Monday, June 9, 2008

The Accidental Investment Banker

This was an interesting book with a prose that flowed more easily than the last book on investment banking I read. The chapter on what investment bankers do and the descriptions of the life in investment banking during the Internet bubble was possibly the most interesting.

1. On investment bankers:

"Both at Goldman and more broadly even at business school, the basic persona of investment bankers or aspiring investment bankers is wholly inconsistent with this compensation structure. [salaries are set by "class" (the year started at Goldman) and compensation is expected to go up by about $100,000 per year.] One cannot spend even a few minutes talking to an investment banker without getting a palpable sense that they view themselves as defined by - and see the extraordinary salaries they make as being justified by - their aggressive, entrepreneurial, risk-taking approach to life and business. But the lockstep compensation scheme described was clearly designed for exactly the opposite type of person." (pg. 57)

"The key to successfully managing large numbers of highly competitive, ambitious people, it seems, is to feed their most unrealistic illusions about themselves. And the best way to keep them is to instill a subconscious belief that those illusions will be shattered when exposed to the light of the outside world. I remember particularly a leadership training course that I went to with a dozen other young vice presidents at Goldman at which we were all asked to put our heads down on the table. The facilitator asked those who believed they were in the top 1 percent of their peer group to raise their hand. The bar was then lowered to top 3 percent and then 5 percent. When we sat up I discovered that I was the only member of the group who had not raised his hand. It takes a very special kind of skill to keep more than 90 percent of the bankers believing they are in the top 5 percent of their class" (pg. 58)

"Bankers by nature are a delusional lot, each imagining they are responsible for much more of any success with which they have some affiliation than an objective observer would consider fully rational." (pg. 132)

2. On the Internet bubble:

"... Morgan Stanley had established a reputation for sponsoring very high-quality companies such as Silicon Graphics in 1986, Cisco in 1990, and, most notably, Netscape in 1995. But there was a cost to limiting yourself to high-quality companies, particularly when the Netscape IPO established for the first time a public market for early stage companies with little operating history and no prospects for profitability. The public had clearly lowered its standards for investing in IPOs; if investment banks followed suit and lowered their standards for underwriting securities there was a lot of money to be made." (pg. 145)

"Although there is no denying that Quattrone was an excellent marketer and effective banker, it is clear that he offered not only extra capacity but a lower quality bar. Quattrone targeted companies that Morgan Stanley and Goldman Sachs told to "wait a quarter or two" before the were ready to go public. Admittedly this would seem an eternity to an entrepreneur whose peers have already gone public and become rich, particularly a sophisticated entrepreneur who knows "waiting a quarter or two" is investment banker-speak for "I don't know when or if you'll be ready but you sure aren't now." This strategy in turn put pressure on Goldman and Morgan to weaken their own internal procedures and lower their standards. Soon companies hungry to join the IPO orgy not always truthfully, when seeking sponsorship from Morgan or Goldman to have been offered to be underwritten by Quattrone." (pg. 148)

"As the boom era moved to an end in the latter part of 2000, among the casualties was the culture of excellence and client service that had once prevailed at the leading investment banking houses. In its place was a culture of celebrity that countenanced a systematic lowering of standards. These included hiring standards, underwriting standards, research standards, standards for conflicts, work quality standards, teamwork standards, and standards of behavior. These lowered standards were apparent to both employees and clients." (pg. 149)

3. On MBA classes at Stanford:

"When I was getting my MBA in the late 1980s at Stanford University, the most intellectually stimulating course I took was the core macroeconomics class. That year my section was taught by Thomas Sargent, a distinguished visiting faculty member who is one of the fathers of the "rational expectations" school of economic thought. Sargent did something unexpected. He decided not to simply offer the usual slightly souped up version of the traditional macro course offered at every liberal arts college in the country. Instead, he recast the class as an introduction to game theory in which the Federal Reserve, the Congress, and consumers were each cast as players. Rather than being stimulated by this provocative approach, my classmates revolted. This was not what they had signed up for. They had lots of other classes to prepare for and job interviews and they really didn't have time to debate the applicability of the prisoner's dilemma to the macro economy. Just provide some sample questions for the final exam and they would take care of the rest." (pp. 152-3)

4. On effects of the crash on investment banks:

"It is rare that anyone knows the exact moment that a bust begins as it is being experienced. ... Whatever the exact date, two highly relevant facts are clear. First, through the first half of 2000, investment baks continued their relentless build up of staff and cost infrastructure. ... Second, by the last months of 2000, all investment banking business had slowed to a crawl. ... This timing had several implications. First, because most bankers are paid based on something close to a calendar-year results ... no one had an incentive to declare the boom permanently over. Second, the relative strength of the overall year's results would temporarily conceal the magnitude of the mismatch between the unprecedented cost base that had been systematically amassed through at least the middle of 2000on the one hand and the new, dramatically reduced transaction base that would need to be serviced in a postboom world. ... because decisions about new hiring levels are made a year in advance, the entering analyst and associate classes that the firms had committed to hiring for the fall of 2001 would be in many cases the largest on record, further inflating the banks' already bloated overhead" (pp. 172-173)

"In boom times, money was obviously the yardstick: how much you could generate for the firm (or be associated with) and how much you could convince the firm to pay you. In a downturn, bankers with time on their hands, knowing the short-term payday would be modest by historic standardsm feeling vulnerable not jut financially but in terms of their status both internally and the world at large, naturally became focused on the only game in town left to play: politics. This is a parallel to the situation in academia, where, as the saying goes, the politics are so brutal because the stakes are so low. In investment banking, when the statkes become temporarily low, energies are quickly redirected toward honing survival skills, managing upward, looking for internal administrative responsibilities, and generally positioning oneself for the eventual upturn." (pg. 183)

5. On the future of investment banking:

"The real role of equity research is to drive investment banks' enormous trading operations. ... Equity research is part of massive "soft dollar" arrangements under which institutional investors are provided with off-setting "value" to compensate for the higher [trading] prices. Radically cutting back proprietary research could have significant implications for this engine of trading operations. The bottom line is that, as I write this, no one knows for sure what the new long-term business model - for research specifically and marketing and distributing securities generally - will ultimately look like post-Spitzer. ... rules for how and when they [investment bankers] can communicate with research analysts vary among firms but pretty uniformly require the presence of the corporate legal department before most interactions. It is now easier for a banker outside of Morgan Stanley to get information from one of its research analysts about how investors look at a particular company than for a banker who works there." (pg. 218)

"The cost structure of the full-service investment banks puts pressure on them to complete as many transactions as possible. It is this transactional focus that has made many clients suspicious about the advice they get from investment banks and limits the kinds of assignment that investment banks are even willing to undertake." (pg. 225)

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