Underwriter compensation in seasoned equity offerings
Abstract
This study investigates how underwriters price the services they provide to firms issuing stock. These services include pricing and legal advice, marketing and distribution, and assumption of risk. Analysis of the risk-bearing service in a firm-commitment offering leads to the following conclusions. First, underwriting fees and the underwriter's residual risk compensation on NASDAQ/AMEX issues are significantly higher than on NYSE issues, even when controlling for firm and issue characteristics such as stock returns volatility, firm size, issue size, industry and underwriter experience. Second, in contrast to a recent finding by Bae & Levy (1990), I find that underwriters of NYSE issues do not receive a higher than "fair" price on a contract signed one day before the issue. Third, utilities benefit more than industrials from the pricing of the risk-bearing service. Finally, controlling for the features of the issue, more experienced underwriters receive lower risk compensation. Extension of the analysis to include implicit compensation in the form of an overallotment option for industrial issues reveals the implicit compensation is substantial regardless of exchange or underwriter experience. However, the previous conclusions remain largely unchanged. Even after controlling for the presence of the overallotment option as well as several other features of the issue, underwriting fees are higher for NASDAQ/AMEX industrial issues and lower for industrial issues underwritten by more experienced investment bankers. A further extension of the analysis to include additional firm and issue characteristics such as the history of the relationship between the firm and the underwriter, the timing of the issue, inside and institutional ownership, and relative trading volume preceding the issue also leaves the main conclusions concerning cross-sectional variation of compensation by industry, exchange and underwriter experience unchanged.
Degree
Ph.D.
Advisors
Sheehan, Purdue University.
Subject Area
Finance
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