Signalling and the Pricing of New Issues




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    • Grinblatt is from the Anderson Graduate School of Management, University of California, Los Angeles. Hwang is from the Katz Graduate School of Business, University of Pittsburgh. The authors would like to thank Franklin Allen, Maxim Engers, David Hirshleifer, George Mailath, John Riley, Sheridan Titman, and Brett Trueman for helpful discussions, as well as Jay Ritter, Ivo Welch, anonymous referees, and seminar participants at Columbia University, the Wharton School, and Yale University for comments on earlier drafts. Financial support was provided by the faculty research grant program at the University of Pittsburgh, Katz Graduate School of Business. Portions of this paper were developed in the doctoral dissertation of Hwang (1988).


This paper develops a signalling model with two signals, two attributes, and a continuum of signal levels and attribute types to explain new issue underpricing. Both the fraction of the new issue retained by the issuer and its offering price convey to investors the unobservable “intrinsic” value of the firm and the variance of its cash flows. Many of the model's comparative statics results are novel, empirically testable, and consistent with the existing empirical evidence on new issues. In particular, the degree of underpricing, which can be inferred from observable variables, is positively related to the firm's post-issue share price.