Investment Bank Reputation, Information Production, and Financial Intermediation

The authors model reputation acquisition by investment banks in the equity market. Entrepreneurs sell shares in an asymmetrically informed equity market either directly or using an investment bank. Investment banks, who interact repeatedly with the equity market, evaluate entrepreneurs' projects and report to investors in return for a fee. Setting strict evaluation standards (unobservable to investors) is costly for investment banks, inducing moral hazard. Investment banks' credibility, therefore, depends on their equity-marketing history. Investment banks' evaluation standards, their reputations, underwriter compensation, the market value of equity sold, and entrepreneurs' choice between underwritten and nonunderwritten equity issues emerge endogenously. Copyright 1994 by American Finance Association.

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