Did you see that the average bonus at Goldman was $622,000 for a year’s work? Arnold Kling asks why here, and here, with follow-up from M. Drapier.
The puzzle, of course, is why the supply of investment banking doesn’t expand so as to lower price and thus wages, in what appears to be a fairly competitive industry.
My take: The high payments solve an agency problem and align interests, and thus they are relatively invariant to competitive pressures. If Goldman does an IPO, the issuing company wants to make sure that Goldman promotes the issue properly. This means, among other things, that Goldman eschews pure market-clearing prices and instead places the issue in the hands of investors who will talk it up and promote it. For this to happen, Goldman has to care more about its relationship with the hiring, security-issuing firm than about some of its external relationships, namely other groups which would like to buy into the offering at favorable prices but which would not promote it as effectively (NB: this is not the only relevant conflict of interest problem, it is just an example).
In other words, the company doing the IPO has to pay Goldman lots to ensure their loyalty.
Competition for doing IPOs won’t much lower the required payments needed to capture the loyalty of Goldman. There could be one million talented investment bankers bidding to do that issue, and ex post the security-issuing firm will still pay the winner large sums to align incentives in the desired manner.
From The Office http://www.quotesfromtheoffice.com/employees/dwight_schrute/:
“Would I ever leave this company? Look, I’m all about loyalty. In fact, I feel like part of what I’m being paid for here is my loyalty. But if there were somewhere else that valued loyalty more highly, I’m going wherever they value loyalty the most.”
Important note: GS made most of its money this year on the back of principal investments, not investment banking. So the question is not why aren’t there more people in I Banking, but why aren’t there more people in trading, hedge funds and private equity. And the answer to the question is: the numbers involved in these areas are growing every day. GS is the largest hedge fund manager in the world, it’s private equity funds are a huge player, and as it reduces the number of agency traders it is simulataneously increasing the number of principal traders. To think of GS as a company populated by I Bankers is incorrect. It is literally the worlds largest hedge fund
Yes, GS is more than Investment Banking. The 26,000 include tech, stock loan, and stock research people as well as those previously mentioned. In a good year the hedge fund and other proprietary trading activity yields returns paid out in bonuses that would look like capital gains if structured as a hedge fund.
Also note that bonuses are part of normal compensation. Base salaries often range from 70-150K for people working in Manhattan.
Investment banking is another case of winner takes most all. Do you want to trust your brain surgery to the second best brain surgeon? Similarly, why trust your IPO to the second best investment banker?
I’m not particularly wealthy, but I’ve just retained one of the biggest and most expensive IP law firms to prepare patent applications for some inventions I’ve devised. The cost of possibly doing it wrong is way way more than the cost of hiring the very best.
Andrew Edwards: Note that there appears to be a huge range in the demands made by different I Banking divisions, and no obvious relationship between variation on that range and variation in performance.
It isn’t clear at all why the I-Banking lifestyle should be so grueling. It makes little sense to say that the compensation is to overcome the rational reluctance of prospective I-Bankers to being tortured if there isn’t any good reason to torture one’s workers in the first place.
Investment bankers make so much money because they have an anti-competitive cartel.
And the link explains why the investment bankers have such a grueling work week. It’s part of maintaining the cartel.
This post on the subject is interesting
http://www.halfsigma.com/2006/12/investment_bank.html#more
I’m sorry but I work in the industry in NYC and this is not the best explination. The link above from Half Sigma is more accurate. The industry is mostly peopled with those who are high on the bell curve for aggressiveness and intelligence. If some feel they aren’t getting their “fair share” of firm’s profits then the can and will leave to start a competing firm.
Though this is a major reason for limited competition it isn’t the only reason. The CYA (cover your a**) issue mentioned is certainly a factor. If you are doing a new offering – debt, equity, hybrid, etc. – and something goes wrong then you will get fired if you hired a small no name firm to do the deal. You won’t get fired if you hired Goldman Sachs. But likely Goldman Sachs et al got to where they are because they don’t get things wrong very often.
Relationships and connections also play a big part in determining success in the business, which is difficult for others to replicate.
Unfortunately I don’t work for GS but at least they set a benchmark that everyone else will have to at least come close to now. I work for a European competitor that has a March fiscal year end so I will have to wait 2 more months to find out what I got.
“I’m sorry but I work in the industry in NYC and this is not the best explination. The link above from Half Sigma is more accurate.”
Thanks for the compliment!
The CYA (cover your a**) issue mentioned is certainly a factor. If you are doing a new offering – debt, equity, hybrid, etc. – and something goes wrong then you will get fired if you hired a small no name firm to do the deal. You won’t get fired if you hired Goldman Sachs. But likely Goldman Sachs et al got to where they are because they don’t get things wrong very often.
This is an example of the marketing economies of scale inherent to big firms. Personally, I doubt that it’s true that Goldman Sachs is less likely to make mistakes than a small boutique firm, but as long as people have an instinctual inclination to place more trust in the big company, you can be sure that the salesmen (aka investment bankers) will play up that fear.
Marketing economies of scale do represent a barrier to entry for small firms. One of the reasons why the good salemen will stick around with Goldman Sachs and live off the massive bonuses. Goldman Sachs gives them a better deal than what they would get trying to compete.
Not mistakes in the sense that you misplace a decimal but a mistake in the sense that you weren’t able to place the whole deal or the pricing was less than the issuing company thought they should have gotten. Which is obviously determined by scale and relationships.
The closer one stands to the vortices of cash flows — the more money one makes.
I’m more interested in why this labor isn’t outsourced to India or (insert lower-wage, good-education country here)
Someone from the hedge fund D.E. Shaw told me their fastest growing office is in Hyderabad where they now have several hundred employees. The number crunching and research components of finance are in the process of being outsourced while the sales and relationship maintenance aspects will have to remain in New York and London where all the money is.
The $622k is not very meaningful, because there’s no obvious way to break it up between back office, support, sales trading, prop trading, pure investment banking, etc. But I think there are really two questions:
1. Why do senior investment bankers make outlandish amounts? This is the question answered by winner take all, CYA, barriers to experience, ivy league networks, collusive fees, etc. And note that even these numbers are dwarfed by many hedge fund or private equity professionals.
2. Why do junior investment bankers (within a few years out of college or b-school), who are still making double or triple or more what their classmates make in other careers, face more competition?
To me the second question is much harder to answer. Brutal work hours are part of it, but not the whole story. Many corporate lawyers, for example, spend more time in a much more difficult grad school environment and work just as hard to make less in the first few years. I was a banker out of college (no longer) and had this conversation with many friends who took other tracks. I think the best synthesis of their answers that I can offer is (1) banking is more cyclical and therefore carries more risk of getting fired (true) and (2) finance just looks harder from the outside than it really is, and there are many very smart people who never cross the gap of thinking of themself as a “numbers person.”
But neither of these feels very satisfactory to me either, so I would be curious what others think.
peter
as a former banker well into the associate role who THEN went back for an MBA to pursue the investment management route, I too am perplexed.
the reality is that the massively compensated hedge fund manager is in the tail of the distribution. the mean compensation for those in investment management is lower than that of investment banking. both require the same finance skills but investment management requires substantially more risk and actual decision making versus the fee-based, transactional nature of investment banking.
my guess is there are more perfect substitutes to investment managers and lower barriers to entry. the fact that there are only 10 global banks to provide all of the world’s financing and M&A advice provides the firm larger returns.
but again, why then do the employees enjoy higher returns?
On Wall Street, most open banking and technical positions take over 6 months to fill. There is just a shortage of qualified candidates around here. That’s why.
Most resumees are rudicoulusly weak and are rejected even without talking.
Yes, the outsourcing to India does happen here. And the quality of things that are flowing back from there is very low. I’m not even sure why do we do that, looks more like an experiment.
Oh, and yes, I do work here, and I’m paid only 2x of the powerty line. It’s a lot, but not that much as you think adjusting to the cost of living. I can’t even think about buying even a small condo in Manhattan, it’s far above my levels.
As someone who has lived in Manhattan for 3 years on <25k, Bob, you really don’t understand ‘poverty’ if you think the line is 100k. Check some income distribution statistics–yes, even for Manhattan–and try to rethink your assumptions.
Investment bankers make so much money because the house’s proprietary traders make so much money. If you look at the profit breakdown of, for example, Goldman Sachs, the biggest profit center, by far, is proprietary trading.
—to anon—
As someone who has lived in Manhattan for 3 years on <25k, Bob, you really don’t understand ‘poverty’ if you think the line is 100k. Check some income distribution statistics–yes, even for Manhattan–and try to rethink your assumptions.
—-no, you misunderstood. As is understandable for those in the 25k income bracket. But he was alluding to the common knowledge that 100k in the investment banking “cartel” is relatively meager, and when you add in the extreme costs of living “acceptably and at least comfortably” in NY, Manhattan, the most expensive plots of dirt on the planet of Earth, it’s just not a lot.
Most can barely sustain simple costs a year, and when they attempt playboy status, i.e. lofts, lambo’s, lago’s, the 100k won’t cut it. …at all. I myself make about twice that and I wet my pants at the thought of having to survive Manhattan. Powerty refers to the new income bracket for well off and “powerful”— i.e. the pow, of powerty–by most American standards, but still well below the need to pay for 2-4 million dollar dwellings, furnishings, expenses.
So, in ending, he did not mean poverty, he used a clever play on words to inform of a growing income state in America where the original indicator or measure of wealth just isn’t what it used to be.
the comments were good
an added advanatge to knowledge.
Guys,
I am not involved with investment banking at all. My background is chemical engineering and just stumbled across this fourm. It is interesting to see the way and the stress some people take to make money.
I think the greatest challange in this world is to know oneself, its not money. But then again its my belief. I suppose there is a limit to richness. But contempt and happiness is something else all together.
I hope you folks stress out less and enjoy life more before its over
the money will follow and after we are gone will be taken over by our kids or someone else.
Hi all.
I’m an italian student. Can Someone in the Ib business explain to me where the conflict between sale guys and traders is? Is it only on brokerage or also on structured products? In which way?
tnks,
HI
I hold a Bachelor of science degree with mathematics and economics as my majors.I really want to be an investment banker and aim to go back to university next year.Can you advice me on which courses to take if I want to make it as an investment banker because I was planning to enroll for Honours in economics
Warm regards
I am an Investment banker with a decade behind me. I will be honest and give you the real (only) reason why people look to I banking as a career. Aspitation of wealth. The hours are too long, the environment is one of high pressure and macchiavelian sniping. (I have been fired twice, no shame in that believe me) But the rewards are immense and reflect the ridiculous people and their posturing you will have to put up with. The turn over of undergraduates is unbelievable. One internship programme we have has got 14 people left after taking on 75. My advice? Do it but know your enemy. I have seen friends divorced, suffer nervous breakdowns, lose tremendous amounts of weight (ok if your fat). Now the plus points, I am in my early thirties (31) own my own home outright. Have a healthy bank account, drive an excellent car. Its December so its nearly bonus time, I never got fired (RE-hired to unravel credit default swaps for Barclays) (Ex lehman). Well there you have it.
The Investment Banking industy is one of the great tragedies of our time. Every year, thousands of new lemmings join investment banks as Grads/Analysts all around the world. They are our best and the brightest. They have excelled in their studies. In generations past they would have been engineers or scientists. Nowadays they become Microsoft Excel jockeys, churning out spreadsheet after spreadsheet. They contemplate possible permutations and combinations of existing businesses. Naively they believe the best way to figure out if two companies should combine is through eps accretion, as if it were hard to calculate. Perhaps they’ve forgotten their university studies about how little value M&A ever generates for shareholders, perhaps they haven’t, but just don’t care.
The lucky ones get out after a year or two, after realising there’s more to life than pitching powerpoint presentations and working stupid hours on deals that hardly ever go anywhere. The next group might wake up in the early thirties. Loaded with cash, a nice car and maybe a wife or husband who was only ever interested in the money behind the investment banker, not the person. After all, how can you have a relationship with someone who works 100-hour weeks? The best years of their lives have been wasted, they look 10 years older than they are, their personalities ruined by spending 10 years in the most disgustingly false and superficial of cultures. Nice car though.
The career investment banker is another creature altogether. Ruthlessly ambitious, selfish and capable of not only producing powerpoint slides that add no value, but actually talking convincingly about them. They probably have kids, some they might know. But I wonder what they are think on the day they retire, when they leave the carpark in the nice new Mercedes. What have I done with my life? What is there to show for all the 100 hour weeks and endless emails and memos? Talented people – they could have built bridges, been doctors or helped the environment. Alas, there is nothing but their cumulative share of the bonus pool. Drawn to banking by the great salaries and prestige. A working life wasted, a tragedy indeed.
It’s a reflection of corporatism, not capitalism…this is not capitalism, it’s the hard rigid structures of corporatism that despise the risk inherent in real capitalism…and the power structures that go into protecting the profession/firm(s). Agency theory is correct.
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