196 S. Drucker and M. Puri
of the evidence from before the enactment of the 1933 Glass–Steagall Act, which pro-
hibited commercial banks from underwriting public securities for nearly sixty years.
Section3.2provides a review of studies that use data from the late 1980s and beyond,
after the relaxation and repeal of the Glass–Steagall Act. In Section3.3, we explore an-
other strand of the literature that examines if commercial banks can use organizational
means to mitigate the potential for conflicts of interest. Also, there are papers that ex-
plore the consequences of a financial intermediary holding equity claims in firms. We
summarize these studies in Section3.4. Throughout, we highlight the many different
methodologies that have been used to test for the presence of conflicts of interest.
There are two primary ways that researchers examine whether banks are net certifiers
of firm value or if commercial banks are subject to conflicts of interest. The first method
is to examine the ex ante pricing of public securities. The foundation of these studies is
that rational investors should anticipate whether commercial banks or investment banks
have a higher net certification effect, and price the securities accordingly. If investors
perceive that conflicts of interest are large, then commercial bank-underwritten securi-
ties will be priced lower than similar investment bank-underwritten securities, while if
conflicts of interest are small, then commercial bank issues will achieve higher prices.
The second method is to examine the ex post performance of underwritten securities. If
commercial bank-underwritten securities perform worse thanex ante similarsecurities
that are underwritten by investment banks, then this would be consistent with commer-
cial banks underwriting securities that they privately know to be of lower quality, which
is indicative of conflicts of interest. In general, there is little support for banks’ exploit-
ing conflicts of interest. In fact, many studies find commercial banks to be net certifiers
of firm value.
3.1. Before the 1933 Glass–Steagall Act
Prior to 1933, commercial banks were permitted to underwrite public securities. How-
ever, after the stock market crash of 1929, concerns over the potential for conflicts
of interest and the fear that the commingling of investment and commercial banking
increases the riskiness of the financial system prompted Congress to enact the Glass–
Steagall Act of 1933, which prohibited commercial banks from engaging in public
security underwriting. Popular support for the Act came from investigations by the Pec-
ora Committee (U.S. Senate Committee on Banking and Currency, 1933–1934), which
examined alleged abuses at the security affiliates of commercial banks, in particular,
National City Company and Chase Securities Corporation.^7 However, many scholars
have argued that evidence of these concerns was anecdotal and little verification was
provided that any abuses were systematic in nature (see e.g.Carosso, 1985; Benston,
(^7) SeeKelly (1985)for details on the legal history of the Glass–Steagall Act.