New corporate financial securities of the 70's and 80's: Neutral mutations or financial innovation?

Kenneth Arnold Carow, Purdue University

Abstract

This thesis takes an in-depth look at the question phrased by Finnerty (1988), "How is the net advantage of financial innovation allocated among the various parties to the transaction, and how does this allocation change over time as the innovative security becomes seasoned and as imitators enter the market?" (p. 18) If there are gains, it can be concluded that many of the securities of the 70's and 80's are 'true' innovations that either reduce constraints to the issuer and/or the investor. The two primary parties involved in bringing a new security to market (and therefore the most likely to gain) are the investment bank, which designs the security, and the issuer, which sells the security. For the investment banks, the abnormal returns for the first issue of a new product are not significantly different from zero on the first announcement that an issuer has been found; however, abnormal returns are significantly greater than zero on the offering date. Furthermore, these returns are significantly greater than the average returns to the investment banks surrounding the offering date of traditional securities. That there are some gains to the investment banks is further confirmed through the finding that frequent innovators have significantly higher market shares of innovative products than traditional security products. Also, investment banks are able to charge significantly higher underwriting spreads for both specially designed securities (securities not imitated by a rival within one year) and during the monopoly period, which is prior to the entry of rival competition. For the issuing firm, abnormal returns on the announcement date are not significantly different from returns of traditional securities nor is any trend in announcement date returns evident. However, on the offering date returns for specially designed, non-imitated, securities are higher than for imitated securities and returns on the offering date decline as the supply of the new securities in the market fills the new market niche. In summary, these findings show that there are benefits from financial innovation and that these gains may be allocated to both the underwriter and the issuer. The underwriter gains through market share and the underwriting spread while early issuers may gain through higher returns on the offering date of early issues.

Degree

Ph.D.

Advisors

McConnell, Purdue University.

Subject Area

Management|Finance

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