Relationship Capital and Competition in the Corporate Securities Underwriting Market

This paper examines how relationship capital drives competition among underwriting banks in the corporate bond underwriting market. The recent deregulation and subsequent re-entry by commercial banks into this market in the U.S. raises policy interest in measuring competitive e ect of the deregulation. The theories of relationship and reputation imply that (1) the entrants' products are di erentiated from those of incumbents due to their pre-existing relationships with issuers, and (2) the issuers' valuation of relationship capital in turn depends on their own reputation in the capital markets. I investigate these hypotheses by using the methods developed in the empirical industrial organization literature, which have not been applied to the nancial context. In doing so the paper also attempts to ll this gap between the two literatures. Using individual issuer data, I jointly estimate a discrete choice model of underwriter demand and a model of issue-speci c pricing by individual banks. I nd that there is a trade-o between relationships and price in the demand equation and that this trade-o is sharply higher for lowreputation issuers such as junk bond issuers and rst-time issuers. The lower is the reputation of the issuer, the more the demander is willing to trade o price for the relationship. This nding is consistent with the certi cation e ect of commercial bank underwriting. Commercial bank entry has increased competition in this market because their client-speci c relationship capital has increased product di erentiation in the market. And since issuers with low reputation value the relationship capital more, it is for this segment of the market that the competitive e ect of the deregulation has been most dramatic. I am indebted to Tim Bresnahan, Doug Bernheim, and Roger Noll for their invaluable guidance. I also thank Masa Aoki, Serdar Dinc, Ken Judd, Manju Puri, John Shoven and all the seminar participants at the Center for Financial Studies at Frankfurt, the Federal Reserve Bank of New York, Kellogg, HBS, IMF, Stanford, UC Berkeley, UC Irvine, Wharton, and the World Bank for many helpful discussions and comments. All errors are my own.