Ch. 5: Banks in Capital Markets 211
lending around the time of a security issuance increase the probability that an under-
writer will be selected as underwriter. Further, asYasuda (2005)points out, lending
relationships increase the likelihood of selection above and beyond any cost reductions.
Given these facts, is it possible for investment banks to remain viable underwriters?
One possibility is that investment banks can remain viable competitors by expanding
their lending activities. Some evidence of investment bank lending and its effects on
financing costs and the choice of underwriter is provided inDrucker and Puri (2005).
They document that investment banks are now making loans and are competing aggres-
sively with commercial banks by providing loans around the time of seasoned equity
offerings.^19 While the authors show that, in concurrent deals, investment banks can-
not compete with commercial banks on the yield spreads that they can charge for the
loan, concurrent lending and prior lending allow investment banks to provide lower
gross spreads on the equity offering, with investment bank lending significantly reduc-
ing gross spreads by between 26 and 44 basis points. These results are consistent with
lending by investment banks creating sufficient economies of scope to allow investment
banks to be viable competitors with commercial banks. This inference is bolstered by
an examination of issuers’ selection of their underwriter. As with commercial banks,
when investment banks have prior lending relationships or provide concurrent loans,
their likelihood of being selected as equity underwriter increases. Further, investment
banks are able to leverage concurrent deals into extended relationships by capturing
future underwriting business.
The evidence inYasuda (2005)also hints that investment banks may use lending to
compete with commercial banks. Her model shows that for the mean debt issue, issuers
that have a lending relationship with an investment bank underwriter are willing to pay
more to use the relationship investment bank as underwriter. Further, investment bank
lending increases the likelihood of winning the underwriting mandate. These results
suggest that firms value lending relationships with investment banks, and as a result,
lending may allow investment banks to remain competitive.
- International evidence
Thus far, we have examined the impact of commercial banks as underwriters in the
United States. However, there is some international evidence on differences between
the ex ante pricing and ex post performance of commercial bank and investment bank-
underwritten issues, additional analyses on the extent to which commercial banking
relationships affect the choice of underwriter, and evidence on other potential conflicts
of interest. Below, we survey the literature related to commercial bank underwriting in
Japan, Canada, and Israel.
(^19) In fact, of the 201 issues where the underwriter provides a loan concurrently with the seasoned equity
offering, investment banks are the underwriter in 110 cases.