Conflicts of Interest, Intermediation, and the Pricing of Underwritten Securities.

Abstract

The paper models securities underwriting where the intermediaries (commercial banks and investment houses) have diverse conflicts of interest leading to differential pricing of securities. When underwriting securities, investment houses have an incentive to underinvest in costly information production. Banks obtain such information from loan monitoring, but have an incentive to misrepresent this information because of bad loan exposure to the issuing firm. Either situation leads to a potential conflict of interest. The paper finds circumstances where banks' underwritings benefit issuers through higher realised prices. It further finds sufficient conditions for banks and investment houses to co-exist. The model also yields new testable implications, in particular, banks are likely to have a pricing advantage for junior and information sensitive securities even when both intermediaries have similar reputations ex-ante.

JEL Classification: G11