Investment bank reputation and compensation in equity issues

How do equity issuing firms and underwriters get together? We develop a theoretical model founded on the idea that issuers and underwriters associate by mutual choice. Underwriters look to the quality of the issuers who may wish to employ their services and issuers look to the abilities of the underwriters they consider employing. Our approach contrasts to the conventional view of one-sided choice established in the existing literature.; Our model suggests that a rematch will occur for subsequent offerings should changes in firm quality and/or underwriter reputation warrant it. Our empirical finding that firms experiencing a relative reduction in quality from IPO to SEO switch to lower reputation underwriters at the SEO stage provides especially convincing support for this notion.; We derive new implications about underwriter market share, showing that (a) high reputation underwriters benefit from a more stable revenue stream and (b) that while their market share increases when overall market activity is reduced, this would be accompanied by a relative decrease in the quality of the issues they underwrite.; In our model, pricing of underwriter services is left to bargaining between the parties after the match between issuers and underwriters is determined. While flat percentage IPO fees are a possible outcome with double-sided matching, high-reputation underwriters make higher dollar revenues by underwriting larger offerings. This is also true for subsequent offerings since high reputation underwriters associate with firms that undertake larger and more frequent security offerings subsequent to their IPO.; We also find that underwriter reputation is negatively related to the probability to withdraw an offering during the registration period and that on average in adverse market conditions underwriter reputation has a higher negative impact on the probability to withdraw than it has in more favorable market conditions.; By examining gross spreads over time we find a significant clustering of percentage gross spreads on round numbers. The evidence suggests that while fixed costs of issuing equity have not changed over time, variable costs have increased. At the same time, percentage spreads have become less sensitive to the relative size and the risk characteristics of the issue.