Certification Effect

As with any other firm commitment offer, the investment bank carries the risk of price fluctuations after the primary market transaction. As with an IPO, this should increase investors’ confidence. As an outside third party, the managing investment bank has examined the issuer and found the firm worth. The bank ‘‘puts its money where its mouth is’’ by giving a firm commitment price and underwriting the issue. This certification effect conveys information to the marketplace that the issue is fairly priced. The investment bank is staking its reputation and profits on the attractiveness of the issuer. Investment banking firms with the highest reputations (e.g., Goldman Sachs, Merrill Lynch, and Morgan Stanley) provide the strongest certification effects with respect to security sales. The certification effect provides a signal to the financial markets regarding the quality of the issuer.