Signalling by underwriter retention rate in the IPO market

Underwriters in Taiwan have to purchase 10-25% of shares offered in initial public offerings (IPOs) for their own accounts. We present a signalling model showing that the underwriter retention rate can serve as a signal of firm value to investors because underwriters are investors as well. This mechanism can reduce information asymmetry between issuers and investors. The model shows that when underwriters retain more proportion of IPO shares, in equilibrium, the initial return is greater and the subscription success rate is lower. We further test the propositions using 616 IPO firms in Taiwan for the period 1998-2004. Overall, the empirical results support the propositions developed from the signalling model.