The Search for Information by Underwriters and Its Impact on Municipal Interest Cost

Abstract

AN UNDERWRITER WHO BIDS on a competitively sold, new municipal issue must search for information concerning market clearing yields prior to submitting his bid.1 This search for information is an attempt to find those buyers who are willing to purchase the bonds at the highest prices (lowest yields). The lower the discovered yields, the lower is the bid the underwriter may submit, and the greater will be his chance of winning the bidding competition. Also, ceteris paribus, the lower are yields, the lower will be municipality interest costs. Thus, it is important to discover those factors which lead to greater aggregate search and the discovery of lower yields. This paper investigates the impact of underwriter search on the interest cost of new municipal bond issues. Kessel [10] was the first to suggest that underwriter search may affect municipal interest costs. In Kessel's study, reported in section II, the number of bids received on a bond issue is used as a measure of underwriter search for price information on the issue. Section III provides a more complete explanation of underwriter search than was attempted by Kessel. The discussion suggests that aggregate underwriter search has two dimensions: the number of searchers and the intensity of search. The implications of this model for measuring aggregate underwriter search are developed in section IV. Both the number of bids and the dispersion of interest rates bid on a bond issue may reflect aspects of total underwriter search on the issue. Section V presents the methodology of this study. Section VI presents the empirical analysis. The analysis indicates that both the intensity of underwriter search and the number of searching underwriters have an independent and significant impact on municipal interest cost. A brief summary of the results is given in section VII.