Underwriter Reputation and the Quality of Certification: Evidence from High-Yield Bonds

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in AbstractThis paper provides primary evidence of whether certification via reputable underwriters is beneficial to investors in the corporate bond market. We focus on the high-yield bond market, in which certification of issuer quality is most valuable to investors owing to low liquidity and issuing firms' high opacity and default risk. We find bonds underwritten by the most reputable underwriters to be associated with significantly higher downgrade and default risk. Investors seem to be aware of this relation, as we further find the private information conveyed via the issuer-reputable underwriter match to have a significantly positive effect on at-issue yield spreads. Our results are consistent with the market-power hypothesis, and contradict the traditional certification hypothesis and underlying reputation mechanism.JEL classification: G11, G14, G24

Corporate Reputation and Cost of Debt

“…In that sense, our study extends recent papers that examine how firms can lower borrowing costs by engaging reputable third-party certifiers, such as auditors, underwriters, banks and securities exchanges. Studies suggest that third-party certification can lower borrowing costs by overcoming information problems between insiders and outsiders (Fang 2005;Pittman and Fortin 2004;Mansi, Maxwell and Miller 2004;Andres, Betzer and Limbach 2012;Livingston and Miller 2000). We show that, in addition to exploiting the reputations of third-party certifiers, firms can also exploit their own good reputations to lower their cost of debt.…”

Do banks and industrial companies have equal access to reputable underwriters in debt markets?

“…In particular, they show that IPOs placed by more reputable underwriters are priced higher than their intrinsic values. Andres et al, (2014) provide evidence of higher downgrade and default risk in high-yield bonds placed by reputable underwriters.…”

“…Supporting the certification hypothesis, prior studies find that issuers' lack of experience is negatively related to the probability of a reputable matching (Andres, et al, 2014;Cao et al, 2014;Fang, 2005;Fernando et al, 2005;Yasuda, 2005). Reputable underwriters are less likely to place a bond of a relatively inexperienced issuer, thus putting their reputation at stake.…”

“…This positive assortative selection leads us to consider not just a simple issuerunderwriter matching but a reputable matching. Generally, this strand of literature has provided empirical evidence on the (deal-level and issuer-level) determinants of the reputable matching, highlighting that deal size and issuer size are particularly relevant (Andres et al, 2014;Cao et al, 2014;Dong et al, 2011;Fang, 2005;Fernando et al 2005;Lee and Masulis, 2011;Loureiro, 2010;Neupane and Thapa, 2013). To the best of our knowledge, there is no empirical evidence about these determinants for banking corporate bonds.…”

“…We focus on the main features of the designvolume of the proceeds raised and bond maturityas proxies of placement complexity (Fang, 2005;Fernando et al, 2015;Lou and Vasvari, 2013;Song, 2004) . Prior studies show that more complex bonds are more likely to be placed by reputable underwriters (Andres et al, 2014;Fernando et al, 2015;Loureiro, 2010;McKenzie and Takaoka, 2013).…”