Tying Knots: Lending to Win Equity Underwriting Business

This article examines the practice of " tying, " which occurs when an underwriter lends to an issuer around the time of a public securities offering in order to secure underwriting business. We examine the following questions: (i) Does the issuing firm benefit from tying practices? (ii) If so, what is the source of these benefits? Why do underwriters tie lending to underwriting? (iii) How has tying affected the competitive structure of the market? We find firms benefit both from a lower gross spread on tied seasoned equity offerings, as well as from discounted loan yields. These results are robust to matching methodology developed by Heckman, Ichimura, and Todd (1997, 1998). We find that underwriters tie lending to underwriting because a tied loan increases the probability of receiving the current equity underwriting business and can also increase the likelihood of being selected to underwrite future equity issues for the tied issuer. The benefits to the firm are consistent with informational economies of scope from combining lending with underwriting. We find that investment banks engage in a substantial amount of tying, contrary to concerns that they are disadvantaged by tying practices. Investment banks and commercial banks are remarkably similar in that they tie lending with underwriting for similar deals and provide price discounts to tied issuers, but they offer price reductions through different channels.