Financial Infrastructure, Underwriter Reputations, and Securities Fraud

Abstract

Prior studies on underwriter reputation focus on individual underwriters. However, it cannot explain the increasing trend of underwriters working in groups and the unusually high number of securities fraud lawsuits during the Internet bubble period. This paper shows empirically how the group's reputation affects individual underwriters' incentives to certify issues that do not merit certification and to assist certain clients to obtain public debt financing. Consistent with this collective reputation hypothesis, well-connected clients and co-led syndicate clients have a higher incidence of securities fraud litigation. These clients also receive higher bond prices, which could result from exploitation on investor beliefs by underwriters. Results also suggest that investors believe in more effective certification when more underwriters' reputations are at stake.