Lead Underwriter Research Articles

Should underwriters be trusted? Reducing agency costs through primary market supervision

We examine the mandated introduction of a supervised auction framework within China's primary bond market. This regulatory intervention resulted in a substantial reduction in debt costs for Chinese Bond issuers, primarily attributed to the alleviation of agency conflicts between underwriters and issuers. Leveraging unique bidder-level data obtained from a lead underwriter, our study provides replicable tools to discern collusive bidding behavior. This sheds light on instances of artificially inflated bond yields, highlighting economically burdensome practices. Our findings can assist regulators, issuers, and investors engaged in unsupervised auction mechanisms. Our insights offer potential enhancements to regulatory frameworks and operational efficiency across various sectors, including securities issuance, construction projects, and procurement.

Are Mondays different? Evidence from initial public offerings

This paper investigates how and why initial public offerings (IPOs) issued on Mondays differ from those on other days. We provide evidence that Monday IPOs make a significantly larger number of filing price amendments during the road show and set offer prices that exceed the filing price range, resulting in higher positive offer price revisions. We also find that Monday IPOs receive less analyst coverage than other-day IPOs, despite their underwriting fees being the same and their total underwriter compensation being higher. Therefore, Monday IPOs are more likely to change lead underwriters in subsequent equity offerings and have a higher risk of delisting as aftermarket support and maintaining good relations with investment banks are critical for their long run survival. We also investigate why underwriters issue IPOs on Mondays. We suggest four possible explanations for Monday IPOs and find indirect evidence that supports the deliberate road show extension explanation.

Multinational Corporations and SEO Discounts

The fact that publicly traded companies incur substantial costs when issuing new equity has been extensively documented in the empirical finance literature. In particular, numerous studies show that seasoned equity offerings (SEOs) tend to be priced significantly below prevailing market prices, thereby causing issuers to leave money on the table. Offer price discounting is an indirect flotation cost borne by pre-SEO shareholders that, according to extant theoretical and empirical research, arises due to asymmetric information. A heretofore unrelated literature argues that corporate multinationalism, i.e., establishing operations in one or more foreign countries, exacerbates the asymmetric information problem via greater costs to shareholders of monitoring the activities and performance of foreign subsidiaries. Motivated by these lines of thought, I investigate the relation between SEO discounting and corporate multinationalism. Using a sample of SEOs completed by U.S. firms between 1998 and 2016, I show that offer price discounting is significantly higher in offerings conducted by multinational firms relative to those conducted by purely domestic firms after controlling for known determinants of SEO discounts. This effect is stronger for multinational firms with foreign subsidiaries spread across a greater number of countries and weaker for multinationals that hire a high-reputation underwriter to lead the underwriting syndicate. These findings suggest that asymmetric information costs borne by seasoned equity issuers are increasing in the geographic scope of a firm’s operations, which can be mitigated by certification from a highly reputed lead underwriter.

The Economics of IPO Stabilization, Syndicates and Naked Shorts

Stabilization is the bidding for and purchase of securities by an underwriter immediately after an offering for the purpose of preventing or retarding a fall in price. Stabilization is price manipulation, but regulators allow it within strict limits – notably that stabilization may not occur above the offer price. For legislators and market authorities, a false market is a price worth paying for an orderly market. This paper compares the rational for regulators’ allowing IPO stabilization with its effects. It finds that stabilization does have the intended effects, but that underwriters also seem to have other motives to stabilize, including favouring certain aftermarket sellers and enhancing their own reputation and profits. A puzzling aspect of stabilization is why underwriters create ‘naked short’ positions which are loss-making to cover when, as is usual, the aftermarket price rises to a premium. We set up a model to show that the lead underwriter may profit from a naked short at the expense of the rest of the syndicate given the way commissions are apportioned between them. We argue that a naked short mitigates the misalignment of interests which stabilization causes between issuer and lead underwriter, although it does so at the expense of the non-lead underwriters.

Can experience mitigate precautionary bidding? Evidence from a quasi-experiment at an IPO auction

This paper explores whether market experience exacerbates or mitigates institutional investors’ precautionary bidding behavior. Using an IPO reform in China as an exogenous shock, we apply a difference-in-difference approach to identify a causal relationship between willingness to bid and market experience. The mutual funds’ willingness to bid for the IPOs decreased by 13.53 percentage points after the removal of the three-month IPO lockup period. A one-standard-deviation increase in market experience in terms of IPO participation mitigated 4.36 percent of the decline. The mitigation effect of market experience on precautionary bidding is more pronounced for IPO firms with disadvantaged geographical locations, is attenuated for IPOs certified by reputable underwriters, and is attenuated in mutual funds that have strong business ties with the lead underwriters. Furthermore, we find investors with more market experience help to improve the efficiency of IPO pricing.

Is money really left on the table? The role of regular investors in IPO pricing

AbstractWe study how ongoing relationships between lead underwriters and institutional investors affect initial public offering (IPO) pricing. By introducing a new approach, we find that stronger relationships reduce the partial adjustment of the offer price, leaving ‘excess underpricing’ that favors regular investors, especially in hot IPOs, while generating an agency cost for issuers. At the same time, stronger relationships lead to higher offer prices, since they reduce information asymmetries and uncertainty in the primary market. This ‘excess price adjustment’ creates value for issuers. Taken together, these two apparently contradictory results reveal a win‐win outcome for issuers and regular investors.

The role of expertise in syndicate formation

AbstractIn most initial public offerings around the world, an underwriter selects syndicate members and uses their information to set the offering price. The objective of this paper is to develop a model of the “book building” process in which the formation of the syndicate is an endogenous decision variable. I analyze when it may benefit the lead underwriter to select syndicate members with different expertise and to acquire all available information about the value of the shares. I show that the underwriter faces a tradeoff between the cost of extracting information and valuation accuracy. Specifically, when the issuer is a low‐risk firm, the costs of acquiring information are higher than the benefits in terms of price accuracy and forming a specialized syndicate is optimal. However, when retail investors' participation is high enough and when the issuer is a high‐risk and transparent firm, the lead underwriter' optimal strategy is to form a diversified syndicate.

Who Watches the Book Build? Supervising Primary Bondmarkets to Reduce Agency Costs

We study the mandated introduction of an auction (and its subsequent supervision) for the pri-mary bond market in China. These regulatory interventions significantly reduce the cost of debt for Chinese issuers. While this reduction is partly driven by reduced information asymmetry, we show the majority of the benefits flow from reduced agency conflict between underwriters and issuers. Using unique bidder-level data from a lead underwriter, we develop replicable tools and techniques to identify collusive bidding behavior that results in artificial (and economically costly) increases in bond yields. Such evidence can benefit global regulators, issuers and investors currently using unsupervised auction mechanisms.

Impact of Universal Banking on Investment Decisions of Bank-Dependent Firms

The advantages and disadvantages of universal banking have long been debated. Using the successive granting of lead underwriter qualifications to commercial banks in China as a quasi-natural experiment, we study the impact of universal banking on non-financial firms’ investment decisions. We find that after a firm’s main lending banks qualify as lead underwriters, the firm’s investment increases by 7.7 to 8.3 percent on a gross or net basis. The underlying mechanism is that universal banking can generate informational economies of scope and relax constraints on the provision of external finance. In contrast, we find no evidence on the conflict of interest between universal banks and their customers. Our study, therefore, sheds light on the potential gains from universal banking.

Hedge Funds and Their Prime Brokers: Favorable IPO Allocations

Do hedge funds receive special treatment from their prime brokers in initial public offering (IPO) allocations? Using a comprehensive dataset, the authors examine investment banks’ allocations of IPOs to their hedge fund clients. They find that investment banks/prime brokers that have business relationships with hedge funds tend to allocate more IPOs to those hedge funds when the banks are the lead underwriters. Moreover, the size of allocation to hedge funds is larger when IPOs are underpriced, and allocations are larger during bear equity markets. The authors document that younger funds or funds with recent poor performance tend to receive relatively larger allocations of underpriced IPOs. The size of these allocations is determined by the strength of the funds’ relationships with their prime brokers, rather than by the level of their managers’ skill. This is supported by the finding that, even after receiving relatively large allocations of underpriced IPOs, these funds fail to generate significant alphas. <b>TOPICS:</b>Security analysis and valuation, exchanges/markets/clearinghouses, real assets/alternative investments/private equity, performance measurement <b>Key Findings</b> ▪ Investment banks that act as prime brokers for hedge funds and are lead underwriters of IPOs tend to allocate larger amounts of underpriced IPOs to their hedge fund clients. ▪ Investment banks tend to allocate a larger amount to their clients during bear equity markets, with younger funds and those with poor recent performance receiving relatively larger allocations. ▪ Investment banks reward those clients that have stronger relationship with them. The skills of hedge fund managers do not drive the favorable allocations.

Geographic distance, firm affiliations, and IPO performance: evidence from China

ABSTRACT Firms going through an initial public offering (IPO) face many uncertainties. Geographic distance between the firm headquarters and the major financial centers, where most investors are located, is another concern. Using a sample of 688 Chinese initial public offerings between 2005 and 2012, we find that remote firms leave investors informationally disadvantaged leading firms to underprice their offering to a greater extent. Furthermore, we find that business affiliations (prestigious lead underwriters and government), which signal firm quality, lessen and the effect of geographic distance on underpricing. Thus, in an IPO context, signals have increasing value for more geographically isolated firms wishing to maximize initial public offering performance. Our study has implications for both academics and practitioners by offering new insights on how geographic distance and signals impact IPO performance.

The Rise and Fall of Banks: What is the Future for Banks?

As of 8/31/2020, the market cap (value) of Facebooks is $835.2 Billion, while the sum market caps of arguably top 5 Banks combined (J.P Morgan, Morgan Stanley, Bank of America, Wells Fargo and Citi Group) only $816.7 Billion. In fact, Facebook cap is 10 times larger than Morgan Stanley, the lead underwriter on the Facebook IPO. What is happening? How the value of a young (IPO in 5/2012) and such an average Tech company (less than half of Apple cap $2.21 Billion) exceeds the values of large banks with estimated asset management of $8.29 Trillion combined? Why a company with a relatively small revenue of only $75 Billion exceeds the value of these Banks with a combined revenue of $405 Billion (2019 revenues). The answer is simple, welcome to the tech revolution and good-bye to the industrial revolution. Facebook revenue grew 26.6% in 2019, while these five banks combined barely 3%; this is the entire story. With an easy access to raise capital via the stock market, and when investors can have zero commission fees due to the raise of Fintech (such as Robinhood), banks struggle. From the agriculture to the industrial revolutions, toward the current tech revolution, we are witnessing the rise and the fall of banks. Thus, Banks are no longer what called as “value stocks”; we brand them as ‘Sunset’ stocks: passed their prime time; and join long lists of companies like railroad, oil and gas, metals. This study also enhance our understanding of the valuation companies like Tesla, Amazon and PayPal stocks.

Do institutional investors play hide-and-sell in the IPO aftermarket?

We document a robust buy/sell asymmetry in the choice of the broker in the IPO aftermarket: institutions that sell IPO shares through non‑lead brokers tend to have bought them through the lead underwriters in the IPO aftermarket. This trading behavior is consistent with institutional investors hiding their sell trades and presumably breaking their laddering agreements with the lead underwriters. The asymmetry is the strongest in cold IPOs and is limited exclusively to the first month after the issue, when the incentives not to be detected are the strongest. We show that the intention to flip IPO allocations is not an important motive for hiding sell trades from the lead underwriters. We find that hiding sell trades is an effective strategy to circumvent underwriters' monitoring mechanisms: the more institutions hide their sell trades, the less they are penalized in subsequent IPO allocations.

When Is the Client King? Evidence from Affiliated-Analyst Recommendations in China’s Split-Share Reform

China’s split-share reform of 2005 (the Reform) converts the previously restricted shares held by founding shareholders to shares tradable on the open market. Against this backdrop, we study how underwriter-affiliated analysts and firms’ large shareholders interact in the event of the latter’s sales of restricted shares. We document that recommendations made by affiliated analysts are significantly more optimistic when firms’ large shareholders plan to sell their restricted shares. This optimism, however, is associated with negative post-sale stock returns, suggesting that large shareholders profit from share sales but at the cost of public investors. Furthermore, large shareholders sell more restricted shares through the affiliated brokerages with analysts issuing more optimistic recommendations and firms under their control are more likely to appoint such brokerages as lead underwriters when they refinance in the future. For the affiliated analysts, they conduct more site visits to the firms after the share sales, thereby improving their earnings forecast accuracy. Our analysis shows how conflicts of interest by financial intermediaries arise following the Reform and leads to large shareholders’ extraction of rents from public investors. These findings have regulatory implications.

When Is the Client King? Evidence from Affiliated‐Analyst Recommendations in China's Split‐Share Reform

ABSTRACTChina's split‐share reform of 2005 (the Reform) converts the previously restricted shares held by founding shareholders to shares tradable on the open market. Against this backdrop, we study how underwriter‐affiliated analysts and firms' large shareholders interact in the event of the latter's sales of restricted shares. We document that recommendations made by affiliated analysts are significantly more optimistic when firms' large shareholders plan to sell their restricted shares. This optimism, however, is associated with negative post‐sale stock returns, suggesting large shareholders profit from share sales. Furthermore, large shareholders sell more restricted shares through the affiliated brokerages for which analysts have issued more optimistic recommendations and firms under their control are more likely to appoint such brokerages as lead underwriters when they refinance in the future. The affiliated analysts also conduct more site visits to the firms after the share sales, thereby improving their earnings‐forecast accuracy. Our analysis shows how conflicts of interest by financial intermediaries arise following the Reform and lead to large shareholders' extraction of rents from public investors.

Sustainability of Analyst Recommendations in Multiple Lead Underwriter IPOs

Recently, a new organizational form of syndicate—multiple lead underwriter (MLU) initial public offerings (IPOs)—has emerged in IPOs. In addition to the increased deal complexity, lead underwriters in MLU IPOs face a new competition between them after underwriter selection, which is not present in single lead underwriter (SLU) IPOs. It is therefore questionable whether recommendations by analysts from lead underwriters of the MLU IPOs are as sustainable as those of the SLU IPOs. We examine IPO recommendations to capture how this new syndicate structure affects analyst behavior in terms of analyst optimism and investment value. In contrast to the popular conflict of interest perspective, our findings point to the notion that the new syndicate structure suppresses bias in recommendations and that reputation upholding incentive dominates pressure from competition. MLU-affiliated analysts are not more optimistic and provide more informative research coverage whose informativeness, however, fades away shortly after the recommendation releases. Our findings overall indicate the existence of sustainability in the MLU IPO recommendations.

Underwriter Networks, Information Asymmetry, and Seasoned Equity Offerings

Using various “centrality” measures from Social Network Analysis (SNA), we analyze, for the first time in the literature, how the location of a lead underwriter in its network of investment banks affects various aspects of seasoned equity offerings (SEOs). We hypothesize that investment banking networks perform an important economic role in the underwriting process for SEOs, namely, that of information dissemination, where the lead underwriter uses its investment banking network to disseminate information about the SEO firm to institutional investors. Consistent with the above information dissemination role, we show that SEOs with more central lead SEO underwriters are associated with a smaller extent of information asymmetry in the equity market. We then develop testable hypotheses based on the information dissemination role of underwriter networks for the relationship between SEO underwriter centrality and various SEO characteristics, which we test in our empirical analysis. Consistent with the above hypotheses, we find that SEOs with more central lead underwriters are associated with less negative announcement effects; smaller offer price revisions; smaller SEO discounts and underpricing; higher immediate post-SEO equity valuations; and greater post-SEO long-run stock returns. We also find that SEOs with more central lead underwriters are associated with greater institutional investor participation. Our instrumental variable (IV) analysis using the industry-average bargaining power of underwriters relative to issuers as the instrument show that the above results are causal. Consistent with greater value creation by more central lead underwriters, we find that more central lead underwriters receive greater compensation as a fraction of total SEO proceeds.

The Lead Underwriter Reputation and Underpricing: Study of Company’s IPO in Indonesia

We analyse the effect of lead underwriter reputation on underpricing during initial public offering (IPO) in the Indonesia Stock Exchange. This study predicts that companies using reputable lead underwriter will have a low level of underpricing. We analyse 163 companies that conduct an IPO from 2010 to 2017. The analysis results show that the reputation of a lead underwriter has a negative and significant effect on underpricing. This finding has an implication in the selection of underwriter during the IPO. For companies, underpricing is considered as the cost of capital. The higher the level of underpricing, the higher is the cost of capital in the IPO. This means that the funds collected by the firm during IPO are not optimal. Therefore, the findings of this study could be considered in determining the lead underwriter during the IPO.

The Determinants of IPO Withdrawals: Evidence From SPACs

This study examines the determinants of IPO withdrawal using a unique sample of Specified Purpose Acquisition Companies (SPACs) in the period 2003-2019. Our results show that both prospectuses' characteristics and market characteristics determine choices of withdrawal. The likelihood of withdrawals is in direct relation with the level of volatility on the day of IPO/withdrawal and if the acquisition target is in the private equity domain. SPACs are less likely to withdraw their IPO if they have a clear focus of acquisition, have a larger number of underwriters in the syndicate, and if their legal counsel is specialized in the SPAC market. We also document that the speed of IPO for SPACs is directly related to the level of the market, size of IPO, and if the CEO was previously manager of other public companies. On the other side, IPO takes longer if two lead underwriters underwrite SPAC.

The lead underwriter reputation and underpricing: study of company's IPO in Indonesia

The lead underwriter reputation and underpricing: study of company's IPO in Indonesia