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effective spread, quoted depth, trading volume, turnover, trade size, and a liquidity in-
dex of the above measures. They report that all the liquidity measures they examine
are significant, with bid–ask spreads being positively related and the depth and activity
levels being negatively related to underwriter spreads. They control for a broad range
of other SEO characteristics and find that underwriting spreads are also negatively re-
lated to offer size, equity capitalization, share price, a multiple book manager indicator
and positively related to return volatility, and Amex and Nasdaq indicators. In con-
trast,Altinkilic (2006)examines the role of underwriter market making immediately
following SEOs to determine whether market making activities are partially paid by
the underwriting spread. She argues that paying for market making in the underwriting
spread takes pressure off the bid–ask spread, thus improving secondary market liquidity
after the offer. Using abnormal share trading volume in the four weeks following the
SEO as a proxy for market making costs, She finds that compensation for market mak-
ing can explain 20% of the lead underwriter’s total compensation, after controlling for
other known determinants and that this underwriting fee component rises as the cost of
market making rises.
More recently,Lee and Masulis (2006)examines the effect on SEO underwriting fees
of financial accounting information quality, using a recent measure of accruals qual-
ity developed in the accounting literature byDechow and Dichev (2002). They report
that as the quality of issuer’s financial accounting deteriorates, both SEO underwrit-
ing spreads, the negative announcement return, and frequency of offer withdrawals rise.
They also find that a large number of other control variables are significant including log
of net offer proceeds, secondary scale percentage, underwriter rank, log of total assets,
stock return standard deviation and indicators for credit rated bonds and shelf offerings.
In another recent study,Drucker and Puri (1989)explore the effects of concurrent and
prior lending and prior equity underwriting on the gross spreads of SEO. They find that
a concurrent lending relationship, a prior lending relationship, or both, all reduce gross
spreads. However, the effect of a concurrent lending relationship is stronger than a past
relationship and a combined relationship is greater than a simple concurrent relation-
ship. They also find that a past equity underwriting relationship reduces gross spreads,
where they allow for a U-shaped spread followingAltinkilic and Hansen (2000).This
last result is consistent with several earlier studies of SEO underwriter competition that
will be discussed later.
Table 7summarizes the existing studies of underwriting spreads. The extant evidence
shows that SEO underwriter spreads (1) exhibit a scale economy effect with diminishing
marginal returns and (2) are negatively related to a firm’s size and the offer’s size relative
to the issuer’s equity capitalization. Finally, there is recent evidence that these under-
writing spreads are negatively related to a security’s liquidity and positively related to
the quality of accounting information and existing and prior banking relationships. The
evidence summarized inTable 7is that SEO underwriting spreads are positively related
to a firm commitment underwriting contract, percentage change in shares, inverse of
offer size, log of offer size squared, underpricing, a missing financial statement indica-
tor, bid–ask spread, prior SEO activity (prior 3 months), Amex and Nasdaq indicators.