The market for certification by external parties: Evidence from underwriting and banking relationships

This paper provides evidence that an underwriter is better able to certify an equity issue if it has a lending relationship with the firm. An announcement of being underwritten by the firm’s lending-relationship bank reduces ex post information asymmetry, thereby improving the announcement return. Further, because this reduction in information asymmetry effectively disseminates what was previously the lending bank’s private information, it decreases its affiliated market maker’s information advantage, thus reducing its contribution to price discovery and liquidity. These results provide evidence on the value of information production and transmission by banks, and more generally on the role of external parties in reducing information asymmetry.     

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.     

Information verifiability, bank organization, bank competition and bank-borrower relationships

This paper investigates whether the benefits of bank-borrower relationships differ depending on three factors identified in the theoretical literature: verifiability of information, bank size and complexity, and bank competition. We extend the current literature by analyzing how relationship lending affects loan contract terms and credit availability in an empirical model that simultaneously accounts for all three of these factors. Based on Japanese survey data we find evidence that the benefits from stronger bank-borrower relationships in terms of credit availability are limited to smaller banks. However, when the benefits are measured as improved credit terms, we find little additional benefit, and in some cases increased cost, from stronger relationships for opaque borrowers and for borrowers who get funding from small banks. These latter findings suggest the possibility that relationship borrowers may suffer from capture effects.     

Bought deals: The value of underwriter certification in seasoned equity offerings

The bought deal is the predominant method of underwriting SEOs in Canada. Offer prices are set and underwriters commit to purchase offerings several days earlier for bought deals than for firm commitment issues, implying stronger underwriter certification for bought deal issues. Consistent with the certification hypothesis, this study finds a significantly smaller negative stock price reaction around the announcement of bought deals compared to firm commitment issues. Bought deals are further shown to have smaller offer price discounts and smaller underwriting fees, implying superior pricing and thus, higher quality offerings. These findings suggest that investment banks’ underwriting method of choice is informative of issue quality.     

Bank size and risk-taking under Basel II

We analyze the relationship between bank size and risk-taking under the Basel II Capital Accord. Using a model with imperfect competition and moral hazard, we show that the introduction of an internal ratings based (IRB) approach improves upon flat capital requirements if the approach is applied uniformly across banks and if the costs of implementation are not too high. However, the banks’ right to choose between the standardized and the IRB approaches under Basel II gives larger banks a competitive advantage and, due to fiercer competition, pushes smaller banks to take higher risks. This may even lead to higher aggregate risk-taking.     

Local underwriter oligopolies and IPO underpricing

We develop a theory of initial public offering (IPO) underpricing based on differentiated underwriting services and localized competition. Even though a large number of investment banks compete for IPOs, if issuers care about non-price dimensions of underwriting, then the industry structure is best characterized as a series of local oligopolies. We test our model implications on all-star analyst coverage, industry expertise, and other non-price dimensions. Furthermore, we posit that venture capitalists (VCs) are especially focused on all-star analyst coverage, and develop the analyst lust theory of the underpricing of VC-backed IPOs. Consistent with this theory, we find that VC-backed IPOs are much more underpriced when they have coverage from an all-star analyst.     

Bank incentives and suboptimal lending decisions: Evidence from the valuation effect of bank loan announcements in Japan

Using a sample of bank loan announcements in Japan, we examine whether or not banks have incentives to engage in suboptimal lending that results in wealth transfer from the banks to the borrowing firms. We find that abnormal returns for borrowing firms are significantly positive, but those for lending banks are sometimes significantly negative. Furthermore, the announcement returns for borrowing firms are negatively related to those for lending banks, especially when poorly performing firms borrow from financially healthy (low-risk) banks. Our results suggest that the positive valuation effect of bank loan announcements for borrowing firms is mainly due to a wealth transfer from lending banks.     

Understanding partial mergers in Japan

Since the late 1990s, Japan has witnessed a substantial increase of partial mergers where two or more firms spin off whole operations in the same business and combine them into a joint venture (JV). This paper provides the first academic evidence on this phenomenon. I find that partial mergers normally occur as a response to negative economic shocks by firms that are larger and more diversified than firms in total mergers. An event study identifies positive and significant returns to partial merger announcements. Unlike total mergers whose value accrues mostly to the shareholders of small (acquired) firms, large and small firms in partial mergers receive comparable returns, which are particularly large to firms forming an equally owned JV. This study also finds that partial mergers are often ex post transformed, with equity sale between partners being the main source of change.     

Disclosure and agency conflict: Evidence from mutual fund commission bundling

This study provides empirical evidence on the role of disclosure in resolving agency conflicts in delegated investment management. For certain expenditures, fund managers have alternative means of payment which differ greatly in their opacity: payments can be expensed (relatively transparent); or bundled with brokerage commissions (relatively opaque). We find that the return impact of opaque payments is significantly more negative than that of transparent payments. Moreover, we find a differential flow reaction that confirms the opacity of commission bundling. Collectively, our results demonstrate the importance of transparency in addressing agency costs of delegated investment management.     

Regulatory competition and forbearance: Evidence from the life insurance industry

Regulatory separation theory indicates that a system with multiple regulators leads to less forbearance and limits producer gains while a model of banking regulation developed by Dell’Ariccia and Marquez (2006) predicts the opposite. Fragmented regulation of the US life insurance industry provides an especially rich environment for testing the effects of regulatory competition. We find positive relations between regulatory competition and profitability measures for this industry, which is consistent with the Dell’Ariccia and Marquez model. Our results have practical implications for the debate over federal versus state regulation of insurance and financial services in the US.     

Banking relationships and access to equity capital markets: Evidence from Japan’s main bank system

We study the role of banking relationships in IPO underwriting. When a firm in Japan goes public, it can engage an investment bank that is related through a common main bank, or can select an alternative investment bank. The main bank relationship can be an efficient way for the investment bank to acquire information generated by the main bank, but may give rise to conflicts of interest. We find that main bank relationships give small issuers increased access to equity capital markets, but that issuers of large IPOs often switch to non-related investment banks that are capable of managing large offerings. While investment banks seek to exploit bargaining power with related issuers, issuers respond to expected high issue cost by switching to non-related investment banks. The net result is that total issue costs through related and non-related investment banks are similar. With respect to aftermarket performance and use of proceeds, we find no evidence of conflict of interest or self-dealing for either the main bank or the investment bank.     

The impact of central clearing on counterparty risk,liquidity, and trading: Evidence from the credit default swap market

This paper examines the impact of central clearing on the credit default swap (CDS) market using a sample of voluntarily cleared single-name contracts. Consistent with central clearing reducing counterparty risk, CDS spreads increase around the commencement of central clearing and are lower than settlement spreads published by the central clearinghouse. Furthermore, the relation between CDS spreads and dealer credit risk weakens after central clearing begins, suggesting a lowering of systemic risk. These findings are robust to controls for frictions in both CDS and bond markets. Finally, matched sample analysis reveals that the increased post-trade transparency following central clearing is associated with an improvement in liquidity and trading activity.     

Competition from Large, Multimarket Firms and the Performance of Small, Single-Market Firms: Evidence from the Banking Industry

We offer and test two competing hypotheses for the consolidation trend in banking using U.S. banking industry data over the period 1982–2000. Under the efficiency hypothesis , technological progress improved the performance of large, multimarket firms relative to small, single-market firms, whereas under the hubris hypothesis , consolidation was largely driven by corporate hubris. Our results are consistent with an empirical dominance of the efficiency hypothesis over the hubris hypothesis—on net, technological progress allowed large, multimarket banks to compete more effectively against small, single-market banks in the 1990s than in the 1980s. We also isolate the extent to which technological progress occurred through scale versus geographic effects and how they affected the performance of small, single-market banks through revenues versus costs. The results may shed light as well on some of the research and policy issues related to community banking.     

Bank Debt versus Bond Debt: Evidence from Secondary Market Prices

This paper uses a new data set of daily secondary market prices of loans to analyze the specialness of banks as monitors. Consistent with a monitoring advantage of loans over bonds, we find the secondary loan market to be informationally more efficient than the secondary bond market prior to a loan default. Specifically, we find that secondary market loan returns Granger cause secondary market bond returns prior to a loan default. In contrast, secondary market bond returns do not Granger cause secondary market loan returns prior to a loan default.     

Bank size, lending technologies, and small business finance

Under the current paradigm in small business lending research, large banks tend to specialize in lending to relatively large, informationally transparent firms using “hard” information, while small banks have advantages in lending to smaller, less transparent firms using “soft” information. We go beyond this paradigm to analyze the comparative advantages of large and small banks in specific lending technologies. Our analysis begins with the identification of fixed-asset lending technologies used to make small business loans. Our results suggest that large banks do not have equal advantages in all of these hard lending technologies and these advantages are not all increasing monotonically in firm size, contrary to the predictions of the current paradigm. We also analyze lines of credit without fixed-asset collateral to focus on relationship lending. We confirm that small banks have a comparative advantage in relationship lending, but this appears to be strongest for lending to the largest firms.     

Lending competition and credit availability for new firms: Empirical study with the price cost margin in regional loan markets

In this paper, I present statistical evidence of the impact of lending competition on credit availability for new firms. A discrete-time duration analysis with respect to the years from the start-up to the first loan approval by a commercial bank or a cooperative bank, which is collected from survey data in Japan, shows that the higher price cost margin (PCM) of banks, which reflects the existence of a quasi-rent for a bank, improves the credit availability for younger firms. Additional analysis to detect the regional determinants of the PCM of banks shows that the share of larger banks in each local credit market has a negative and significant impact on the PCM. In light of the existing empirical finding that smaller banks are more likely to provide relationship banking, these findings provide indirect evidence for the hypothesis that the intensity of relationship banking in each local credit market increases the PCM and this encourages banks to extend a loan to new firms so that they can pre-empt the opportunity to establish lending relationships that are expected to yield such quasi-rents.     

Short-sale inflow and stock returns: Evidence from Japan

Using a 10-year panel of flow-based information on stock borrowings and constructing a flow-based measure for shorting demand, I examine the relation between shorting demand and subsequent stock price movements. I find that the least heavily shorted stocks tend to outperform the most heavily shorted stocks and that this outperformance persists up to three months. In addition, using proxies for information asymmetry derived from the market microstructure literature, I find that this outperformance is not confined to stocks with high information asymmetry. These empirical findings indicate that short sellers act not only as informed investors who gain negative news but also as skillful investors who detect stock price deviations from fundamental values.     

Bank Mergers, Competition, and Liquidity

We model the impact of bank mergers on loan competition, reserve holdings, and aggregate liquidity. A merger changes the distribution of liquidity shocks and creates an internal money market, leading to financial cost efficiencies and more precise estimates of liquidity needs. The merged banks may increase their reserve holdings through an internalization effect or decrease them because of a diversification effect. The merger also affects loan market competition, which in turn modifies the distribution of bank sizes and aggregate liquidity needs. Mergers among large banks tend to increase aggregate liquidity needs and thus the public provision of liquidity through monetary operations of the central bank.     

Bank regulatory capital and liquidity: Evidence from US and European publicly traded banks

The theory of financial intermediation highlights various channels through which capital and liquidity are interrelated. Using a simultaneous equations framework, we investigate the relationship between bank regulatory capital and bank liquidity measured from on-balance sheet positions for European and US publicly traded commercial banks. Previous research studying the determinants of bank capital buffer has neglected the role of liquidity. On the whole, we find that banks decrease their regulatory capital ratios when they face higher illiquidity as defined in the Basel III accords or when they create more liquidity as measured by Berger and Bouwman (2009). However, considering other measures of illiquidity that focus more closely on core deposits in the United States, our results show that small banks strengthen their solvency standards when they are exposed to higher illiquidity. Our empirical investigation supports the need to implement minimum liquidity ratios concomitant to capital ratios, as stressed by the Basel Committee; however, our findings also shed light on the need to further clarify how to define and measure illiquidity and also on how to regulate large banking institutions, which behave differently than smaller ones.     

Momentum Strategies: Evidence from Pacific Basin Stock Markets

We investigate the profitability of momentum investment strategy in six Asian stock markets. Unrestricted momentum investment strategies do not yield significant momentum profits. Although we find that a diversified country‐neutral strategy generates small but statistically significant returns during 1981–1994, when we control for size and turnover effects we find that the country‐neutral profits dissipate. Our evidence suggests that the factors that contribute to the momentum phenomenon in the United States are not prevalent in the Asian markets.