Are Investment Banks Special Too? Evidence on Relationship‐Specific Capital in Investment Bank Services

The question of whether optimal provision of these services comes mainly from established relationships between banks and client firms or can result from arms'‐length market transactions has been the topic of considerable recent debate. This discussion has paralleled the debate in the commercial banking literature on the “specialness” of banks and whether lending can and should be relational or purely transactional. Whether the provision of investment bank services is relationship‐based or transactional is especially relevant now thanks to recent trends that have blurred the distinction between commercial and investment banks, and changed the competitive landscape for investment bank services. In their study summarized in this article, the authors examine whether investment bank‐client relationships create valuable relationship‐specific capital using stock market evidence from the period surrounding the collapse of Lehman Brothers. Specifically, they studied the effect of the Lehman collapse on companies that used Lehman for (1) underwriting equity offerings, (2) underwriting debt offerings, (3) advice on mergers and acquisitions, (4) analyst research services, and (5) market‐making services. The study addressed two specific questions. First, which investment bank services, if any, are associated with the creation of relationship‐specific capital; and second, what are the value drivers of this relationship capital? The authors report finding that companies that used Lehman as lead underwriter for public equity offerings experienced significantly negative abnormal stock returns in the days surrounding Lehman's bankruptcy announcement. By contrast, they find no significant reaction to the announcement for Lehman's debt underwriting clients or any of the other client categories they examine. While most of these investment bank services have at least the potential to create relationship‐specific capital, the authors' findings suggest that except for equity underwriting, all the other investment bank services appear to be transactional rather than relationship‐based, at least in the average case. Moreover, the authors report significant differences even among different groups of Lehman's equity underwriting clients. An equity underwriting relationship with Lehman appears to have been especially valuable for smaller, younger, and more financially constrained firms—those firms which presumably had a high degree of dependence on Lehman to access the capital market.     

Determinants of Underwriting Fees by New Entrant Banks: Evidence from the Japanese IPO Underwriting Market

This research investigates how banks expand market share after entering the underwriting market by examining the relation between commercial bank equity investments and underwriting fees. First, we find that not only bank underwriters with private information about issuers but also those without private information discount their fees, especially for smaller and riskier firms. This result is robust when using multiple firm‐bank relationship measures or when changing the investing stage. This is consistent with the strategic discount view that predicts that bank underwriters discount fees to expand bank market shares in underwriting markets.     

Great expectations: Banks as equity underwriters

We examine the in-roads commercial banks have made into equity underwriting over 1990–2002. While banks end the period handling upwards of 25% of equity underwriting, this increase results almost exclusively from acquisitions of investment banks with an already established market share of equity underwriting. We find a significant decline in the market share of equity underwriting that banks acquired in the post-merger period, a decline that is larger than that experienced by independent investment banks of comparable reputation. Banks lose market share because they originate fewer IPOs and their IPOs have a lower incidence of follow-on SEOs compared to independent investment banks. Following the merger, banks experience a large fall off in their ability to retain follow-on SEOs and are less successful in winning SEO mandates when an issuer switches from its IPO underwriter. Overall, the findings suggest it has been difficult for banks to achieve scope economies in equity underwriting.     

The Competitive Impact of Commercial Bank Underwriting on the Market for Municipal Revenue Bonds

This paper examines the impact of commercial bank entry in the market for municipal revenue bonds. We show that issues underwritten by commercial banks have lower underwriter spreads but not lower yields relative to issues underwritten by nonbank investment firms. In particular, this is more significant for non-investment-grade bonds underwritten by commercial banks. Our results are consistent with the interpretation that bank entry has resulted in increased competition in the municipal revenue bond market and that the lower yields observed for bank-underwritten commercial bonds may be due to banks having private information. Overall, our results suggest that policy changes leading to the relaxation of restrictive provisions concerning bank underwriting of municipal revenue bonds have had beneficial effects.     

Competing for underwriting market share: The case of commercial banks and securities firms

This study analyzes changes in the underwriting market share of securities firms and commercial banks over a 20-year period that encompasses the deregulation period of 1989–1999. The study finds that, after controlling for firm combination effects, there is no evidence that commercial banks gained share at the expense of ranked traditional underwriters. There is strong evidence that market breadth helps both securities firms and commercial banks to gain market share, whereas greater share in the underwriting of a specific security has the opposite effect on next year's market share. There is supportive but limited evidence that high-volume years favor commercial banks, whereas low-volume years favor prestigious underwriters. The influence of firm-specific factors is limited to a few markets, which may explain the stickiness of underwriting market share of ranked firms over time.     

Missing them yet? Investment banker directors in the 21st century

Subsequent to the stricter corporate governance listing standards adopted by the NYSE and NASDAQ in the early part of this century and the independence requirements of the Sarbanes Oxley Act of 2002 (SOX), the number of investment bankers (IB) serving on corporate boards has declined significantly. We document that the firms that lose the relationship with the investment bank after SOX become relatively more financially constrained soon after. The evidence is similar, albeit weaker, after departures of investment bankers at the advent of the financial crisis. We examine the mechanisms through which the constraints might be lowered, and observe that firms with IB directors face lower underwriting spreads when they issue equity and debt. Inconsistent with the hold-up problem associated with IB directors, the market reaction to seasoned equity offerings in firms with IB directors is less negative than comparable firms. The results point to costs associated with the increased attempts to improve board independence.     

Bank underwriting of debt securities: modern evidence

This article examines debt securities underwritten by Section20 subsidiaries of bank holding companies relative to thoseunderwritten by investment houses. Consistent with a net certificationeffect for banks, bank underwriting of lower credit rated firmsto whom the bank lends results in relatively higher prices (loweryields). We find no evidence of conflicts of interest even whenan issue is used to repay bank debt. Further, banks bring arelatively larger proportion of small issues to the market.Contrary to the contention that universal banking stunts availabilityof finance to small firms, bank underwritings appear to benefitsmall firms.     

Do subordinated debt holders discipline bank risk-taking? Evidence from risk management decisions

I test the market discipline of bank risk hypothesis by examining whether banks choose risk management policies that account for the risk preferences of subordinated debt holders. Using around 500,000 quarterly observations on the population of U.S. insured commercial banks over the 1995–2009 period, I document that the ratio of subordinated debt affects bank risk management decisions consistent with the market discipline hypothesis only when subordinated debt is held by the parent holding company. In particular, the subordinated debt ratio increases the likelihood and the extent of interest rate derivatives use for risk management purposes at bank holding company (BHC)-affiliated banks, where subordinated debt holders have a better access to information needed for monitoring and control rights provided by equity ownership. At non-affiliated banks, a higher subordinated debt ratio leads to risk management decisions consistent with moral hazard behavior. The analysis also shows that the too-big-to-fail protection prevents market discipline even at BHC-affiliated banks.     

Does the market discipline banks? New evidence from regulatory capital mix

While bank capital requirements permit a bank to freely substitute between equity and subordinated debt, lenders and investors view debt and equity as imperfect substitutes. It follows that, after controlling for the level of regulatory capital, the mix of debt in capital isolates the role that the market plays in disciplining banks. I document that the mix of debt in capital affects bank behavior, but only when investors can impose real constraints. In particular, the mix of debt reduces the probability of failure and future distress for BHC-affiliated institutions (where the investor has control rights through an equity position) and for stand-alone banks before the Basel Accord (when debt issues included restrictive covenants). However, substituting equity for subordinated debt at the bank holding company level or in stand-alone banks since the Basel Accord (where the investor has few protections) only increases the probability of distress and failure.     

Bank Equity Investments: Reducing Agency Costs or Buying Undervalued Firms? The Information Effects

Abstract:   This paper analyses the relevance of two different reasons for banks to acquire firms' stock: the increase of agency costs in the lending relationship (the agency costs hypothesis), and participation in the expected profits of undervalued firms (the information asymmetry hypothesis). Results indicate not only that banks make equity investments for both reasons but also that the market exploits their lending decisions to learn which of the two motivations was in play. Bank equity investments concurrent with reductions in bank debt are consistent with the agency costs hypothesis, whereas bank equity investments concurrent with increases in bank debt are consistent with the information asymmetry hypothesis.     

DO BANK RELATIONSHIPS MATTER IN PUBLIC DEBT OFFERINGS?

Finance theorists have argued that banks have a comparative advantage over public debtholders and other suppliers of debt both in gathering information about and in monitoring corporate borrowers. Although underwriters of public debt issues and private placements have access to inside information when executing specific transactions, commercial bankers have ongoing relationships with their corporate borrowers that have often been built up over years. Perhaps more important, banks are also often in a better position and have stronger incentives than a dispersed collection of bondholders to keep tabs on what the borrowers do after receiving the capital.
This theoretical argument received striking empirical support from a study by Chris James published in 1987 in the Journal of Financial Economics. Entitled "Some Evidence on the Uniqueness of Bank Loans," the study documented that announcements of new bank lending aggreements by public firms are received positively, on average (and in a large majority of cases) by the stock market. This finding offered a pointed contrast to the neutral to sharply negative stock-price responses that accompany announcements of almost all other kinds of securities offerings, including private placements of debt and public offerings of straight debt.
In this article, the authors discuss their own recently published study that provides another piece of evidence of the value added by banking relationships. Specifically, the authors report that the first public debt offerings of companies with bank relationships carry spreads that are 85 basis points less than the spreads of initial debt issues by comparable firms without bank relationships. As the authors interpret their findings, a banking relationship not only helps to "certify" the value of corporate borrowers to their stockholders, but also provides other lenders with valuable "cross-monitoring" benefits that are reflected in lower borrowing costs.     

IPO underwriting and subsequent lending

This study investigates the relation between IPO underwriting and subsequent lending. We find that when a bank underwrites a firm’s IPO, the bank is more likely to provide the issuer with future loans at a lower cost, compared to banks without an IPO underwriting relationship. The evidence also suggests that the underwriting banks share information surplus with the IPO firms in the post-IPO loans, supporting the cost-saving hypothesis. Overall, the evidence for the relation between prior IPO underwriting and subsequent lending supports the notion that firms can derive value from investment bank relationships.     

The Rise of Accelerated Seasoned Equity Underwritings

Seasoned equity offerings (SEOs) executed through accelerated underwritings have recently seen significant increases in global market share, and now account for a majority of the proceeds from both U.S. and European SEOs. Based on their study of over 30,000 global SEOs during the period 1991‐2004, the authors conclude that accelerated offerings occur more rapidly (as their name suggests), raise more capital, and require fewer underwriters than conventional fully marketed SEOs. Accelerated transactions also typically involve larger, better‐known companies that tend to be selling substantial amounts of secondary as well as primary secondary shares (whereas traditional SEOs consist almost entirely of primary shares). Besides speed of execution, the growing popularity of accelerated deals is also attributed to lower spreads, the reduced price risk for issuers resulting from the brief underwriting period, and “market‐impact” costs that are no larger than those that accompany traditional SEOs. Indeed, according to the authors' estimates, accelerated deals reduce the total issuance costs of U.S. issuers—in the form of lower spreads, market‐impact costs, and underpricing—by 250 basis points, on average, while the cost reduction for European sellers is said to be close to 400 basis points. The authors also present an analysis of SEO investment banking syndicates that illustrates that accelerated deals yield much smaller, more capital‐intensive, and presumably riskier underwriting syndicates that generate comparable revenues over much shorter transactions periods. In so doing, they enable larger, more reputable banks to “buy” market share and league table rankings. The authors' findings underscore three major trends that are shaping global investment banking. First, the fact that accelerated deals are marketed almost exclusively to institutional investors, and that these underwriting methods are gaining market share, suggests the declining importance of retail investors in equity markets everywhere. Second, the rise of accelerated deals both promotes and reflects increasing concentration in the investment banking industry, since only the largest banks have the capital base and risk tolerance required to buy large share blocks outright and assume all or most of the price risk of later resale. Finally, the increasing use of accelerated underwritings for SEOs provides another case of the “commoditization” of financial transactions characterized by relatively low asymmetric information. Since ATs can be employed for shares of only large and well‐known companies, these offerings are executed very quickly and cheaply—in much the same way plain vanilla corporate bonds are sold—and with minimal need for the placement and marketing services that investment banks use for IPOs and other non‐transparent security offerings.     

Do Bank Relationships Affect the Firm's Underwriter Choice in the Corporate‐Bond Underwriting Market?

This paper studies the effect of bank relationships on underwriter choice in the U.S. corporate‐bond underwriting market following the 1989 commercial‐bank entry. I find that bank relationships have positive and significant effects on a firm's underwriter choice, over and above their effects on fees. This result is sharply stronger for junk‐bond issuers and first‐time issuers. I also find that there is a significant fee discount when there are relationships between firms and commercial banks. Finally, I find that serving as arranger of past loan transactions has the strongest effect on underwriter choice, whereas serving merely as participant has no effect.     

Do the equity holding and soundness of bank underwriters affect issue costs of SEOs?

This paper examines the effects of characteristics of bank underwriters on issue costs in seasoned equity offerings in Japan following deregulation in 1999. I find that banks’ holding loans have a negative effect on price discounts and no effect on underwriting fees. However, banks’ equity holdings have no effect on discount rates and a positive effect on underwriting fees. Furthermore, issuers with unhealthy banks pay higher discount rates, are more likely to be weak in their ex-post operating performance, and are less willing to switch underwriters. I conclude that the characteristics of banks have different effects on issue costs.     

On the wealth and risk effects of commercial bank expansion into securities underwriting: An analysis of Section 20 subsidiaries

We investigate the abnormal returns and market-based risk effects of four Federal Reserve Board decisions to allow bank holding companies to engage in investment banking through Section 20 subsidiaries. Positive abnormal returns for commercial banks were observed for initial, limited powers granted by the Federal Reserve. However, authorization to engage in underwriting corporate debt and equity and subsequent expansion of potential revenues from underwritings produced negative abnormal returns and increases in risk.     

Global equity offerings and access to domestic loan market: U.S. evidence

This study examines whether and to what extend global equity offerings at the IPO stage may affect issuing firms' ability to borrow in the domestic debt market. Tracking bank loans taken by U.S. IPO firms in the domestic syndicated loan market, we observe that global equity offering firms experience more favorable loan price than that offered to their domestic counterparts. This finding holds for a set of robustness tests of endogeneity issues. We also find that, compared with their domestic counterparts, global equity offering firms are less likely to have financial distress, engage more in international diversification, and are more likely to wait a longer time to apply for syndicated loans.     

Some Evidence on the Uniqueness of Initial Public Debt Offerings

Debt initial public offerings (IPOs) represent a major shift in a firm's financing policy by both extending debt maturity and altering the public-private debt mix. In contrast to findings for seasoned debt offerings, we document a significantly negative stock price response to debt IPO announcements. This result is consistent with debt maturity and debt ownership structure theories. The equity wealth effect is negatively related to the offer's maturity, and positively related to the degree of bank monitoring. We find that firms with less information asymmetry and firms with higher growth opportunities experience a less adverse stock price response.     

银行竞争提高了企业投资水平和资源配置效率吗？——基于分支机构空间分布的研究

银行贷款是我国企业融资的重要方式,在企业生产经营中发挥着举足轻重的作用。2006年和2009年,我国先后两次放松了商业银行分支机构市场准入规制,银行分支机构空间分布发生了较大变化,银行竞争水平和服务实体经济能力明显提升。本文利用2001-2012年国家统计局工业企业数据,以企业周边银行分支机构的数量衡量银行竞争水平,研究银行竞争对企业投资的影响。研究发现,银行分支机构数量的增加显著提高了企业投资水平和投资效率。进一步研究表明,银行分支机构数量增加对企业投资效率的提升作用主要表现在投资不足的企业和非国有企业中,企业融资约束降低和代理冲突减弱是银行竞争提高企业投资效率的主要原因。本研究拓展了银行竞争以及企业投资和资源配置效率的相关文献,对供给侧结构性改革和银行业高质量发展具有启示意义。     

Breaking down the barriers: Competition,syndicate structure,and underwriting incentives

We argue that the entry of commercial banks into bond underwriting led to the evolution of co-led underwriting arrangements and lowered the screening incentives of underwriters. Lead underwriters in co-led syndicates faced weaker incentives to screen issuer quality. In boom markets, issues underwritten by co-led syndicates were more likely to be involved in financial misrepresentation events. Underwriter incentives in co-led syndicates were particularly weak in industries where commercial banks stole substantial market share. Similar patterns do not hold in bust markets where investors are likely to engage in their own information collection efforts. Our results suggest that competition may have an adverse effect on the incentives of financial intermediaries in market environments where their information production is more valuable to investors.