Investment Banks and Their Affiliated Mutual Funds: International Evidence from IPO Allocations

Abstract

We examine the way investment banks allocate IPOs to their affiliated mutual funds worldwide. An underwriter may allocate hot IPOs to its affiliated funds to improve fund performance and increase asset management fees. Alternatively, a bank may allocate to its affiliated mutual funds poorly-performing IPOs that would otherwise be undersubscribed, using affiliates as a “dumping ground” to preserve investment banking fees. We analyze IPO allocations to affiliates globally and find significant cross-country differences in the first-day returns of these IPOs. Although IPOs allocated to affiliated funds outside the U.S have significantly lower first-day returns, IPO allocations to all mutual funds — both affiliated and unaffiliated — in countries with strong investor protection tend to have higher first-day returns, benefiting fund investors. Furthermore, strong investor protection appears to discourage underwriters from allocating IPOs with negative first-day returns to their affiliates. Overall, the evidence suggests the presence of an economically significant conflict of interest within financial conglomerates for which prior literature has not found robust empirical support. Results also highlight the importance of effective investor protection in mitigating this conflict.