Underwriter Competition and Bargaining Power in the Corporate Bond Market

We study the impact of underwriter competition on corporate bond contracts. We develop a new measure of underwriter power and a novel empirical approach, based on the underwriter’s comparative ability to place bonds. When an issuer has few "outside options" to take his bond to the market, the underwriter enjoys a stronger bargaining power over the issuer. The key feature of our approach is that underwriter power varies within a given underwriter at a given point in time across different issuers, allowing us to separate the effects of power from those of reputation and certification with a fixed effects strategy. Using our measure, we document that powerful underwriters are able to extract rents at the expense of bond issuers, in the form of higher fees, issuance yield spreads, and underpricing. Issuers facing underwriters with the highest bargaining power have a $1.5 million higher issuance cost, or about 16% relative to the average issue. A number of checks rule out alternative explanations based on certification, loyalty, and omitted issuer and/or issue characteristics. Our findings suggest that lack of underwriter competition results in material costs for corporate bond issuers.