The Price of Loyalty: An Empirical Analysis of Underwriting Relationships and Fees

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Abstract
We analyze cross-sectional and time-series patterns in the relationship between firms that are frequent issuers of new securities and their underwriters over the 1970-1996 period. In particular, we focus on the relation between fees charged for underwriting services and the closeness of the firm's relationship with its primary underwriter. We find that firms that are more loyal to their primary investment bank tend to pay higher fees when issuing securities. The loyalty premium is smaller for public utilities than it is for other industrial firms. Fees are also somewhat lower when a firm switches from its primary bank to another underwriter. We propose and investigate alternative hypotheses for the loyalty premium. We can reject, for instance, the hypothesis that it is underwriter market power in particular industry segments that accounts for higher loyalty and fees. There is, however, evidence that the concentration of firms in an industry segment is negatively related to underwriting fees. We find that it is firms that are of smaller size, issue securities less often and have lower credit ratings, that tend to be more loyal and to pay higher fees. This is supportive of the notion that the loyalty premium may partly reflect compensation for a relatively higher level of underwriter advice and service regularly sought by the less experienced and unsophisticated issuers. We also find a decrease in firm loyalty over the sample period, with the larger, and presumably more prestigious, underwriters tending to have more loyal clients. Average fees have also declined over this period, at least in part due to the introduction of shelf registration.