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Wei-Ling Song Drexel University & Wharton Financial Institutions Center

Explore how commercial bank entry shapes the bond underwriting market structure, impacting fees, reputation, and competition. This study examines the effects on incumbent investment banks and the emergence of niche reputation. Data analysis from 1991-2000 highlights changes due to the Gramm-Leach-Bliley Act and the dynamics of competition. The findings shed light on market imperfections, specialization, and regulatory implications.

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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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