Conflict of Interest in Universal Banking: Evidence from the Post-Issue Performance of IPO Firms

02/09/1997 |  Ber Hedva, Yafeh Yishay, Yosha Oved

Abstract

Using a unique newly constructed data set on Israeli IPO firms in the 1990s, we study costs and benefits of universal

banking. The post-issue accounting profitability of firms underwritten by bank affiliated underwriters that were also

borrowers from the same bank in the IPO year, is significantly better than average. This is interpreted as evidence that

universal banks use their superior information regarding underwritten firms to float the cherries, not the lemons. We also

find, however, that the stock price performance of these firms during the first year following the IPO is lower than average.

Furthermore, among these firms, the stock price performance of firms whose equity was purchased by an investment fund

that is affiliated with the underwriting and lending bank is even lower. We also compute first day returns for the IPO stocks.

The first year underperformance is interpreted as IPO overpricing, which is consistent with the first day returns. Thus, bank

managed funds pay too much for bank underwritten IPOs at the expense of the investors in the funds. We conclude that there

is conflict of interest in the combination of bank lending, underwriting, and fund management. Although universal banks use

their superior information regarding underwritten firms to float the cherries, investors in bank managed funds end up paying too

much for the equity of these firms.

 

 


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