A Theory of Investment Banking

Arnold Kling asks, “Why Aren’t There More Investment Bankers?”
It’s an interesting question. Given the compensation, why doesn’t the demand overwhelm supply. Kling suggests that supply and demand are, indeed, out of balance — the wannabe bankers have too little self-respect.

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.

Posted by on December 13th, 2006 at 10:31 pm


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