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

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

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