Underwriter Compensation and the Returns to Reputation

Abstract

Underwriter reputation and compensation are both topics that have received considerable attention but the question of whether underwriter fee structures provide adequate incentives for investment banks to build and maintain their reputation remains unresolved. We examine this question for equity underwriting and find that underwriters with higher reputations earn significantly higher underwriting revenues. For example, underwriters with the highest Carter-Manaster (CM) reputation ranking of 9 receive around $10 million per IPO, on average, whereas underwriters with rankings below 9 receive around $3 million. When we control for differences in characteristics of issues underwritten by banks of different reputations while also accounting for endogenous matching between issuers and underwriters, we find that CM9 underwriters earn a premium of $2.6 ($2.0) million per IPO (SEO). When spreads are measured as a percentage of proceeds, CM9 IPO underwriters receive a reputational premium of 1.79 to 3.21 percentage points from an average IPO spread of 6.71% while a third of the 4.28% spread that CM9 SEO underwriters receive, on average, is attributable to their higher reputation. Overall, our findings show that a significant premium to reputation is evident for different measures of underwriter reputation and model specifications, and provide compelling evidence of statistically and economically significant returns to reputation building in equity underwriting.