The Role of Equity Underwriting
Relationships in Mergers and Acquisitions
Hsuan-Chi Chen
Anderson School of Management, University of New Mexico
Keng-Yu Ho
Department of Finance, National Taiwan University
Pei-Shih Weng
Department of Finance, National Dong Hwa University
Prior Literature
• Academic research has provided some evidence of
the relationship between lending relationships and
future underwriting business.
• Drucker and Puri (2005, JF).
• SEO underwriters engaged in concurrent lending
provide lower underwriting fee and discounted loan
yield spread.
• Yasuda (2005, JF).
• Positive and significant effect of banking relationships
on a firm’s underwriter choice for debt issue.
• The underwriting fee discount is also significant when
the bank is the arranger in the prior loans.
Prior Literature
• Ljungqvist, Marston, and Wilhelm (2006, JF).
• The main determinant of winning underwriting
mandates is the strength of prior underwriting and
lending relationships rather than aggressive analyst
behavior.
• Bharath, Dahiya, Saunders, and Srinivasan (2007, JFE).
• Using bank loan, IPO, SEO, and debt issue data.
• A bank with (without) prior lending relationship has
a chance of 42% (3%) as future loan lender.
• Prior lending relationship increase the probability for
gaining future debt or equity underwriting business.
Relationship Banking
Do prior business relationships affect subsequent
transactions?
The answer to this general question:
“YES”
Motivation
• Extend the prior equity underwriting relationships
to subsequent M&A advisory (a gap in the
literature).
• Financial advisors involved in M&As worth more
than $1 trillion in 2005, earning advisory fees of $2
billion (Chang, Shekhar, Tam, and Zhu, 2012)
• In 2009, global M&A deals announced > 38,000;
the value > $2.07 trillion.
Research Questions
• Does the prior equity underwriting relationship affect the chance of
winning subsequent M&A advisory?
 Yes!
• Does the prior underwriting relationship affect the fees of M&A
advisory?
 Yes, the prior underwriting relationship helps reduce the
advisory fees for the target firms.
• Does the prior underwriting relationship affect the performance
(merger synergy) of M&A transaction?
 Yes, the prior underwriting relationship helps increase the
synergy gains for the target firms.
Why equity underwriting relationships?
• Extending from James (1992), an equity underwriter may
invest in relationship specific assets with its client from due
diligence. The established relationship may create a "lock in"
effect, making them costly to switch to a different bank for
subsequent M&A services.
• Extending from Hansen and Torresgrosa (1992), an equity
underwriter monitors the underwriting process to ensure good
performance and strong leadership. Valuable information is
acquired to reduce the monitoring costs of subsequent M&As.
• By examining the impacts of failure or near failure of
investment banking firms on their industrial clients, Fernando,
May, and Megginson (2012) and Kovner (2012) provide
evidence supporting the importance of equity underwriting
relationships.
Contributions
• Filling a gap in the literature, we extend the literature to
shed new lights on the role of equity underwriting
relationships and provide linkage for the equity
underwriting market and M&A advisory market.
• Fernando, May, and Megginson (2012) and Kovner
(2012) provide evidence supporting the importance of
equity underwriting relationships. By exploring the
relation between the prior equity underwriting
relationships and subsequent M&A advisory, our study
contributes to provide a positive answer to the longstanding question of whether firms derive value from
investment bank relationships.
Hypothesis 1: The increasing
retention likelihood hypothesis
• Either the theory of relationship-specific assets or
the theory of underwriter monitoring predicts that
the equity underwriting relationship increases the
likelihood of advising subsequent mergers and
acquisitions for prior underwriting banks.
• The bank that underwrites a firm’s IPO/SEOs is
more likely to engage in future M&A advisory
business with the same firm than other banks that
do not have this underwriting relationship.
Hypothesis 2a: The cost-saving hypothesis
• The underwriter-client relationship becomes a valuable
asset that lowers the cost and improves the quality of the
services provided. The benefits emerge if the bank
acquires a better understanding of the client’s operations
and learns to work more effectively with the client from
due diligence in the underwriting process.
 The prior underwriting relationship can reduce the
advisory fees paid by the acquirers or target firms in
subsequent M&As if the firms can capture part of the cost
savings from their financial advisors.
• Banks that subsequently advise their underwriting clients
will charge lower advisory fees than the banks without
underwriting relationship.
Hypothesis 2b: The rent expropriation hypothesis
• Banks may not share saving with the clients,
particularly if they have informational advantage
(Petersen and Rajan (1994)).
• Firms may pay higher fees to financial advisors
with whom they had relationships in the past if they
worry that their advisors may abandon them and
advise their merger counterparties (Chang et al.
(2012)).
• M&A firms will pay higher advisory fees to their
M&A financial advisors with underwriting
relationship than to those without such relationship.
Hypothesis 3: The positive merger synergy hypothesis
• Top-tier investment bankers are able to structure
mergers with higher synergies (Golubov et al. (2012)).
• We argue that the equity underwriting relationship
between the advisors and the firms lowers the
information asymmetry and enables investment banks to
provide better advisory services.
• The equity underwriting relationship between the
financial advisors and the firms lowers the information
asymmetry and then enables investment banks to
provide better advisory services, there would be a
positive effect, in term of merger synergy, on the
relationship M&A transactions.
Data
• Data sources:
• IPOs/SEOs/M&As: SDC Platinum of Thomson Reuters
• Firm characteristics: CRSP and Compustat
• Identifying bank-firm relationship:
• Mergers and acquisitions among banks: Assuming the
client relationships of an acquired bank are inherited by
the acquiring bank.
Data
• U.S. M&A deals completed: 1,580 acquirers and 844 targets
from 1995-2007, excluding firms without SIC codes,
financial firms and government agencies, deals without
transaction values and firms without hiring financial advisors
• 1,514 U.S. IPOs/SEOs from 1990-2002 (5-year lag):
Excluding ADRs, REITs, mutual funds, financial firms,
utilities, and unit offers
• To be included in the final sample, a firm must have at least
one equity offering (IPO or SEO) completed within five
years before its merger and acquisition announcement.
 1,016 acquirers and 632 targets from 1995-2007
Descriptive Statistics: Bank-Firm Pairs (Table 1)
Descriptive Statistics (Table 2)
Descriptive Statistics (Table 2-continued)
Advisor Choice: Probit Model (Table 3)
Advisor Choice: Bivariate Probit Model (Table 4)
M&A Advisory Fee: OLS (Table 5)
M&A Advisory Fee: Heckman Procedure (Table 6)
M&A Synergy Gains: OLS (Table 7)
M&A Synergy Gains: Heckman Procedure (Table 8)
Conclusion
• This paper provides evidence on the role of prior equity
underwriting relationship in M&As.
• We find that a firm tends to choose the bank with prior
equity underwriting relationships as the financial advisor in
subsequent merger transactions.
• We also find that the prior equity underwriting relationship
helps reduce the advisory fees and increase the synergy gains
for the target firms.
• By exploring the relation between the prior equity
underwriting relationships and subsequent M&A advisory,
our study contributes to partly provide a positive answer to
the long-standing question of whether firms derive value
from investment bank relationships.