Review of Accounting Studies, 6, 331–359, 2001
2001 Kluwer Academic Publishers. Manufactured in The Netherlands.
A Rude Awakening: Internet Shakeout in 2000
University of Rochester
New York University
Abstract. This study explores various value-drivers of business-to-consumer (“B2C”) Internet companies’ share
prices both before and after the market correction in the spring of 2000. Although many market observers had
predicted that the shakeout would eventually occur (e.g., Perkins and Perkins 1999), the ultimate and previously
unanswered challenge lay identifying which stocks would fall and which ones would survive the shakeout. We
develop an empirical valuation model and provide evidence that the Internet stocks that this model suggests were
relatively over-valued prior to the Internet stock market correction experienced relatively larger drops in their
price-to-sales ratios when the shakeout occurred. This result is robust to the inclusion of competing explanatory
variables suggested by the economics literature related to industry rationalizations.
We examine the ability of a valuation model comprised of both ﬁnancial (accounting) variables and nonﬁnancial
web trafﬁcmetrics to explain Internet companies’ market values during each of 1999 and 2000. Our ﬁndings suggest
that the reach and stickiness web trafﬁc performance measures are value-relevant to the share prices of Internet
companies in each of 1999 and 2000. Our ﬁndings of signiﬁcance for the year 2000 contradict the recent claims of
some analysts that web trafﬁc measures are no longer important. We also explore the valuation role of our proxy
for B2C companies’ current rate of “cash burn” and ﬁnd that this proxy is a signiﬁcant value-driver in each of
1999 and 2000, but with differential valuation implications for each period. Our results suggest that the market
was favorably disposed towards Internet companies’ aggressive cash expenditures in 1999, but appeared to adopt
a more critical view of Internet companies’ cash burn rates in 2000. Our results further suggest that investors
adopted a more skeptical attitude towards expenditures on intangible investments as the Internet sector began to
mature. We ﬁnd that investors appear to implicitly capitalize product development (R&D) and advertising expenses
(customer acquisition costs) during the earlier period when the market was more optimistic about the prospects
of B2C companies. However, only product development costs are implicitly capitalized into value, on average,
subsequent to the shakeout in the spring of 2000. Finally, we provide statistical evidence to support the conjecture
that different parameter vectors characterize the estimated market valuation models for each of 1999 and 2000.
Overall, our study provides a preliminary view of the shakeout and maturation of one of the most important New
Economy industries to emerge to date–the Internet.
Keywords: Internet, New Economy, valuation, intangibles, web trafﬁc, market correction, industry rationalization
The market capitalization of U.S. publicly traded Internet stocks plummeted in value by
approximately 45% from February to May 2000, as measured by the ISDEX, an authoritative
and widely cited Internet stock index (see Figure 1).
Although the Internet sector was badly
mauled from this stock market correction, it remains a signiﬁcant component of the U.S.
economy. The market capitalization of U.S. publicly traded Internet stocks was estimated
to be over $1 trillion dollars prior to the shakeout (Barron’s Online, March 20, 2000), $843
Please address all correspondence to: Elizabeth Demers, Simon School of Business, University of Rochester,
Rochester, NY 14627-0100, phone: (716) 273-1650, fax: (716) 442-6323.