Underwriter Reputation and Pricing of Risk: Evidence from Seasoned Equity Offerings

Posted: 19 Feb 2016 Last revised: 13 Jul 2016

See all articles by Chongyang Chen

Chongyang Chen

Pacific Lutheran University

Cathy Cao

Seattle University

Joyce Qian Wang

Kean University - School of Accounting and Finance

Date Written: February 19, 2014

Abstract

This paper investigates how underwriter-issuer matching choices and firm risks affect the cost of equity issuance. We show that underwriter-issuer matching is not random; it reflects underwriter reputation and risk concerns, issuers’ quality, and equity market conditions. We apply Heckman self-selection estimation model to control for the endogenous underwriter-issuer matching. We find that the matching choice leads to considerable heterogeneity in pricing of issuer systematic and firm-specific risks in SEO underwriting fees. Low-reputation underwriters require compensation for bearing issuer’s systematic risk but not for firm-specific risk, while high-reputation underwriters do the opposite. Moreover, evidence in this paper suggests that the underwriter-issuer matching decision entails a non-linear relation between SEO spread and underwriter reputation: high- and low-reputation underwriters earn higher spreads than medium-reputation underwriters. Our findings highlight the importance of accounting for underwriter-issuer matching in assessing SEO underwriting contracts. The results are robust to alternative underwriter reputation measure, model specifications, sample periods, and different samples of firms.

Keywords: Seasoned equity offering, investment bank, underwriter, reputation, risk, gross spread

JEL Classification: G24, G32, L14

Suggested Citation

Chen, Chognyang and Cao, Cathy and Wang, Joyce Qian, Underwriter Reputation and Pricing of Risk: Evidence from Seasoned Equity Offerings (February 19, 2014). Review of Quantitative Finance and Accounting, Vol. 44, No. 4, 2015, Available at SSRN: https://ssrn.com/abstract=2734587

Chognyang Chen

Pacific Lutheran University ( email )

South Garfield Street
Tacoma, WA 98112
United States

Cathy Cao (Contact Author)

Seattle University ( email )

900 Broadway
Seattle, WA 98122
United States

Joyce Qian Wang

Kean University - School of Accounting and Finance ( email )

Willis Hall 206-G
1000 Morris Ave.
Union, NJ 07083
United States

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