Bank underwriting of corporate bonds: Evidence from Japan after the financial system reform of 1993

In 1993, the corporate bond primary market in Japan underwent a major change. The Financial System Reform Act allowed banks to enter the underwriting business by setting up securities subsidiaries. This paper analyzes yield differentials between issues underwritten by bank subsidiaries and those underwritten by securities houses. By estimating a regression model with correction for self-selection bias, we can distinguish between several hypotheses concerning the effect of bank underwriting of corporate bonds on their yields. We show that investors discount corporate bonds underwritten by bank-owned subsidiaries because they suspect conflict of interest. Bank-owned subsidiaries, on the other hand, try to avoid this conflict by underwriting bonds intended for institutional investors and bonds issued by firms with weak main bank ties. While investors' suspicions of conflict of interest may put bank-owned subsidiaries at a disadvantage with respect to incumbent security houses, this study suggests that an aggressive entry strategy on the part of bank-owned subsidiaries has offset the disadvantage so far. In light of the recent repeal of the Glass Steagall Act, these findings will be of particular interest to observers of the changing nature of the securities business in the United States