Before entering a formal agreement, investment banks carefully investigate the companies whose securities they underwrite; this is especially true of the issues of firms going public

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Before entering a formal agreement, investment banks carefully investigate the companies whose securities they underwrite; this is especially true of the issues of firms going public

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Before entering a formal agreement, investment banks carefully investigate the companies whose securities they underwrite; this is especially true of the issues of firms going public for the first time. Because the banks do not themselves plan to hold the securities but intend to sell them to others as soon as possible, why are they so concerned about making careful investigations?

Explanation & AnswerSolution by a verified expert

Explanation

In an underwriting agreement, risk of selling securities is transferred from the issuing firm to the investment bank.
So, the banks perform complete analysis of securities as well as the firm issuing securities to overcome the risk and loss they might incur while approaching investors.
In case of companies going public for the first time, a strict investigation is required by the investment bank before entering the agreement as the company is offering securities for the first time and investors in the market are not versed about the company which might increase the risk of the underwriters and harm their image in the market.

Verified Answer

In an underwriting agreement, the risk of selling securities is transferred from the issuing firm to the underwriter. So in order to mitigate the risk, investment banks have to perform strict investigation while making an agreement.

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