Signaling and the Valuation of Unseasoned New Issues: A Comment

  • Author(s): JAY R. RITTER
  • Published: Apr 30, 2012
  • Pages: 1231-1237
  • DOI: 10.1111/j.1540-6261.1984.tb03907.x


In the March 1982 issue of this Journal, David Downes and Robert Heinkel [1] present an empirical examination of the role of signaling in the valuation of initial public offerings of common stock. For a large sample of unseasoned new issues, they examine the Leland‐Pyle [2] signaling hypothesis that firm value should be positively related to the fraction of equity retained by the original shareholders. Downes and Heinkel conclude that the data are consistent with the Leland‐Pyle signaling hypothesis.

In this comment, I present a more complete test of the Leland‐Pyle signaling model. I also present two alternative explanations for the positive empirical relation between firm value and insider holdings, which I label the agency hypothesis and the wealth effect hypothesis. I find that the testable implications of the agency hypothesis are supported, while the evidence is ambiguous with respect to the testable implications of the wealth effect and signaling hypotheses.

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