L2 - Investment Bank as a Corporate PDF

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Investment Bank as a Corporate...

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Lecture 2: Investment Bank as a Corporate What is the organisational structure of IBs? What are the requirements for a leader in IBs? What is the remuneration policy of IBs? Readings: Liaw (2012): Ch.3 a nd Davis (2003): Ch.4-6, 10 Organisational structure of Investment Banks • Business Ecosystem • Relationship management • Importance of networks 1.0 Business Ecosystem 1.1 Cyclical industry • Exposure to risk induced by economic cycles • Other industries? • Their impact 1.2 Corporate structure There are 11 departments in Company Management of Morgan Stanley: All those departments together provide information and strategic thinking to the company’s management committee and help ensure long-term growth and efficient day-to-day functioning of businesses. (Liaw) 1.3 Service range – Key business areas: M&A and Underwriting • High profit margins Relatively low costs • High salaries • But: very cyclical business. More risky but risk premium (and returns) should be higher than for Commercial Banks – Many business areas not ‘really’ profitable • Low margins (even negative) • Provide entry to gain more profitable business in the future – Primarily through relationship banking • Support other (profitable) businesses – E.g. financial analysis/brokerage/market making support major M&A and Underwriting businesses 2.0 Relationship Management The more important the client The more senior the manager – Integrated client relationship • Close collaboration between specialists – Coordinated by the relationship manager – Eg. Corporate Financier/Underwriter, Market Maker, Analyst, Treasurer, Structured Deal maker (Investment Banker) etc – Only one contact ฀ Personality driven • Reliance on ‘personality’ of Investment Banker and Company Manager 2.1 Advantages and disadvantages of relationship management

Differ from commercial banks as IBs Focus on individual products • Specialisation of employees • Several contacts in the bank managed by relationship managers 2.2 Organisational consequences: • Eccles and Crane (1988) “…network structures of investment banks are flat, flexible and complex” • Relationship management and speed of change – IBs: have a very flat structure • Individuals given wide range of autonomy • Top-down management in IBs ‘very limited’ • [possible for] General strategies to be formulated lower down the organisation 3.0 Importance of Networks 3.1 Internal network of people allows: – Coordination across different specialists and hierarchical levels – Information sharing… • Or do they??? Release control of client or bonus pot? 3.2 Network: Important for employees – i.e. ‘to be included in deals’ • Establish themselves in the bank • Determines bonus payments and promotions • Access to companies and other specialists • Staff retention •

Stories “The organisational structure tends to be quite flat, and team-based. Everyone from the analyst to the partner is a valued and integral member of the team and contributes to the process and the discussions . ” Executive Director at Goldman Sachs Deutsche Bank is proud of its flat organizational structure – this means that we all communicate with each other. For example, Managing Directors will discuss projects with more junior Analysts, and the same Analysts are encouraged to raise any problems or issues they have with their senior colleagues . ”

Vice President at Deutsche Bank

3.3 Network structure – Entire teams move NOT one individual – Other banks ‘chase’ the whole team – Example: In 1998, CSFB hired Frank Quattrone and 132 other staff from Deutsche Bank • Technology team (Cisco Systems, Amazon) – In 2000 (before the tech bubble burst): Quattrone’s team accounted for c.$1.5bn in revenue • Quattrone: bonus = $120m in 2000 • Consequences: – Lack of loyalty (except to money!) – Frequent turnover – Melting pot of individual cultures • Fundamentally different from commercial banks – Hierarchy much more important • Cultural difference a problem when UK merchant banks entered investment banking • Perceived lack of discipline • Barclays – Bob Diamond 4.0 Culture and Innovation: • Lyons, Chatman and Joyce (2007) ‘Innovation in Services: Corporate Culture and Investment Banking’ • Traditional determinants of innovation: Leadership (ethical???) • Sets precedent – Organisational size and structure – Resource availability • In the context of IB – Organisational culture is another important factor 4.1 Culture of investment banks: • Highly competitive environment • Service (& product) innovation • Client demand for services across bank: • Opportunities across divisions (one-stop-shop) • Facilitation through modern IB structure • Broad and deep client relationships: • “We constantly strive to anticipate the rapidly changing needs of our clients and to develop new services to meet those needs” • Non-divisible work – Preparing financial model • Unpredictable workflow – Fluid clients demands – Urgent needs • Outcome? 80 hours work per week • Tight integration between design and execution: – Need to provide “total product” (design + execution) E.g. structured products – Feedback loop with client input • Vision of innovation – Articulated at the top – Autonomy at team level • Fools Gold: JP Morgan 4.2 Cause of toxic culture 5.0

Leadership in Investment Banking 5.1 Leadership • The culture and organisation of IBs - High requirement for specific/specialised skills • Investment bankers: – Eccentric and egomaniacs – Behaviour worsened by: High incomes and Number/value of successful deals • Need ‘leader’ to guide them and form a team – Sound understanding of business and culture – ‘Talk-the-talk’ (sometimes rude and crass) – Trust in the leader • ‘Outsider’ unlikely to succeed – In many industries • Common to appoint senior managers from other sectors • Uncommon in Investment Banking

Understanding of the business is insufficient • Strong knowledge of culture required – Leaders highly involved in day-to-day business • Must be able to “fit in” – Speak the same language and exhibit similar behaviour – E.g. commercial bank – Andrew Hornby CEO of Halifax Bank of Scotland C  ommunication is vital to effective leadership –

• 5.2 Trust • Trust in the qualities of senior managers is essential • Trust: Easiest: someone who is well known In the bank itself, or via their Reputation from when they worked in another bank • Without trust there is Autonomy of employees: • Prevent manager making any changes or give meaningful directions • Reason ‘outsiders’ not successful 5.3 Moral role model (i.e. Moral compass) “Leaders shape and reinforce an ethical or unethical organizational climate by what they pay attention to, how they react to crises, how they behave, how they allocate rewards, and how they hire and fire individuals” Sims and Brinkmann (2002) Example: how John Gutfreund (CEO of Salomon Brothers in 1991) shaped an unethical climate … – Attention: (short-termism) • He looked at the most recent bottom line profits and disregarded long-term implications of employee actions – Reaction to crises: • He lied, covered up ethical and legal transgressions, • Tried to preserve his own position at any cost – Role model: • He set an example for secret deals and for unethical behaviour being tolerated and hidden – Allocation of rewards: • He promoted those who were most like him, • i.e. those lacking any commitment to ethical principles – Criteria for selection and dismissal: • He had vague policies that confused employees

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6.0 Remuneration policy 6.1 Bonus-dominated compensation • Problem with many (European) commercial banks acquiring IBs – Commercial banks - bonuses much lower – Increasingly: clash of cultures • Solution: system of partnership – Most investment banks began as limited partnerships – Profits are pooled and distributed according to individual contribution – Very subjective… - influenced by social circles (& likeability factor) – Senior manager reviews individual performances (based on different inputs) – Other things have to be taken into account (e.g. market conditions) – Justification for bonus-based compensation: financial markets are more volatile than other markets ฀ bonus should vary with revenues • Importance of bonus ฀ incentive to make deals – Even against the client’s interest – Increases conflicts of interest 6.2 High pay • Remuneration is the key to attract and retain employees • Compensation for long and very stressful hours • • • • Barclays -

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18 hours a day in key stages of a deal and No weekends

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Fixed cost in a downturn Only manoeuvre: Bonuses and Redundancies

High salaries In order to attract/retain staff in boom time: Bonuses are guaranteed for several years Result: Aggravating losses further and Reduced ‘commitment’ Bonus = substantial part of total pay and does  not depend on the position in hierarchy (Senior managers don’t get higher bonus) • Profit sharing • Often higher than fixed salary

Cut 12,000 jobs to ‘trim costs’. The bank's total bonus pool for 2013 rose by 10% to £2.38bn, from £2.17bn in 2012, with the investment bank's bonus pool increasing by 13%. "At Barclays, we believe in paying for performance and paying competitively“ [Antony Jenkins, CEO]. “Overall, the bank's pay-to-income ratio rose to 43.2% from 40% in 2012, well above the bank's mid-30s target.” RBS (December 2015) Retail Bank. There are no bonuses for Retail Banking staff. Salary increase averaging 1% Investment Bank. Increased bonuses for Investment Bank. Salary increase >5%...