Underwriting Compensation
For both competitive bids and negotiated sales, underwriters are compensated by the difference between the price they pay the issuer for the bonds and the price at which they resell them to the public. This difference is called the spread, which is made up of several components. The managing underwriter gets a percentage of the entire issue, each of the syndicate members gets a percentage of the sales they make, and if a selling group is participating, they get a cut as well. A selling group is a group of dealers that will help the underwriters sell the bonds to the public but will not underwrite the issue. Selling group members do not take on the financial risk of unsold shares.
The components of the spread are generally described in terms of bond points. A bond point is equivalent to 1% of the face value of a bond. For a bond having a face value of $1,000, one point is worth $10. Assume that the bonds for a new issue will have a face value of $1,000 and the underwriters’ spread is one point. That means that for every $1,000 bond sold, the underwriters as a group will receive $10.
The manager’s fee is the payment to the lead underwriter for services rendered.