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Wei-Ling Song Drexel University & Wharton Financial Institutions Center

The Industrial Organization of Bond Underwriting Market with Bank Entry: Evidence from Underwriting Fees. Wei-Ling Song Drexel University & Wharton Financial Institutions Center. Motivations.

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Wei-Ling Song Drexel University & Wharton Financial Institutions Center

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  1. The Industrial Organization of Bond Underwriting Market with Bank Entry: Evidence from Underwriting Fees Wei-Ling Song Drexel University & Wharton Financial Institutions Center

  2. Motivations • The market structure of bond underwriting business may affect underwriters’ incentive to maintain reputation and to do due diligence. • Anand and Galetovic (2000) contend that an oligopolistic structure is necessary for the market to exist. • A competitive market does not provide enough rents, monopoly rents invite entry.

  3. Motivations (Cont’d) • Commercial bank entry in security underwriting • The Gramm-Leach-Bliley Act • Song (2004) documents that underwriting incentive is lower in the high commercial bank entry industries. Issuing clients in those industries have a significantly higher probability of being sued for financial reporting fraud

  4. Research Questions • Is bond underwriting market oligopolistic? • Does commercial bank entry into bond underwriting change the market structure?

  5. Hypotheses • The oligopolistic market hypothesis • oligopolistic structure arising from market imperfection implies segmentation or specialization – niche reputation • underwriting fees and niche reputation are positively correlated • The competitive pressure hypothesis • Bank entry reduces incumbent investment banks’ ability to share rents from niche reputation.

  6. Underwriter Selection Example Firm H’s bond net yield had it underwritten by A bA Bond Net Yield bB Firm H Firm L Inf. Asymmetry

  7. Niche Reputation • Switching regressions with endogenous switching

  8. Sample and Data Sources • Fixed-rate nonconvertible domestic corporate bond issues from SDC Platinum U.S. Corporate New Issues database • Sample period covers 1991-2000 • Bank loan exposure is from DealScan of Loan Pricing Corporation • Firm characteristics are from COMPUSTAT database and CRSP daily return database

  9. Commercial Bank Entry

  10. Bond Issue Characteristics

  11. Underwriting Fees Regressions

  12. Main Findings • During 1991-1996, incumbent investment banks charged higher fees for their niche reputation, which suggests an oligopolistic market structure. • During 1997-2000, such rents were competed away as bank entry became prominent. • As entrants, commercial banks always charge lower fees for their niche reputation

  13. Conclusions • Bank entry altered the structure of bond underwriting market. • Bond underwriting market was difficult to penetrate. • Besides, both types of underwriters selectively, rather than universally, reduced fees in the industries where competition was stronger and imminent.

  14. Contributions • Develops the measure of niche reputation in bond underwriting • Provides a broader assessment of the impact of commercial bank entry – changing market structure • Provides important policy implications on the issues regarding market failures in the financial markets and optimal competition

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