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THE ECONOMICS OF THE PRIVATE MARKET

The Role of Agents

Almost all new public issues of bonds are managed by an underwriter on the basis of a firm commitment. New issues of private placements, however, are often assisted by an agent or adviser. ¹¹⁸  Agents provide various services to issuers, including advice about the structure, pricing, and timing of financings; assistance in locating investors; and help in negotiating with them. Agents assist traditional private issues on a best-efforts basis, but many Rule 144A transactions are firm-commitment underwritings.  Although no quantitative evidence is available, remarks by market participants indicate that an agent assists in about two-thirds of traditional private issues; the rest of these issues involve direct contacts between issuers and investors. Apparently, although lenders and borrowers in the private placement market might be able to find each other and write contracts by themselves, such a process would be costly; in many cases, employment of a third-party agent is more efficient.

The role of agents in the private placement market is somewhat more complicated than the previous paragraph may imply. Like the private market itself, the agent industry exists primarily to solve problems associated with costly and asymmetric information. Agents add value in several ways:

• They reduce search costs for both borrowers and lenders by maintaining information about lenders' preferences and by screening out unqualified borrowers. ¹¹⁹

• They have knowledge of prevailing market prices and the tradeoff rates between prices and other contract terms. Borrowers need such information for both search and negotiation, and buying it from an agent is often cheaper than gathering it.

• They provide technical advice and other assistance to borrowers during negotiations, helping them obtain better terms.

• They enforce informal bargaining conventions that reduce bargaining costs for everyone.

The private market is thus broader and deeper than it would be without agents: More borrowers are served, and more competition exists among lenders.

The structure of the agent industry is influenced by economies of scale and scope, by limited strategic relationships between agents and lenders, and to some extent by specialization. The primary economy of scope is with the provision of other corporate financial services: Agents tend to flourish in those large commercial banks and investment banks that sell a large volume and variety of corporate finance products, such as loans or underwritings. The relationship officers of such banks can refer significant numbers of potential clients to the private placement agents within the organization. Economies of scope also exist with public-issue underwriting, in that sales forces for public securities can distribute some private placements.

The primary economy of scale is related to the costs of gathering information. These costs are smaller for high-volume agents for two reasons.  First, the fixed costs of gathering information can be spread over many clients. Second, an agent acquires information as a byproduct of assisting individual transactions, both reducing the amount of information it must gather by other means and providing more to trade in the information marketplace. Agents and lenders gather information through informal sharing arrangements with each other, and high-volume participants are more sought after as partners in such arrangements.

Economies of scale and scope influence an agent's style of providing services as well as the degree of concentration of the industry. Although most agents are in large measure generalists, they have some variety in the technologies they can choose when conducting their business, especially with regard to the distribution of securities. They also tend to specialize somewhat in the technologies best suited to the kinds of client their host organization's relationship officers tend to refer. ¹²⁰

Although large agents may have advantages, competition appears substantial because entry and exit costs are relatively low and the roster of agents is constantly changing.

118. Technically, an agent has the power to commit the issuer, whereas an adviser does not. We use the word agent to refer to both.

119. For example, some lenders may offer better terms than others to borrowers in a particular industry, perhaps because they have particular expertise in lending to that industry.

120. For example, some agents assist mainly large placements (say, more than $100 million in face value), some serve mainly investment-grade borrowers, and others serve mainly below-investment-grade borrowers. Some agents may get a disproportionate share of a given industry's business.

Who are the Agents?

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