Luke Heath Milsom, Vladimír Pažitka, Isabelle Roland and Dariusz Wójcik
Exports of financial services decline with geographical distance at a rate comparable to that for international trade in goods (eg, Portes and Rey (2005)). This is surprising since there are no transportation costs involved. The consensus is that distance is a proxy for information frictions. We show how cross-border syndication can help overcome information barriers to trade in financial services. We zoom in on the equity underwriting industry where international syndicates reduce information asymmetry between issuers and investors located in different countries.
International linkages between financial institutions are a key feature of global financial market integration. Recent contributions have shed light on their positive effects on international trade in goods (Caballero et al (2018), Claessens and Van Horen (2021)). Surprisingly, little is known about the empirical impact of international linkages on international trade in financial services. We set out to fill this knowledge gap.
Geographical patterns of international equity transactions are heavily influenced by information frictions, which represent barriers that investors face in accessing and interpreting price-relevant information, particularly soft information, about foreign issuers (Sarkissian and Schill (2004), Portes and Rey (2005)). Information frictions can, however, be mitigated by financial and reputational intermediaries, including venture capitalists, equity research analysts, accountants, auditors, law firms and securities underwriters among others (Dunbar (2000), Pollock et al (2004), Ljungqvist et al (2009), Jeon and Ligon (2011)). We focus on the role of equity securities underwriters’ networks, which play a crucial role in enabling firms to access global capital markets.
Cross-border syndication plays an important role in global equity issuance activity. When firms issue equity securities domestically or abroad, the offering can be underwritten by a single underwriter or a so-called underwriting syndicate, a group of financial institutions formed temporarily to sell the new securities to investors. The purpose of underwriting syndicates goes far beyond risk sharing among underwriters. In fact, information production is one of their key purposes. Underwriters involved in a syndicate collectively have a higher potential for information collection and dissemination than any individual syndicate member. Ties formed through international underwriting syndicates therefore facilitate cross-border information flows and mitigate information frictions between issuers and investors located in different countries.
In a recent Bank of England Staff Working Paper (Milsom et al (2023)) we argue that, through this channel, syndication ties promote exports of equity underwriting services, and provide supporting evidence using theory-consistent gravity equations. We construct a comprehensive country-pair panel data set of trade flows by aggregating transaction-level data on revenue flows associated with the underwriting of new issues of equity securities from the Dealogic Equity Capital Market database. Our data set covers 122 countries of origin and 145 countries of destination for the period 2000–15.
Exploiting syndicate structure to measure information flows generated by syndication ties
We build a measure of newly formed ‘core syndication ties’ that proxies for information flows between the trading partners. To do so, we exploit the structure of underwriting syndicates. The lead underwriter is primarily responsible for due diligence, while the other syndicate members mainly sell securities to investors within their networks. In other words, information acquisition is mainly conducted by lead underwriters. Therefore, information flows between the trading partners are strongest when the underwriter in the importing (issuing) or exporting country is the lead underwriter. We denote such syndication ties as ‘core syndication ties’. While information is still expected to flow between the trading partners when the underwriters in both countries are non-lead underwriters, the information content of new syndication ties should be lower. We denote such syndication ties as ‘peripheral syndication ties’. The question we ask is whether newly formed ties increase the flow of underwriting services between trading partners? Therefore, our explanatory variables measure the number of newly connected bank dyads for each pair of countries in each year.
Identifying the impact of newly formed syndication ties on exports
We estimate gravity equations and find that a 1% increase in new core syndication ties increases exports by 0.243%. In other words, doubling the change in the intensity of core ties is associated with a 24.3% increase in exports. In accordance with their lower information content, new peripheral syndication ties have a smaller effect on exports. The effect of a 1% increase in new core syndication ties on exports is roughly seven times larger than the effect of new peripheral ties.
Our aim is to isolate the causal effect of syndicates on exports through information production (supply-side effects). The identification of this causal effect is endangered by reverse causality, whereby underwriters from export markets establish new linkages in import markets in anticipation of an increase in exports due to demand shocks in the importing country (demand-side effects). To rule out reverse causality, we develop an instrumental variable approach which focuses on plausibly exogenous supply-side shocks. Specifically, we measure shifts in the interest of the exporting country’s underwriters’ in each importing country as an export destination unrelated to changes in demand-side prospects in the importing country itself. When instrumented, the effect of new core ties is only slightly smaller: doubling the change in the intensity of core ties is associated with a 22.1% increase in exports.
Syndication mitigates information frictions between issuers and investors
We provide further evidence that syndicates promote exports by mitigating information frictions. First, we show that new core syndication ties matter more when the importing (issuing) country is riskier. The effect of new core syndication linkages on exports is larger when the destination country scores worse on the International Country Risk Guide index, has a worse sovereign credit rating as measured by Moody’s, and performs worse in terms of resolving insolvencies according to the World Bank Doing Business surveys. Second, we show that new core syndication ties also matter more for more information-sensitive transactions, namely initial public offerings as opposed to follow-on offerings and convertible debt.
In conclusion, cross-border syndication is a crucial mode of supply in financial services trade, especially when information frictions between the trading partners are severe. The ability of a country’s underwriters to form international syndication ties is a crucial, but little researched, determinant of a country’s export potential.
Luke Heath Milsom works in the Department of Economics, University of Oxford, Vladimír Pažitka works in the Leeds University Business School, University of Leeds, Isabelle Roland works in the Bank’s Macro-financial Risks Division and Dariusz Wójcik works in the School of Geography and the Environment, University of Oxford.
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