The Quality and Price of Investment Banks' Service: Evidence from the PIPE Market
Dai, Na, Jo, Hoje, Schatzberg, John D., Financial Management
We investigate the market structure and the pricing by placement agents of private investments in public equities (PIPEs). Our findings indicate that more reputable agents are associated with larger offers and with firms possessing lower risk. Agent reputation is positively associated with lower discounts and an enhanced post-PIPE trading environment, issuers pay a higher dollar fee for these benefits, although more reputable agents charge a lower percentage fee. The evidence suggests that it is the quality of the issuing firm, and the pricing and reputational concern of the placement agent, that drives the equilibrium in the PIPE market.
Private investment in public equity (PIPE) involves the selling of securities issued by companies that have publicly traded stocks to private investors and represents an increasingly important avenue for raising equity capital. (1) The primary goal of the current paper is to examine and provide detailed quality and pricing evidence concerning the role of investment banks in this emerging market. We examine four fundamental issues in this regard: 1) the selection process between issuers and placement agents, 2) whether placement agents help lower transaction and information costs, 3) whether placement agents with strong reputations provide higher-quality services, and 4) whether these higher-quality services, should they exist, enable agents to charge higher fees. To the best of our knowledge, this is the first such analysis of these topics.
We empirically contrast two existing and competing models pursuant to the analysis of the selection process between the issuer and the investment bank. Chemmanur and Fulghieri (1994) present an equilibrium whereby more reputable investment banks underwrite less risky issues, obtain higher prices for the issuers, and receive higher compensation. Within this framework, issuer quality and the pricing of investment banks' services comprise the essential attributes that enable the equilibrium pairing. More recently, Fernando, Gatchev, and Spindt (2005) model the matching between issuers and underwriters as a bilateral selection process. Their model predicts that the underwriting spread is the result of bargaining and does not precondition the matching of issuers and underwriters. The key differences between these two models are twofold: 1) whether the fee structure determines the matching process or whether it is negotiated after the matching is concluded, and 2) whether more reputable underwriters charge higher fees. The existing empirical evidence is mixed. In support of Chemmanur and Fulghieri (1994), Fang (2005) finds that more reputable underwriters provide higher-quality services and command a fee premium in the corporate bond market. Alternatively, Chen and Ritter (2000) find that in the US market, more than 90% of IPOs raising from $20 million to $80 million have spreads of exactly 7%. Further, survey data presented by Krigman, Shaw, and Womack (2001) reveal that fee structure received the lowest ranking among all decision criteria when selecting a lead underwriter in the IPO market. Surprisingly, Livingston and Miller (2000) present evidence that higher prestige underwriters actually charge significantly lower underwriting fees after controlling for their greater repeat business. Here, we provide new insights to this debate by examining the matching process and pricing mechanisms in the PIPE market.
The PIPE market has been accelerating over the last 10 years. (2) However, in comparison with more traditional equity issuance forms, such as IPOs and SEOs, research in this area is still developmental. Hillion and Vermaelen (2004) examine PIPE offerings of floating convertibles and demonstrate that such issuing firms perform poorly in the long run. Furthermore, they suggest that these securities encourage short selling by convertible holders and that the resulting dilution triggers a permanent decline in the share price. …