Ch. 5: Banks in Capital Markets 207
- Empirical evidence on competition between commercial and investment banks
The empirical evidence in Section3 on conflicts of interest raises an important point:
If commercial banks are net certifiers of firm value and conflicts of interest can be
mitigated, then commercial banks may be superior underwriters compared to investment
banks. If so, can both types of underwriter co-exist? How can competition between them
affect the services they offer to firms?
By combining lending with underwriting, banks may achieve informational econo-
mies of scope by jointly delivering lending and underwriting services and re-using the
same client specific information for several purposes (see e.g.Benston, 1990; Saunders
and Walter, 1994). As emphasized inKanatas and Qi (2003), informational economies
of scope can lower transaction costs and can theoretically reduce underwriting fees if
banks pass along costs savings to firms.Puri (1999)derives sufficient conditions for
commercial banks and investment banks to coexist. One implication of this analysis
drawn out in the paper is that, under some circumstances, commercial banks may charge
higher underwriting fees than investment banks. We survey the literature on underwrit-
ing fees in Section4.1. The analyses inKanatas and Qi (1998, 2003)emphasize that
large scope economies from combining lending and underwriting will be important in
determining if an issuer selects its commercial bank lender as public security under-
writer.Rajan (2002)points out that the bank’s information advantage from lending may
allow it to secure the underwriting mandates of its borrowers. In Section4.2,wesum-
marize the studies that examine the effect of bank lending on underwriter selection. In
Section4.3, we provide some additional evidence on how investment banks are adapting
to competition from commercial banks.
4.1. Underwriting fees
We begin by providing evidence that commercial bank entry after the relaxation of
the Glass–Steagall Act caused lower overall underwriting fees, consistent with a pro-
competitive effect on corporate securities underwriting markets.Gande, Puri, and Saun-
ders (1999), using a sample of 2,992 debt issues from 1985 through 1996, document that
following bank entry into debt underwriting in 1989, the gross spread, or underwriting
fee, declined significantly.^18 Further, this decline is more pronounced in samples where
commercial banks gained a larger market share (non-investment-grade and smaller is-
sues). This result stands in contrast to equity markets where commercial banks had not
yet gained much market share, and where similar declines in gross spreads are not ob-
served in this time period.
Gande, Puri, and Saunders (1999)also find that among the sample of 1,180 debt is-
sues between 1989 and 1996, commercial banks and investment banks charge similar
(^18) The authors capture the impact of bank competition on gross spreads in two ways. First, they use a dummy
variable that is one after 1989, when banks were first allowed to underwrite corporate debt. Second, they use
the logarithm of commercial banks market share in debt underwriting.