| Investment banking is a business of building long-term relationships. Your job, as an investment banker, is to become close to the people who possess giant piles of money, in the hopes that one day they will do giant deals with their giant piles of money and give you some of it. If you are at the weekly meeting of an investment-banking group and everyone is going around the room talking about what they did last week, and someone says "I did a billion-dollar merger and earned an $8 million fee for the bank," and you say "I played Settlers of Catan with Mark Zuckerberg," you win, because the expected value of proximity to a giant pile of money is so much higher than the value of an actual fee from a normal-sized pile of money. One result of this is that banks are always happy to give freebies to the possessors of giant piles of money. "We'll do this work for Facebook at no charge because the opportunity there is so vast and we want them to owe us one." The possessors of giant piles of money are, often, smart. Also they got to possess all of that money because they like hanging on to their money. One obvious result here is that if you happen to possess a giant pile of money you can get free or discounted investment-banking services pretty much forever. You do a multibillion-dollar acquisition, your banker comes to you with a bill, you look at her in disappointment and say "a bill? I thought we were friends," her heart skips with joy, she tears up the bill, she goes back to her bosses and says "the giant pile of money thinks we're friends," her bosses congratulate her on her success in relationship-building, everyone is happy, and they all salivate to think about how much money they'll make on your next, really big deal. And then you do the next, really big deal, and you repeat this process forever. I promise you will never stop seeing these stories about Saudi Arabia: The latest crop of Saudi Arabia's market newcomers is proving just as frugal when it comes to paying investment bankers. Despite attracting $125 billion in orders from investors for an initial public offering of Saudi Telecom Co.'s internet-services unit, banks including Morgan Stanley and HSBC Holdings Plc are set to share just about $12 million in fees, Arabian Internet and Communications Services Co., also known as solutions by stc, said in its prospectus. That's just 1.3% of the offering value, compared with an average of about 5% or more for IPOs in the U.S. or Europe. Morgan Stanley alone had a bigger payday during UiPath Inc.'s $1.54 billion IPO in April, which generated a total of $67 million in fees. ... IPO riches have yet to materialize for global banks despite a bonanza of share sales this year. Wall Street heavyweights like JPMorgan Chase & Co., Goldman Sachs Group Inc. and Citigroup Inc. have still flocked to the kingdom, hiring teams on the ground and sending in their top executives to sway local officials in the hope of winning advisory roles.
If banks are flocking to you because you have so much money, you don't have to give them any of it. I think that a basic rule is that if you have devoted your professional life to corporate inversions, in which U.S. companies merge with companies in low-tax jurisdictions in order to reduce their tax bills, you have devoted your life to doing the inversions. There's money in that! A company comes to you and is like "we would like to pay lower taxes so we could have more money," and you are like "let me spend months structuring a deal to make that happen," and you do and it works, and you send the company a large bill and they cheerfully pay it. You have rendered a valuable service and gotten paid for it. It is less likely, if you have devoted your professional life to corporate inversions, that you have devoted your life to stopping the inversions. There is no money in that! A company comes to you and is like "we would like to pay lower taxes so we could have more money," and you are like "no, that is unpatriotic, stay here," and the company is like "huh okay whatever" and goes to someone else.[1] You have rendered no service and gotten no money, and eventually you will have to find something else to do for work if you want to keep paying rent. Now of course there is a possible exception, which is government service. In theory you could work for the Internal Revenue Service and have a career as an inversion-fighter. But it is unlikely for simple institutional-design reasons. If the IRS decides as a policy "we will fight every inversion," it won't just go do that; it will write a rule saying "inversions are illegal" or whatever. And then people will stop doing them and start doing other tax structuring instead. Or more likely the IRS will write a rule saying "inversions like this are legal, and inversions like that are illegal," and professional inversion-doers will focus on doing the legal kind of inversions and arguing that gray-area cases are more like the legal kind, and IRS employees will be in the business not of fighting inversions but of evaluating which close calls are okay. And they will approve some and fight others and maybe take an overall skeptical view but not be knee-jerk inversion fighters. Also they won't have that much work, because most of what the professional inversion-doers do will be clearly legal inversions rather than borderline cases, so the IRS won't employ that many inversion-examiners relative to the absolutely booming private-sector professional field of inversion-doers. The IRS inversion-examiners will be generalists who do inversion examining as one part of a larger portfolio of responsibilities, or they will be inversion specialists but there will be like two of them. Also of course the IRS will pay less than the private sector but that's not the main point. The main point is that doing creative complicated things to minimize the taxes that companies pay is a big industry because it generates a lot of money (in reduced taxes), but doing creative complicated things to maximize the taxes that companies pay is not a big industry with a lot of specialists. And so if you are the IRS and you want to write some new rules about corporate inversions and you think to yourself "we need to hire the world's 10 leading experts in corporate inversions," every single one of them will have built a private-sector career helping corporations do inversions, and every single one of them, after a few years of government service, will go back to a private-sector career helping corporations do inversions, and when you ask them "what rules should we write about inversions" they will say "you should write very complicated rules about inversions, because that will increase the value of my advice, but also you should definitely write rules that allow lots of inversions, because that will also increase the value of my advice." No, no. They will be much less cynical than that; they are good people who have, in a burst of public-spiritedness, accepted a job at the IRS writing new rules. But they have spent their lives doing inversions, and their natural tendency will be to like inversions and prefer rules that allow for lots of them. Anyway here's a New York Times story about the revolving door for tax lawyers at big accounting firms who work on various corporate tax issues, go to the IRS for a few years to write industry-favorable rules on those issues, and then go back to the accounting firms to keep working on those issues with the new more favorable rules. How could it be otherwise? Few dispute that the Treasury Department and the I.R.S. must rely in part on lawyers from the private sector to understand the real-world effects of the tax code and how companies and wealthy individuals try to navigate around it. "If you want to know where the bodies are buried, you've got to get some of those people," said Chye-Ching Huang, the head of the Tax Law Center at New York University's law school.
Yes, right, if you want to craft smart careful corporate tax regulations,[2] you need people who have worked in corporate tax, and the reality is that anyone who has worked in corporate tax has only worked in minimizing it. Sometimes countries borrow a lot of money from investors in other, richer countries, and then they cannot pay back the money, and they go to the creditors and ask to restructure their debt. Typically the restructuring request is along the lines of "instead of paying you back 100 cents on the dollar this year what if we paid you back 70 cents on the dollar in 10 years," or whatever, and the creditors grumble and negotiate and some deal is or isn't reached. These things are always a bit more ad hoc and negotiated than, say, a corporate bankruptcy, because unlike in a corporate bankruptcy the creditors mostly can't foreclose on the country. There is no international super-court that would let the creditors come in and seize all of the country's airplanes or tanks or government offices or attractive tourist beaches or whatever, though a hedge fund did once famously seize an Argentine navy ship over unpaid debt. But in principle I suppose a country could say "hey we're a little short on cash but would you take a few miles of beach as repayment?" It doesn't happen much, I suppose mostly because it is not great domestic politics to be like "sorry we don't have any beaches anymore, we gave them to bondholders." Anyway here's a story about Belize handing over some coral reefs to its creditors: Belize is inching towards a deal with international bondholders after admitting it cannot afford to pay back its debt, and counting on an unusual asset to help: its coral reefs.
No, actually, I'm kidding, it's more interesting than that: Earlier this month the Caribbean nation, with its tourism-heavy economy ravaged by the pandemic, agreed to buy back its only international bond from investors at a huge discount, using cash lent by the Nature Conservancy, a US-based environmental group. As part of the deal, Belize will pre-fund a $23.4m endowment to support marine conservation projects on its coastline, home to the world's second-largest barrier reef. Some more investors still need to agree to the scale of the buyback discount before the deal is done. But if Belize can achieve the approval it needs on this $530m bond, the country could secure the first green-tinged debt restructuring, capitalising on the hunger among big fund managers to demonstrate their commitment to environmental, social and governance-driven investing. Investors and advisers say the agreement could serve as a template for future restructuring talks, in which cash-strapped nations use the promise of environmental conservation to drive a harder bargain — in effect creating a mechanism for investors in rich countries to pay poorer nations to protect the natural world. "We live in a world where many institutional investors profess ESG sensibilities," said Lee Buchheit, the veteran sovereign debt restructuring lawyer who is advising the Belizean government. "In any restructuring things always get tight when you get down to the last few pennies. We were hoping the environmental aspect would sweeten the transaction."
I suppose one way to read this story is that creditors want money from Belize, and Belize is like "hmm, nice coral reefs we've got here, would be a shame if anyone were to destroy them due to lack of international funding," and the creditors were like "fine fine fine we will take less money if you promise to leave the coral reefs alone." Another way to read the story is as "Belize is handing over some coral reefs to its creditors," but those creditors are interested in burnishing their environmental, social and governance (ESG) credentials, so they will leave the coral reefs alone. But probably the best reading is Buchheit's. Investors ascribe some value to ESG: Green bonds have a " greenium" (investors accept lower returns to fund more environmentally friendly projects), ESG loans charge lower interest if the borrower meets environmental targets, etc. Similarly here if you are a country that has run out of money you can go to creditors and say "we'll pay you 60 cents on the dollar," they might say no, but if you say "we'll pay you 55 cents on the dollar and also mutter an ESG incantation," they will say yes, because that ESG incantation has value to them: A group of investors led by GMO, Abrdn and Greylock Capital, representing half of the bondholders, has already given the scheme its blessing. Carlos de Sousa, a portfolio manager at Vontobel Asset Management — a member of this group holding about 10 per cent of the bond — said the proposal chimes with his company's focus on ESG. "Even though 55 is not the most amazing recovery value, we like the deal," he said, adding that investors had got more of their money back in previous restructurings. "To think that we are contributing to saving the second-biggest coral reef in the world is certainly a positive. It makes you somewhat less inclined to push for 60."
I gather that, here, there is some money going into active conservation efforts, but you could imagine using this template without that. A country runs out of money, it says "well we have a bunch of trees, if you let us haircut our debt we won't chop down all the trees," and the creditors say yes. The creditors get valuable ESG points, the country gets money, and the trees, well, who can say whether they would have been cut down without the deal. An argument that I have, like, one-quarter-jokingly made a lot around here over the last couple of years is that, as all the stocks are increasingly owned by the same handful of giant diversified index and quasi-index investors, those giant investors will think of themselves less as owners of particular companies and more as owners of the economy. To the extent that they think at all about their portfolio companies' business decisions, they will not ask questions like "does this decision maximize this company's profits" but rather "is this decision good for the world," because they own the world. Of course they don't own the world; they own a large sample of the equity in the world's public companies. The thesis here is not, like, "BlackRock Inc. are our benevolent overlords and will make decisions for the good of society." If there's some decision that is in the long-term interests of corporate shareholders, as a class, but bad for corporate employees, as a class, then presumably BlackRock will prefer that shareholders win. But they really are diversified and long-term holders, and in the long run the interests of shareholders are pretty good. Like you want a booming global economy, rising productivity, increasing wealth and consumption, stable governments, the rule of law, minimal extreme weather events and pandemics, etc.; the overlap between "good stuff for the world" and "good stuff for public-company shareholders" is not perfect but it is large. We have talked a lot about two particular applications of this. One is Covid-19 vaccines: If you are BlackRock, and one of your portfolio companies develops a Covid-19 vaccine and is like "we would like to roll this out slowly and charge a lot to maximize profits," you probably say "absolutely not you give that away free to anyone who wants it and license it to anyone who wants to manufacture it," because the profits of one drug company matter to you so much less than reopening the economy generally. The other is climate change. If you own all the companies, and the seas rise and wash away all the companies, you will lose a lot of money. If all of your money is in oil companies you might say, well, sure, seas rising is bad, but I rely on these dividends so let's sell as much oil as we can for as long as we can. But if you are a diversified owner of the world's economy, you have to take a broader view. And so BlackRock is constantly talking about climate change, and explicitly arguing that it cares because of its economic interests as a long-term diversified shareholder. I think that this stuff is interesting but you can definitely be a skeptic. Roberto Tallarita of Harvard Law School is a skeptic; here is his recent paper on "Portfolio Primacy and Climate Change": Climate change is a quintessential market failure. Individual companies do not have economic incentives to reduce their carbon emissions and therefore produce more emissions than is socially desirable. However, according to a theory that is gaining increasing support among academics and market players, large asset managers (and, in particular, index fund managers) can become "climate stewards" and force companies to reduce their impact on climate change. This view is based on the premise that index fund portfolios mirror the entire economy and, therefore, internalize climate risk. According to this theory, by maximizing the value of their entire portfolio (portfolio primacy) rather than the value of the individual company (shareholder primacy), index fund managers have strong economic incentives to steer companies towards decarbonization. This Article offers the first systematic critique of this theory. First, it demonstrates that the composition of investment portfolios can distort the incentives of index funds with respect to climate risk. In particular, it shows that index funds' incentives are strongly aligned with the interests of carbon emitters, rich countries, and large companies, but weakly aligned with the interests of firms and countries that are more vulnerable to climate change. Second, it shows that the stock market is a highly imperfect mechanism to address climate risk: stock prices do not accurately reflect future climate damages; private investors discount the distant future at a higher rate than the correct social discount rate; and public companies represent a limited (and increasingly smaller) portion of the economy. Therefore, index funds inevitably underestimate the costs of climate change and the benefits of mitigation measures. Third, it examines the agency problems and fiduciary conflicts of index fund managers, and it argues that even if index fund portfolios benefitted from climate stewardship, fund managers would have very weak incentives to take on such a role.
I do think that a relevant question here is "compared to what?" I think that a lot of these arguments had their origin in comparing large index investors to smaller less diversified investors. Compared to a concentrated active equity investor, a big index investor is going to care more about curing societal ills, because it necessarily cares less about squeezing out operational efficiencies or competing on price or other company-specific things; the only way for it to fundamentally improve returns is to improve market-wide outcomes.[3] But Tallarita's point is that index funds will care less about climate change than, you know, the median human on earth,[4] and so (somewhat idealized) democratic processes are probably a better way to address the problem than leaving it to BlackRock. "If policymakers want to use corporate governance as a tool to fight climate change, they should change the incentives of individual companies rather than trust the portfolio incentives of index funds," he writes. But if policy makers don't want to fight climate change then BlackRock will probably do something anyway. A good empirical question in academic finance is: When investment bankers work for the target in a merger, do they try to get a high price or a low price? The obvious answer is "high price": The bankers work for the target, they are negotiating against the acquirer, and the higher the price they get the more they have won. They are repeat players in this business, and when they go pitch other companies to represent them in mergers, they will want to show their negotiating credentials by pointing to all the times they negotiated high prices. But there is a good contrarian argument for "low price." For one thing there are conflicts of interest: A banker who represents a target in one deal might represent an acquirer in the next, and big acquirers provide more repeat business than targets do; if you give a private equity acquirer a good deal today they might hire you tomorrow. Also, though, if you are a sell-side M&A banker, your main economic incentive is to get a deal done: You get paid more for getting a deal done at a higher price (generally), but you get paid nothing if there's no deal. So your job is not just to try to extract the highest possible price out of the acquirer; it is also to get your own client comfortable with a lower price, because your main goal is to make a deal happen at some price. Anyway here is a paper titled "Peer Selection and Valuation in Mergers and Acquisitions," by Gregory Eaton, Feng Guo, Tingting Liu and Micah Officer, on a related question: Using unique data, this paper examines investment banks' choice of peers in comparable companies analysis in mergers and acquisitions. We find strong evidence that product market space is amongst the most important factors in peer selection, but we provide evidence indicating that Standard Industrial Classification (SIC) codes, particularly three- and four-digit codes, do a poor job of categorizing related firms in this setting. Banks strategically select large, high growth peers with high valuation multiples, factors that are also positively related to premiums. Our evidence is consistent with target-firm advisors selecting peers with high valuation multiples to negotiate higher takeover prices.
How much is a company worth? Well, loosely speaking, it is worth (1) its annual earnings before interest, taxes, depreciation and amortization times (2) the median enterprise-value-to-Ebitda ratio of its peers.[5] So the way to value a company is to pick a list of peers. If you pick a list of companies with high EV/Ebitda ratios as "peers," you will get a high valuation; if you pick a list of companies with low multiples, you will get a low valuation: That selection process is almost surely driven by the target's principal advisor in the M&A transaction, which is typically an investment bank or advisory firm. The true incentives driving investment bankers' peer selection are, of course, unobservable. However, in this paper we examine whether the characteristics of peer firms chosen by target firms' investment banks suggest that banks choose peers to aid in the negotiation of a higher offer price for target firm shareholders, or, conversely, choose peers that help with the completion of a proposed deal. The latter of which enables the bank to collect their advisory fees, a large fraction of which are typically conditional on deal completion. ... The incentive to select peers in such a way that helps the target in negotiation with a prospective bidder would imply that the target's investment bank chooses peers that, all else equal, have higher valuation multiples, which make the perceived value of the target firm appear higher. Conversely, the incentive to select peers in a way that helps with the closing of a transaction (and the bank's collection of its advisory fees) would imply that the investment bank chooses peers that, all else equal, have lower valuation multiples. This would make the bidder's offer appear more generous to target shareholders, increasing the probability that they accept the offer. Because the investment bank advising the target firm in the transaction has significant discretion in the choice of peers, which of the incentive effects dominates is an empirical question and is the main focus of our study.
I actually think that, if you've met investment bankers, it's fairly clear that the "high price" incentives would dominate and that sell-side bankers would pick high-valuation peers, and that is in fact the result the authors get. (If you're a banker you tend to view yourself as a master negotiator and put your effort into squeezing out a higher price; later, when you write the fairness opinion, you'll regret all your bluster about how valuable the company is, but that regret is not going to change your behavior.) Also though bankers in management buyouts — where the target management is also the buyer — are more conflicted and might choose lower multiples: We examine some additional incentive effects in the peer selection process. Specifically, we examine whether the results described above also hold in a sample of management buyout deals. Management buyouts present a setting where concerns about agency problems are particularly germane because the target firm's managers have the incentive to purchase their firm from shareholders at the lowest possible price. Our results in this subsample suggest that peers selected in buyout deals tend to have lower valuation ratios and weaker operating performance. However, these results weaken once we control for bidder characteristics. Thus, although we are not able to reach a definitive conclusion, we provide some evidence that investment banks may strategically select low-value peers to justify the lower premiums offered in buyout deals.
A further possibility is that bankers use high-value peers when negotiating the deal, and then low-value peers when writing the fairness opinion to try to get the deal approved, but that seems a bit unsporting. Evergrande Moment of Truth Arrives With Bond Payment Deadlines. How Beijing's Debt Clampdown Shook the Foundation of a Real-Estate Colossus. China Defends Tech Crackdown in Meeting With Wall Street Chiefs. Suspicious trades were made before Goldman's $2.2 billion acquisition of GreenSky, options experts say. Kyrgyzstan Blocked From London Gold Trading Over Missing Bars. Credit Suisse charges investors to prop up Greensill Capital. Realtors Face Federal Scrutiny of Broker Commissions. What the Solana Blackout Reveals About the Fragility of Crypto. SoftBank partner took investor meeting barefoot and smoking, says Monzo founder. Murdoch set up TV station because he 'wanted something to watch.' If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! [1] There will be *occasional* weird cases where a company is like "we want our competitor to pay higher taxes" and hires someone to fight their inversion, but realistically they're going to hire a professional inversion-doer to do that, not a professional inversion-fighter, because the latter category does not really exist. [2] The other professional category of people who might make a career out of fighting to raise corporate taxes is of course *politicians*. But realistically they are going to be less specialized than professional corporate-tax-reducers are, so they will just not have the same level of expertise. The Times describes a couple of tax provisions as "hastily passed and sloppily written," and explains that a former PwC official who had moved to Treasury now had "to figure out how to put those new taxes into effect." Being an expert, he presumably put them into effect in a more careful, measured and professional way than the hastily-written legislation, but also obviously in a way that was more favorable to companies. [3] I say "a big index investor," but as Tallarita points out there are some important agency/incentive problems for index-*fund* managers, who get paid like a couple of basis points to track an index and arguably have no incentives to do *anything* to improve performance. Still in the long run it is probably somewhat useful for BlackRock to be able to tell its investors, like, "index investing with us produces good returns and we try to improve those returns." [4] More strictly, "index funds will have less *incentive* to care about climate change than the median human on earth"; in actual fact the median human is probably not paying attention. [5] I enjoyed this Morgan Stanley research note from last month, by Michael Mauboussin and Dan Callahan, arguing that "Everything Is a DCF Model," that discounted cash flow valuation is the underpinning of all valuation, and that more investors should spend more time doing DCF models. But they do admit that in practice valuation is mostly done by multiples: "However, a recent survey of professional equity analysts found that 'market multiples' were '[b]y far the most popular approach to valuation' among nearly 2,000 respondents. Specifically, these analysts said that when valuing companies they used price-earnings multiples 88 percent of the time and enterprise value-to-earnings before interest, taxes, depreciation, and amortization (EBITDA) multiples 77 percent of the time." I suspect that if you asked people in the M&A business (as opposed to the public investing business) you'd get more votes for EV/Ebitda and fewer for P/E. But nothing turns on this and you can substitute P/E — or some other multiple — for EV/Ebitda in the text. | 
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