Skip to main content
SpringerLink
Log in

Underwriter syndication and corporate governance

  • Original Research
  • Published:
Review of Quantitative Finance and Accounting Aims and scope Submit manuscript

Abstract

The main purpose of this paper is to examine underwriters’ response to issuers’ ineffective corporate governance. Given the growing importance of corporate governance for the success of equity offerings, we examine this response using a sample of seasoned equity offerings (SEOs). Previous studies suggest various rationales behind underwriter syndication, such as risk sharing, market-making, information production, certification, and monitoring. We offer an information-asymmetry-reduction hypothesis for the persistence of underwriter syndication. We argue that less effective corporate governance decreases information credibility, which, in turn, increases information asymmetry, leading underwriters to increase syndicate size to mitigate subsequent agency problems. Consistent with this prediction, we find that the size of the underwriter syndication is inversely related to proxies that measure the effectiveness of corporate governance. Results remain robust even after controlling for other confounding factors.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1

Similar content being viewed by others

Notes

  1. Syndicated underwriting in a financial market is accompanied by complex sets of contracts among members, as well as buying agreements between underwriters and issuers and selling agreements between underwriters and members of the selling group (Pichler and Wilhelm 2001). Syndicated underwriting in the US financial market dates at least back to an 1870 bond offering by Pennsylvania Railroad. The syndicate primarily used in the marketing of railroad bonds gained a broader usage after 1893 (Galston 1925), and underwriting syndicates continue to exist in current-day security offerings.

  2. For instance, Goldman Sachs and Morgan Stanley hire a law firm, such as Sonnenschein Nath & Rosenthal LLP, to regularly provide practical legal advice that the equity issuer’s boards, special committees, and audit committees can readily use in connection with corporate governance matters. Their corporate governance practice also includes conducting corporate governance audits (Sonnenschein’s Corporate and Securities Practice 2006). Credit Suisse Group also makes sure that the issuers’ board of directors is composed of a majority of independent members and that audit and compensation committees are composed exclusively of independent directors for the success of equity offerings (Credit Suisse Group Company Profile 2006).

  3. See Menger (1954); Debreu (1959), and Lancaster (1968) for a formal definition.

  4. The issue of information asymmetry is initially addressed in Leland and Pyle (1977). Healy and Palepu (2001) also argue that demand for corporate transparency arises from information asymmetry and agency conflicts between managers and outside investors. While previous researchers in underwriter syndication do not focus on resolving information asymmetries, researchers in extant literature on venture capital syndication do study this issue. Admati and Pfleiderer (1994) and Lerner (1994) argue that a rationale for venture capital syndication is based on information asymmetries between early-round investors and other late-round potential investors. While their emphasis is different, Lakonishok et al. (1991) claim that venture capital syndication exploits information asymmetries and overstates their performance to potential investors.

  5. See Wilson (1968); Chowdhry and Nanda (1996); Brigham and Ehrhardt (2008); Cornett et al. (2009), and Ross et al. (2010). Brigham and Ehrhardt (2008), for example, argue that as the amount of money involved becomes larger, it becomes more likely that investment banks form underwriting syndicates. Cornett et al. (2009) indicate that stock registration prepared by the issuing firm and underwriter syndicate includes managements’ background, the risks involved with the security, information about the issuer’s business, and the key provisions and features of the security to be issued.

  6. See, for example, Fama (1980); Fama and Jenson (1983); Mace (1986); Jensen (1993), and Hermalin and Weisbach (1998), among others.

  7. See Hanouna (2005) and Boone et al. (2007) for board evolvement. Since firms conducting SEOs are usually larger, older, and more widely covered by analysts than IPOs, the board structure of SEO firms may be much closer to the firm’s desired or equilibrium level of board structure than that of IPO firms.

  8. Following Larcker et al. (2007), we use effective corporate governance and “good” corporate governance interchangeably. Likewise, we interchangeably use ineffective corporate governance and “bad” corporate governance.

  9. While 1999 amendments to NYSE and NASDAQ listing standards permit each firm some discretion in determining board independence, the SOX dampens this loophole by granting the Securities and Exchange Commission (SEC) discretion to overrule independence criteria on a case-by-case basis (see Klein 2003).

  10. The issuer’s benefits from the underwriter service include more efficient use of raised capital if the issuer has more effective corporate governance than those of other issuers with less effective corporate governance.

  11. We use the date of annual meeting in the IRRC database for the date of proxy statement.

  12. Chen and Ritter (2000) write: “Underwriters such as Merrill Lynch, with their large institutional and retail distribution networks, do not need other investment banks to assist in distributing a given issue. And with their large capital bases, risk-sharing would seem to be important only for the very largest issues” (p. 1120).

  13. Using 27 European IPOs, Jenkinson and Jones (2004) argue that their results cast some doubt upon the extent of information production during the bookbuilding period.

  14. Mace (1986) and Jensen (1993), however, argue that outside directors are more likely to be aligned with management, because outside directors tend to own a smaller equity position than other directors and top management has more power than outside directors who sit on the board.

  15. Monks and Minow (2004) suggest that this excludes not only full-time firm employees, but also employees’ family members and the company’s lawyer, banker, and consultant. Baue (2003) reports that, “Director independence is seen by many as a panacea to the corporate governance rot that has been revealed over the last few years. The New York Stock Exchange (NYSE) and NASDAQ have proposed new listing standards requiring a majority of independent outside directors on boards. However, the exchanges' definition of independence does not prevent certain director relationships and dynamics that can undermine independence.”

  16. Our board size, however, is about the same as those of the entire IRRC sample, of which the mean and median board size are 9.23 and 9, respectively.

  17. We also run Poisson regressions of the number of co-managers, instead of all underwriters, in the syndication with board structure variables and the other control variables. Our untabulated results suggest that although we obtain the same signs as found in the syndication size regression, the significance is weaker, presumably because the number of co-managers is usually limited, ranging from 1 to 3 in most cases. However, because existing rationales behind underwriter syndication, including risk sharing, market making, information production, monitoring, and certification, are mainly developed for underwriter syndication rather than only for the number of co-managers, our empirical design using syndicate size is more appropriate for examining the impact of board structure on the underwriter syndicate’s response.

  18. See subsection 3.3 for the process of choosing the seven board structure variables.

  19. Unreported OLS results are qualitatively similar.

  20. The problem of endogenous explanatory variables can arise in a variety of contexts. Typical situations include: omitted variable bias, errors in variables problem, and simultaneity bias. Because it is unlikely that syndicate size determines the board structure, the endogeneity problem in our analysis is not from simultaneity, but from omitted variable bias. Thus, the simultaneous equation system is not appropriate for our framework.

References

  • Admati A, Pfleiderer P (1994) Robust financial contracting and the role of venture capitalists. J Financ 49:371–402

    Article  Google Scholar 

  • Altinkiliç O, Hansen R (2000) Are there economies of scale in underwriting fees? Evidence of rising external financing costs. Rev Financ Stud 13:191–218

    Article  Google Scholar 

  • Baue W (2003) First sustainable socially responsible financial planners and investment advisors. Corporate Social Responsibility Press Releases

  • Beatty R, Ritter J (1986) Investment banking, reputation, and the underpricing of initial public offerings. J Finan Econ 15:213–232

    Article  Google Scholar 

  • Benveniste L, Spindt P (1989) How investment bankers determine the offer price and allocation of new issues. J Financ Econ 24:213–232

    Article  Google Scholar 

  • Block D, Hoff J (1999) Underwriter due diligence in securities offerings. Cadwalader, Wickersham & Taft LLP

  • Boone A, Field L, Karpoff J, Raheja C (2007) The determinants of corporate board size and composition: an empirical analysis. J Financ Econ 86:66–101

    Article  Google Scholar 

  • Brennan M, Subrahmanyam A (1995) Investment analysis and price formation in securities markets. J Financ Econ 38:361–381

    Article  Google Scholar 

  • Brigham E, Ehrhardt M (2008) Financial management, 12th edn. Thompson South-Western

  • Bushman R, Piotroski J, Smith A (2005) Insider trading restrictions and analysts’ incentives to follow firms. J Financ 60:35–66

    Article  Google Scholar 

  • Carter R, Manaster S (1990) Initial public offerings and underwriter reputation. J Financ 45:1045–1067

    Article  Google Scholar 

  • Chen H, Guo W (2010) Divergence of opinion and initial public offerings. Rev Quant Financ Acc 34:59–79

    Article  Google Scholar 

  • Chen H, Ritter J (2000) The seven percent solution. J Financ 55:1105–1131

    Article  Google Scholar 

  • Chowdhry B, Nanda V (1996) Stabilization, syndication and pricing of IPOs. J Financ Quant Anal 31:25–42

    Article  Google Scholar 

  • Chung K, Jo H (1996) The impact of security analysts’ monitoring and marketing roles on the market value of firms. J Financ Quant Anal 31:493–512

    Article  Google Scholar 

  • Cooney J, Larry C, Bradford J, Singh A (2004) Who is #1? A new approach to ranking U.S. IPO underwriters. Working paper, Texas Tech University

  • Core J, Holthausen R, Larcker D (1999) Corporate governance, chief executive officer compensation and firm performance. J Financ Econ 51:371–406

    Article  Google Scholar 

  • Cornelli F, Goldreich D (2001) Bookbuilding and stratgic allocation. J Financ 56:2337–2369

    Article  Google Scholar 

  • Cornelli F, Goldreich D (2003) Bookbuilding: how informative is the order book? J Financ 58:1415–1443

    Article  Google Scholar 

  • Cornett M, Adair T Jr, Nofsinger J (2009) Finance: applications and theory. McGraw-Hill, NY

    Google Scholar 

  • Corwin S, Schultz P (2005) The role of IPO underwriting syndicates: pricing, information production, and underwriter competition. J Financ 60:443–486

    Article  Google Scholar 

  • Credit Suisse Group Company Profile (2006) Credit suisse group

  • Davidson W, Xie B, Xu W (2006) IPO placement risk and the number of co-managers. Financ Rev 41:405–418

    Article  Google Scholar 

  • Debreu G (1959) Theory of value. Wiley, London

    Google Scholar 

  • Denis D, Sarin A (1999) Ownership and board structures in publicly traded corporations. J Financ Econ 52:187–223

    Article  Google Scholar 

  • Ellis K, Michaely R (2000) When the underwriter is the market maker: an examination of trading in the IPO aftermarket. J Financ 55:1039–1075

    Article  Google Scholar 

  • Fama E (1980) Agency problems and the theory of the firm. J Pol Econ 88:288–307

    Article  Google Scholar 

  • Fama E, Jensen M (1983) Separation of ownership and control. J Law Econ 26:301–325

    Article  Google Scholar 

  • Galston A (1925) Security syndicate operations: organization, management and accounting. Roland Press, New York

    Google Scholar 

  • Hanouna P (2005) The evolution of ownership and board structure in newly public corporations. unpublished Ph.D. dissertation, Purdue University

  • Hansen R, Torregrosa P (1992) Underwriter compensation and corporate monitoring. J Financ 47:1537–1555

    Article  Google Scholar 

  • Healy P, Palepu K (2001) Information asymmetry, corporate disclosure and the capital markets: a review of the empirical disclosure literature. J Acc Econ 31:405–440

    Article  Google Scholar 

  • Hermalin B (2005) Trends in corporate governance. J Financ 60:2351–2384

    Article  Google Scholar 

  • Hermalin B, Weisbach M (1998) Endogenously chosen boards of directors and their monitoring of the CEO. Amer Econ Rev 88:96–118

    Google Scholar 

  • Hermalin B, Weisbach M (2003) Boards of directors as an endogenously determined institution: a survey of the economic literature. FRBNY Econ Pol Rev 7–26

  • Jenkinson T, Jones H (2004) Bids and allocations in European IPO bookbuilding. J Financ 59:2309–2338

    Article  Google Scholar 

  • Jensen M (1993) The modern industrial revolution, exit and the failure of internal control systems. J Financ 48:831–880

    Article  Google Scholar 

  • Jo H, Kim Y (2007) Disclosure frequency and earnings management. J Financ Econ 84:561–590

    Article  Google Scholar 

  • Klein A (1998) Firm performance and board committee structure. J Law Econ 41:275–303

    Article  Google Scholar 

  • Klein A (2003) Likely effects of stock exchange governance proposals and Sarbanes-Oxley on corporate boards and financial reporting. Acc Horiz 17:375–400

    Google Scholar 

  • Knyazeva D (2007) Corporate governance, analyst following, and firm behavior. Working paper, New York University

  • Lakonishok J, Shleifer A, Thaler R, Vishny R (1991) Window dressing by pension fund managers. Amer Econ Rev 81, Papers and Proceedings 227–231

  • Lancaster K (1968) Mathematical economics. Macmillan, NY

    Google Scholar 

  • Lang M, Lundholm R (1996) Corporate disclosure policy and analysts behavior. Acc Rev 71:467–492

    Google Scholar 

  • Larcker D, Richardson S, Tuna I (2007) Corporate governance, accounting outcomes, and organizational performance. Acc Rev 83(4):963–1008

    Article  Google Scholar 

  • Leland H, Pyle D (1977) Informational asymmetries, financial structure and financial intermediation. J Financ 32:317–387

    Article  Google Scholar 

  • Lerner J (1994) The syndication of venture capital investments. Financ Mgt 23:16–27

    Article  Google Scholar 

  • Lim T (2001) Rationality and analysts’ forecast bias. J Financ 56:369–385

    Article  Google Scholar 

  • Mace M (1986) Directors: myth or reality. Harvard Business School Press, Boston

    Google Scholar 

  • Menger K (1954) The logic of laws of return: a study in meta-economics. In: Morgenstern O (ed) Activity in econ anal. Wiley, NY

    Google Scholar 

  • Miller G (2000) Association response to NYS banking due diligence proposals. Bondmarkets.Com

  • Miller M (2005) Is American corporate governance fatally flawed? In: Chew D, Gillan S (eds) Corporate governance at the crossroads: a book of readings. Mcgraw-Hill, Boston

    Google Scholar 

  • Monks R, Minow N (2004) Corporate governance, 3rd edn. Blackwell, Oxford

    Google Scholar 

  • Morck R, Shleifer A, Vishny R (1989) Alternative mechanisms for corporate control. Amer Econ Rev 79:842–852

    Google Scholar 

  • Narayanan R, Rangan K, Rangan N (2004) The role of syndicate structure in bank underwriting. J Financ Econ 72:555–580

    Article  Google Scholar 

  • Petersen M (2009) Estimating standard errors in finance panel data sets: comparing approaches. Rev Financ Stud 22:435–480

    Article  Google Scholar 

  • Pichler P, Wilhelm W (2001) A theory of the syndicate: form follows function. J Financ 56:2237–2264

    Article  Google Scholar 

  • Raheja C (2005) Determinants of board size and composition: a theory of corporate boards. J Financ Quant Anal 40:283–306

    Article  Google Scholar 

  • Ross S, Westerfield R, Jordan B (2010) Fundamentals of corporate finance, 9th edn. Mcgraw-Hill, Boston

    Google Scholar 

  • Sonnenschein’s corporate and securities practice (2006) Sonnenschein Nath & Rosenthal LLP

  • Sopranzetti B, Venetian E, Wang X (2006) The market for new issues: impact of offering price on price support and underpricing. Rev Quant Financ Acc 26:165–176

    Article  Google Scholar 

  • Thomas R, Cotter J (1998) Are firm commitment underwritings risky? The role of the over-allotment option. Working paper, Vanderbuilt University

  • Weisbach M (1988) Outside directors and CEO turnover. J Financ Econ 20:431–460

    Article  Google Scholar 

  • Wilson R (1968) The theory of syndicates. Economet 36:119–132

    Article  Google Scholar 

  • Yermack D (1996) Higher market valuation of companies with a small board of directors. J Financ Econ 40:185–212

    Article  Google Scholar 

  • Yermack D (2004) Remuneration, retention, and reputation incentives for outside directors. J Financ 59:2281–2308

    Article  Google Scholar 

  • Yu F (2008) Analyst coverage and earnings management. J Financ Econ 88:245–271

    Article  Google Scholar 

Download references

Acknowledgments

We appreciate an anonymous referee for providing valuable comments, as well as Fabio Caldiero, Robert Collins, Sanjiv Das, Paul Hanouna, Robert Hendershott, Helen Popper, Meir Statman, and William Sundstrom for their helpful comments and discussions. John Lee and Donna Maurer provided editorial assistance. Jo acknowledges financial support from the Dean Witter Foundation. Kim acknowledges support from the Accounting Development Fund of Santa Clara University. Shin acknowledges financial support from the Presidential Research Grants of Santa Clara University.

Author information

Authors and Affiliations

  1. Department of Finance, Leavey School of Business, Santa Clara University, 500 El Camino Real, Santa Clara, CA, 95053-0388, USA

    Hoje Jo

  2. Department of Accounting, Leavey School of Business, Santa Clara University, 500 El Camino Real, Santa Clara, CA, 95053-0388, USA

    Yongtae Kim

  3. Department of Economics, Leavey School of Business, Santa Clara University, Santa Clara, CA, 95053, USA

    Dongsoo Shin

Authors
  1. Hoje Jo
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Yongtae Kim
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Dongsoo Shin
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Hoje Jo.

Appendix: Definitions and measures of variables considered

Appendix: Definitions and measures of variables considered

Table 5
Full size table

Rights and permissions

Reprints and permissions

About this article

Cite this article

Jo, H., Kim, Y. & Shin, D. Underwriter syndication and corporate governance. Rev Quant Finan Acc 38, 61–86 (2012). https://doi.org/10.1007/s11156-010-0219-7

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11156-010-0219-7

Keywords

JEL Classification

Search

Navigation