Foreign entry into underwriting services: evidence from Japan's "Big Bang" deregulation

We examine the impact of foreign underwriting activity on bond markets using issue level data in the Japanese "Samurai" and euro-yen bond markets. Firms choosing Japanese underwriters tend to be Japanese, riskier, and smaller. We find that Japanese underwriting fees, while higher overall on average, are actually lower after conditioning for issuer characteristics. Moreover, firms tend to sort properly in their choice of underwriter, in the sense that a switch in underwriter nationality would be predicted to result in an increase in underwriting fees. Finally, we conduct a matching exercise to examine the 1995 liberalization of foreign access to the "Samurai" bond market, using yen-denominated issues in the euro-yen market as a control. Foreign entry led to a statistically and economically significant decrease in underwriting fees in the Samurai bond market, as spreads fell by an average of 23 basis points. Overall, our results suggest that the market for underwriting services is partially segmented by nationality, as issuers appear to have preferred habitats, but entry increases market competition.Japan

The Tying of Lending and Equity Underwriting

This article examines the practice of tying,' which occurs when an underwriter lends to an issuer around the time of a public securities offering. We examine whether there are efficiencies from tying lending and underwriting which lead to benefits for issuers and underwriters. We find evidence consistent with tying occurring for issues when there are informational economies of scope from combining lending and underwriting. Firms benefit from tying through lower financing costs, as tied issuers receive lower underwriter fees on seasoned equity offerings and discounted loan yield spreads. These financing costs are significantly reduced for non-investment grade issuers, where informational economies of scope from combining lending with underwriting are likely to be large. These results are robust to matching methodology developed by Heckman, Ichimura, and Todd (1997, 1998). For underwriters, tying helps build relationships that augment an underwriter's expected revenues by increasing the probability of receiving both current and future business. Both commercial banks and investment banks tie lending and underwriting and offer price discounts, albeit in different ways, with commercial banks discounting loan yield spreads and investment banks offering reduced underwriter spreads.

Developer's Expertise and the Dynamics of Financial Innovation: Theory and Evidence

We study product innovation and imitation in the market of corporate underwriting with a dynamic model where client switching costs and the bankers' expertise in deal structuring characterize the life cycle of a security. While the clientele loyalty allows positive rent extraction, the superior expertise can account for the documented market leadership of the innovator. As expertise on product structuring is acquired by imitators, the innovator's market share advantage decreases. Also, the speed of entry by imitators increases for later generation products. Our predictions are consistent with well documented evidence on the market share leadership of innovators. We also present new evidence from equity-linked and derivative corporate products that supports the dynamic predictions of our learning model.Innovation and imitation, first-mover advantages, learning

Developer's Expertise and Dynamicsof Financial Innovation: Theory and Evidence

We study product innovation and imitation in the market of corporate underwriting with a dynamic model where client switching costs and the bankers’ expertise in deal structuring characterize the life cycle of a security. While the clientele loyalty allows positive rent extraction, the superior expertise can account for the documented market leadership of the innovator. As expertise on product structuring is acquired by imitators, the innovator’s market share advantage decreases. Also, the speed of entry by imitators increases for later generation products. Our predictions are consistent with well documented evidence on the market share leadership of innovators. We also present new evidence from equity-linked and derivative corporate products that supports the dynamic predictions of our learning model.Innovation and imitation, first-mover advantages, product differentiation, learning

Does Prospect Theory Explain IPO Market Behavior?

We derive a behavioral measure of the IPO decision-maker’s satisfaction with the underwriter’s performance based on Loughran and Ritter’s (2002) application of prospect theory to IPO underpricing. We assess the plausibility of this measure by studying its power to explain the decision-maker’s subsequent choices. Controlling for other known factors, IPO firms are less likely to switch underwriters for their first seasoned equity offering when our behavioral measure indicates they were satisfied with the IPO underwriter’s performance. Underwriters also appear to benefit from behavioral biases in the sense that they extract higher fees for subsequent transactions involving satisfied decision-makers. Although our tests suggest there is explanatory power in the behavioral model, they do not speak directly to whether deviations from expected utility maximization determine patterns in IPO initial returns

Does Prospect Theory Explain IPO Market Behavior?

We derive a behavioral measure of the IPO decision-maker’s satisfaction with the underwriter’s performance based on Loughran and Ritter’s (2002) application of prospect theory to IPO underpricing. We assess the plausibility of this measure by studying its power to explain the decision-maker’s subsequent choices. Controlling for other known factors, IPO firms are less likely to switch underwriters for their first seasoned equity offering when our behavioral measure indicates they were satisfied with the IPO underwriter’s performance. Underwriters also appear to benefit from behavioral biases in the sense that they extract higher fees for subsequent transactions involving satisfied decision-makers. Although our tests suggest there is explanatory power in the behavioral model, they do not speak directly to whether deviations from expected utility maximization determine patterns in IPO initial returns

What makes issuers happy? Testing the Prospect Theory of IPO Underpricing

We derive a behavioral measure of the IPO decision-maker's satisfaction with the underwriter's performance based on Loughran and Ritter's (2002) prospect theory of IPO underpricing. We assess the plausibility of this measure by studying its power to explain the decision-maker’s subsequent choices. Controlling for other known factors, IPO firms are less likely to switch underwriters for their first seasoned equity offering when our behavioral measure indicates they were satisfied with the IPO underwriter’s performance. Underwriters also appear to benefit from behavioral biases in the sense that they extract higher fees for subsequent transactions involving satisfied decision-makers. Although our tests suggest there is explanatory power in the behavioral model, they do not speak directly to whether deviations from expected utility maximization determine patterns in IPO initial returns

The Economics of Conflicts of Interest in Financial Institutions

A conflict of interest exists when a party to a transaction could potentially make a gain from taking actions that are detrimental to the other party in the transaction. This paper examines the economics of conflicts of interest in financial institutions and reviews the growing empirical literature (mostly focused on analysts) on the economic implications of these conflicts. Economic analysis shows that, although conflicts of interest are omnipresent when contracting is costly and parties are imperfectly informed, there are important factors that mitigate their impact and, strikingly, it is possible for customers of financial institutions to benefit from the existence of such conflicts. The empirical literature reaches conclusions that differ across types of conflicts of interest, but overall these conclusions are more ambivalent and certainly more benign than the conclusions drawn by journalists and politicians from mostly anecdotal evidence. Though much has been made of conflicts of interest arising from investment banking activities, there is no consensus in the empirical literature supporting the view that conflicts resulting from these activities had a systematic adverse impact on customers of financial institutions.

Universal Banking and Conflicts of Interest: Evidence from German Initial Public Offerings

This paper investigates conflicts of interest associated with relationship banking. Using a sample of 270 German initial public offerings (IPOs), we ask if universal-bankunderwritten IPOs perform differently from IPOs underwritten by specialized investment banks. We find that universal-bank affiliation is correlated with higher first-day returns (underpricing) but uncorrelated with long-term performance. This suggests that underpricing compensates for potential conflicts of interest. The results also suggest that preexisting bank relationships, rather than issuer characteristics, may determine the choice of underwriter

Sharing Underwriters with Rivals: Implications for Competition in Investment Banking

We conjecture that issuing firms seek to avoid sharing underwriters with their product-market rivals in order to limit the risk that strategically sensitive information is leaked to a rival firm via the underwriter relationship. We investigate this conjecture in a sample of 5,272 equity deals and 12,453 debt deals by large U.S. firms between 1975 and 2003. Using several distinct sources of identification, we find that this phenomenon is at least as important in determining the choice of lead underwriter as the bank’s reputation or the issuing firm’s existing relationship with the underwriter. We argue that this finding has important implications for understanding the nature of competition among investment banks, the durability of underwriting relationships, the success of entrants, and the likely impact of investment bank mergers on market power