This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
A brokerage house in good standing which undertakes to sell a bond or a stock issue will first of all wish to inform itself fully and accurately as to the soundness of the issue. It will carry on a preliminary investigation along the same lines that have been fully described in Chapter X, "Promotion." In case the preliminary investigation is satisfactory and the terms are agreed upon, the house will then, probably through its own engineers and accountants, delve still deeper into the records of the corporation and satisfy itself beyond a doubt of the conservatism of all statements upon which the sale of the security is to be based. Then it will proceed to dispose of the securities. Sometimes an advertisement of the security will be approved, and there may be some circularizing with a dignified prospectus. Generally speaking, the real object of this advertising and circularizing is probably not so much to dispose of the issue immediately in hand, as to build up the firm's list of prospective buyers of securities.
It is this list of prospective buyers which is the firm's chief asset. Having this list, it is not necessary that it should continually incur the great expense above referred to of securing the names of prospective buyers through advertising and circularizing; that is, this expense is spread over the cost of selling many different issues instead of being chargeable wholly to one issue.
It is clear that so far as investigation is concerned the expense is almost as great for a small issue as for a large issue. Furthermore, the large issue can generally be sold in larger blocks than can the small issue. It is likely to be the issue of a better known corporation and is more easily sold. All three of these reasons operate to make the brokerage house anxious to secure the privilege of selling large issues at small commissions, and reluctant to undertake the disposal of small issues even at high commissions.
When the great joint loan of the English and French governments amounting to $500,000,000 was placed in this country in the fall of 1915, the bankers accepted for themselves a commission of I 1/2 %. This is the greatest sale of securities and the smallest commission on record in this country. When the National City Bank of New York in the latter part of 1914 undertook to sell $15,000,000 of the notes of the Argentine government in this country, the commission was 3 1/2 %. The large bond issues of great railroad corporations are ordinarily sold on a commission of 3 to 5%. The smaller bond issues and the first-class preferred stock issues of industrial concerns are sold at commissions of 5 to 10%. Sometimes commissions go higher, but that is not usual for the reason that the better established houses do not care to identify themselves with any security which requires more than a 10% commission to cover all selling expenses and still leave a satisfactory profit. It is, of course, true that even higher commissions and special bonuses payable in stock of the issuing corporation are not unknown.
When a brokerage house is handling a small issue and finds it difficult to make cash sales, it may frequently resort to "swapping" for other better known securities that are owned by its clients. In this way the brokerage house may obtain bonds or stocks which it can actually sell for cash. The process, however, is more or less risky and expensive and amply justifies a high commission.