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The role of equity underwriters in shaping corporate disclosure

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Abstract

We find that the exogenous shock of the collapse of Lehman Brothers leads to significant increases in the disclosure of management earnings forecasts and voluntary 8-K items by equity underwriting clients of Lehman relative to clients of other underwriters of similar status. The increases in disclosure are more pronounced among Lehman clients with stronger underwriting relationships with Lehman or those that experienced more negative stock returns at the time of the collapse. Additional analyses reveal that, while Lehman clients experienced reductions in liquidity compared to non-Lehman clients after the collapse, this reduction is significantly attenuated among Lehman clients that increased the volume of their voluntary disclosures. Finally, we expand the sample to a larger set of underwriters and document that equity underwriter reputation changes are negatively associated with subsequent client disclosures, consistent with a substitution effect between client firms’ voluntary disclosures and the information roles played by high-quality underwriters. Overall, our results underscore the importance of the informational role of firms’ equity underwriters beyond the initial public offering (IPO) period.

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Data availability

All data used in the study are available from public sources identified within.

Notes

  1. See https://www.sec.gov/rules/other/2020/34-90768.pdf and https://www.sec.gov/rules/sro/nasdaq/2021/34-91947.pdf for the detailed rules for NYSE and Nasdaq, respectively.

  2. See Section 2.4 for the detailed discussions.

  3. For example, according to Loughran and Ritter’s (2004) underwriter reputation ranking, Lehman was scored 8 with 9 being the highest reputation during 2008–2009. We also observe no significant changes in Lehman’s reputation ranking score or its underwriting market share in the years leading up to its collapse.

  4. Fernando et al. (2012) find that, while this negative market response is evident among Lehman’s underwriting clients, it is negligible among Lehman’s other client groups, such as those that received debt underwriting service, merger and acquisition advisory services, NYSE specialist services, and analyst coverage from Lehman. This particular result suggests that the negative market response is associated specifically with the value of the underwriting relationship but not with a general negative reputation spillover from Lehman’s collapse.

  5. Fernando et al. (2012) identify Lehman clients based on Lehman as a lead underwriter for one or more equity offerings during the 10 years leading up to September 2008. Our results are robust if we identify Lehman clients based on underwriting relationship in the last five or seven years or the most recent underwriting relationship prior to Lehman’s collapse.

  6. Although we view underwriters are substantially different from other intermediaries, like analysts and auditors, mainly due to their access to client proprietary information and their connections to a network of investors, we acknowledge that our results do not preclude the possibility that other intermediaries, like analysts and auditors, can also step up their informational roles after Lehman’s collapse.

  7. See more detailed discussions at https://www.thestreet.com/markets/lehman-brothers-collapse-14703153 or https://knowledge.wharton.upenn.edu/article/the-good-reasons-why-lehman-failed/.

  8. Auditors and underwriters differ in their informational roles. For example, auditors focus on generally accepted auditing standards, while underwriters have expertise in assessing valuations and risks as well as determining market interest, like knowledge about retail investor bases and institutional clients.

  9. Prior research has also found various economic consequences of Lehman’s collapse for other Lehman-affiliated entities. For example, stocks held by Lehman-connected hedge funds experienced greater declines in market liquidity following the bankruptcy than other stocks (Aragon and Strahan 2012). Chakrabarty and Zhang (2012) find that firms with direct financial exposure to Lehman suffered more severe negative effects in terms of wider bid-ask spread, higher price effect, greater information asymmetry, and greater selling pressure, relative to unexposed firms. Examining bank lending behavior, Ivashina and Scharfstein (2010) find that, after Lehman’s failure, banks with greater co-syndication with Lehman suffered more liquidity stress, indicating that the failure put more of the funding burden on other members of the syndicates and increased the likelihood that more firms would draw on their credit lines.

  10. See https://www.sec.gov/news/speech/speecharchive/1997/spch176.txt for a speech by former SEC Chairman Arthur Levitt on this issue.

  11. Jo et al. (2007) state that, in the due-diligence information collection process, “the information includes, for example, the issuer’s current financial health, the validity of the security offerings, and the issuer’s future financial prospects, along with the independent auditors’ analysis and opinions.” James (1992) discusses “for example, information concerning the issuing firm's line of business, management strengths, and any inside information that may diminish firm values.”.

  12. For example, based on field survey evidence, Krigman et al. (2001) find that firm executives who switch underwriters give low marks to the post-transaction follow up by the underwriter’s corporate finance department, highlighting the importance of post-IPO interactions.

  13. As discussed by PwC (2009), in the setting of the Lehman collapse, Lehman clients may have also wanted to increase their disclosures after the collapse to handle possible counterparty risks.

  14. Following Fernando et al. (2012), we treat the following 10 investment banks as having similar industry status as Lehman around the Lehman collapse: Merrill Lynch, Goldman Sachs, Morgan Stanley, JP Morgan, Citibank, UBS, Credit Suisse, Deutsche Bank, Bank of America, and Wachovia.

  15. Testing H1 with this smaller sample yields results qualitatively similar to those tabulated.

  16. Table 8, Panel B of Table 9, and Table 10 are the exceptions. Specifically, in Table 8 and Panel B of Table 9, we update the weights for the subsample of firms covered by Lehman analysts. In Table 10, we do not use entropy balancing weights because we expand our analyses to a broader sample of underwriter reputation changes.

  17. Section 2 filings relate to the results of operations and financial conditions and discussion of off-balance-sheet items, and impairments. Section 7 filings include Regulation FD disclosures. Section 8 filings relate to other events. And Section 9 filings are financial statements and exhibits (Lerman and Livnat 2010; Nagar et al. 2019). We randomly selected 10 Lehman clients and found that, after the collapse, they provide 8-K items related to financial performance, credit risks, etc. Some examples include cost associated with exit or disposal activities, entry into a material definitive agreement, termination of a material definitive agreement, creation of a direct financial obligation or an obligation under an off-balance-sheet arrangement of a registrant, special note on factors affecting future results, and amendments to credit agreements.

  18. Our results remain robust when we use the number of press releases as another measure of the voluntary disclosure level.

  19. Our results are robust to using the North American Industry Classification System (NAICS) to classify the industry. When we use the two-digit SIC classification, our results are in general consistent with those reported in Table 5, except for one specification where the coefficient of interest has the correct sign with one-sided significance. This result is unsurprising, given that prior studies find that SIC codes are inferior to both GICS and NAICS at grouping firms in the same industry (Bhojraj et al. 2003; Krishnan and Press 2003).

  20. Following prior studies (Hasbrouck 1999, 2009; Chordia et al. 2009; Agarwal et al. 2015), we employ the square-root transformation of the Amihud measure to eliminate the effect of its skewness and kurtosis. We resize our illiquidity measure by multiplying it with 106.

  21. Control variables may also have different impacts on voluntary disclosures before and after Lehman’s collapse. In additional untabulated analyses, we also interact POST with all the controls and find robust results.

  22. Our sample size increases to 4,103 due to the additional observations added to observe pre-2008 trend.

  23. We also measure the strength of the underwriting relationship based on the recency of the underwriting relationship with Lehman. We find our results are significant for clients whose last equity issuance with Lehman is more recent but insignificant for other Lehman clients.

  24. We measure clients’ stock market reaction to Lehman’s collapse as the value-weighted market return-adjusted three-day cumulative abnormal return surrounding September 14, 2008. In addition to clients’ stock market reaction, we further use a principal component analysis based on factors that affect the extent of the shocks (i.e., size, age, and financial constraints), following Fernando et al. (2012), and find similar results.

  25. Fernando et al. (2012) do not find that firms followed by fewer non-Lehman analysts react more negatively to Lehman’s collapse. They attribute the loss of the market value by Lehman clients only to the loss of the equity underwriting relationship (as opposed to the loss of analysts).

  26. We use the 10-year window (10 years preceding Lehman’s bankruptcy) to define analyst coverage relationship with Lehman for both Lehman underwriting clients and non-Lehman underwriting clients. This design choice is made to (1) keep consistency since we identify the Lehman clients (or underwriting relationship) using the 10-year window and (2) get a larger sample size for test power. Our results are robust when using more recent analyst coverage (i.e., from 2006 to 2008) to identify the subsample.

  27. We use the underwriter reputation ranking measure of Megginson and Weiss (1991) because it is a continuous measure and provides more variation for our change analysis. In contrast, the Carter and Manaster (1990) rankings based on underwriters’ relative positions in IPO tombstone announcements are unavailable for some underwriters and lack time-series variation. Consistent with the caveat, we find weaker results when using the Carter and Manaster (1990) rankings.

  28. deHaan (2021) argues that first-differencing (i.e., change analyses) and firm fixed effects are alternative methods to mitigate the effects of unobservable Zs, with the first-differencing method having some advantages in some settings.

  29. We acknowledge that part of our main analysis windows overlaps with the financial crisis. However, our change analysis, which is based on a longer sample period, suggests that our main results are generalizable to other sample periods and unlikely to be driven by the crisis. Furthermore, our change analysis results are robust to excluding observations in year 2008 from the sample.

  30. These results are robust to using five-day abnormal returns or using observations with the lowest quintile or quartile abnormal returns as our pseudo-treatment firms.

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Acknowledgements

We thank Ted Christensen, Lakshmanan Shivakumar (editor), Aida Wahid, an anonymous referee, and participants at 2023 Haskayne and Fox Accounting Conference and workshop participants at the University of Arizona for helpful comments and suggestions.

Author information

Authors and Affiliations

  1. Eller College of Management, The University of Arizona, Tucson, AZ, USA

    Mei Cheng

  2. Naveen Jindal School of Management, The University of Texas at Dallas, Richardson, TX, USA

    Yuan Zhang

  3. School of Accountancy, The Chinese University of Hong Kong, Shatin, N.T., Hong Kong

    Meiling Zhao

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  1. Mei Cheng
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  2. Yuan Zhang
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  3. Meiling Zhao
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Correspondence to Mei Cheng.

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Table 11 Variable Definitions
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Cheng, M., Zhang, Y. & Zhao, M. The role of equity underwriters in shaping corporate disclosure. Rev Account Stud (2024). https://doi.org/10.1007/s11142-023-09817-1

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