Bond Underwriting Research Articles

Credit default swaps and corporate debt structure

Whether and how credit default swaps (CDSs) affect corporate debt structure remains an unanswered question. We find that firms use more public debt relative to bank debt when CDSs referencing their debt start trading. The results are robust to the endogeneity of CDS trading. Furthermore, the increase in public debt is concentrated in senior bonds and notes, which are the most common CDS reference assets. The effect of CDS trading is most pronounced when bond underwriters take a net selling CDS position and for informationally opaque firms. These findings suggest that the hedging and informational roles of CDSs have real effects on corporate debt structure.

Label or lever? The role of reputable underwriters in Chinese green bond financing

This paper examines the role of underwriter reputation in the cost of green bond financing by focusing on the Chinese scenario for the period 2016–2022. Our empirical results show that bond underwriters’ reputation is negatively associated with the issuance cost of green bonds. Such impact is significantly moderated by the enterprise ownership structure and listed conditions, thereby verifying the existence of bonding and information mechanisms. The effect of underwriter reputation is sounder for enterprises in pilot areas and with high profitability. The economic significance is also estimated to confirm the necessity of selecting reputable underwriters in green bond financing.

Overallocation and secondary market outcomes in corporate bond offerings

Bond underwriters, lacking “Greenshoe options” and formal systems to track “flipping” activity, have fewer tools than equity underwriters to manage secondary market order flow uncertainty. We show that bond underwriters respond by selectively “overallocating” some issues to attain net short positions. Overallocations are economically substantive, facilitate the syndicate's price stabilization efforts, and are largely offset in the days after issuance. These issues on average experience more net selling by institutional investors and, despite large syndicate purchases, appreciate less in the secondary market. Thus, overallocation is an observable indicator that underwriters anticipate weakness in net secondary market demand.

Conflicts of Interest in Municipal Bond Advising and Underwriting

A regulation following from Dodd-Frank prohibits municipal financial advisors from simultaneously acting as municipal bond underwriters. Using a difference-in-differences approach, I test whether this reduction in advisor privileges affects financial advice and bond outcomes. Bonds with potential dual advisor-underwriters see financing costs fall by 11.4 basis points (5.3% of average yield) after the advisor is no longer allowed to underwrite. The decline is concentrated in opaque school district bonds and new money issues. Non-advisors compete for underwriting business more aggressively since they are less likely to face adverse selection after previously conflicted advisors encourage creditworthy borrowers to obtain credit ratings.

Post‐financial crisis changes in financial system structure: An examination of the J.P. Morgan & Co. Syndicates after the 1907 Panic

AbstractIn the post‐2008 crisis period, policy makers debate the implications of banking system concentration. To shed light on this debate, we study a postcrisis period in which less banking regulation existed than in the present period, reasoning that an examination of a less regulated market might reveal useful insights about present day market agents' postcrisis actions. The years immediately following the Panic of 1907 merit study because the period shares important features with the post‐2008 crisis financial system: increasing interconnectedness, the growing complexity accompanying the rise of new industries, the rapid deployment of new communications technologies, and substantial innovation in financial instruments. Because the 1907 crisis preceded the Clayton Anti‐Trust Act of 1914, it also provides a window into studying market agents' behavior before legislation was enacted to discourage banking system concentration. We find evidence that the market share of corporate bond underwritings at J.P. Morgan & Co. increased in the post‐1907 crisis period. We suggest a mechanism by which market share increased: a more concentrated configuration of corporate bond underwriting syndicates. We also indicate that Morgan's increased share may have been a proxy for increased certification value of underwriter reputation because of systemic knowledge Morgan gained during the resolution of the Panic of 1907 rather than for increasing bargaining power. We do not find evidence that Morgan used market power to extract rents from issuers despite increased market share and more concentrated syndicate organization. While our results must be interpreted cautiously due to data limitations, possible lessons for present‐day policy makers are that consolidations in the financial system after a financial crisis are complex. Some consolidations may come about from information and reputational gains produced during the crisis. Others may be moves by some firms to concentrate market power and still others from efforts to improve efficiencies in intermediation.

Does Bribery Pay? Evidence from Credit Ratings

Using manually collected data associated with bribery in China, we find that firms receive higher credit ratings when their travel and entertainment expenses are abnormally high. Higher credit ratings help firms to expand their debt capacity, which incentivizes issuers to bribe rating firms for rating favor. We find no evidence that the results are driven by bribery of government officials or bond underwriters. Exploiting the exogenous shock from China’s unprecedented anti-corruption campaign, we show that the effect of entertainment on credit rating is causal. The results are more pronounced during credit crunches and for firms with limited access to external finance. Overall, we identify a specific, external financing channel for bribery to create value for issuers and our study is among the first to quantify the marginal effect of bribery on firm value.

Credit Default Swaps and Corporate Debt Structure

Whether and how Credit default swaps (CDSs) affect corporate debt structure remains an unanswered question. We find that firms use more public debt and less bank debt when CDSs reference their debt start trading. The results are robust to the endogeneity of CDS trading. Furthermore, the increase in public debt is concentrated in senior bonds and notes, which are the most common CDS reference assets. The effect of CDS trading is most pronounced when bond underwriters take a net selling CDS position and for informationally opaque firms. These findings suggest that the hedging and informational roles of CDSs have real effects on corporate debt structure.

On the Benefits of Universal Banks: Concurrent Lending and Corporate Bond Underwriting

In this note, we explore whether "universal banks" provide value to firms through their ability to provide both lending and underwriting services.

What Makes Dealers Central? Evidence from Credit Interdealer Networks

We present a novel method for identifying the effect of search costs, risk appetite, and skill in explaining the differences between core and periphery dealers in the U.S. corporate bond market. Using a hand-constructed dataset that matches the trading activity of credit dealers in corporate bonds and positions from trading in CDS markets, we investigate the interdealer network structure at the bond-issuer level across both markets. We analyze the mean, volatility, and skewness of market-making returns to test theoretical predictions on dealer centrality and the distribution of their profit. Bond dealer centrality is associated with greater skill and risk appetite. More central dealers appear to have significantly less negative skewness in their trading returns, indicative of their ability to avoid bad trades. Bond underwriters, who have a search advantage, exhibit even less negative skewness, but lower mean and volatility of profits. Taken together, the moments of trading returns reveal a dealer's role in a market. These findings inform our understanding of regulatory policies such as the Volcker rule which target dealer trading in OTC markets.

Incentive Fees: Do They Bond Underwriters and IPO Issuers?

This paper examines the impact of incentive fees in mitigating conflicts of interest between the IPO firms and their underwriters. Consistent with cost minimisation hypothesis, our results show that granting incentive fees to underwriters results in lower listing costs and high IPO proceeds. We find IPOs that are large, not cash constrained at the time listing and those underwritten by reputable underwriters are more likely to offer incentive fees. Further tests reveal that incentive fees are granted when the market is volatile, but the average listing costs as a proportion of gross proceeds is 9.328% compared to 12.293% for IPOs that do not provide incentives to their underwriters. The listing costs decrease by 6.724% specifically for IPOs that offer incentive fees. Overall, the evidence shows that large Hong Kong IPOs can minimise their listing costs and maximise their proceeds by offering incentive fees to their underwriters as part of their compensation package.

Investment Opportunity Set, Product Mix, and the Relationship between Bank CEO Compensation and Risk-Taking

The product mix changes that have occurred in banking organizations during the 1990s provide a natural experiment for investigating how firms adjust their executive compensation contracts as their mix of businesses changes. Deregulation and new technology have eroded banking organizations’ comparative advantages and have made it easier for nonbank competitors to enter banking organizations’ lending and deposit-taking businesses. In response, banking organizations have shifted their sale mix toward noninterest income by engaging in municipal revenue bond underwriting, commercial paper underwriting, discount brokering, managing and advising open- and close-ended mutual funds, underwriting mortgage-backed securities, selling and underwriting various forms of insurance products, selling annuities, and other investment banking activities via Section 20 subsidiaries. These mix changes could affect firms’ risk and the structure of CEO compensation. The authors find that as the average banking organization tilts its product mix toward fee-based activities and away from traditional activities, equity-based compensation increases. They also find that more risky banks have significantly higher levels of equity-based compensation, as do banks with more investment opportunities. But, more levered banks do not have higher levels of equity-based CEO compensation. Finally, the authors observe that equity-based compensation is more important after the Riegle-Neal Act of 1994.

Bond markets and banks in inter-war Japan

The issuance of bonds increased in inter-war Japan, the main investors being banks because the demand for loans declined in this period. Banks that were more tolerant to risk (that is, whose capital ratio was higher) made a larger amount of loans, which were riskier than bonds. While national bonds were traded actively in secondary markets, local bonds, corporate bonds, and bank debentures were not traded actively during this period. After the formation of cartels of banks and securities firms for bond underwriting and trading during the Great Depression, bond trading in secondary markets diminished, except for national bonds.

Which Factors Affect Bond Underwriting Fees? The Role of Banking Relationships

Abstract The question of which factors are relevant in determining bond underwriting fees is empirically investigated by analysing 2,202 bond issues completed by European firms during the 1993 – 2003 period. Four major results emerge from the analysis. First, the introduction of the single currency in 1999 has generated an increase in competition among banks, and, as a result, a reduction in underwriting fees. Second, a strong relationship with the issuer's main bank reduces the level of underwriting fees. Third, new issuers are charged with lower underwriter fees relative to firms that have completed issues without building any strong relationship with a bank. Fourth, higher reputation banks charge lower underwriting fees. The implications of these findings are also discussed.

Distance Still Matters: Evidence from Municipal Bond Underwriting

Using a sample of municipal bond offerings, I find that “local” investment banks have substantial comparative and absolute advantages over nonlocal counterparts--locals charge lower fees and sell bonds at lower yields. Local investment banks’ strongest comparative advantage is at underwriting bonds with higher credit risk and bonds not rated by rating agencies. These findings suggest that high-risk bonds and nonrated bonds are more difficult to evaluate and market, and that investment banks with a local presence are better able to assess “soft” information and place difficult bond issues.

The Cost of Barriers to Entry: Evidence from the Market for Corporate Euro Bond Underwriting

The advent of the euro has eroded many of the barriers that segmented the European corporate bond market along currency lines and given rise to a unified market comparable in size to the one denominated in US dollars. In doing so, the new currency has made it easier for investment banks to explore scale economies in the provision of underwriting services, lowered the entry barriers to this industry, and made it easier for European borrowers to benefit from scope economies by combining their purchasing of commercial and investment banking services. This paper shows that the arrival of the euro led to a reduction in the underwriting fees of corporate bonds issued in the new currency and that this reduction was largely due to greater contestability of the investment banking business in the post-EMU European market. Our paper also shows that the elimination of market segmentation led to a migration of underwriting business towards the larger international investment banking houses, particularly those from the United States, rather than an intensification of the business links between euro area borrowers and bankers from the same country. Moreover, borrowers that chose American investment banks appear to have made extra savings in the underwriting fees. Finally, our analysis shows that these fee savings were not overcome by an increase in the credit spreads of these borrowers' bonds at issue date. Altogether, these results suggest that borrowers attach more weight to placing capacity than to business relationships in the choice of an underwriter.

Corruption, Political Connections, and Municipal Finance

We exploit unique features of the U.S. municipal bond underwriting market to assess how political integrity affects primary financial market outcomes. We show that state corruption and political connections have strong effects on several aspects of municipal bond sales and underwriting. Specifically, we find that higher state corruption is associated with greater credit risk, higher bond yields, greater use of external credit enhancement, and use of lower quality underwriters. States that are more corrupt can eliminate the corruption yield penalty by purchasing credit enhancements, effectively selling integrity-related default risk to an independent financial intermediary. Underwriting fees do not vary with cross-state corruption, but were significantly higher during an era when under writers routinely made political campaign contributions to win underwriting business. Furthermore, this pay-to-play underwriting fee premium exists only for negotiated bid bonds where underwriting business can be allocated on the basis of political favoritism. Overall, our results show a strong impact of state corruption and political connections on economic and financial outcomes.

Distance Still Matters: Evidence from Municipal Bond Underwriting

Using a sample of municipal bond offerings, I find that investment banks have substantial comparative and absolute advantages over non-local counterparts - locals charge lower fees and sell bonds at lower yields. Local investment banks' strongest comparative advantage is at underwriting bonds with higher credit risk and bonds not rated by rating agencies. These findings suggest that high risk bonds and non-rated bonds are more difficult to evaluate and market, and that investment banks with a local presence are better able to assess soft information and place difficult bond issues.

Warranty Bonds from the Perspective of Surety Companies

The recent economic downturn and an unexpected increase in losses have greatly affected the surety industry. Several top underwriters have left the surety market, and a large number of acquisitions and mergers have recently taken place in the industry. Also, many surety companies have changed their underwriting philosophy and raised their underwriting criteria and standards. Consequently, contractors are currently facing a more comprehensive list of questions in the underwriting process, as well as the reluctance of surety companies to increase bonding capacity Hughes 2002 . However, the concerns in the surety industry are not limited only to the recent unexpected losses. Another source of concern is the requirement for long-term warranty bonds by state departments of transportation DOTs on warranted highway projects. Sureties are mostly worried about the risks involved in issuing these long-duration bonds and the additional effort needed in the underwriting process. The ensuing increase in the premium rates and the limited availability of warranty bonds to small contractors are additional matters of concern Hastak et al. 2003 . In view of these observations, this forum provides valuable up-to-date information on warranty bonds from the perspective of surety companies and presents the results of a survey that was conducted for this purpose. Since the analysis is based on responses from surety companies in the United States that have experience with warranty bonds, the study becomes beneficial for industry practitioners and researchers because it can help them understand the opinions, expectations, and recommendations of warranty bond underwriters in the surety market.

Specialization of Bond Underwriters: Exogenous versus Endogenous Switching

This paper demonstrates that previous finding of commercial banks being superior to investment banks as bond underwriters is an artifact of misusing the treatment model. Although the treatment model considers endogenous selection, it does not permit selection based on the observable firm characteristics that also interact with different treatments (exogenous switching). Using the more general switching regressions model, I find that there is no such dominance between underwriter types. Issuers seeking to minimize interest costs have rationally selected the appropriate underwriters. The presence of exogenous switching also indicates that the matched sample method should be used cautiously.

Corporate Bonds Underwritten by Commercial and Investment Banks: Analyzing the Default Risk

Starting in the early 1990s, banks began to slowly make their way into securities underwriting using their Section 20 subsidiaries. With the enactment of the Gram-Leach-Bliley Act of 1999, the long-standing restrictions between commercial- and investment-banking activities were formally removed. Banks have not wasted any time utilizing these new powers, making significant inroads in bond and equity underwriting over the last few years. In 2003, banks accounted for 53 percent of the IPO volume and 61 percent of corporate bond underwriting. The rapid ascendancy of many large banks in the underwriting league tables has renewed the debate concerning the gains (private information certification benefits) and costs (conflicts-of-interest costs) of combining commercial and investment banking. This paper examines these competing views on bank entry by analyzing the post-issue performance of corporate bond issues managed by investment and commercial banks during 1990-2003. We find that both commercial banks and investment banks underwrote the same quality of high-yield bonds. Investment-grade bonds underwritten by banks exhibited higher default rates than investment bank issues. Bank-advised unrated bonds had a lower default rate, suggesting that banks may be better at certifying unrated opaque firms where private information is more critical. Moreover, we find that the aftermarket performance of bonds was not adversely influenced by pre-existing syndicated loan relationships between bank underwriters and issuers.