Searching for Google’s Value: Using Prediction Markets to Forecast Market Capitalization Prior to an Initial Public Offering

Searching for Google’s Value: Using Prediction Markets to Forecast Market Capitalization Prior to an Initial Public Offering

by Joyce E. Berg George R. Neumann Thomas A. Rietz*

May 2007

Abstract To inform theory and to investigate the practical application of prediction markets in a setting where the distribution of information across agents is critical, we conducted markets designed to forecast post-IPO valuations before a particularly unique IPO: Google. Because prediction markets allow us to infer the distribution of information before the IPO, the combination of results from our markets and the unique features of the IPO help us distinguish between underpricing theories. The evidence leans against theories which require large payments to buyers to overcome problems of asymmetric information between issuers and buyers. It is most consistent with theories where underpricing is in exchange for future benefits. This is but one of many potential applications for prediction markets in testing information-based theories. JEL Classification Codes: C53, C93, G10, G14, G24, G32 Keywords: Initial public offering, underpricing, asymmetric information, prediction markets

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Berg: Department of Accounting; Neumann: Department of Economics; and Rietz: Department of Finance; Tippie College of Business, University of Iowa, Iowa City, Iowa 52242-1994. IEM Price data used in this paper are available at http://www.biz.uiowa.edu/iem/. We thank Thomas George, Bruce Johnson, Thomas Noe and seminar participants at the Federal Reserve Bank of Atlanta, the University of Iowa Department of Accounting and the University of Iowa Department of Finance. We also thank the members of the IEM project team, especially Forrest D. Nelson, for their many insightful comments and suggestions. Corresponding Author: Thomas A. Rietz Department of Finance University of Iowa Iowa City, Iowa 52246 Phone: 319-335-0856 Fax: 319-335-3690 e-mail: Thomas-Rietz@uiowa.edu

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