What do underwriters learn from investors? Evidence from equities, corporate bonds, and leveraged loans

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When companies issue securities, they turn to investment banks or “underwriters” for help. One of the main tasks of the underwriter in the issuance process is to solve a demand discovery problem: To sell the security at the highest possible price, the underwriter must find out how much investors are willing to pay. An investor knows her willingness to pay but the underwriter does not, so the willingness to pay is a form of private information. Underwriters use a procedure called bookbuilding to elicit this private information from investors. What is the nature of this private information? Is it information about investors’ preferences, or is it information about the fundamentals of the issuing firms? I propose to empirically investigate these questions in this project. The answer to these questions has important financial and real consequences. The type of information revealed during bookbuilding affects the information content of prices in the primary market and therefore the allocation of capital in financial markets, and, ultimately, real investment. Understanding who has which type of private information is also crucial for understanding the economic function of underwriters in the issuance process. In the literature, many explanations of underwriters revolve around postulating that they have or acquire better information about the fundamentals of the issuing firms than investors. If, instead, investors have better information about firms than underwriters, then many explanations of the role of underwriters would require a re-evaluation. The prior literature has used the change between the initial price proposed by the underwriter and the final issuance price (a.k.a the “price adjustment”) as a proxy for the private information revealed during the bookbuilding process. To see what type of information investors reveal, I propose to examine whether price adjustments predict future fundamentals and/ or returns of the security being issued.