Conflicts of Interest in Financial Markets - Evidence from Bond Underwriting in the Nineties

Dario Focarelli and Alberto Pozzolo

Economics & Statistics Discussion Papers from University of Molise, Department of Economics

Abstract: This paper presents some new evidence on the conflict of interest that may arise when banks underwrite corporate securities and sell them to their customers. Two alternative views are confronted; a) that commercial banks possess private information on the financial condition of their clients and so perform better screening (the certification hypothesis); and b) that commercial banks might convert loans to firms in financial difficulties into bonds marketed to unsuspecting clients (the ‘naïve investor’ hypothesis). The empirical analysis compares the default rates between 2000 and 2002 of a sample of more than 5,000 securities issued from 1991 to 1999. Our results show that, on average, securities underwritten by investment houses and by commercial banks had the same probability of default. However, investment-grade issues underwritten by commercial banks had a lower probability of default than those underwritten by investment houses, while the reverse was true for noninvestment- grade issues. Based on this latter result, it is not possible to refute the ‘naïve investor’ hypothesis, as instead in Kroszner and Rajan (1994).

Keywords: Conflicts of interest; Glass-Steagall Act; Securities underwriting; Default performance. (search for similar items in EconPapers)
JEL-codes: G21 G24 N22 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2005-01-13
New Economics Papers: this item is included in nep-acc, nep-fin and nep-fmk
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Persistent link: https://EconPapers.repec.org/RePEc:mol:ecsdps:esdp05023

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