A New Test of the Signaling Theory of IPO Underpricing

Abstract

This study develops an empirical algorithm within which the incentive for signaling of private information in course of IPOs is implemented as a conditional, as opposed to an unconditional incentive. Suppose high quality issuers of IPOs signal private information, and suppose presence of cohorts of comparable non-signaling lower quality issuers. Empirical results demonstrate signaling enables the most positive post IPO price drift (most positive post IPO returns) within populations of IPOs. Linkage of signaling with the most positive post-IPO price drift is novel to this study. Consistent with quality characterizations, signalers are associated with significantly smaller SEO underwriting or gross spreads and larger SEO proceeds in future periods. Comparisons of forecast power demonstrate formulation of signaling incentives to be conditional, as opposed to unconditional significantly improves accuracy of forecasts of SEO activity in future periods.

Keywords: Underpricing, Initial Public Offering (IPO), Price Drift, Signaling, Quality, Proceeds, IPO Performance

JEL Classification: G11, G12, C34, C58