Journal of Banking and Finance 17 (1993) 117-129. North-Holland Asymmetric information, investment banking contracts and the certification hypothesis* P.C. Kumar zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA The American University, Wshington, DC 20016, USA George P. Tsetsekos Drevrl zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA Lliniwrsifg, Philadelphia, PA 19104, USA Received September 1991. final version received May 1992 This study posits a hierarchy of investment banking contracts reflecting differential levels of certification. The analysis supporting the existence of this hierarchy is based on the reputational capital paradigm. The lirm commitment-negotiated arrangement is perceived to have the highest quality of certitication, followed by the tirm commitment-competitive, best efforts-negotiated and best efforts-competitive arrangements in that order. The existence of this hierarchy is investi- gated by measuring market reactions to the announcements of such issues. The empirical results reveal sharp distinctions between firm commitment and best efforts contracts. However, within firm commitment contracts, signalling between negotiated and competitive arrangements is attentuated and the distinction is weak. 1. Introduction Activities relating to the capital-raising function have been the traditional domain of the investment banking industry. Incomplete information charac- terizes primary securities market as issuers and potential investors do not have total information about each other. Hence detailed arrangements are necessary for a successful issue. In the primary market, the investment banker (IB) performs the function of zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQP information intermediary, advising the issuer about the nature of the market, as well as type, size and price of issues Correspondence to: P.C. Kumar, Kogod College of Business Administration, The American University, 4400 Massachusetts Ave., Washington, DC 20016-8044, USA. Telephone (202) 885-1947. *The authors acknowledge helpful comments received from D. Choi at the 1990 Eastern Finance Association Meeting and participants in workshops at The American University and Securities and Exchange Commission, Washington, DC. The usual caveat ~ the authors are responsible for any errors applies. This study was partially supported by a summer research grant awarded by the Kogod College, The American University, to the first author. 037884266/93/$06.00 ~i.8 1993-Elsevier Science Publishers B.V. All rights reserved