Several empirical studies suggest that, on the average, bond issues sold by negotiation have a higher cost structure than similar competitively sold bond issues. This holds true for all three components of cost—net interest cost, underwriter’s spread and reoffering yield. Of particular importance to investors is the fact that the reoffering yields on negotiated bonds are approximately 23 to 27 basis points higher than the yields on equivalent competitively reoffered bonds. Investors thus have the opportunity to purchase these bonds below their true market equilibrium price. Evidence also suggests that, because underwriters tend to adjust reoffering yields and spreads simultaneously in the same direction, higher than normal underwriter spreads may be a tip-off to substantial underpricing. In general, an increase of $1.00 per $1,000 of underwriter spread corresponds to an increase in reoffering yield of five to 10 basis points.
The intensity of underwriter bidding for competitive issues also influences the interest cost differential between competitive and negotiated bond issues. There may be little difference in reoffering yields between negotiated and competitively sold bonds if the competitive issue receives only one or two bids; however, with three or more bids the reoffering yields on negotiated bond issues are higher than the yields on similar reoffered competitive bonds. During unstable market conditions, the relative behavior of negotiated and competitive issues is less clear. There is some evidence that reoffered negotiated bonds still tend to be underpriced. If underpricing does occur, however, larger than normal underwriter spreads will not act as a signal for underpricing, as is the case during normal market conditions.