Journal of Applied Corporate Finance, Spring 1999
INTERNET INVESTMENT BANKING: THE IMPACT OF INFORMATION TECHNOLOGY ON RELATIONSHIP BANKING
by William J. Wilhelm, Jr.,
The banker’s network of personal relationships is perhaps the central element of the production technology of the 20th-century investment bank. In his classic history of Investment Banking in America (1970), Vincent Carosso argued that investor networks began to take shape in the 1870s as the evolution of the corporation increasingly required banks to distribute large blocks of securities.1 More recently, in an article published in this journal, Charles Calomiris and Carlos Ramirez traced bank ...view middle of the document...
S. public debt and equity markets returned to their former prominence.4 And yet, in spite of the historical success of this relationship-based production technology, evidence is mounting that it could be displaced—at least in part.
In this article, I provide an economic perspective on how recent advances in information technology have begun to lay siege to the relationship-based technology. Most of the discussion takes place in the context of recent applications of Internet technology to the pricing and distribution of securities. In particular, I focus on strategies pioneered by Wit Capital and, more recently, W.R. Hambrecht + Co. in the market for initial public offerings (IPOs) of equity. Then, near the close of the article, I broaden the focus by sketching some implications of my analysis for other aspects of the investment banking business.
SECURITIES PRICING AND DISTRIBUTION
Securities offerings feature a complex series of events that are orchestrated by the issuing company’s investment bank. In part, these events reflect regulatory demands for full and complete disclosure of information that might be relevant to prospective investors. The bulk of these activities consist of the due diligence effort conducted by the issuing firm’s bank, auditors, and legal advisors followed by the registration of the offering with the Securities and Exchange Commission and the distribution of a preliminary prospectus account. Although not required, a series of roadshows aimed at the institutional investor community is a common supplementary source of information.5
A subtle intermediation problem arises as investors gain access to information and begin forming opinions about the value of the firm’s offering. Historically, investment banks have attempted to assess these opinions as accurately and efficiently as possible by “building a book” for the offering. The book contains institutional investor responses to the bank’s request for “indications of interest.” These indications typically take the form of offers to purchase a certain number of shares at the market price or, alternatively, the number of shares the investor is willing to purchase at a particular price or range of prices.6 Although indications of interest are legally non-binding, they are offered in the context of an ongoing relationship between the bank and its institutional investor network. Failure to stand by an implicit commitment can lead to an investor’s exclusion from future deals managed by the bank.
Ideally, the bank would canvass the entire investor population to establish the demand curve for a securities offering. Until very recently, however, it would have been folly to even consider such an undertaking. Faced with relatively primitive information technology, bookbuilding methods economized on search costs by seeking the opinions of a relatively narrow but influential pool of institutional investors. In this capacity, investment bankers have long employed a strategy analogous...