192 S. Drucker and M. Puri
There are considerable differences in regulatory environments and quality of the finan-
cial markets across countries, so additional insight into the causes and consequences
of potential conflicts of interest can be ascertained from these studies. As the literature
has grown, researchers have become increasingly sophisticated in using many different
empirical methodologies to test for the presence of conflicts of interest. We highlight
these methods throughout this survey.
Can investment banks, which generally do not provide lending services, co-exist with
commercial banks? Some theoretical models suggest that this is a realistic possibility.
For example, issuers may choose commercial banks when economies of scope are large
and choose investment banks when the costs from conflicts of interest are sizable. Other
models point out the possibility that investment banks and commercial banks can co-
exist by charging different underwriter fees that reflect their relative benefits and costs.
Another possibility, not generally addressed in the theoretical literature, is that invest-
ment banks will compete with commercial banks by expanding their lending activities.
We survey the empirical literature on this topic by highlighting a number of papers
that examine the effects of commercial bank re-entry into underwriting on the costs of
intermediation, the impact of lending relationships on underwriting fees, and whether
lending influences the likelihood of winning underwriting mandates.
In addition to the direct interaction between commercial banks and the capital mar-
kets, there is an indirect role of commercial banks on capital markets. Through screening
and monitoring, banks gather private information about their borrowers. Even if banks
do not directly participate in underwriting, banks’ lending decisions can still signal the
quality of firms to investors. Generally, researchers have examined this possibility by
quantifying the firm’s stock price reaction to loan initiations, renewals, and sales. Other
studies examine if lending relationships provide positive information to outsiders by
documenting the effects of bank loans from non-underwriting banks on the pricing of
public security offerings. We provide a detailed summary of banks’ ability to convey
quality to outsiders through signaling.
Finally, we explore a number of areas where more research is needed. One such
topic concerns the ability of banks to hold equity in firms, which is currently limited in
the United States but is allowed in other countries, such as Germany and Japan. There
is some evidence from the United States on the effects of banks and other financial
intermediaries holding equity through venture capital subsidiaries. However, the conse-
quences of banks holding equity remain unclear and highlight the need for additional
research so that we can more fully understand the interaction between banks and capital
markets.
- Commercial banks as underwriters: Theoretical literature
When a commercial bank underwrites a firm’s public securities, a number of benefits
may arise. First, the private information that a bank gathers in the lending process may
be valuable in public security underwriting. Insider banks know more about a firm’s