266 B.E. Eckbo et al.
and selling concessions to the syndicate members selling the shares to institutional
and retail customers. In this literature, spreads are almost always measured as a per-
centage of offering size or gross proceeds. Most studies focus on either underwriter
gross spread or underpricing costs, while very few studies estimate both the direct
and indirect flotation costs of security offerings. Most studies also limit themselves
to studying one security class, with SEOs being the most intensively examined offering
type.
Moreover, most existing research on flotation costs focuses on the experiences of
U.S. companies, primarily issuing common stock listed on major U.S. stock exchanges.
Over the last 20 years, nearly all security offerings sold in the U.S. have relied on a
firm commitment underwriting contract and a large majority of existing studies restrict
their investigations to this sample. Most of these studies also limit their analysis to
unregulated industrial firms. Since many of these studies also require the availability of
machine readable accounting data, typically extracted from Compustat, the samples are
further reduced by excluding many smaller firms not covered in this financial accounting
database.
Kim, Palia, and Saunders (2005a)report underwriting spreads of industrial issues for
SEOs, IPOs and straight corporate debt issues over the 1970–2000 period. They find that
for the last three decades (i.e., 1970s, 1980s and 1990s) average underwriting spreads
have fallen from 5.6 percent to 4.7 percent for SEOs, and from 7.7 percent to 6.7 percent
for IPOs, with increased clustering of SEO spreads at 5 percent and IPO spreads at 7
percent. Similarly, average underwriting spreads have dropped in half from 1.6 percent
to 0.8 percent for debt issues.
A consistent result found in the security offering literature is that underwriting spread
rises with a security’s total risk measured by return standard deviation over a pre-
offering (SEOs) or post-offering (IPOs) estimation period. First, underwriting spreads
are substantially larger for IPOs than SEOs, larger for SEOs than convertibles debt of-
fers and smallest for straight debt offers. The average total risk (stock return standard
deviation) of these classes of securities can likewise be ranked from highest to lowest.
The rankings of total risk across security classes mirror those for security underwriter
spreads: Total risk is on average highest for IPOs, followed by SEOs, then convert-
ible debt and finally is smallest for straight debt. Within each of these security classes,
there is also evidence that underwriter spreads are directly related to a security’s return
standard deviation.
The second major characteristic of security offerings found to reduce spreads is the
offering size and this has been interpreted as an underwriting economy of scale effect
due to the presence of large fixed costs, which exhibits increasing returns to scale. How-
ever,Altinkilic and Hansen (2000)takes issue with this interpretation. They point out
that the observed fees do not fall steeply enough if they consist mostly of fixed costs.
Thus, they argue that most of the fee is a variable cost, rather than a fixed cost. Offering
size is also often measured as a percent of equity capitalization where it is interpreted
as capturing an adverse selection effect.