofek and Richardson (2001), Chen, Hong, and Stein (2002), Du⁄e, Garleanu, and Pedersen (2002), and Jones and Lamont (2002), among others). In these models, asset prices are a weighted average of beliefs about asset payo¡s.While the asset prices are equilibrium determined to the extent that they re£ect the underlying beliefs about payo¡s, short sales restrictions force the pessimistic investors out of the market, leaving only optimistic investors and thus in£ated asset price levels. THE JOURNAL OF FINANCE VOL. LVIII, NO. 3 JUNE 2003 Stern School of Business, New York University and Stern School of Business, New York University and NBER, respectively.We would like to thank an anonymous referee, Rick Green (the editor), Ken French (the NBER discussant), Stewart Myers, Jay Ritter, Jeremy Stein, RobertWhitelaw, and participants at MIT, NYU, the NBER summer institute, NewYork Federal Reserve, the DRP conference, and the SQA seminar series for helpful comments and suggestions.