This Chapter discusses and summarizes the previous studies on all variables under study. The review is divided into four sections. The first section presents the concepts of …………… theory. The second section discusses the previous studies about the choosing of underwriters in IPOs in general. The third section reviews a reasonable volume of findings of studies that have been carried out on the effect of each of the following common determinants of choosing of underwriters in IPOs, underwriter's reputation, underwriter's expertise, underwriter's quality of research coverage, and underwriting fees. Summary of the chapter will be the fourth section.
2.2 The..............................................theory
2.3 Previous researches on choosing of underwriters in IPOs in general
The written works on this research suggest a few introducing points to start understanding choosing of underwriters because this area of research is considered a recent area. In their study about comparing chief financial officers (CFO) points of view to current scholarly theory, Brau and Fawcett (2006) examine underwriter selection in addition to other issues. They develop the IPO written works by examining unique data from surveys of (CFOs). Particularly, they investigate the following seven concerns: incentives for going public, timing of the IPO, underwriter selection, underpricing, signalling, IPO process issues, and the decision to remain private. Regarding Surveying CFO thought toward underwriter choosing determinants, they find that CFOs select underwriters according to overall reputation, quality of the re-search department, and industry expertise.
In another study James (1992) investigates underwriters (investment bankers) selection and the decisions to replacement underwriters. James finds that the marginal expense of redoing the offerings with the same underwriter is lower, which lead underwriters to cost lower initial fees when they anticipate follow-on contracts with the same issuing company. Moreover, he finds that pricing mistakes at the time of the IPO, whether underpricing or overpricing, are related to the decision to switch lead underwriter. Finally, James finds that the longer the time between the IPO and the follow-on offering, the more probability the underwriter will be swished by the issuing company according to the usefulness of its company information degrades.
As we know, the selection of an investment bank is not totally at the choice of the issing company, for the investment bank could reject to involve in the offering. However, the truth stays that the issuing companies have some choice in selecting an investment bank. Habib and Ljungqvist (2001) find that issuing companies can select to employ a topping underwriter, at a higher fee, and get the advantage from the excellence certification that the underwriter may give, or they can employ the cheapest underwriter available. On the top of that, they find that issuing companies should select a favorable approach, which implies decision making regarding which investment bank and auditor to select and how much to invest on advertisments, also all the other actions that could help in reducing the underpricing.
Fernando et al. (2005) investigate sample of 13,059 IPOs and SEOs between 1970 and 2000. In their study, the relative location of an underwriting bank on the tombstone reports of Carter and Manaster (1990) and the relative market share has been used to identify underwriting bank ability. The findings of the study are that underwriting agreements are achieved among those issuers and underwriting banks who jointly approve that their benefits correspond. The anomaly is when the companies grant their offerings to the highest applier in a competitive public sale between underwriting syndicates. Finally, these results support the opinion that the correlations of issuers and underwriting banks are transactional rather than relationship-based, which means the issuing companies look for the underwriters who involve in their services and the underwriting banks look for the excellence of the issuers who want to hire their services.
Finally, Robert, Hansen and Khanna (1994) conduct t-statistics for investment bank selection. The findings of their study show that the mean values for negotiated offer pairs are substantially higher than their relevant mean values under competitive bidding (relevant t-statistics are 2.22 and 3.77 and relevant correlated p-values are 0.03 and 0.001). These findings emphasise on that, underwriter selection is higher under negotiation than under competitive bidding. In short, their findings lead us to say that underwriter investigation is significant and the competition decreases efficient exploration for investors.
2.4 Previous studies on the determinants of choosing the underwriters in IPOs
There are few literatures found regarding the determinants of choosing the underwriters in IPOs. Brau and Fawcett (2006) indicate that CFOs' standards for selecting underwriting banks have stayed steady in the pre- and post-bubble era. They show that in big companies CFOs think that IPO spinning which means assigning shares to possible customer-company members is further of an interest in underwriter choice than small companies CFOs. In sum, CFOs in companies with high-prestige underwriters choose underwriters based on reputation, quality, expertise, and institutional investor client base. On the other hand, CFOs in companies which use low-prestige underwriters are further concerned with valuation promises, retail investor client base, and fee structures. These results are not driven by a size impact.
The following section reviews the findings of studies about the nature of determinants of the underwriters' selection in IPOs.
2.4.1 Underwriter's reputation
Underwriter's reputation has been studied by many researchers. In their study about the relation between underwriter reputation and the long-run performance of IPO stocks, Carter, Dark and Singh (1998) conduct tests of underwriter reputation measures using a sample of IPOs issued from January 1, 1979 through December 31, 1991. Their findings show that, companies that associated with more reputable underwriters had a less affected underperformance of IPO stocks compared to the market during the three-year period than companies associated with a low reputable underwriters. Moreover, they indicate that IPOs conducted by further prestigious underwriters are related with less short-run underpricing.
On the other hand, Kenourgios, Papathanasiou and Melas (2007) study sample consists of 169 IPOs listed on the Athens Stock Exchange (ASE) during 1997-2002. They investigate the initial performance and two primary determinants of short-run underpricing of this sample. The findings of their analysis on the initial performance of the IPOs provide an indication of significant underpricing. Additionally, the cross-sectional analysis on the determinants of the IPOs indicates that the underwriters' reputation substantially influences the underpricing level of the IPOs.
Jones and Swaleheen (2010) investigate the association between underwriter reputation and IPOs initial returns over a 24-year, from 1980 to 2003. They aim to identify how the selection of IPO underwriter is associated to initial returns when taking into consideration the reputation as an endogenous variable. The results of their study indicate that the reputation of an underwriter is substantially positively related to IPO initial returns for 1980 to 2003 and 1992 to 2003 and insignificantly related, for 1980 to 1991.when considering the selection of the reputation of an underwriter as endogenous to features of the company.
Finally, in their study about examining the relation between the profitability and volatility of IPO companies and underwriter reputation, Lee and Yi (1999) investigate 1032 companies that made IPOs underwritten between 1987 and 1991. Their findings indicate that companies taken public by more reputable underwriters have higher post-IPO profitability and lower volatility when compared to those underwritten by underwriters without a founded high reputation.
2.4.2 Underwriter's expertise (Industry specialization)
There are few literatures found regarding underwriter's expertise and its relationship with the choosing of underwriters in IPOs.
When the underwriters understand the issuing company's business and have the ability to market its stocks to institutional investors, they can win a specific IPO mandate. Accor-dingly, Liu and Ritter (2010) examine underwriter's industry expertise as a one of the non-price dimensions in choosing underwriters in IPOs. In their study, they use three various measures of industry expertise to examine underwriter's industry expertise on a sample that consists of 4,510 IPOs from 1993-2008. They indicate that if the issuing company concern about industry expertise, they will charge for it with more underpricing.
Furthermore, they find that the underwriting industry in IPOs is differentiated by a series of local oligopolies established on industry specialization.
In his study about investigating the industry specialization as a one of the important elements which influence the underwriting banks' market share, Dunbar (2000) examines the data of IPOs between 1984 and 1995. He finds that industry specialization has a substantial effect on fluctuations in the market share in addition to other factors such as IPO first-day returns, established investment banks, one-year abnormal performance, abnormal compensation, and analyst reputation. The clear influence of previous elements is in low-volume IPO markets. As well as, he shows that industry expertise has an adverse influence on market share fluctuations for well-founded investment banks, so investment banks are best served by maintaining broad expertise. The results of this study are consistent with the extensively disputed significance of research ability in illustrating an is-suing company's selection of the underwriters.
2.4.3 Underwriter's quality of research coverage
Research coverage has become a basic component in the process of issuing securities in the latest years. For indication that researches analyst affects the issuing companies' selection of underwriting bank to handle its offerings, Ljungqvist, Marston and Wilhelm (2006) investigate 16,625 U.S. debt and equity offerings accomplished through December 1993 to June 2002. The results of their study show that there is no indication that aggressive analyst behaviour raised their investment bank possibility of winning an underwriting contract.
Relying on a sample that consists of 1,050 companies executing IPOs through1993 to 2000, Cliff and Denis (2004) investigate the connections between IPO underpricing, post-IPO research coverage, and the probability of changing investment bank. They find a significant positive relation between underpricing and analyst coverage by the managing underwriter. On the top of that, they find a negative relationship between the possibility of changing underwriters through IPO to SEO and the unpredictable amount of post-IPO research coverage. Finally, they come out with that result after controlling the other possible determinants of switching underwriters.
2.4.4 Underwriting fees
Issuing stocks as a one of the financing activities provide important returns for underwriting banks. The selection of an underwriter is disputed to rely on some qualitative and quantitative factors, such as the quality of analyst coverage of the underwriting bank, the pricing and performance of past contracts underwritten by the bank and the bank's management quality. Dunbar (2000) finds that U.S. banks that cut their fees profit on market share, showing that issuing companies to some extent are affected in their investment banker selection by the fees they are quoted. In addition, he finds that the well established banks can win a high market share regardless of charging high fees, showing that issuing companies predict some compensating interests from associated to such underwriters.
Moreover, Booth and Smith (1986) show that if the underwriting banks with a fewer reputation decrease its fees the issuers may be ready to agree on accepting more positive first-day returns. On the other hand, Megginson and Weiss (1991) relate the reputation of investment banks to the market portion of accomplished offerings. They show that the highest-quality underwriters will win the large-volume of the offerings in addition to the largest share of fees.
Nanda and Warther (1998) investigate the association between the fees paid to underwriting bank fees and loyalty, described as the re-issuing securities with the same managing underwriter. Their results indicate that fees are not significant in the changing decision, in spite of companies that show higher loyalty pay greater underwriter fees. Moreover, they show that more common issuers of securities are more probably to switch managing investment banks.
The survey of Krigman et al. (2001) shows that the changing underwriters depending on underwriting fees are given underwriting fees is given low priority. It also indicates that during making the decision determinants regarding choosing the managing underwriter, the Fee structure got the weakest ranking.
2.5 Summary
This chapter summarizes and presents mainly the literature of the variables under study. Firstly, it presents the concepts of ............... theory. Secondly, it discusses the previous studies about choosing the underwriters in IPOs which is the dependent variable. Lastly, the literature on the four independent variables is reviewed.
Iv 3
Thus, in choosing an underwriter, an important consideration for an issuing firm is that the underwriter has a well-respected analyst following the industry, who can be counted on to produce bullish research reports. These bullish research reports are especially important for creating demand when insiders are selling shares in the open market.
As issuers placed more importance on hiring a lead
underwriter with a highly ranked analyst to cover the firm, they became less concerned
about avoiding underwriters with a reputation for excessive underpricing
Hong and Kubik (2003) report that analysts making optimistic forecasts are more likely to
move to a higher-status brokerage firm if they change jobs. Furthermore, analysts whose
employer underwrites stocks that they cover are more likely to be forced out, the less optimistic
their forecasts are. Hong and Kubik report that these biases became even stronger in the
1999-2000 period. Discussions with executives of firms going public in 2001-2003 suggest
that analyst coverage is still an important determinant of underwriter choice, in spite of the
Global Settlement restrictions on analyst participation in IPOs.
Cliff and Denis (2004) test the analyst lust hypothesis using a sample of 1,050 US firms
conducting IPOs during 1993-2000 that subsequently conducted at least one follow-on equity
offering during 1993-2001. They find that issuers are less likely to switch underwriters for
their first SEO if there had been greater underpricing, and if the IPO underwriter's analyst
covered the stock one year after the IPO. In their Table 6 regression with an analyst coverage Loughran & Ritter • Why Has IPO Underpricing Changed Over Time? 11
instrument, they report that having an all-star analyst in the industry of the issuing firm at
the time of the IPO is associated with first-day returns that are 16.3% higher. Furthermore,
their subperiod results show higher incremental underpricing associated with hiring an
underwriter with an II all-star covering the firm in the bubble period than earlier.
The evidence in all these studies is consistent with the analyst lust hypothesis, and those
that report subperiod results find that the effects were stronger in the late 1990s when
valuations were highest, just as we predict.
The changing issuer objective function hypothesis posits two reasons for why issuers
became more complacent about underpricing in the 1990s and internet bubble period. First,
the analyst lust hypothesis states that analyst coverage became a more important factor for
issuers choosing a lead underwriter, due to higher valuations than in the 1980s. Since
underwriters do not charge explicit fees for providing analyst coverage, issuers pay through
the indirect cost of underpricing.
Iv 4 fees
