Lead Underwriter Research Articles

SOME LENDERS ARE MORE EQUAL THAN OTHERS.

This paper considers the use of financing as a strategic variable. Specifically, I investigate the value creation of bank loans and how that value is moderated by lender reputation and potential conflicts of interest between the lender's securities underwriting and loan-making functions. Using an empirical specification that accounts for the endogeneity of lender selection, I find a strong positive association between lender reputation and the magnitude of the borrower stock price response to the public announcement of the loan, suggesting that better lenders create more firm value for their borrowers. In addition, when the borrower is a high volume issuer of debt or equity, I find that the borrower stock price response is higher if the lender does not act as a lead underwriter for one of the borrower's securities issues soon before or after the loan becomes public information. The implication for managers is that developing a relationship with the right financial intermediary is a key driver for building firm value.

IPO Placement Risk and the Number of Co‐Managers

AbstractPrevious studies show that co‐managers mainly affect initial public offering (IPO) aftermarket activities. We investigate the role of co‐managers in IPO pre‐market activities. We argue that co‐managers help reduce IPO placement risk and hypothesize that IPO issuers hire more co‐managers when placement risk is higher. We find the number of co‐managers is positively associated with three proxies for placement risk. IPOs with more price uncertainty and high‐tech IPOs hire more co‐managers, while IPOs in regulated industries hire fewer co‐managers. We also find larger IPOs, recent IPOs, and IPOs with more reputable lead underwriters hire more co‐managers.

Strength of analyst coverage following IPOs

Firms with poor aftermarket performance are given higher target prices and are more likely to receive strong buy recommendations, especially by analysts affiliated with the lead underwriter. This favorable coverage is relatively short lived, typically lasting less than six months. Controlling for the quantity of coverage received, stock prices of newly public firms increase more when the target price ratio is high and recommendation is a strong buy. These results suggest that when a firm goes public, underwriter-affiliated analysts provide protection in the form of “booster shots” of stronger coverage if the firm experiences poor aftermarket stock performance.

Small Investor Demand and Allocation in Commercial Bank Managed IPOs

There is a burgeoning literature on IPO allocations to institutions with retail clientele typically being treated as a monolithic entity. However, there is potential for differential treatment of different groups of retail investors because of the underlying relationship with the underwriter. We use a unique proprietary dataset from Germany to analyze how commercial banks treat different groups of retail investors in their underwriting of new equity issues. Do banks take advantage of retail investors to dump lemons or do their retail investors benefit from getting higher allocation of underpriced issues? We provide evidence that lead underwriters' retail customers demand more of the highly underpriced issues and end up with a higher allocation of underpriced issues. We additionally provide evidence on the underlying incentives of the bank to treat their retail clientele well by examining cross-selling potential from other services of the bank. In particular, we document an increase in both new brokerage accounts and retail consumer loans which are related to increased IPO underwriting, especially underwriting of underpriced IPOs by the commercial bank. Our results support the notion that the underlying relationship with the retail clientele and the potential to offer other services can not only result in differential or favored retail treatment but can lead to incentives for the bank to underprice IPOs to attract new retail customers. This suggests a number of new research questions relevant in many regimes including the current US regulatory setting where both commercial banks and investment banks underwrite.

Purchasing Ipos with Commissions

Using a proprietary database of institutional trades, we find direct evidence that institutions churn stocks, increase the average commission per share they pay, and pay unusually high commissions on some trades in order to send abnormally high commissions to lead underwriters of upcoming profitable IPOs. We show that these excess commission payments are a particularly effective way for transient investors to receive lucrative IPO allocations, and that the presence of abnormal commission payments is related to underwriter characteristics, including the concentration of the underwriter’s client base. Our results suggest that the underwriter’s concern for their long-term client relationships limits the payment-for-IPO practice. We estimate that abnormal commission payments are large for the most profitable issues, and that an additional $1 excess commission payment to the lead underwriter results in $2.21 in investor profits from allocated shares.

An examination of large sell orders in cold IPO aftermarkets

It is well-known that investment banks routinely take large naked short positions for low demand IPOs, and for such cold IPOs, the immediate sale of initial allocations back to the market accounts for a relatively large proportion of total trading volume. In this paper, we investigate the relationship between investment banks and institutional investors during the stabilization period. Specifically, we hypothesize that lead underwriters cover their short positions through selective share buy-back from institutional investors at the offer price. Using trade data, we examine the trading patterns of large (institutional) and small (retail) trades during the stabilization period. We find that a large proportion of institutional sells take place at the offer price, while a large proportion of retail sells take place below the offer price in a cold IPO stabilization period. We then estimate the information content of all trades to determine whether seller-initiated trades from institutional investors are correctly anticipated by the investment bank in an effort to cover their short position. If they are anticipated, these trades would carry little to no new information. Indeed, we find that the information content of large sell orders in cold IPO aftermarkets is lower than the information content of small trades, and is the least compared to several control samples. The results are robust and survive controls for external factors such as volume, turnover, and volatility. These results suggest that lead underwriters allow their valuable buy-side clients to sell back cold IPO allocations at the offer price.

An Examination of Large Sell Orders in Cold IPO Aftermarkets

Investment bankers routinely take large naked short positions in low demand or cold IPOs, and flipping accounts for a relatively large proportion of trading volume in cold IPOs. We hypothesize that lead underwriters cover their short positions through selective buy-back of shares from institutions at the offer price during the stabilization period. The empirical implication is that the information content of these anticipated bulk trades will be small relative to other trades. Our results support this hypothesis and we offer the following explanation. Lead underwriters provide institutions with an escape mechanism if they do not wish to retain their initial share allocations because they are valuable buy-side clients involved in a repeated game. Such an escape mechanism entails the investment banker anticipating that some bulk flipped trades will occur that s/he will use to cover the short position in cold IPOs. Thus, there is no 'surprise' or information content in such bulk flipped trades. The idea that lead underwriters provide selective price support to institutions in the stabilization period is consistent with accounts in the popular press which indicate that restrictions on flipping are not uniformly applied and retail clients are specifically under duress not to flip their allocations.

Strength of Analyst Coverage Following IPOs

Firms with poor aftermarket performance are given higher target prices and are more likely to receive strong buy recommendations, especially by analysts affiliated with the lead underwriter. This favorable coverage is relatively short-lived, lasting for only the first one or two analyst reports, typically less than six months. Controlling for the quantity of coverage received, stock prices of newly public firms increase more when the target price ratio is high and the recommendation is a strong buy. These results suggest that when a firm goes public, underwriter affiliated analysts provide protection in the form of market-moving booster shots of stronger coverage if the firm experiences poor aftermarket stock performance.

Analyst Hype in IPOs: Explaining the Popularity of Bookbuilding

The bookbuilding procedure for selling initial public offerings (IPO) to investors has captured significant market share from auction alternatives in recent years, despite the significantly lower costs related to the auction mechanism in terms of direct fees and initial underpricing. This article shows that in the French market, where the frequency of bookbuilding and auctions was approximately equal in the 1990s, the ostensible advantages to the issuer using bookbuilding were advertising-related benefits. Specifically, we find that book-built issues were more likely to be followed and positively recommended by the lead underwriters, as well as to receive booster shots after issuance if the shares had fallen. Even nonunderwriters' analysts appear to promote book-built issues more but only as a way of currying favor with the IPO underwriter for allocations of future deals. Yet we do not observe valuation or post-IPO return differentials that suggest these types of promotion have any value to the issuing firm. We conclude that underwriters using the bookbuilding procedure have convinced issuers of the questionable value of the advertising and promotion of their shares.

Who trades IPOs? A close look at the first days of trading

I examine the enormous trading volume in the first two days of trading following an initial public offering (IPO) with a sample of Nasdaq IPOs. The composition of trading varies widely with the initial return and not all trading is investor-related. Cold IPOs have a high proportion of interdealer sell trades, whereas hot IPOs have balanced investor buying and selling. Market makers hold zero inventory throughout trading, offsetting any investor inventory imbalance with a trade with the lead underwriter. The paper also helps resolve the disconnect reported in the literature between high initial trading volume and low “flipping” activity.

Affiliated Mutual Funds and the Allocation of Initial Public Offerings

We examine how investment banks use initial public offerings (IPOs) in relation to their affiliated mutual funds. The dumping ground hypothesis predicts that the lead underwriter allocates cold IPOs to its affiliated funds so that more deals can be completed when demand for these IPOs is weak. Affiliated funds may also receive more cold IPOs because the lead underwriter uses allocations of hot IPOs to unaffiliated funds to gain trading commission business. The nepotism hypothesis predicts that the lead underwriter allocates hot IPOs to its affiliated funds to boost their performance and thus attract more money. We find little evidence supporting the dumping ground hypothesis, although there is some evidence supporting the nepotism hypothesis, especially during the internet bubble period of 1999-2000.

Commercial Banks in IPO underwriting: How do their Retail Investors Fare?

This paper analyzes how universal banks treat different groups of retail investors in new equity issues. Do banks take advantage of their retail investors to sell lemons or do their retail investors benefit from getting more of the issues? We provide evidence from a proprietary dataset to show that lead underwriter's retail customers demand more of the highly underpriced issues and less of the overpriced issues. As a result lead-retail investors end up with a higher allocation of underpriced issues. Thus, underwriters care about their retail customers who benefit from getting more of hot issues as opposed to lemons. One important reason for the favorable treatment, that we provide some evidence for, is the cross-selling potential from new brokerage accounts that customers have to open to subscribe to new equity issues.

Do Independent Analysts Provide Superior Stock Recommendations?

Many investors were upset with the losses they experienced by following the recommendations of stock analysts during the recent market downturn. Allegations that these recommendations were often tainted by investment banking relationships fueled their anger. This study examines the investment performance of stock recommendations made by analysts employed by lead underwriters as compared to analysts independent of investment banking. The results indicate that during the 1994-2003 time period, affiliated analysts offered inferior investment advice for all recommendation categories except Sell. The paper then examines possible causes and finds that investment banking conflict of interest is a more complete explanation than a selection bias.

The Naked Short Puzzle, Syndicate Conflicts and IPO Underpricing

This paper provides a model to explain a puzzle connected with IPOs: why underwriters often create naked short positions - not covered by an over-allotment option - when share prices usually increase in the aftermarket, exposing them to loss. We focus on the economics of stabilization and naked short positions, and show how the lead underwriter's objectives can differ from those of the other underwriters. The disparity between the lead's share of stabilization profits and losses on the one hand and her share of selling concession on the other provides an explanation why she may have an interest in establishing a naked short even if the coverage of it is costly to the underwriters as a whole. Naked shorts, once established, incentivize the lead to price IPOs accurately. They could, if made a requirement by issuers, limit underpricing.

Why are IPO Investors Net Buyers through Lead Underwriters?

In Nasdaq IPOs between 1997 and 2002, clients of the lead underwriter bought shares worth $35.36 billion on the first day of public trading but sold shares worth only $21.45 billion, leading to a net buy imbalance of $13.91 billion, or 8.79 percent of the shares issued. The strong net buying activity through the lead underwriter is driven by large trades and widely present in IPOs of various degrees of underpricing. We investigate several explanations and find no support for long-term shareholders buying to build larger positions, for clients buying because of superior execution quality, or for clientele effects. Consistent with lead underwriters extracting rents from their clients, client net buying is driven by large trades, persistent even in cold IPOs, greater for underwriters that issue multiple IPOs, coupled with relatively higher transactions costs and associated with more transient institutional ownership. Price contribution analyses show that client net buying through the lead underwriter contributes significantly to first-day price increases.

Analyst Hype in IPOs: Explaining the Popularity of Bookbuilding

The bookbuilding procedure for selling initial public offerings (IPO) to investors has captured significant market share from auction alternatives in recent years, despite the significantly lower costs related to the auction mechanism in terms of direct fees and initial underpricing. This article shows that in the French market, where the frequency of bookbuilding and auctions was approximately equal in the 1990s, the ostensible advantages to the issuer using bookbuilding were advertising-related benefits. Specifically, we find that book-built issues were more likely to be followed and positively recommended by the lead underwriters, as well as to receive booster shots after issuance if the shares had fallen. Even nonunderwriters' analysts appear to promote book-built issues more but only as a way of currying favor with the IPO underwriter for allocations of future deals. Yet we do not observe valuation or post-IPO return differentials that suggest these types of promotion have any value to the issuing firm. We conclude that underwriters using the bookbuilding procedure have convinced issuers of the questionable value of the advertising and promotion of their shares

Stacking the deck: the effects of top management backgrounds on investor decisions

Young firms going public are dependent upon the decisions of investors for a successful public offering. Yet convincing investors to invest is not easy, as young firms have limited track records and, thus, face challenges associated with gaining legitimacy in their respective industries. This paper examines ways in which select information about firms undertaking an initial public offering (IPO) can affect investor decisions. Building upon recent research on upper echelons and signaling theory, we propose that the composition of a firm's top management team can signal organizational legitimacy that in turn affects investor decisions. In the context of young firms undertaking an IPO, such signals are critical, especially when objective measures of firm quality are not easily available. We introduce a typology of signals of organizational legitimacy to elaborate on our hypotheses. Analyses of a comprehensive set of data on the career histories of the top management teams of young biotechnology firms show that investor decisions are affected by the extent to which a firm's top management team has employment affiliations with prominent downstream organizations (e.g., pharmaceutical companies), with a diverse range of organizations, and upon the role experience of one key member of the top management team—the Chief Scientific Officer. We assess and find that these effects are not mediated by the prestige of a firm's lead underwriter. We conclude with a discussion of the implications of our study for strategy research on upper echelons and organizational legitimacy. Copyright © 2006 John Wiley & Sons, Ltd.

Underwriter Competition and Gross Spreads in the Eurobond Market

We investigate the competitive landscape of underwriting services in the Eurobond market including the choice of underwriter and underwriter gross spread. We find a significant but declining association between the home market of the Eurobond's currency of denomination and that of the lead underwriter. These bonds underwritten by unerwriters 'local' to the currency also carry significantly lower underwriter gross spreads vis-a-vis other Eurobonds. The amalgamation of the European currencies into the Euro resulted in a significant shift in the competitive landscape for underwriting services. We find a significant portion of market shares shifted from the 'local' European underwriters to non-'local' U.S. underwriters with the introduction of the Euro. Moreover, the volume of new issues rose and the gross underwriter spread declined significantly. Our empirical results suggest that Eurozone underwriters responded to the increased entry of U.S. and other Eurozone underwroters with aggressive discounting of the underwriter gross spread.

Do Initial Public Offering Firms Purchase Analyst Coverage with Underpricing?

ABSTRACTWe report that initial public offering (IPO) underpricing is positively related to analyst coverage by the lead underwriter and to the presence of an all‐star analyst on the research staff of the lead underwriter. These findings are robust to controls for other determinants of underpricing and to controls for the endogeneity of underpricing and analyst coverage. In addition, we find that the probability of switching underwriters between IPO and seasoned equity offering is negatively related to the unexpected amount of post‐IPO analyst coverage. These findings are consistent with the hypothesis that underpricing is, in part, compensation for expected post‐IPO analyst coverage from highly ranked analysts.

The benefits and costs of underwriters’ social capital in the US initial public offerings market

This study explores the factors that influence the degree to which brokers in mediated markets employ their social capital to benefit either buyers or sellers in the context of underwriters’ involvement in the US initial public offerings (IPO) market. This study finds that the embeddedness of the lead underwriter with institutional investors in an IPO deal network is negatively associated with IPO stock underpricing when demand for the offering is low, thereby benefiting the seller, but is positively associated with the amount of underpricing when demand for the IPO is high, thereby benefiting the buyers. High underwriter embeddedness with institutional investors also reduces the negative relationship between underwriters’ reputation and underpricing.