Underwriter Certification: Evidence from Seasoned Equity Issues

This proposal examines the relationship between certification and the reputation of underwriters. Based on seasoned equity offers between 1976 and 2005, in the first part of this proposal I document a positive abnormal announcement return associated with the selection of an underwriter that is more reputable than expected given publicly available firm and issue characteristics. Having an issue underwritten by a surprisingly more reputable underwriter is associated with a durable decrease in bid-ask spreads lasting about three quarters. This effect and the aforementioned one on announcement returns are both stronger with firms that have higher levels of asymmetric information ahead of the offering. These results are consistent with the quality of the underwriter being directly related to the often mentioned certification effect, consisting of a reduction in information asymmetry. In the second part of this proposal, I analyze the firm's use of a commercial vs. an investment bank in equity underwriting, while considering the underwriter's reputation and the endogeneity of the fees. Firms with higher levels of asymmetric information are more prone to have their equity issues underwritten by a commercial bank. The firms react to the fees that would be charged by the different bank types and reputations. After controlling for the underwriter's reputation, the effect on announcement returns of a surprise announcement of being underwritten by a commercial bank is directly related to the firm's level of information asymmetry. This is consistent with the commercial banks' competitive advantage in certification residing in economies of scope/ information transfers, and the investment banks' relative strength consisting of an outsider certification capability that is less variable across the spectrum of firms transparency.