UUnniivveerrssiittyy ooff PPeennnnssyyllvvaanniiaa SScchhoollaarrllyyCCoommmmoonnss Publicly Accessible Penn Dissertations 2015 TThhee GGlloobbaall SSeettttlleemmeenntt,, AAllll--SSttaarr AAnnaallyysstt DDeeppaarrttuurreess,, aanndd TThheeiirr IImmppaacctt oonn tthhee CCaappiittaall MMaarrkkeettss Xin Wu Mahaney-Walter University of Pennsylvania, [email protected] Follow this and additional works at: https://repository.upenn.edu/edissertations Part of the Economics Commons, and the Finance and Financial Management Commons RReeccoommmmeennddeedd CCiittaattiioonn Mahaney-Walter, Xin Wu, "The Global Settlement, All-Star Analyst Departures, and Their Impact on the Capital Markets" (2015). Publicly Accessible Penn Dissertations. 1871. https://repository.upenn.edu/edissertations/1871 This paper is posted at ScholarlyCommons. https://repository.upenn.edu/edissertations/1871 For more information, please contact [email protected]. TThhee GGlloobbaall SSeettttlleemmeenntt,, AAllll--SSttaarr AAnnaallyysstt DDeeppaarrttuurreess,, aanndd TThheeiirr IImmppaacctt oonn tthhee CCaappiittaall MMaarrkkeettss AAbbssttrraacctt The Global Research Analyst Settlement prohibited twelve large investment banks from tying equity analysts' compensation to investment banking revenues, causing a large number of Institutional Investor "all-star" analysts to exit the sell-side industry. Using a difference-in-differences specification, I find that the departure of all-stars caused their bank-industry underwriting groups to lose equity issuance market share. Market share losses were more severe for IPOs than for IPOs and follow-on underwritings combined. The higher the average quality of all-stars in a bank-industry, the more severe were the bank- industry's losses. Additionally, the departure of all-stars raised the cost of equity capital for IPOs underwritten by their bank-industry groups, particularly for IPOs that were more difficult to value. Ultimately, the loss of sell-side research talent, an unintended consequence of regulation, forced issuers to accept research coverage of inferior quality, raising the cost of obtaining public capital. DDeeggrreeee TTyyppee Dissertation DDeeggrreeee NNaammee Doctor of Philosophy (PhD) GGrraadduuaattee GGrroouupp Finance FFiirrsstt AAddvviissoorr Luke A. Taylor KKeeyywwoorrddss Capital Markets, Equity Research, Global Research Analyst Settlement, Investment Banking SSuubbjjeecctt CCaatteeggoorriieess Economics | Finance and Financial Management This dissertation is available at ScholarlyCommons: https://repository.upenn.edu/edissertations/1871 THEGLOBALSETTLEMENT,ALL-STARANALYSTDEPARTURES, ANDTHEIRIMPACTONTHECAPITALMARKETS XinWuMahaney-Walter ADISSERTATION in Finance FortheGraduateGroupinManagerialScienceandAppliedEconomics PresentedtotheFacultiesoftheUniversityofPennsylvania in PartialFulfillmentoftheRequirementsforthe DegreeofDoctorofPhilosophy 2015 SupervisorofDissertation LukeTaylor AssistantProfessorofFinance GraduateGroupChairperson EricT.Bradlow ProfessorofMarketing,Statistics,andEducation DissertationCommittee: ErikGilje,AssistantProfessorofFinance DavidMusto,RonaldO.PerelmanProfessorinFinance LukeTaylor,AssistantProfessorofFinance THEGLOBALSETTLEMENT,ALL-STARANALYSTDEPARTURES,ANDTHEIR IMPACTONTHECAPITALMARKETS c COPYRIGHT (cid:13) 2015 XinWuMahaney-Walter Thisworkislicensedunderthe CreativeCommonsAttribution NonCommercial-ShareAlike3.0 License Toviewacopyofthislicense,visit http://creativecommons.org/licenses/by-nc-sa/3.0/ ACKNOWLEDGEMENT I thank my advisors Luke Taylor (committee chair), Erik Gilje, and David Musto. This work would not have been possible without their guidance and support. I am also grateful toDavidEricksonforhishelp. iii ABSTRACT THEGLOBALSETTLEMENT,ALL-STARANALYSTDEPARTURES, ANDTHEIRIMPACTONTHECAPITALMARKETS XinWuMahaney-Walter LukeTaylor TheGlobalResearchAnalystSettlementprohibitedtwelvelargeinvestmentbanksfromty- ingequityanalysts’compensationtoinvestmentbankingrevenues,causingalargenumber ofInstitutionalInvestor“all-star”analyststoexitthesell-sideindustry. Usingadifference- in-differences specification, I find that the departure of all-stars caused their bank-industry underwriting groups to lose equity issuance market share. Market share losses were more severeforIPOsthanforIPOsandfollow-onunderwritingscombined. Thehighertheaver- agequalityofall-starsinabank-industry,themoreseverewerethebank-industry’slosses. Additionally, the departure of all-stars raised the cost of equity capital for IPOs underwrit- ten by their bank-industry groups, particularly for IPOs that were more difficult to value. Ultimately, the loss of sell-side research talent, an unintended consequence of regulation, forced issuers to accept research coverage of inferior quality, raising the cost of obtaining publiccapital. iv TABLE OF CONTENTS ACKNOWLEDGEMENT iii ABSTRACT iv LISTOFTABLES vi LISTOFILLUSTRATIONS vii CHAPTER1: INTRODUCTION 1 CHAPTER2: RESEARCHDESIGNANDHYPOTHESES 9 2.1 ResearchDesign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 2.2 HypothesesandPredictions . . . . . . . . . . . . . . . . . . . . . . . . . . 11 CHAPTER3: DATAANDSUMMARYSTATISTICS 20 3.1 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 3.2 SummaryStatistics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 CHAPTER4: RESULTS 33 4.1 ImpactofGlobalSettlementonInvestmentBankingDealFlow . . . . . . . 33 4.2 ImpactofGlobalSettlementonCostofEquityCapital . . . . . . . . . . . 43 CHAPTER5: CONCLUSIONS 74 BIBLIOGRAPHY 75 v LIST OF TABLES 1 GlobalResearchAnalystSettlement,andTreatmentGroup . . . . . . . . . 18 2 SummaryStatistics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 3 EffectofGlobalSettlementonInvestmentBankingDealFlow . . . . . . . 48 4 PlaceboTest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 5 All-StarAnalystDepartures . . . . . . . . . . . . . . . . . . . . . . . . . . 57 6 RepeatAll-Stars . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 7 AnalystQuality–DescriptiveStatistics . . . . . . . . . . . . . . . . . . . 62 8 AnalystQuality–RegressionResults . . . . . . . . . . . . . . . . . . . . . 65 9 AnalystQuality,CompositeMeasures–RegressionResults . . . . . . . . . 68 10 EffectofGlobalSettlementonCostofEquityCapital . . . . . . . . . . . . 70 vi LIST OF ILLUSTRATIONS 1 MarketShareofIPOsandFollow-OnOfferings,TreatmentGroupvs. Con- trolGroup . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 2 MarketShareofIPOs,TreatmentGroupvs. ControlGroup . . . . . . . . . 53 3 Underpricing of IPOs, Non-Tech vs. Tech, Treatment Group vs. Control Group . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 vii CHAPTER 1: INTRODUCTION TheGlobalResearchAnalystSettlement(the“GlobalSettlement”)isanenforcementagree- ment proposed in December 2002 and finalized on April 28, 2003, among the SEC, the NASD,theNYSE,theNewYorkStateAttorneyGeneralandten(latertwelve)ofthethen- largest investment banks operating in the United States.1 Allegedly, from approximately mid-1999throughmid-2001,underthepressuretoattractinvestmentbankingbusiness,re- search analysts at these banks had been generating research that was tainted by conflicts of interest. The goal of the Global Settlement was to restore the integrity of research by severingthe tiesbetween thebanks’ researchand investmentbanking divisions. Under the terms of the agreement, the banks were required to make total payments approximating $1.5billion,including$942millionindisgorgementandpenalties,$85millionforinvestor education, and $460 million to fund independent research. In addition, the banks were re- quiredtoseparatetheirresearchandinvestmentbankingdivisions,adheretonewdisclosure rules, and make independent research available to their investing customers by contracting withindependentresearchfirms. This paper studies the impact of the Global Settlement on the capital markets. How did the Global Settlement affect the investment banking deal flow of the sanctioned banks or equityissuers’underwriterchoices? HowdidtheGlobalSettlementaffectthecostofequity capitalforissuancesunderwrittenbythesanctionedbanks? ThesequestionsaremotivatedbytheevidencedocumentedinGuan,Lu,andWong(2013) that an exceptionally large number of “all-star” analysts – as named by the Institutional 1The original ten investment banks included in the Global Settlement are Bear, Stearns & Co. Inc.; CitigroupGlobalMarketsInc.(f/k/aSalomonSmithBarney,Inc.);CreditSuisseFirstBostonLLC;Goldman, Sachs & Co.; J.P. Morgan Securities Inc.; Lehman Brothers Inc.; Merrill Lynch, Pierce, Fenner & Smith Incorporated;MorganStanley&Co. Incorporated;UBSWarburgLLC;andU.S.BancorpPiperJaffrayInc. DeutscheBankSecuritiesInc. andThomasWeiselPartnersLLCjoinedthesettlementinAugust2004. 1