Competition For Underwriting: Implications For Information Production And Insurance

We examine a novel two-stage mechanism for selling securities. in stage 1, the security is underwritten but the underwriting is auctioned using a discriminatory auction. First stage winners join the second stage auction in which the security is sold. Here, winning underwriters have dual roles, as bidders and as insurers who must absorb excess security supply. While the government uses first-stage underwriting to insure against auction failure, we argue that it has important effects on bidding and information generation relevant to security pricing. Using proprietary data on treasury auctions in India between 2006 and 2012, we show that the underwriting auction is powerful in explaining auction outcomes including devolvement, bid shading, and post-auction price movements in the secondary market price. The direct costs of underwriting appear to be offset by its indirect benefits to the auction process, thereby lowering issuer cost of capital. We show that the winner’s curse risk of unsold inventory is a critical driver of our results. We confirm the importance of this channel by exploiting policy changes that induce natural variation in inventory costs differentially across bidders.