Legal Perception and IPOs: An Investigation into the Impact of Legal Signaling on Firm Valuation

Abstract

In this paper, we contribute to the literature on institutional determinants of IPO valuation. We introduce the concept of “legal signaling,” which focuses on the perception of law and thus complements the existing institutional approaches to IPO valuation which consider the quality of the positive law (“standard view”) and firm-level corporate governance practices (“firm signaling view”). Our approach explicitly models the difference between the effect of the positive law and the effect of the perception of law on IPO value. Based on a world-wide longitudinal dataset of IPO performance across a large number of countries, we find strong support for the claim that the perception of quality of law, operationalized as a country’s legal shareholder protection, is more important than its actual quality to explain post-IPO firm value. We also uncover that the effect of perception on IPO value is stronger when the law’s quality is correctly perceived than when it is misperceived. Overall, our findings underscore the need for a more sophisticated theorization of the ways in which law affects entrepreneurial finance.