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Conflicts of Interest in Financial Markets - Evidence from Bond Underwriting in the Nineties

  • Focarelli, Dario
  • Pozzolo, Alberto Franco


This paper presents some new evidence on the conflict of interest that may arise when banks underwrite corporate securities and sell them to their customers. Two alternative views are confronted; a) that commercial banks possess private information on the financial condition of their clients and so perform better screening (the certification hypothesis); and b) that commercial banks might convert loans to firms in financial difficulties into bonds marketed to unsuspecting clients (the ‘naïve investor’ hypothesis). The empirical analysis compares the default rates between 2000 and 2002 of a sample of more than 5,000 securities issued from 1991 to 1999. Our results show that, on average, securities underwritten by investment houses and by commercial banks had the same probability of default. However, investment-grade issues underwritten by commercial banks had a lower probability of default than those underwritten by investment houses, while the reverse was true for noninvestment- grade issues. Based on this latter result, it is not possible to refute the ‘naïve investor’ hypothesis, as instead in Kroszner and Rajan (1994).

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Paper provided by University of Molise, Dept. EGSeI in its series Economics & Statistics Discussion Papers with number esdp05023.

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Length: 33 pages
Date of creation: 13 Jan 2005
Date of revision:
Handle: RePEc:mol:ecsdps:esdp05023
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  1. Gande, Amar, et al, 1997. "Bank Underwriting of Debt Securities: Modern Evidence," Review of Financial Studies, Society for Financial Studies, vol. 10(4), pages 1175-1202.
  2. Randall S. Kroszner & Raghuram G. Rajan, . "Organization Structure and Credibility: Evidence from Commercial Bank Securities Activities Before the Glass-Steagall Act," CRSP working papers 325, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  3. Richard Blundell & Mónica Costa Dias, 2008. "Alternative Approaches to Evaluation in Empirical Microeconomics," CEF.UP Working Papers 0805, Universidade do Porto, Faculdade de Economia do Porto.
  4. Saunders, Anthony & Stover, Roger D., 2004. "Commercial bank underwriting of credit-enhanced bonds: are there certification benefits to the issuer?," Journal of International Money and Finance, Elsevier, vol. 23(3), pages 367-384, April.
  5. Puri, Manju, 1994. "The long-term default performance of bank underwritten security issues," Journal of Banking & Finance, Elsevier, vol. 18(2), pages 397-418, January.
  6. Paul Gompers & Josh Lerner, 1998. "Conflict of Interest in the Issuance of Public Securities: Evidence from Venture Capital," NBER Working Papers 6847, National Bureau of Economic Research, Inc.
  7. Roten, Ivan C. & Mullineaux, Donald J., 2002. "Debt underwriting by commercial bank-affiliated firms and investment banks: More evidence," Journal of Banking & Finance, Elsevier, vol. 26(4), pages 689-718, April.
  8. Steven Drucker & Manju Puri, 2004. "The Tying of Lending and Equity Underwriting," NBER Working Papers 10491, National Bureau of Economic Research, Inc.
  9. Donald P. Morgan, 2002. "Rating Banks: Risk and Uncertainty in an Opaque Industry," American Economic Review, American Economic Association, vol. 92(4), pages 874-888, September.
  10. Heckman, James J & Ichimura, Hidehiko & Todd, Petra, 1998. "Matching as an Econometric Evaluation Estimator," Review of Economic Studies, Wiley Blackwell, vol. 65(2), pages 261-94, April.
  11. Ber, Hedva & Yafeh, Yishay & Yosha, Oved, 2001. "Conflict of interest in universal banking: Bank lending, stock underwriting, and fund management," Journal of Monetary Economics, Elsevier, vol. 47(1), pages 189-218, February.
  12. Marcia Millon Cornett & Evren Ors & Hassan Tehranian, 2002. "Bank Performance around the Introduction of a Section 20 Subsidiary," Journal of Finance, American Finance Association, vol. 57(1), pages 501-521, 02.
  13. Gande, Amar & Puri, Manju & Saunders, Anthony, 1999. "Bank entry, competition, and the market for corporate securities underwriting," Journal of Financial Economics, Elsevier, vol. 54(2), pages 165-195, October.
  14. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
  15. Konishi, Masaru, 2002. "Bond underwriting by banks and conflicts of interest: Evidence from Japan during the pre-war period," Journal of Banking & Finance, Elsevier, vol. 26(4), pages 767-793, April.
  16. Narayanan, Rajesh P. & Rangan, Kasturi P. & Rangan, N.K.Nanda K., 2004. "The role of syndicate structure in bank underwriting," Journal of Financial Economics, Elsevier, vol. 72(3), pages 555-580, June.
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