Conflict of interest in the underwriting of IPOs and corporate governance in emerging markets

Abstract

This project has two objectives: 1) to study the effect of conflicts of interest in underwriting and price stabilization in IPOs and 2) to study corporate governance (CG) in emerging countries.CONFLICT OF INTEREST: There is controversy about the potential conflict of interests over banks as capital suppliers and underwriters. Conflicted banks can distribute overvalued securities, harming investors. On the other hand, a bank that provides capital to a company has access to private information, making of it a better underwriter of securities of the company than other banks. Moreover, the possible loss of reputation can prevent opportunistic behavior. The literature on the topic is not conclusive.Conflict of interest can be motivated by loan (loan-conflict) or equity when the bank holds shares of the company (equity-conflict). Loan-conflict has been extensively studied, without evidence of opportunistic behavior. This suggests that the potential loss in reputation is sufficient to prevent opportunism. This result can also be derived from two factors: relatively weak incentive for overvaluation when there is loan-conflict and the lack of opportunity to camouflage the overvaluation in the underwriting debt securitiesWe argue that incentives for opportunistic behavior may be stronger in equity-conflict than in loan-conflict. The return that banks receive on loans do not depend on the price of the securities that firms subsequently emit, while the return on stocks depends. The opportunities to disguise overvaluation are higher in equity that debt, because the process of price stabilization in IPOs allows the underwriter to manipulate prices in the short run.Our main hypothesis is that equity-conflict leads underwriters to overvalue IPOs and use the price stabilization to camouflage it. Existing studies on equity-conflict in the issuance of IPOs do not control the effects of price stabilization and find no evidence of conflicts of interest.Brazil offers a good case to study conflict of interest in the IPO market. Many of the companies that made IPO received loans or equity contribution. The regulation of price stabilization also makes Brazil suitable for a study of price stabilization. Firstly, disclosure of information about the stabilization is mandatory. Secondly, all IPOs that occurred between 2004 and 2008 had the same period of stabilization (30 running days), allowing an analysis of price returns at the end of the stabilization period.CORPORATE GOVERNANCE (CG): The goal of this project is to improve the understanding of how GC affects the market value of the companies and identify the factors that affect the voluntary choices about CG practices that companies do. These studies will be conducted in a comparative approach with other emerging countries (Korea, India, Russia and Turkey).The institution by the Brazilian Securities Commission (CVM) of the "Questionário de Referencia" in 2009 made it mandatory the disclosure of information that allow the collection of systematic data on CG practices to the universe of publicly traded companies. This allowed collection of CG practices in 2010, 2011, 2012, 2013 and 2014.At the same time, the adoption of international accounting practices (IRFS) in 2010 allowed the collection of a larger number of accounting and financial information. The combination of these two changes motivates the current project, as it allows the application of more robust methods of analysis and a greater number of control variables. (AU)