Why do investment bankers make a lot of money?

"Almost every profession" - what are the exceptions And A lot of life should read as A lot of 'time'. Because at the other extreme, little money does not = a lot of life.

antibanker:

There is a very simple equation which holds true in almost every profession in the industrialized world. The equation goes like this:

A lot of life = little money Litte life = a lot of money

As I said, this equation holds true to almost all professions. And investment banking ist just on the extreme of little life (in this case, no life) and, thus, a lot of money.

If you do not like it that way, than you should seek something in the middle, i.e. some life and some money.

big unit:

Honestly, my friend graduated as an industrial engineer and now he regulates PH levels in water tanks at a large chemical company. He does the same thing every day. How much does that suck?

very much.

Great responsibility? You are in for a rude awakening.

At a recent closing dinner for one of our acquisitions I asked an associate from the bank who was running our deal (who I am close with) what he thought about his job and whether or not I should consider banking after b-school. His response was a bit surprising and he basically said that I would be disappointed with the lack of responsibility that I would have as a 1st and 2nd year associate (esp. compared to my current position).

The reason that bankers are well-paid is best explained by the well-known story about a jeweler (which I will surely misquote) who charged his client 3 grand to cut a stone the way he had requested. The customer is surprised at the usurious charge to which the jeweler responds, it only cost me $20 dollars to use the tools to cut the diamond but the knowledge of where to precisely make the cut was far more expensive.

The problem with this analogy and why it has become less and less applicable for i-bankers is because the industry has changed over the years as information flows more freely and bankers/information has become more commoditized.

"Banking isn't rocket science," and "What we do here isn't that hard."

Both completely true statements. The difficulty in banking isn't the brain power required. You write everything in bullet points, and aside from some business math, most things are accomplished with addition and subtraction (throw in a little multiplication or division if you're feeling antsy).

Banking is however, a huge pain in the ass. You have to be willing to work the equivalent of two or three jobs at once, have no control over your life, and be someones bitch for your entire career. You didn't read the other comments about "turning a single paragraph 27 times" or worrying for 3 hours about what font to use on the caption for a graph. How about the 6 hour phone call to do a page turn at 2am with some guys in Hong Kong.

The only brain power that is required is the ability to learn quickly. By that I mean you need to learn the relevant facts about an industry quickly, learn tax decisions (not necessarily understand them just be able to use them). You also need a decent memory to pull up all of the facts and figures about any given model in the middle of a meeting with no notes.

It isn't hard (as in high IQ), it's hard like prison. That's why they pay.

OK, here goes: 1. Correct, the actual work (the Excel or PowerPoint) that a banker does is not hard at all, at least once you learn how to do it. 2. It is so competitive because of (1) the level of compensation, (2) the exit opps (at least at the Analyst level) and (3) to a much smaller extent, the prestige 3. The level of compensation is high due to the enormous sacrifices one must make to be successful as a banker (at all levels). It's more than just the number of hours. Those sacrificies are what makes banking "hard." Comp for bankers is also somewhat more risky than for other professions given the fact that your comp is mostly bonus. Obviously, higher risk, higher reward. 4. The "responsibility" that you mentioned is b/s. Your clients (companies) "change the economic landscape...". You just facilitate your clients.

The reason people create posts like this is because they have a skewed idea of what banking is. See the above post: "the actual work (the Excel or PowerPoint) that a banker does is not hard at all." While there is a tremendous amount to be said for what you can learn as an analyst, and understanding how to model something in excel does help you understand how a transaction or company works financially, Excel and Powerpoint aren't "investment banker work;" they are analyst work. Most of the smartest, shrewdest bankers out there are useless with excel, and would prefer to go into a meeting and talk without a slide deck at all. Analysts are paid a lot because they take a lot of shit, they have the ability to create expensive problems if they drop the ball at the wrong moment, and because for banks to be able to provide a value add at the senior levels in the future, they need to be able to attract smart people now to train / give experience to. Investment bankers (not analysts) are paid a lot because they provide strategic advice, market access, and tremendous knowledge and experience dealing with situations where a lot is on the line. Analysts = analysts, investment bankers = dealmakers. There is something to be said for the recent flight of talent to "the buyside" and the deteriorating quality of people in investment banks. However, while I think lots of smart people will still move to investment functions, I think that trend was exaggerated by the extraordinary favorable conditions of the past several years. Just read some of the articles on KKR in the 90s, when it was considered seriously passe to work there.

I agree with what Junkbondswap wrote. The industry has changed and maybe the analogy junkbondswap used doesn't fit as well as it used to but I think it goes a long way towards answering the question asked.

The Prince of Wall Street

http://www.princeofwallstreet.com

Ruscal makes an extremely good point and one that should be noted by all regarding the overly exaggerated "flight to the buyside." I work on the buyside and one of my Managing Partners recently said at lunch that "shit, we should go back to the sell-side, these guys get paid big bucks to advise and take no execution risk." As the days of cheap money wane and PE loses a bit of its luster (esp if any of these carried interest tax laws go into effect) I think i-banking will return to a greater prominence.

I think everything said here is true.

But I don't think anyone has really hit on the specific reason why bankers are paid so much. Yes, there are sacrifices required. Yes, it is competitive. Yes, you put up with a lot.

But bankers make a lot of money because they deal with a lot of money.

Imagine if you sold cars and got a commission on each one. If your average selling price were $15K, you're not going to make much money.

But now imagine if you sold houses for $500K-$5 million each. Obviously you'll get a higher commission.

Bankers are just salesmen; the companies they sell are worth way more than mere houses, so their commission is far higher. That is why investment banker salaries are so high.

More broadly speaking, this is why the rest of the financial services industry, include private equity and hedge funds, makes so much as well: they work with larger sums of money than can be found in any other industry, and they take a cut off the top.

Ruscal, you make a very correct statement that analysts (and associates) are not really "investment bankers." However, the OP seems to have been asking about the difficulty of "analyst work." I must respectively disagree with your assertion that bankers provide "strategic advice, market access, and tremendous knowledge." Market access yes. Strategic advice and tremendous knowledge, not so much IMO. I don't think my views are skewed, though perhaps cynical.

Dosk, you make a very good point that bankers are sales people selling "high-priced" goods and therefore earn high commissions. There are however other jobs within finance where people deal with a lot of money but don't earn anywhere near the same amount as investment bankers. Commercial bankers are also selling products with lots of 000's. The difference is that the margin on investment banking products is far higher. The interesting question is will that margin decline as banking becomes more commoditized, as other posters have noted. Econ101 tells you that it should, which will lead to lower comp over time. Same question applies to PE (see junkbondswap's post above) and HFs.

And I'd agree that bankers provide way more in the way of "market access" vs. "strategic advice".... most bankers, unless they've worked as C-level executives before, do not have much operational knowledge.

And yeah definitely true that the margin on banking products is way higher than with other products in finance; the salespeople analogy is just how I like to explain it to others outside the finance industry who want to understand why people in it get paid so much. :)

I would tend to agree that the margins will decline, and I think we've already seen some of that happening with recent news of HFs this past fall underwriting their own debt, companies not using advisors as much, etc. (I don't have the specific data in front of me to support that right now).

I feel a GOOD portion of sell-side M&A processes are basically just commodities. Clients definitely overpay in a lot of cases.

Quite honestly, I'm also surprised that the 2 and 20 structure in PEs/HFs has held up so long - it's a relic from when the industry first started. I read somewhere that most buyside institutions actually make more from management fees than from the carry, which suggests to me that it may be time for lower management fees...

totally agree re sell-side m&a. agree also with your thoughts on 2/20. it is amazing to me that institutional investors haven't tried to crack down. everyone knows that only top quartile or quintile PE and VC firms produce acceptable returns. So how is that rest persist to have the same fee structure? Plus, in PE land, you've also got deal fees which of course is absurd.

now, part of the answer of why 2/20 persists is due to the nature of 2 and 20. if you don't have good returns, you don't get your carry. so fees do come down if returns suck even if the fee structure stays the same. that will obviously happen in PE and is certainly happening in HF land. HFs are getting institionalized (read: commoditized). The big get bigger (and do often lower fees) and the small disappear. That's happening now and the trend will accelerate as the markets continue to suffer. Most HFs are just beta. that only becomes apparent to investors in bad markets.

sorry to get off topic. btw, if anyone is interested in this stuff you should read Pioneering portfolio management by David Swensen (the guy who runs Yale's endowment).

ex-banker -Every PE/VC/HF claims to be top-quartile (and can justify it one way or another). Sort of like how every BB claims to be at the top of the league tables.

I saw that article too about management fees earning more than carried interest. It is interesting that this news comes at the same time that the whole industry is freaking out about taxes on carry. If the bulk of earnings is already taxed as ordinary income, then who cares? My guess is that even the most fee-heavy GPs still believe that the bulk of their earnings will come from carried interest. i.e. it is disappointing to them, too, to find out that carry is less than their management fees. I guess this goes hand-in-hand with what I said above: everyone thinks they are top quartile (and thus earning sizable returns, and thus sizable carry), but the majority of them (75% to be precise) are not.

to make it rain. On dem hoes.

I guess most of the investment bank's revenue will no longer come from M&A in the future. Probably more from underwriting and private placements.

First off Princeofwallstreet should be banned from posting - he clearly doesn't/hasn't worked on wall street and provides inaccurate and invented information.

Second, sure, many bankers, especially in massively favorable markets, get by, just leveraging their firm's capital and network without adding real strategic value, just as there are PE shops that have posted decent returns without creating a lot of value over periods where asset values have just trended upward. But when the market goes to shit, those guys are the ones struggling to hold onto their jobs (or the firms struggling to find a reason to stay in the business - see BofA). The great guys in the deal business, whether at banks or funds, are the ones that have ideas, experience and creativity. On the "sell side," these guys are valuable even when markets get choppy because their advice is an asset in good and bad markets.

What is Dosk talking about with "operation experience?" If you want operational experience you hire McKinsey. Bankers are largely in the business of providing financial, not operational, strategy. There's a tremendous amount of creativity and potential competitive advantage in even just the structuring of a given acquisition, let alone judgment about what to acquire, how much to pay, etc. If you want to see some complex structures look at how Cerberus took out KKR in the GMAC deal (although they probably wish they hadn't at this point) or what they did with Chrysler (again, looking regrettable but you can't deny it was creative).

The only point I really wanted to make before is that analyst work is not the reason an investment bank charges a mega million dollar fee on a large transaction, and analysts are not "investment bankers." Among top guys in the deal business, people are more interested in how smart and good at doing business you are, and less interested in the statements you see on this board like "buy side > sell side." Sure I'm going to the buyside like so many other guys once my commitment's up, but mostly because I think it will give me a valuable and interesting experience and broaden my options post B school. If it comes down to it, I'd rather be a smart, well respected partner at a top bank with a number of large clients that turn to me, than a mediocre partner at a medium investment firm riding a market wave. And the former makes more money over any period long enough to encompass a couple market cycles, and, provided he's a hitter, can move to the buyside pretty easily anyway.

The statement "strategic advice, market access, and tremendous knowledge" - definitely agree with market access and how to structure a deal. As you've pointed out, bankers are experts on structuring deals and a different deal structure can make a big difference.

I interpreted "strategic advice" to mean "What should our company's strategy be in the market? How do we beat our competitors?" Although some bankers do this in certain situations, a company in the market will generally know much more about its competitors and what it wants to achieve than a bank will.

If by "strategic advice" you were referring to proper strategy around how to structure or win a deal then sure, bankers do provide that.

Excellent feedback thus far.

junkbondswap - could you explain to me what role associates play? I have always believed that analysts do the grunt work and are responsible the numbers are right while the associates are ultimately responsible for making sure the numbers work in the grand scheme of things - taking into consideration discounts for marketability or control premiums or special tax situations. Are associates not responsible for all of the presentation materials? Are associates supposed to be sourcing deals?

ex-banker - Economics 101 has failed me. The supply of labor for IB jobs is high, so shouldn't that drive down wages? I-banks can select from the cream of the crop b/c so many people want to get into the industry. Given the exit opps and the other advantages of working in I-banking, I personally would work for less, but I am damn glad I don't have to. Given the opportunities, would you work for less? Also, I don't think I agree with your risk/reward reason. In the Accidental Investment Banker, the author makes it clear that bankers are much more risk averse than other professionals such as entrepreneurs or HF managers.

Ruscal - interesting comment about The Prince. Hey - how the hell did he amass so many damn banana points? He's been a member for five weeks!

F9, I'll take the easy one first: Knee (the author of the Accidental IB) is correct to generalize that bankers are more risk averse than entrepreneurs and hf managers. being an entrepreneur or hf manager is higher risk, higher reward than being a banker. to make the obvious point, there are billionaire hf managers and billionaire entrepreneurs but there aren't any billionaire investment bankers. my point was that banking is higher risk/higher reward than less lucrative professions (say, being a lawyer or accountant or consultant).

as for the econ lesson, its not as simple as to say the supply of labor is high (in other words, the demand for jobs is strong) and therefore wages should be low. i hate when sports analogies are used in banking but i'll use one anyway. when i was a kid i wanted to be a major league baseball player when i grew up. lots of other kids wanted to be baseball players too. there's obviously a high demand for being a baseball player. there are plenty of minor league baseball players dying to get a chance. yet, the average salary of a major league baseball player is almost $3 million. why aren't those salaries lower?

investment banking compensation is probably fair, compared to other industries, given all of the requirements for the job discussed above (intelligence but not at rocket science levels as you pointed out in your original post, hours, lifestyle sacrifices, etc.) and risk. this is especially true of you average compensation over a full market cycle (keep in mind the last couple of years were boom years).

you say that you would work for less money now, and that may be true, but I can almost guarantee that once you work your ass off for a full year, if you don’t get paid market (the same level as your peers at other banks), you’re going to be pretty pissed off and look to leave. Banks obviously know this which is why they all pay about the same at the junior levels. They’ve invested a lot in you as banking has a steep learning curve. But always remember, if banking has a lousy year, your comp goes down because your bonus is discretionary and because your bonus is the majority of your comp. as discussed above, few other jobs (other than entrepreneur/hf/pe) have this type of comp structure. In most jobs, nominal wages never decline (unless you are laid off). Part of the reason why comp is high in banking is to compensate you for this risk.

At the senior levels of banking, the bankers (at least the goods ones) are very much free agents. Bankers with relationships can pack up their rolodexes and move on to other banks very easily. Just like in sports, the stars get paid outsized comp.

to answer your question regarding associates, associates are responsible for checking the work of the analysts and also will help doing the work. Associates sometimes do the modeling and associates generally write large portions of the presentations. Associates are not generally responsible for sourcing deals.

hope this helps.

Professional athletes get paid way more than bankers do, and the work they do isn't difficult from an intellectual standpoint.

I'm tempted to write a blog post about this topic at some point now.

The professional athletes point is a good one and shows how you're not really compensated in the real world for "intellectually challenging" work - banking, truthfully, is not quantum physics (as we've already established), and neither is anything athletic.

However, both do involve hard, consistent work and effort over many years of your life to get to the top.

I think that gets to the heart of the issue: unlike school, in the real world effort matters much more than pure intellectual capacity.

Sure, you can't be stupid and get a really high-paying job, but once everyone's at a certain level, those who work the most will get ahead.

I disagree with the athlete/banker analogy only to the extent that the % of the population capable of competing at the professional level is far less than the % of the population that could work in banking. Pro athletes are a combination of pure talent and years of cultivating that talent. Athletes are paid an exorbitant amount because of their rarity (relative to the population) and ability to generate revenue (which is largely due to the introduction of television and other various media outlets).

F9,

Associates are given more responsibility than analysts but still engage primarily in grunt work (building models or overseeing analyst models, building/editing pitch books in accordance with VP/MD comments, carrying pitching books into meetings and generally keeping their mouths shut unless asked a question, sending out Outlook meeting invites, scheduling travel logistics/closing dinners)

This is not to say that associates do not play a valuable role in the process but they certainly are not responsible for deal generation. Deal generation and relationship maintenance is left to the MDs (and to a lesser extent VPs).

From my experience I would say that "Monkey Business" provides a fairly accurate depiction of associate life.