Tuesday, December 28, 2010

What He's Really Thinking the First Time You Have Sex

It's almost year end, so it's just about time for the annual festival of wrap up articles in the financial media. These are published to remind us what happened in 2010, how we are supposed to think about it, and why we should run out immediately and buy that fetching luxury item prominently displayed next to the articles in our favorite mainstream media outlet. I, for one, am thankful the journalists and editors of our crack fourth estate work so selflessly after a tiring year to fill the blank space between Mercedes and Rolex ads with such informative and helpful copy:
Lorem ipsum dolor sit amet, consectetur adipisicing elit...

But journalism is a competitive business nowadays, resembling nothing so much as a high-speed game of musical chairs (where the internet calls the tune), so we should not be surprised that some practitioners are early out of the gate. Today's contribution to year-end gun-jumping comes from The Wall Street Journal. There, Dana Cimilluca and Anupreeta Das report the absolutely gobsmacking news that Wall Street firms are deeply engaged in their annual brawl over M&A league table rankings.

Now, if you are like me, Dear Reader, you are absolutely shocked, shocked that this hoary old chestnut still merits the time of day, much less seven column inches. This tale is older than dirt, and dustier than Cher's bustier. It was already old and dusty over three years ago when I took respite from my busy schedule of rapine and slaughter to pen an explicatory aperçu to a lament by Dennis Berman on the topic at the same broadsheet.

At that time, Mr. Berman did pen a couple of bons mots worth repeating:

The [M&A league] tables have become home to the most petty and wheedling impulses of the industry's most-respected institutions, which are rabid about staying high in the rankings. If you want to understand the Street at its absurd best, watch men in Rolexes grub for credit for deals they barely worked on for clients who probably won't pay them.

Cimilluca and Das offer comparatively little in the way of insight in the current piece, other than a few reported nuggets on AIG and other deals where credit is being contested. Missing from their piece, and from Berman's 2007 article, is an explanation why Wall Streeters act so petty over league tables. Indeed, watching entitled plutocrats scratch and claw over billions of dollars of profitless business may indeed engage the disinterested observer's sense of humor and/or schadenfreude, but I suspect many of my Dedicated Followers would in fact like to know the reasons behind it.

So, in the spirit of selfless public service for which Your Bountiful and Beneficent Correspondent is so widely and aptly known, I offer up a few select nuggets from my prior piece which should shed some illumination on the subject. (In consideration of those Long Faithful Readers who may have read the original piece in full, and those new readers who have something better to do than to wade through my fulsome juvenilia, I have chosen to edit my remarks to the meat of the matter. All of you are welcome.)

I quote my earlier self:

M&A league tables, in contrast, are and always have been a farce. There are no uniform reporting requirements concerning advisory roles or fees for M&A transactions. In order to be given credit for advising on a deal, all a bank has to do is persuade a client to confirm to the reporting services that it worked on it. No real work need take place, and no real money need change hands. Hence, you get examples of highly-discounted or no-fee "services" being "performed" by five, six, or eight otherwise totally uninvolved banks solely in order to claim credit for a big or high profile deal. It is not unheard of or even rare for a bank to deliver a last-minute "fairness opinion" for no fee at all in order to get full credit for "advising" on a $30 billion transaction.

But if, as Mr. Berman reports, everyone knows these league tables are crap, why does Wall Street spend so much time and energy gaming them?

Well, for one thing they are good recruiting tools. All those eager university and business school graduates who are aching to rub shoulders with John Mack, Stan O'Neal, and Henry Paulson What's-His-Name are massively impressed by league tables that show which of their preferred future employers has bragging rights in particular business areas. ...

Second, the published league tables, which tend to appear in the general financial press every quarter and often with higher frequency in the i-bank trade rags, are a nifty form of free advertising. Who, I ask you, does not like free advertising?

But third—and perhaps most surprising—at the end of the day investment banks spend enormous energy and real money on league table positioning and presentation because their customers want them to.

[That is your cue to ask why.]

M&A, for most companies, is a rare thing, a once in a lifetime event fraught with all sorts of terrors and confusions. Furthermore, it is not trivial to say that every M&A situation is truly different, so even if you are in the minority of corporate managers who have actually been involved in a deal, it is almost certain you will not be completely prepared for the next one. Lastly, very few corporate executives are capable of judging the quality of advice given to them in the course of a deal, since (a) they usually cannot figure out exactly what is going on in the room at any particular time and (b) the outcome of any deal depends on an extremely complex interaction of numerous factors, only one of which is the skill of their advisor.

Mergers and acquisition advice is an archetypal example of what Charles Green over at The Trusted Advisor calls "complex intangible services." M&A advice is hard to deliver, impossible to evaluate ex ante, difficult to evaluate ex post, and embedded in a deal process where the criteria for success are multifaceted and highly variable across deals. It is widely viewed as expensive, although at around 1% of aggregate deal value (and declining as a percentage the larger the deal gets), M&A fees are trivial in relation to the value at stake, whether you consider that value to be the future health of the company, the reputation and personal financial condition of the senior executives involved, the net worth of the company's shareholders, or the lives and livelihoods of its employees, vendors, and other stakeholders. This is one reason why everyone pays what in absolute terms look like obscenely large advisory fees even as they complain loudly about having to do so. As many an investment banker has asked a reluctant client during fee negotiations, "You wouldn't pick your brain surgeon solely on the basis of who offers the lowest price, would you?"

[Now for the money shot]:

[But] unlike for many other complex intangible services like accounting, law, and consulting—where a client has a good chance of being able to "test drive" its advisors before it hires them—potential consumers of M&A advice are thrown back on two primary sources of information to use in choosing an advisor: public brand or reputation, and what the investment bankers tell them. Now, most corporate executives are clever enough to perceive when they are being sold, and most investment bankers are pretty effective salesmen and women, so being able to point to some sort of external validation of a bank's skills and reputation is a valuable thing. (Remember how no-one used to get fired for picking IBM? Well no-one gets fired for picking the #1, 2, or 3 M&A advisor, either, even if the deal goes completely pear-shaped.) Hence the continued reliance on published league tables.

The fact that these league tables are widely known to be manipulated does not dissuade the average client, either. You can argue that the fact that a bank is able to persuade big clients to give it public credit for work it has not done is a pretty good indication of decent client relationships and persuasive negotiating skills, both of which are important M&A advisory skills in their own right. And, the mere fact that i-banks so obviously scrap, struggle, and expend copious resources they could otherwise use in their main business trying to reach and stay at the top of the industry league tables month after month is reassuring to clients that the bank in question (a) has surplus resources to devote to an apparently noneconomic activity and (b) cares about its reputation. This is analogous to what naturalists would call a marker of genetic or reproductive health: the same reason peahens look for the gaudiest peacocks with the most energetic courtship dances, even though such activities and energy expenditures on the part of the male are wasteful and even dangerous from a pure survival perspective.

Finally, it is important to remember that investment banking is at its core a network business. Investment banks' skills and capabilities derive from the extensive personal and business relationships of its professional employees, and this is arguably the most compelling value proposition any investment banker brings to a client. What better way to demonstrate the strength of your network, and the extent of your connectivity, than a league table showing how many deals you worked on and how many clients you served? Even if some of them are fake.

So there you have it, children: investment banks scrap like toddlers over league table rankings because, at the end of the day, their clients want them to. After all, investment banking is a service business. And the client is always right, n'est-ce pas?

* * *

Notwithstanding my potshots at the Journal and its confrères above, I fully understand why the financial press has to trot these silly league table articles out on a regular basis. For one thing, the investment banks would scream bloody murder if they didn't get their quarterly free advertising. For another, most people who read the financial press couldn't care less about understanding Wall Street and its silly rituals and business models. They just like to imagine Lloyd Blankfein and James Gorman locked in a mud-wrestling match at a dive bar in Hoboken over who gets bragging rights to the #1 slot in 2010 M&A. Good fight stories sell newspapers.

Finally, just as in those highly successful infotainment marketing vehicles known as women's magazines, it does not do for a periodical to demystify a recurring topic like sex or league tables by explaining it too deeply. For if you do, who will buy the next issue to read the same reheated crap all over again?

By the same token, what woman really wants to know that the true answer to the question posed in this post's title 1 is:

"How soon after I'm done can I go home and watch the football game?"

1 And, no, I did not make that question up. I strive for authenticity in everything I do. It is the genuine article.

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