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Analyst Behavior and Underwriter Choice

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Abstract

We examine the role that analysts play in a firm's choice of underwriter using a sample of major U.S. investment banks. In order to best capture the competitive environment, which is critical to the potential role that analysts play, we limit our sample of firms to 161 real estate investment trusts (REITs) issuing debt or equity between 1996 and 2004. Using the estimation technique of Ljungqvist et al. (Journal of Finance 61:301–340 2006), which accounts for the endogeneity of analyst behavior and the coverage self-selection decision, we find that target prices that are optimistic relative to competitors' target prices, significantly increase an underwriter's probability of attracting underwriting business. This result holds for both equity and debt issues with fees greater than one million dollars. We also find evidence consistent with the notion that increased regulatory scrutiny of conflicts of interest between analysts and investment banks has decreased the impact of analyst behavior on underwriter choice.

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Notes

  1. See the SEC's web page, http://www.sec.gov/news/press/2003-54.htm, for details.

  2. See Cole (2001) and Gasparino (2005) for a discussion of some high profile cases.

  3. See Kallberg et al. (2003) and Boudry (2010) for a discussion of the payout policy of REITs.

  4. J.P Morgan had an equity market share of 2.7% in 2004, but underwrote no equity deals from 1999 to 2003.

  5. In our sample the average seasoned equity issuance is $90 million and the average debt issuance is $100 million. These are slightly smaller than the averages for similar issuances reported in Ljungqvist et al. (2006).

  6. We chose 2001 as the break point in the sample simply because the allegations made in the global settlement related to actions before this period.

  7. See Booth and Smith (1986).

  8. See for example Ljungqvist et al. (2006).

  9. See James (1992) for a discussion of underwriters and firm specific capital.

  10. See O’Brien and Bhushan (1990) for a discussion of a brokerage's decision to cover a firm.

  11. See Maddala (1983) for a discussion of this econometric specification.

  12. The maximum likelihood standard errors obtained from the Heckman probit do not account for the fact that the fitted value from the first step is measured with error. This leads to downward biased standard errors. Murphy and Topel (1985) provide an asymptotic adjustment to correct the second stage standard errors for the measurement error contained in the fitted value.

  13. See Boudry et al. (2010) for a discussion of REIT security issuance decisions.

  14. Issuances made by the limited partnership associated with a given REIT are treated as if the issuance was made by the REIT itself.

  15. See Corwin and Schultz (2005) and Ljungqvist et al. (2009) for a discussion of underwriting syndication.

  16. The normalized Hirschman-Herfindahl Index falls from over 0.2 to around 0.1 during the sample period. In terms of competition, the Department of Justice considers a HHI of 0.1 to 0.18 to be moderately concentrated. See their web page for a discussion http://www.usdoj.gov/atr/public/testimony/hhi.htm .

  17. See Gande et al. (1999) for a discussion of the entrance of commercial banks into the bond underwriting market after the relaxation of Section 20 of the Glass-Steagall Act.

  18. For example, in 2002 a deal underwritten by Citigroup is considered to be underwritten by Salomon Smith Barney.

  19. A classic example is Thomas Weisel Partners, which competes for all deals in the Ljungqvist et al. (2006) study, but has never underwritten a REIT offering and is unlikely ever to, since it focuses on growth industries.

  20. A comparison of First Call's brokerage level target prices and hand collected reports from Investext, in which the analyst is identifiable, suggests that First Call's estimates come from lead analysts.

  21. There does not appear to be a systematic rule governing back filling. For example, while Deutsche Bank is back filled, the Paine Webber and UBS merger is not.

  22. Essentially what it entails is checking for each industry whether both merged banks provided analyst coverage, and if so, dropping all observations before the merger. Dropping observations in this non-random manner has the potential to lead to some unwelcome sample selection issues.

  23. Although both Investext and First Call are incomplete in their individual coverage, the merged data set for the brokerages of concern in this study, is similar to the coverage provided by I/B/E/S.

  24. Ljungqvist et al. (2006) also try several other metrics, but each is a variant of a recommendation minus the median recommendation.

  25. See the SEC's web page, http://www.sec.gov/spotlight/globalsettlement.htm for examples.

  26. See Gasparino (2005) and Cole (2001) for numerous illustrative examples.

  27. See Mikhail et al. (1999).

  28. For new entrants the last year fee revenue is zero. For these firms Fee to Last is set equal to one.

  29. See Burch et al. (2005) for a discussion of underwriter loyalty.

  30. This is a simplified version of the measure used in Burch et al. (2005) and is the same as that used by Ljungqvist et al. (2006) and Ellis et al. (2005).

  31. See Stickel (1992) and Fang and Yasuda (2009) for a discussion of All Star analysts.

  32. See Boudry et al. (2007) for a discussion of REIT institutional ownership.

  33. See Ljungqvist et al. (2007) for a discussion.

  34. All results are similar if a 5-year window is used.

  35. See Corwin and Schultz (2005) Appendix A for a list of investment bank mergers. The date of the remaining mergers in the sample were obtained from searches of Lexis-Nexis.

  36. See, for example, Booth and Smith (1986), Beatty and Ritter (1986) and Carter and Manaster (1990).

  37. Fernando et al. (2005) argue that if underwriter choice is a two-sided matching, higher underwriter reputation may not be associated with a higher probability of winning a deal. This would only be true for high reputation issuers.

  38. See Drucker and Puri (2005) for a discussion of the links between commercial loans and underwriting deals.

  39. See, for example, Michaely and Womack (1999), Burch et al. (2005) and Ellis et al. (2005).

  40. Combining all deals together in one estimation leads to results very similar to, although slightly weaker than, the equity deal sample.

  41. These insignificant findings may be the result of the smaller size of our sample. Ljungqvistet al. (2006) have approximately 10 times the number of observations in their estimation.

  42. See Brav and Lehavy (2003) for a discussion of recommendations versus target prices.

  43. See Cole (2001) for a discussion of the incident.

  44. The Securities and Exchange Commission makes direct reference to this on their investor education web page: http://www.sec.gov/investor/pubs/analysts.htm.

  45. In the estimation we reverse this so a Strong Buy is rated 5.

  46. This process is also used by I/B/E/S, so although previous studies have used that data, the problem of comparing analyst recommendations remains.

  47. We are grateful to our discussant at the DePaul REIT Symposium, Jim Booth, for this observation.

  48. See Clarke et al. (2007) and Ljungqvist et al. (2006).

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Acknowledgements

We are grateful to Yakov Amihud, Stephen Brown, Bill Greene, Victoria Ivashina, Alexander Ljungqvist, Yang Lu, Amrut Nashikkar, Tony Saunders, Jonathan Spitzer, Charles Trczinka and Robert Whitelaw and seminar participants at AREUEA 2007 in Chicago, Cornell University, George Washington University, NYU and UNC Chapel Hill for helpful comments. We thank our discussant, James Booth, and other participants at the October 2008 DePaul University REIT Symposium for constructive criticism. Finally, we acknowledge the assistance of the editor, Jim Shilling, and two anonymous referees in improving this study. Jared Chung and Eric Su provided excellent research assistance. All errors are our own.

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Authors and Affiliations

  1. Leonard N. Stern School of Business, New York University, 44 W 4TH St, Suite 9-190, New York, NY, 10013, USA

    Walter I. Boudry

  2. Thunderbird School of Global Management, Glendale, AZ, 85306, USA

    Jarl G. Kallberg

  3. School of Hotel Administration, Cornell University, 440 Statler Hall, Ithaca, NY, 14853, USA

    Crocker H. Liu

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  1. Walter I. Boudry
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  2. Jarl G. Kallberg
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  3. Crocker H. Liu
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Correspondence to Walter I. Boudry.

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Boudry, W.I., Kallberg, J.G. & Liu, C.H. Analyst Behavior and Underwriter Choice. J Real Estate Finan Econ 43, 5–38 (2011). https://doi.org/10.1007/s11146-010-9246-3

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