This paper will try to elaborate on the different and sometimes mixed empirical results, testing the relationship between underwriter’s reputation and the price of the capital issue. Firstly, the two most cited and used ways of measuring reputation will be explained. Secondly, the relationship between reputation and issue pricing will be analysed from different perspectives. Thirdly, the existence of a relationship between reputation and fees as well as between reputation and proceeds will be proven. After that commercial and investment banks as underwriters will be compared and it will be shown that there are reasons to choose a commercial bank as an underwriter. Finally, the mechanics of how underwriters are being chosen and the reasons for switching underwriters will be analysed, before ending this study with a conclusion.
Table of Contents
1. Introduction
2. How Reputation is Measured
2.1 Tombstone Announcement Measure
2.2 Market Share Measure
3. The Relationship between Underwriter Reputation and Issue Pricing
3.1 Overpricing, Underpricing and Asymmetric Information
3.2 The Underpricing Equilibrium
3.3 Price Support
4. Fees and Proceeds
4.1 Fees
4.2 Proceeds
5. Commercial vs. Investment Banks
6. How Are Underwriters Being Chosen and Why Do Companies Switch Underwriters?
7. Conclusion
8. List of References
Research Objectives and Core Themes
This paper examines the influence of underwriter reputation on capital market outcomes, specifically investigating its impact on issue pricing, underwriter compensation, and the strategic selection or switching of underwriters by issuing firms.
- The correlation between underwriter prestige and capital issue pricing.
- Methodological approaches to measuring underwriter reputation.
- The certification effect and its role in mitigating information asymmetry.
- Comparison of commercial versus investment banks in underwriting roles.
- Mechanics and drivers behind the firm-underwriter selection and switching process.
Excerpt from the Book
3.1 Overpricing, Underpricing and Asymmetric Information
When capital is being issued by using an underwriter, it is possible that there exists a substantial amount of asymmetric information in the market and that is what investors fear when considering participating in a transaction. With asymmetric information, there is the risk that an investor will overvalue the price of the issue and so will agree to pay the underwriter an overstated price for the product. Since the investor is aware of this possible loss, this risk will be accounted for in the price assessment and so he will reduce the price he is willing to pay. This price assessment process is, as Booth and Smith (1986) put it, similar to the one described by Akerlof (1970) in his famous “lemons model”.
This investor-induced price reduction does not need to happen if the underwriter can “credibly certify that an issue is not overpriced” (Ng & Smith, 1996). Through this certification, the underwriter can mitigate the informational asymmetry in the market (Ng & Smith, 1996). Here is where the reputation variable comes into play; reputation is the tool that makes the underwriter’s certification credible. A bank that is known to act opportunistically will not be able to make a credible certification and so, from the investor’s point of view, cannot mitigate the risk. Through contract choice, bad-reputation underwriters are able to establish some kind of credibility. If the underwriter shows confidence in his price assessment he can by his compensation to the long-run performance of the issue. Doing so he can establish “the bond that is necessary for issue price certification” (Ng & Smith, 1996).
Summary of Chapters
1. Introduction: The introduction outlines the necessity of underwriters in capital markets and establishes the primary research objective regarding the impact of reputation on capital issuance.
2. How Reputation is Measured: This chapter defines the two primary methodologies, the Tombstone Announcement Measure and the Market Share Measure, used to quantify underwriter prestige.
3. The Relationship between Underwriter Reputation and Issue Pricing: This section analyzes how reputation mitigates asymmetric information through certification and price support, establishing the concept of an underpricing equilibrium.
4. Fees and Proceeds: The chapter explores the mixed empirical evidence regarding whether prestigious underwriters charge higher fees or if they seek higher market share through fee competition, alongside the impact on long-run proceeds.
5. Commercial vs. Investment Banks: This chapter examines why issuers choose commercial banks over investment banks, highlighting the role of prior lending relationships and private-debt reputation.
6. How Are Underwriters Being Chosen and Why Do Companies Switch Underwriters?: The text discusses the mutual selection process and the “graduation effect” as primary reasons for firms switching underwriters after their initial public offering.
7. Conclusion: The conclusion summarizes the finding that underwriter reputation is a critical variable in reducing information asymmetry, influencing pricing strategies, and determining the long-term success of an issuance.
8. List of References: This section provides the comprehensive bibliography of academic studies and journals referenced throughout the paper.
Keywords
Underwriter Reputation, Capital Issuance, Certification Effect, Asymmetric Information, Underpricing Equilibrium, Price Support, Investment Banks, Commercial Banks, Tombstone Announcement, Market Share, IPO, SEO, Graduation Effect, Financial Intermediation, Issue Pricing.
Frequently Asked Questions
What is the core focus of this research?
The research focuses on the impact of underwriter reputation on various facets of capital market transactions, including pricing strategies, fee structures, and the strategic decisions made by issuers.
What are the central themes discussed?
The central themes include the measurement of underwriter reputation, the reduction of information asymmetry, the certification role of banks, and the dynamics of issuer-underwriter selection.
What is the primary objective of the study?
The goal is to determine how prestigious underwriters use their reputation to influence the pricing of capital issues and to investigate why companies engage in specific behaviors, such as switching underwriters.
Which scientific methodology is employed?
The paper utilizes a meta-analytical approach, synthesizing existing empirical literature and academic research findings to evaluate the relationship between reputation and market outcomes.
What is covered in the main body of the work?
The main body covers the quantification of reputation, the theoretical link between reputation and pricing (including overpricing/underpricing), the comparison of bank types, and the reasons for underwriter switching.
What are the primary keywords that characterize this paper?
The work is defined by terms such as Underwriter Reputation, Certification Effect, Asymmetric Information, IPO, and Market Share.
How does a commercial bank compete with an investment bank in underwriting?
Commercial banks leverage their existing lending relationships and the reputation built in private-debt markets to provide "lending-related issue certification," which helps mitigate investor concerns regarding opportunistic behavior.
Why do companies choose to switch underwriters after an IPO?
Companies typically switch not due to dissatisfaction with the IPO performance, but to "graduate" to more prestigious underwriters who offer better research coverage, thereby reducing perceived information asymmetry.
- Arbeit zitieren
- Ricardo Falter (Autor:in), 2013, The Impact of Underwriter’s Reputation on the Price of Capital, the Return and the Underwriter Selection, München, GRIN Verlag, https://www.hausarbeiten.de/document/266032
