William J. Wilhelm, Jr.
Published Research and Working Papers
Investment Banking: Institutions, Politics, and Law, with Alan Morrison, Oxford University Press, 2007.
Investment Banking: Institutions, Politics, and Law provides an economic rationale for the dominant role of investment banks in the capital markets, and uses it to explain both the historical evolution of the investment banking industry and also recent changes to its organization. Although investment decisions rely upon price-relevant information, it is impossible to establish property rights over it and hence it is very hard to coordinate its exchange. The authors argue that investment banks help to resolve this problem by managing "information marketplaces," within which extra-legal institutions support the production and dissemination of information that is important to investors. Reputations and relationships are more important in fulfilling this role than financial capital.
Information Markets, with Joseph Downing, Harvard Business School Press, 2001.
This book is about the intermediaries who promote trade in financial markets by balancing the tension between self interest and collective interests in information. Financial markets always have been dominated by information. For those who envision the world in the midst of transition to a ‘new economy,’ a world where economic welfare depends more on trade in information, we believe there is much to be learned from the experience of bankers, traders and other practitioners of high finance. Financial markets have witnessed a slow, steady shift in the balance of power between Wall Street and Main Street over the course of the twentieth century. The internet has punctuated this shift, but its effect is different in degree not in kind from previous advances in information technology. Careful attention to the slower-paced democratization of financial markets offers useful perspective to managers and entrepreneurs.
The Industrial Organization of Financial Market Information Production, with Zhaohui Chen, January 2007.
Information-producing agents can opt to produce from the sell-side or the buy-side of a financial market. In the former case, they act as intermediaries who can only sell their information to other market participants. In the latter capacity they can trade on their own own private information or that acquired from an intermediary. There are welfare gains when an agent opts to become an intermediary because financial market prices are more sensitive to information produced from the sell-side of the information market. We examine conditions under which sell-side information production is sustainable and examine the implications of the model for ongoing restructuring within the securities industry.
Scaling the Hierarchy: How and Why Investments Banks Compete for Syndicate Co-Management Appointments, with Alexander Ljungqvist and Felicia Marston, September 2005.
We investigate the empirical puzzle why banks pressured their analysts to provide aggressive assessments of issuing firms during the 1990s when doing so apparently had little positive effect on their chances of receiving lead-management appointments and ultimately led to regulatory penalties and costly structural reform. We show that aggressively optimistic research can attract co-management appointments and that co-management appointments eventually lead to more lucrative lead-management opportunities. Our results suggest a potential unintended anti-competitive effect of the Global Settlement if forcing greater separation of research and investment banking diminishes co-management opportunities for (and thereby potential competition from) marginal competitors in securities underwriting, especially in the debt markets.
A Theory of the Transition to Secondary Market Trading of IPOs, with Zhaohui Chen, May 2005.
We developed a model in which investment banks and institutional investors collaborate in smoothing an IPO's transition to secondary market trading. Their intervention promotes welfare under the assumption that significant new information arrives in the market in the immediate aftermath of the IPO. Under this assumption, it is optimal to stage the offering and suboptimal to commit to selling shares at a uniform price. The optimal strategy yields an economic rationale for secondary market price stabilization for IPOs carried out via a well-coordinated network of repeat institutional investors.
Investment Banking: Past, Present and Future, with Alan Morrison, Journal of Applied Corporate Finance, 2007.
This article provides an overview of our book entitled "Investment Banking: Institutions, Politics and Law.
The Demise of Investment-Banking Partnerships: Theory and Evidence, with Alan Morrison, September 2006, forthcoming, Journal of Finance.
Until 1970, the New York Stock Exchange prohibited public incorporation of member firms. After the rules were relaxed to allow joint stock firm membership, investment-banking concerns organized as partnerships or closely-held private corporations went public in waves, with Goldman Sachs (1999) the last of the bulge bracket banks to float. In this paper we ask why the Investment Banks chose to float after 1970, and why they did so in waves. Our explanation extends previous work which examined the role of partnerships in fostering the formation of human capital (Morrison and Wilhelm, 2003). We examine in this context the effect of technological innovations which serve to replace or to undermine the role of the human capitalist and hence we provide a technological theory of the partnership’s going-public decision. We support our theory with a new dataset of investment bank partnership statistics.
Bookbuilding, Auctions and the Future of the IPO Process, Journal of Applied Corporate Finance, Winter 2005.
This article examines how investment banks sustain relationships with institutional investors and how they are put to work on behalf issuers. This sets the stage for discussing how recent advances in communications technology and auction theory might reshape current securities underwriting practices.
Culture, Competence, and the Corporation, with Alan Morrison, October 2004.
We provide an economic treatment of two central ideas from management studies: corporate culture, and corporate competence. We follow Weber and Camerer’s (2003) experimental work, which identifies both the importance of cultural norms in communication, and the efficiency costs of moving to an unfamiliar culture. These costs reduce employee mobility and hence serve to incentivise employer-financed training in general skills. To the extent that cultural ties bind skilled employees to the firm, their competences are the corporation’s. This suggests a cultural link between technological shocks and training incentives: if new information systems reduce the cultural specificity of communication channels then employees will become more mobile and firms will perform less training. Advances in information technology will therefore increase the demand for professional schools, and will increase employee mobility.
Why are European IPOs so Rarely Priced Outside the Indicative Price Range?, with Tim Jenkinson and Alan Morrison, May 2005, Forthcoming, Journal of Financial Economics.
In contrast to practice in the U.S., European IPOs are very rarely priced outside the indicative price range, and frequently are priced at its upper bound. We develop a model that provides a rationale for this seemingly inefficient pricing behavior. The model allows for the practice, observed in Europe but not in the U.S., whereby underwriters obtain information from investors prior to establishing the indicative price range. With this alternative staging of the information game, first studied by Benveniste and Spindt (1989), a commitment to not exceeding the upper bound is necessary to extract private information from investors. The model has important implications for empirical research based on European primary market data.
Does Prospect Theory Explain IPO Market Behavior?, with Alexander Ljungqvist, Journal of Finance, August 2005.
We derive a behavioral measure of the IPO decision-maker's satisfaction with the underwriter's performance based on Loughran and Ritter (2002) and assess its ability to explain the decision-maker's choice among underwriters in subsequent securities offerings. Controlling for other known factors, IPO firms are less likely to switch underwriters for their first seasoned equity offering when our behavioral measure indicates they were satisfied with the IPO underwriter's performance. Underwriters also extract higher fees for subsequent transactions involving satisfied decision-makers. Although our tests suggest there is explanatory power in the behavioral model, they do not speak directly to whether deviations from expected utility maximization determine patterns in IPO initial returns.
Competing for Securities Underwriting Mandates: Banking Relationships and Analyst Recommendations, with Alexander Ljungqvist and Felicia Marston, October 2004, Forthcoming, Journal of Finance.
We investigate directly whether analyst behavior influenced the likelihood of banks winning underwriting mandates for a sample of 16,625 U.S. debt and equity offerings sold between December 1993 and June 2002. We control for the strength of the issuer’s investment-banking relationships with potential competitors for the mandate, prior lending relationships, and the endogeneity of analyst behavior and the bank’s decision to provide analyst coverage. We find no evidence that aggressive analyst recommendations or recommendation upgrades increased their bank’s probability of winning an underwriting mandate after controlling for analysts’ career concerns and bank reputation. Our findings might be interpreted as suggesting that bank and analyst credibility are central to resolving information frictions associated with securities offerings.
Partnership Firms, Reputation and Human Capital, with Alan Morrison, December 2004, American Economic Review.
In human capital intensive industries where it is difficult to contract upon the training effort of skilled agents a socially suboptimal level of training may occur. We show how partnership organisations can overcome this problem by tying human and financial capital. Partnerships are opaque so that the willingness of clients to pay depends upon reputation. Partnerships are illiquid and partners must stay with the firm until clients discover their types and update the firm's reputation. This renders unskilled agents, who will adversely affect reputation, unwilling to accept partnerships. Skilled agents therefore train the next generation so as to ensure that there is an adequate market for their own shares. We comment upon the salient differences between partnerships and joint stock firms.
IPO Pricing in the Dot-Com Bubble, with Alexander Ljungqvist, April 15, 2002, Journal of Finance.
IPO initial returns reached astronomical levels during 1999-2000. We show that the regime shift in initial returns and other elements of pricing behavior can be at least partially accounted for by a variety of marked changes in pre-IPO ownership structure and insider selling behavior over the period, which reduced key decision-makers' incentives to control underpricing. After controlling for these changes, the difference in underpricing between 1999-2000 and the preceding there years is much reduced. Our results suggest that it was firm characteristics that were unique during the "dot-com bubble" and that pricing behavior followed from incentives created by these characteristics.
IPO Allocations: Discriminatory or Discretionary?, with Alexander Ljungqvist, August 29, 2001, Journal of Financial Economics.
We estimate the structural links between IPO allocations, pre-market information production, and initial underpricing and find that
allocation policies favor institutional investors, both in the U.S. and worldwide
increasing institutional allocations results in offer prices that deviate more from the pre-marketing price range
constraints on bankers' discretion reduce institutional allocations and result in smaller price revisions, indicating diminished information production
initial returns are directly related to information production and inversely related to institutional allocations.
Our results indicate that discretionary allocations promote price discovery in the IPO market and reduce indirect issuance costs for IPO firms.
Global Integration in Primary Equity Markets: The Role of U.S. Banks and U.S. Investors, with Tim Jenkinson and Alexander Ljungqvist, September 3, 2002, Review of Financial Studies.
We examine the costs and benefits of the global integration of IPO markets associated with the diffusion of U.S. underwriting methods in the 1990s. Bookbuilding is becoming increasingly popular outside the U.S. and typically costs twice as much as a fixed-price offer. However, on its own bookbuilding only leads to lower underpricing when conducted by U.S. banks and/or targeted at U.S. investors. For most issuers, the gains associated with lower underpricing outweighed the additional costs associated with hiring U.S. banks or marketing in the U.S. This suggests a quality/price trade-off contrasting with the findings of Chen and Ritter (2000), particularly since non-U.S. issuers raising US$20m-80m also typically pay a 7% spread when U.S. banks and investors are involved.
Evidence of Information Spillovers in the Production of Investment Banking Services, with Lawrence Benveniste, Alexander Ljungqvist and Xiaoyun Yu, February 2002, Journal of Finance.
We provide evidence that firms attempting IPOs condition offer terms and the decision whether to carry through with an offering on the experience of their primary market contemporaries. Moreover, while initial returns and IPO volume are positively correlated in the aggregate, the correlation is negative among contemporaneous offerings subject to a common valuation factor. Our findings are consistent with investment banks implicitly bundling offerings subject to a common valuation factor to achieve more equitable internalization of information production costs and thereby preventing coordination failures in primary equity markets.
Information Externalities and the Role of Underwriters in Primary Equity Markets, with Lawrence Benveniste and Walid Busaba, Journal of Financial Intermediation, January 2002.
Firms that go public produce information that influences the production decisions of their rivals as well as their own. If information-production costs are borne primarily by pioneering firms, market failures can occur in which both pioneers and followers remain private and make ill-informed investment decisions. Solving this coordination problem requires a transfer between pioneers and followers that leads to a more equitable distribution of information-production costs. We contend that investment banks can enforce such a transfer by effectively bundling IPOs within an industry. This suggests an explanation for clustering of IPOs through time and within industries.
A Theory of the Syndicate: Form Follows Function, with Pegaret Pichler, Journal of Finance, December 2001.
We relate the organizational form of investment banking syndicates to moral hazard in team production. Although syndicates are dissolved upon deal completion, membership stability across deals represents a barrier to entry that enables the capture of quasi-rents. This improves incentives for individual bankers to cultivate investor relationships that translate into greater expected proceeds. Reputational concerns of lead bankers amplify the effect. We derive conditions under which restricted entry and designation of a lead banker strictly Pareto dominate, in which case it is also strictly Pareto dominant for the syndicate's fee to be greater than members' cost of participation.
The Internet and Financial Market Structure, Oxford Review of Economic Policy, June 2001.
Financial markets are markets for information. As such, they are directly influenced by advances in information dissemination, storage, and processing associated with commercial development of the Internet. On the other hand, given the long-standing centrality of information in financial markets, the consequences of the Internet for financial markets can be understood as evolutionary rather than revolutionary. This article provides a framework for understanding how the historical interplay between information technology and human capital has influenced financial market structure. In doing so, it sheds light on the recent reorganization of financial markets. The daring reader might infer implications for reorganization of product markets where the impact of the Internet is more abrupt.
Internet Investment Banking:The Impact of Information Technology on Relationship Banking, Journal of Applied Corporate Finance, Spring 1999. Reprinted in Corporate Finance: Where Theory Meets Practice, (McGraw-Hill Irwin, New York, 2001).
The banker’s network of personal relationships is perhaps the central element of the production technology of the 20th-century investment bank. Given the relatively primitive state of information technology for much of this century, this relationship-based production technology appears to have been a remarkably effective institutional adaptation to the information-intensive nature of the investment banking industry. When these financial networks were suppressed in the wake of New Deal financial reforms, the activity and amount of capital raised in public securities markets fell dramatically—and, perhaps more surprisingly, took decades to rebound. Indeed, it was not until the 1960s, when investment bank relationships were able to restore their ties to institutional investors, that U.S. public debt and equity markets returned to their former prominence. And yet, in spite of the historical success of this relationship-based production technology, evidence is mounting that it could be displaced—at least in part. This article provide an economic perspective on how recent advances in information technology have begun to lay siege to the relationship-based technology. Most of the discussion takes place in the context of recent applications of Internet technology to the pricing and distribution of securities.
Secondary Market Price Stabilization of Initial Public Offerings, Journal of Applied Corporate Finance, Spring 1999.
In this article I describe the various practices that fall under the rubric of price stabilization and outline several economic rationales for what is by definition a manipulative but legal practice. I also summarize recently published evidence characterizing the winners and losers when IPO prices are stabilized and outline some conclusions from a roundtable discussion that might serve as a guide to policymakers.
Initial Public Offerings: Going by the Book, with Lawrence Benveniste, Journal of Applied Corporate Finance, Summer 1997. Reprinted in The Best in Securities Offerings, (Bowne & Co., Inc., New York, 1998).
a book for an IPO involves little more than polling institutional investors
prior to pricing the offering in an attempt to gauge market demand for the
issue. This demand information is
then used to determine the size, price, and allocation of the offering.
In practice, ensuring a successful book-building effort is somewhat more
complicated than this simple description suggests, and generally requires use of
discriminatory tactics that draw criticism from investors and regulators alike. Despite
such criticism, book-building methods are now used in most large international
Other PublicationsWho Benefits from Price Stabilization of Initial Public Offerings? with Lawrence Benveniste and Sina Erdal, Journal of Banking and Finance 22 (1998), 741-767.
Price Stabilization as a Bonding Mechanism in New Equity Issues, with Lawrence Benveniste and Walid Busaba, Journal of Financial Economics 42 (1996), 223-255.
An Empirical Investigation of Short-Selling Activity Prior to Seasoned Equity Offerings, with Assem Safieddine, Journal of Finance 51 (1996), 729-749.
Evidence on the Strategic Allocation of Initial Public Offerings, with Kathleen Weiss Hanley, Journal of Financial Economics 37 (1995) 239-257. Reprinted in The International Library of Critical Writings in Financial Economics: Vol. 4, Empirical Corporate Finance, Michael Brennan, Ed. (Edward Elgar).
Contract Design for Problem Asset Disposition, with Lawrence Benveniste, Dennis Capozza, and Roger Kormendi, Journal of the American Real Estate and Urban Economics Association 22 (1993), 149-166.
The Failure of Drexel Burnham Lambert: Evidence on the Implications for Commercial Banks, with Lawrence Benveniste and Manoj Singh, Journal of Financial Intermediation 3 (1993), 104-137.
What's Special About the Specialist?, with Lawrence Benveniste and Alan Marcus, Journal of Financial Economics 32 (1992), 61-86.Market Making in the Options Markets and the Costs of Discrete Hedge Rebalancing, with Mel Jameson, Journal of Finance 47 (1992), 765-780.
A Comparative Analysis of IPO Proceeds Under Alternative Regulatory Environments, with Lawrence Benveniste, Journal of Financial Economics 28 (1990), 173-207.
The Impact of the 1980 Depository Institutions Deregulation and Monetary Control Act on Market Value and Risk: Evidence From the Capital Markets, with Paul R. Allen, Journal of Money, Credit, and Banking 20 (1988), 364-380.