Organization structure and credibility: Evidence from commercial bank securities activities before the Glass-Steagall Act

We examine the two ways in which US commercial banks organized their investment 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 seemingly 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 consistent with investors discounting for the greater likelihood of conflicts of interest when lending and underwriting are within the same structure. As a result, commercial banks evolved toward choosing the separate affiliate structure. Our results suggest that internal structure is an effective commitment mechanism, and absent other distortions, market pressures would propel banks to adopt an internal structure that would address regulators' concerns about conflicts of interest.