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.

International Financial Management

14th Edition

ISBN:9780357130698

Author:Madura

Publisher:Madura

Chapter1: Multinational Financial Management: An Overview

Section: Chapter Questions

Problem 10QA

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