Consider the IPO (initial public offering) market. In this market, private firms raise money by selling a portion of their firm to the public (by listing their shares on a stock exchange). Suppose there are only two types of firms. Half of the firms are high quality and are worth $100/share. The other half are low quality and are worth only $50/share. Assuming firms know whether their quality, but the public does not, we would expect only v to sell their shares to the public at a price of $ v per share. One way to signal a firm's value is for the owner's to maintain equity in the firm. In order for high quality firms to signal their higher value, the cost of holding equity must be v for high quality firms than low quality firms.
Consider the IPO (initial public offering) market. In this market, private firms raise money by selling a portion of their firm to the public (by listing their shares on a stock exchange). Suppose there are only two types of firms. Half of the firms are high quality and are worth $100/share. The other half are low quality and are worth only $50/share. Assuming firms know whether their quality, but the public does not, we would expect only v to sell their shares to the public at a price of $ v per share. One way to signal a firm's value is for the owner's to maintain equity in the firm. In order for high quality firms to signal their higher value, the cost of holding equity must be v for high quality firms than low quality firms.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:high quality firms
low quality firms
50
75
100
higher
lower
Transcribed Image Text:Consider the IPO (initial public offering) market. In this market, private firms
raise money by selling a portion of their firm to the public (by listing their shares
on a stock exchange). Suppose there are only two types of firms. Half of the
firms are high quality and are worth $100/share. The other half are low quality
and are worth only $50/share. Assuming firms know whether their quality, but
the public does not, we would expect only
v to sell their
shares to the public at a price of $
v per share.
One way to signal a firm's value is for the owner's to maintain equity in the
firm. In order for high quality firms to signal their higher value, the cost of
holding equity must be
v for high quality firms than low
quality firms.
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