Thursday, March 12, 2009

The Bigger the Better?

Much has already been said about the role that a skewed compensation model for bankers and traders played in the current crisis. But a recent story on fees related to the proposed Merck-Schering Plough merger reminded me of another issue that's also troubling: The way the banks themselves get paid for advisory work.

Goldman Sachs Group Inc., JPMorgan Chase & Co. and Morgan Stanley may split as much as $146 million advising on Merck & Co.’s $41.1 billion purchase of Schering- Plough Corp., as health-care takeovers dominate the slowest merger market in five years.

The story doesn't actually mention this, but among other fees, banks receive a large portion of their compensation from clients based on the size of the transaction that gets done. Obviously, this encourages them to promote big deals regardless of whether it's good for either company (And executives with huge egos and a thirst for more power are more than willing to buy the bankers' pitches). Companies often tout vague benefits such as "synergies" and "efficiencies" when they announce their mergers, but shareholders are soon hurt when these mega-deals turn into mega-disasters (See Time Warner-AOL*, DaimlerBenz-Chrysler**, RBS-ABN Amro***, etc.).

*A debacle that led to the largest loss ever reported by any company at that time -- $99 billion in 2002. (Although, to be fair, this deal probably made sense from AOL's perspective, since its stock was wildly overvalued.)
** THE case study for how a clash of cultures can doom a merger.
*** Advice given by Andrea Orcel, the Merrill banker that took home a $33.8 million bonus last year. I'll leave this one to Paul Volcker:

“ABN Amro and Royal Bank of Scotland are both bankrupt and their leaders are disgraced, but the investment banker who put it together walks off with $30 million,” Paul Volcker, a former chairman of the Federal Reserve and now head of President Barack Obama’s Economic Recovery Advisory Board, said at a conference at New York University’s Stern School of Business last week. “There’s something the matter with that system.”

Lawyers take a lot of flak for their practice of billable hours. But no one ever complains about the conflict of interest here. Despite it's role as an "impartial" advisor, the bank's incentive is to sell its client on a deal no matter the circumstances -- the bigger the better****. Again, I imagine the difference is while people know how lawyers bill their clients, people never realized how investment bankers did.

**** And don't forget the investment bankers try to sell a bunch of other products produced by the rest of the bank, such as financing, whether or not it's in the best interest of clients.

I really have no opinion on the Merck-Schering-Plough merger. Maybe it will work out great, just as they say. But if it doesn't, I won't be surprised.

No comments: