Rs. Kroszner et Rg. Rajan, ORGANIZATION STRUCTURE AND CREDIBILITY - EVIDENCE FROM COMMERCIAL BANK SECURITIES ACTIVITIES BEFORE THE GLASS-STEAGALL ACT, Journal of monetary economics, 39(3), 1997, pp. 475-516
We examine the two ways in which US commercial banks organized their i
nvestment banking operations before the 1933 Glass-Steagall Act forced
the banks to leave the securities business: as an internal securities
department within the bank and as a separately incorporated affiliate
with its own board of directors. While departments underwrote seeming
ly higher quality firms and securities than did comparable affiliates,
the departments obtained lower prices for the issues they underwrote.
The higher risk premium associated with the internal department is co
nsistent with investors discounting for the greater likelihood of conf
licts of interest when lending and underwriting are within the same st
ructure. As a result, commercial banks evolved toward choosing the sep
arate affiliate structure. Our results suggest that internal structure
is an effective commitment mechanism, and absent other distortions, m
arket pressures would propel banks to adopt an internal structure that
would address regulators' concerns about conflicts of interest.