A Model of the Demand for Investment Banking Advising and Distribution Services for New Issues

Posted: 17 Nov 2009

See all articles by David P. Baron

David P. Baron

Stanford University - Graduate School of Business

Date Written: 1983

Abstract

Develops a theory for the demand for the advising and distribution services of investment banks when there is information asymmetry between an issuer of new securities and the investment bankers. The advising services of the investment banker are valuable when the banker has better information about the capital market, while the distribution services are useful when the banker is able to create demand for the issue. This analysis considers the delegation contract between the issuer and the banker in a negotiated, fixed price offering. The delegation contract exists when the issuer enlists the banker to both advise on the offering price and distribute the securities. In this case, the banker's decision as to whether the contract should be accepted is based on the banker's private information. Given these conditions, a model is presented, and an example is provided to illustrate the optimal delegation contract. Also examined are the situation in which the issuer only utilizes the distribution services of the banker and the situation in which the investment banker is not engaged at all. Results show that when the banker is better informed than the issuer, the new issues are underpriced. Further, those issuers of unseasoned securities who are less informed about the capital market than the issuers of seasoned securities are more likely to seek the advice of investment bankers. (SRD)

Keywords: Advisory services, Contracts & agreements, Information asymmetry, Underpricing, Investment banks, Securities offerings, Investment policies, Valuation

Suggested Citation

Baron, David P., A Model of the Demand for Investment Banking Advising and Distribution Services for New Issues (1983). University of Illinois at Urbana-Champaign's Academy for Entrepreneurial Leadership Historical Research Reference in Entrepreneurship, Available at SSRN: https://ssrn.com/abstract=1505228

David P. Baron (Contact Author)

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-723-3757 (Phone)
650-725-6152 (Fax)

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