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UBC Theses and Dissertations

A two-period model of signaling with ownership retention Courteau, Lucie


This dissertation is an extension of Leland and Pyle's (1977) signaling model. It introduces the length of the retention period to which the entrepreneur commits in the prospectus as a signal of firm value, in addition to the retention level. The analysis uses concepts of game theory to examine a two-period model where an entrepreneur seeks to issue shares on the market and invest in a productive project that generates outcomes which are publicly announced at the end of the next two periods. The entrepreneur can retain some of her firm's shares and trade them later on the secondary market, after information has been released about the outcomes. The length of the retention period is found to be a signaling mechanism that complements ownership retention. Depending on the information structure of the firm, a longer retention period may reduce or increase the retention level necessary for separation. The model also shows that there are realistic situations in which entrepreneurs prefer to retain a portion of their firm's shares for longer than the minimum retention period imposed by regulations, and others in which she prefers the shortest period possible. The optimal combination of under-diversification and commitment is shown to depend on the information structure and the probability distribution of outcomes of the firm. The empirical implications of the model are tested on the set of firms that made an initial public offering in 1981. Although the results of the tests are generally consistent with the predictions of the model, they are not strong enough to reject the null hypotheses.

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