Inventory Capacity and Corporate Bond Offerings

We study how underwriters' inventory capacity effects the initial allocation, pricing and trading of corporate bond offerings. We theoretically show that a decrease in aggregate inventory capacity incentivizes those underwriters having access to relationship investors to excessively allocate bonds to them. In exchange, relationship investors obtain increased underpricing and resell their excessive holdings in the secondary market. Using an instrumental variable we  empirically show that, through the relationship channel, the post-crisis drop in inventory capacity leads to a simultaneous increase in underpricing and customer sales. Our results suggest that a lowering of inventory imposes a negative externality on bond issuers.