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Guest comment: M&A bankers don’t deserve their pay

William D. Cohan, a former managing director at JPMorgan Chase & Co. and former VP at Lazard Frères, explains why M&A bankers don’t merit mega-bucks.

The end of the first quarter of 2007 brought the news that global announced M&A deal volume for the three-month period topped US$1.1trillion – making this first quarter the busiest first quarter on record. Not surprisingly, the investment bankers shepherding all these deals are positively giddy, as they and their firms will soon collect – and divvy up – some US$5bn in fees just for putting them together.

But as the bankers prepare to drive off – yet again – with their new Ferrari 612 Scagliettis and Bentley Continental GTs, it is more appropriate than ever to ask why investment bankers get paid so much anyway. What do they do that could possibly justify multi-million dollar paydays year after year?

No pain, lots of gain

Unlike investors, entrepreneurs and some private equity and hedge fund moguls, investment bankers take no financial risk – zero! – for their excessive compensation. In case anyone wonders, M&A bankers provide specialised advice to their clients on mergers, acquisitions and divestitures. These assignments can be successfully concluded in a week’s time for a merger of two determined public companies, although far more often these deals take months, and often years, to consummate.

Another type of investment banker – the so-called ‘coverage bankers’ – have less specialised skills than M&A bankers; they are in charge of the ‘overall relationship’ with a client and are responsible for ‘delivering the firm’ and all of its products – M&A, debt and equity underwriting, research, money management, clearing – to corporate executives. Coverage bankers also have the arduous task of taking clients to the Super Bowl, Final Four and the Masters. The bankers’ fees are received only when the deal closes.

These responsibilities are hardly rocket science, world changing or socially redeeming. True, for the bankers involved the hours are long, the travel gruelling and unrewarding and the internal politics brutal, Darwinian and utterly unattractive. The old saw about investment bankers – “You won’t know your children, but you’ll get to know your grandchildren really well” – is sadly still true. But the excessive pay more than makes up for any inconvenience: managing directors at top Wall Street firms routinely receive several million dollars a year; the best can easily make more than US$10m, especially in a hot market. In contrast, Wall Street lawyers get paid by the hour – as much as US$750 per – regardless of whether a deal closes or not.

Adam Smith would not be pleased

One thing is certain about the enormity of these fees: they are not based on strictly free-market forces, any more than the price of a litre of gasoline is set simply by supply and demand.

Like OPEC, investment banking services are controlled by a cartel of the same top 15 Wall Street firms, year after year. The firms set the price of their M&A services using a uniform ‘fee grid’, which provides for a fee equal to a sliding percentage on the deal size: the larger the deal, the smaller the percentage.

For raising capital, the pricing is even more rigid: for instance, 7% for an IPO or 3% for a high-yield deal. But while the percentages are small, the absolute amounts of the fees are huge. Unlike OPEC, though, Wall Street firms do not meet together behind closed doors to agree on prices. They are far too clever to commit such a blatant felony. Rather, there is a more subtle form of collusion that depends on anecdotal evidence about what competitors charge. The information is not hard to come by. For the top firms, the key is to not break ranks and give discounts (although this does occasionally happen).

But it takes two to tango, as they say. Corporate CEOs are the ones paying these ridiculous fees to the investment bankers, in part because of the cartel – after all, access to capital is the life blood of capitalism – and, as important, because CEOs and boards of directors consider the advice they get from bankers an insurance policy if things go wrong. The fee is akin to an insurance premium.

Time for a change

Temperately-inclined bankers might rein in their excessive fees. But, let’s face it – Wall Street has never been very good at cutting its own compensation.

Accordingly, the time has come for corporate CEOs, boards of directors and shareholders to break the investment banking fee cartel. Stop paying millions for services worth far less. There is plenty of evidence it can be done, too. One need only see how tightly screwed down the banking fees are when Wall Street is paying them to itself.

Look no further than the below-market fees paid by Lazard to Wall Street for its own IPO in May 2005 – 5% instead of 7%, saving the firm around US$17m – or the rock-bottom fees that Blackstone is expected to pay to Wall Street for its highly anticipated IPO. According to one banker involved, his firm is doing the deal “for charity”. All it takes is a little courage.

· William D. Cohan is author of The Last Tycoons: The Secret History of Lazard Frères & Co., published by Doubleday Books.

Comments (9)

  1. 7% fee for IPOing a company, come on, where did you see this kind of fees? I can admit that Patrick Bateman could charge this kind of fees, but only threatening his client with a hammer or an axe!

  2. This story is like what some people believe in athletes, pop stars and other celebs: “How come, a person with little or no education earns millions of dollars?”. Well, this person of relatively zero imagination generates millions of dollars in advertising revenues, something that makes his team, sponsors, advertisers, stakeholders, the crowds, and himself happy. In the case of investment bankers, they bring about $$ huge deals, which makes their bosses and stockholders happy, company CEOs benefit by floating their shares, aquiring a new company, or be it issuing sukuks. At the end of the day, everybody makes money.

    This story also brings to mind the Traders Vs. Investment Bankers issue. Who’s better and who worth more than the other. Lets be honest and straightforward here, traders of all geners bet their banks as much as they can (or allowed to) to generate income and claim the bounty at the end of the year, its all about being able to handle the risk-stress equation. On the other hand, Investment bankers have to bend for their clients in order to bring deales, so its about being nice, seductive,making sure that the client is being looked after.No one’s better, but vive le traders

  3. to continue,

    For finance professionals, if you are a good relationship manager and truly cannot take on the market, then investment & corporate banking is for you. However, If you are smart, quantitative, risk-taker, then trading is for you.

    For the mideast market, investemnt banking has seen a tremendous jump in the volume of deals and the array of products delivered over the past three years. However, because of huge amount of liquidity generated from the oil market, banks in the region are setting-up large dealing rooms in the region to trade in the money market, bond market, and the FX market and to assist investment bankers in underwriting and pricing of new issues of securities.

    Large wholesale banks have started treasury businesses in the region : Deutsche bank – Saudi, BNP Paribas have set up a treasury and an asset management alliance with a saudi bank, JP Morgan has been liecenced to deal recently, more speciallized institutions are starting to flock to the region, especially to Dubai and Riyadh.

    Who run those dealing rooms? Usually,expats from large money centers particularly from the London market.Who run the trading books? regional traders with local contacts.

  4. Who is William D Cohan and why is he waxing lyrical after he milked the same cow? Is this not a case of a self-publicist trying to plug his name or a book? “Reformed” ex-investment bankers who were MDs and made out well who now preach against their former livelihood lack credibility and moral standing. Best shut up and count your self lucky William D Cohan.

  5. If william D Cohan feels that he was overpaid, would he like to put his money where his mouth is and donate some money to charity?

  6. Never mind the position of investment bankers near the trough. The damage done to society by grossly overpaying finance professionals compared to most other professions that have much greater bearing upon our well-being, such as doctors, teachers,scientists etc. is ever growing.

  7. No pain? Lots of gain? Did you work in the same industry you’re actually refering to? I doubt it.

  8. Blah blah blah. I don’t think bankers are worth what they are paid but so what? Where is the damage to society exactly? Let’s see some evidence that this is harmful rather than bleating about inequality.

  9. Completing a merger in a weeks time for two public companies? What planet do you live on?

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