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Simultaneous Signaling in IPOs via Management Earnings Forecasts and Retained Ownership: An Empirical Analysis of the Substitution Effect

This study empirically tests the substitution effect outlined in theoretical bivariate signaling models using a Canadian IPO setting. We first show that retained ownership and the provision of management earnings forecasts are credible (value-relevant) signals for our sample of IPOs, and that they jointly affect IPO valuation. We then use simultaneous equations to investigate what factors affect managers' choices of these two signals and whether the two signals act as complements or substitutes. Our analysis indicates that managers' choices of the earnings forecast and retained ownership signals are jointly determined after controlling for other factors that affect each decision independently, and that a substitution effect exists between managers' choices of the two signals. These findings are consistent with Hughes's (1986) bivariate signaling model.