Categorization Effects in Capital Markets: Evidence From Unicorn IPOs

Abstract

We use the introduction of the Unicorn nomenclature to reference venture-backed firms with valuations in excess of $1 billion to examine how firm categorization influences investor demand and retail trade activity during IPO price formation. We predict and find evidence to suggest that the positive appeal associated with an IPO firm’s Unicorn categorization increases IPO investor demand, as evidenced by the firm’s shares pricing above the proposed IPO pricing range and experiencing higher first-day returns relative to an entropy-matched sample of control firms. Adopting a structural-equation methodology that considers explicitly the sequence of IPO price formation, we also show that Unicorn categorization is informative for understanding retail trade activity both directly and indirectly through the mediating effects of news coverage. We also show that Unicorn categorization relates negatively to post-IPO stock performance, and that Unicorn categorization increases the sensitivity of post-IPO stock performance to pre-IPO profitability. These findings, taken together, provide evidence that categorization hides category members’ individual idiosyncrasies and causes them to assume the category’s affective tone.