A signalling model is developed which demonstrates how the offer price and the proportion of shares sold through an issue of ordinary shares when a company goes public, a so-called 'initial public offering' (IPO), can be used by 'good' (shareholder-value maximising) initial owners to separate themselves from bad owners whose controlling influence depresses the market value of company equity because they are known to sacrifice cash flows in order to preserve their private benefits of control, for instance, by blocking value-increasing new equity issues, restructuring, takeover or voluntary liquidation. Unlike previous IPO signalling theories, this model offers a rationale for IPO underpricing which is consistent with existing empirical evidence. The model provides explanations for hot-issue periods and observed long-run IPO underperformance, and sheds light on the reasons for the chronic lack of liquidity on lower-tier stock-markets, and on the effect of issue method on IPO pricing. Further testable implications on the relation between IPO performance and corporate ownership and governance are derived.
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