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the decline of status in investment banking

During an NPR program I listened to Monday one of the commentators noted that few pure investment banks still exist – Goldman Sachs and Morgan Stanley being the lone survivors.  Most have been acquired by what are becoming known as global wealth management or financial services firms. The new global financial services firms look much more like diversified conglomerates, financial Wal-Marts, than they do Wall Street banks.

This transformation of the finance industry certainly seems like an odd twist to an economic sociologist trained in the last decade.  Like many of you, I learned about the function of status in markets by reading Joel Podolny’s work on investment banks.  I remember very clearly reading his 1993 paper for an undergraduate class and seeing the tombstone advertisement listing the investment bank underwriters, in order of status, of a new security.  Reading Podolny’s paper sent off all sorts of “this is cool!” signals inside of me, which helped me decide that year that I wanted to be a sociologist.  Perhaps this is why it seemed so strange (and kind of sad) that most of the high status banks in his study no longer exist.

Table 2 (pg. 857) ranks the banks by status.  Interestingly, two of the three highest status banks still exist as independent entities.  Morgan Stanley (#1) and Goldman Sachs (#3) are still kicking around and refuse to dip their toes into the waters of commercial banking (but for how long?).  First Boston (#2) was acquired by Credit Suisse in 1988 and the FB name was officially phased out in 2006.  Bank of America will acquire Merrill Lynch (#4) and Lehman (#6) and Bear Stearns (#13) are both goners.  Travelers Group acquired Salomon Brothers (#5) in 1998, which has since been subsumed by the giant Citigroup.  Investment banking seems to no longer be a viable model; commercial banks, in contrast, have more sources of funding and have been more profitable. It may not be long before Morgan Stanley and Goldman Sachs are forced to either buy a commercial bank or allow themselves to be acquired by one.

What happens to status-based competition in this kind of market? There are only two high status players left and it’s not clear that they will have any sort of advantages over the diversified financials in underwriting.  Podolny asserted in a footnote of his 1993 article that market stability was key to status competition.  “[M]arkets in which status is positively correlated with profits will be more stable than markets in which status is inversely correlated with profits” (847).  The assumption has been that investment banks had higher status than commercial banks and that they could protect their market niche by limiting the ability of new market entrants, like commercials or other diversified financial firms, to compete for price.  However, this no longer seems to be the case, and as a result the profitability of pure investment banks has disintegrated.  Following Podolny’s thinking, then, status relations should no longer be an effective relational mechanism in the market.  Status may matter again in the future, but probably not until there is some level of market stability.

Written by brayden king

September 17, 2008 at 3:32 pm

4 Responses

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  1. “listing the investment bank underwriters, in order of status, of a new security”

    This is not quite exact. I couldn’t read the source, but tombstones list the banks not in order of status but in order of their contribution to the deal. The bank that does the most work, has the biggest allotment, and has the cooler title is listed higher and to the left. Title (sole bookrunner, joint manager) and placement on the tombstone are heavily negotiated for each deal. Over time obviously they correlate strongly with status but the two are not one and the same. Maybe that is what Podolny meant.

    Also the viability of investment banking depends what you mean by investment banking. It seems that the pure advisers at least will survive. Underwriting may not.

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    Timothy

    September 17, 2008 at 7:05 pm

  2. Brayden, thanks for the post (and for reminding us of a very relevant classic)
    Just a commnt: one of the main reasons investment banks did not ‘dip their toes’ in the waters until relatively recently is, of course, the Glass-Steagall Act that prohibited investment banks from receiving deposits from the public. That part of the G-S Act was revoked, in effect, in 1999. And, indeed, since then we witnessed the frantic mergers and buyouts in investment banks that you mentioned.

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    yuvalmillo

    September 17, 2008 at 9:16 pm

  3. Timothy – Yes, that’s right. No single tombstone can perfectly convey the status rankings of the banks. Status is reflected in the aggregate pattern of ordering. The basic intuition is that high status firm have a disincentive to do security underwriting that would cause them to be listed significantly lower in the ordering than other banks that they perceive as having less status. A bank like Morgan Stanley would simply withhold from a particular transaction if it meant be listed lower than, say, Bear Stearns.

    Yuval – Thanks for reminding me of that. In this case it appears that deregulation was the trigger that provoked market instability.

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    brayden

    September 17, 2008 at 9:24 pm

  4. Probably, the high status banks were guarding their fort so strongly that the regulator had to intefere to allow the low status players get a fair share of the pie.

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    Rajiv Krishnan Kozhikode

    September 19, 2008 at 6:18 pm


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