A Theory of Investment Banking
By Arnold Kling
The latest news:
Goldman Sachs has turned moneymaking into an art form…The bank will pay out almost $16.5bn in bonuses to its employees – up 40% increase on last year. With around 26,000 workers globally, each employee can expect an average [bonus] of more than $622,000.
The question I asked the other day, Why Aren’t There More Investment Bankers?, is actually quite tricky. If you think that there is an easy answer, my guess is that you are not thinking hard enough.
This fellow is trying.
At a fundamental level, I think there aren’t more investment bankers for any reason other than the fact that the world simply doesn’t need more of them. If Lehman Brothers or any other well-capitalized firm needed more bankers, they clearly have the resources to hire, train, and pay them exceedingly well.
But that won’t do. If the world does not need more investment bankers, and plenty of people are willing to do it, then that is an excess supply, and their incomes should fall.
I think you have to come up with a story about barriers to entry. One plausible story that occurs to me is that some highly-remunerated aspects of investment banking require experience. For example, if a corporate client is involved in a megabucks merger, the client cannot afford a mistake. So the client would pay a premium to have an experienced M&A (mergers and acquisitions) team.
The scarce resource in M&A is the experienced investment banker. The barrier to entry is that you cannot get experience without doing big deals, and you cannot do big deals until you get experience.
What that suggests is that if you are young and greedy, you would pay an investment bank to give you experience. And in fact, young investment bankers do feel exploited–working incredibly long hours, doing tedious stuff, and toadying up to people in a way that no self-respecting intelligent person would otherwise be willing to do. In return for that exploitation, you earn a decent living, but more importantly, you get the experience that gives you a chance to work/luck your way into the ranks of the truly rich.
My favorite inside account of investment banking is Liar’s Poker, by Michael (“Moneyball”) Lewis.
UPDATE: Tyler Cowen seems to be trying to tell an efficiency-wage story. You pay a high wage as a motivational tool, to buy loyalty. Maybe, but I prefer my compensation-for-experience story.
Also, as far as books go, I should have mentioned Barbarians at the Gate, by Helyard and Burrough. In Googling to remember the authors, I find that there was a TV movie, starring James Garner. It probably was pretty good.