Underwriter Compensation Structure: Can It Really Bond Underwriters?


  • We thank the editors (Robert and Bonnie Van Ness) and two anonymous referees for their helpful comments and suggestions. We also thank participants at the 2010 Financial Management Association meeting.


Underwriter compensation can be structured as all cash or a combination of cash and warrants. Using a sample of small initial public offerings (IPOs), we find that underwriter compensation contracts that include warrants in exchange for cash can serve as certification for IPO firms by substituting for reputation capital. When underwriters accept warrants when they could have received more cash compensation, the IPOs avoid the well documented long-run underperformance. However, when underwriters receive warrants after maximizing cash compensation, the IPO experiences higher underpricing and poorer long-run performance. The findings are consistent with a motivation by the underwriters to circumvent regulatory constraints.