Insider Holdings and the Pricing of Initial Public Offerings

For a large sample of initial public offerings of common stock, insider holdings are positively related to market value/book value ratios. Three hypotheses are presented to explain this relation: (i) insider holdings signal relative firm value, (ii) an agency relation is present, so that firms with higher insider holdings have harder-working managers, and are thus worth more, and (iii) small firms with high values have wealthier managers, and these managers do not fully diversify their portfolios, so that the aforementioned statistical finding is merely a "wealth effect." A number of tests are performed on the implications of these hypotheses, with no single hypothesis by itself being fully consistent with the data. Insider holdings do appear to be a signal of firm value, but the wealth effect magnifies the relation. No evidence is found supporting the agency hypothesis.