U.S. public and private venture capital markets, 1998-2001: A fundamental information analysis

Systematic analysis of U.S. capital markets reveals important empirical facts that analytical modeling or empirical research seeking to explain the 1998-2001 movements needs to recognize. There is no single "bubble point" at which U.S. capital markets had an epiphany that valuations required a sharp downward re-evaluation. Rather, different sectors had different points after which ex post sustained declines occurred. For the NASDAQ/NYSE/AMEX public capital markets, the sustained ex post declines occurred starting in March 2000 for the computer software industry and in September 2000 for the computer hardware industry. Private venture capital investment in new ventures peaked in the March 2000 quarter for software and in the September 2000 quarter for hardware and communications. Four sectors exhibiting extreme price movements are identified - computer hardware, computer software, telecommunications, and biotech/pharmaceuticals. These sectors had observable characteristics prior to 1998 that implied higher risk - they had higher relative risk (CAPM beta), higher standard deviation of security returns, more extreme revenue growth increases (decreases) in the upper (lower) tails, and a higher propensity for negative net income. During the 1998-2001 period, companies in these sectors had abnormally high revenue growth rates. An Internet sample of companies exhibits even higher abnormal revenue growth rates relative to either prior periods or other companies in the 1998-2001 period. The large relative increases and decreases in the market capitalization of U.S. capital markets in 1998-2001 may well have more grounding in risk-reward asset pricing theory than many commentators have recognized.