Tying Knots: Lending to Win Equity Underwriting Business

Abstract

This article examines the practice of "tying," which occurs when an underwriter lends to an issuer around the time of public securities offering in order to secure underwriting business. We examine the following questions: (i) How far do investment banks compete directly in tying? (ii) How does tying affect issuers, and in particular, their financing costs? (iii) Why do underwriters tie lending to underwriting? We find that investment banks engage in a substantial amount of tying, contrary to concerns that they are disadvantaged by tying practices. We find that tying allows firms to reduce their financing costs, as tied issuers receive lower underwriter fees on seasoned equity offerings and discounted loan yield spreads. These results are robust to matching methodology developed by Heckman, Ichimura, and Todd (1997, 1998). Lower financing costs are consistent with informational economies of scope from combining lending with underwriting. From the underwriters' perspective, we find that tying helps build relationships that augment an underwriter's expected investment banking revenues by increasing the probability of receiving both current and future equity underwriting business.