If the issuer is more informed than investors, rational investors fear a lemons problem: Only issuers with worsethan-average

quality are willing to sell their shares at the average price. To distinguish themselves from the pool of
lowquality issuers, high-quality issuers may attempt to signal their quality. In these models, better quality issuers
deliberately sell their shares at a lower price than the market believes they are worth, which deters lower quality
issuers from imitating. With some patience, these issuers can recoup their up-front sacrifice post-IPO, either in
future issuing activity ~Welch ~1989!!, favorable market responses to future dividend announcements ~Allen and
Faulhaber ~1989!!, or analyst coverage ~Chemmanur ~1993!!. In common with many other signaling models, highquality firms demonstrate that they are high quality by throwing money away. One way to do this is to leave money
on the table in the IPO. On theoretical grounds, however, it is unclear why underpricing is a more efficient signal
than, say, committing to spend money on charitable donations or advertising.
The evidence in favor of these signaling theories is, at best, mixed: There is evidence of substantial postissuing
market activity by IPO firms ~Welch 1989!!, and it is clear that some issuers approach the market with an intention
to conduct future equity issues. However, there is reason to believe that any price appreciation would induce
entrepreneurs to return to the market for more funding. Jegadeesh, Weinstein, and Welch ~1993! find that returns
after the first day are just as effective in inducing future issuing activity as the first-day returns are. Michaely and
Shaw ~1994! outright