There has been a lot written lately about the insider trading scandals in the states, particularly the one involving Raj Rajaratnam and his old hedge fund Galleon Group. I did my 4th year business ethics term paper on Raj, and I have kept an eye on the events as they've unfolded. The big takeaways I've gathered are that: in business it often boils down to intent, and that although painted black and white these scandals are often very grey.
For instance think about the whole purpose of hedge funds. Their goal is to achieve returns above the market return. If they are able to do this with less risk then they have just disproven either Semi-Strong Form (SSF) or Weak Form efficency (ie. are they arb, valuation, or trading based). Market crashes aside, the market seems to be fairly SSF efficent, and so any hedge fund manager making ground must be cheating.
Galleon group had expert panels. This seems like an obvious must to a firm whose strategy is valuation. Talk to industry participants about where they think the industry is going, and then tailor your investments accordingly. If industry expert A says "I think that the semi conductor industry is ready for a comeback, data warehousing is going to bring in a huge demand force. If I were you, TriQuint would be a hot buy right now - they are really poised to sell into data warehouse demand.", then that's pretty above board advice. But what if expert A is telling you this and his firm is a data-warehousing firm, who is about to make a big play for a TriQuint. A lot shadier. This is were it can come down to intent, and the court gets to decide your motives, not you.
In finance this is painted with a much broader brush against the whole industry, and I experience it in conversations all the time. People on the capital side of the business are seen as the fat cats, who care about nothing except personal gain. Why?
Umm what do you do exactly?
Focusing on investment banking, I think it gets it's reputation for several reasons. First it's confusing. The general public has very little concept of how a investment banker adds value. It's easy to think you understand what an astronaut, firefighter, tax accountant, surgeon, does in a day, or how a car company makes money. Even trading seems somewhat understandable, but what in the hell do those i-bankers do to make 6 figure salaries right out of college? The average joe either just envisions an open excel spreadsheet, or a golf course. They don't see any output, there is no product, it's just really really hard to think of what the work is.
When I began talking to my parents about roles I was considering, or where I landed, I saw first hand the difficulties in explaining the business. Now that we've switched over to Skype to ease the international phone bill, I can literally see their eyes gloss over when I talk about how I plan on valuing a target oil company for a Chinese bidding firm.
Now my laymen one liner is: "I attempt to put a price on a really large business by predicting, as accurately as possible, how much it will make from now to forever." or if I'm feeling quippy "I price the future", "I value things that are hard to value", and if I'm trying to pick up, "Come back to my place and I'll tell you what you're worth" (bet she's not imagining the excel filled night I am....).
Okay so how does this help anybody?
Or put bluntly by a friend, "explain to me why you're not increasing world suck". This is a bit harder to defend because you do hear about situations when you can be forced between a moral choice and a profitable choice. I conceed this point, but I'd point out that every job has the ability to hurt society from time to time. Think car mechanic. Sometimes your mechanic may overcharge you for the work, or replace things that don't need replacing. This is because there is a large information asymmetry - you know nothing about your car. The thing is some mechanics will do it the right way, and they'll quickly be recommended by their customers, so although you may know nothing about your car, you do end up getting to know who is a good mechanic. The mechanic may add to world suck everyonce in a while, but too many fraudulant transactions and he's lost his business.
It has to be the same way in the business world. If someone is going to pay me, I have to be helping someone. I see the M&A i-banking role contributing two things. The first big one is information. Through my days toiling at the office I am creating information where none existed, I am lessening the information asymmetry between the bidder and the target (or on the issuance side the investor and the company). A creator of knowledge is a pretty good thing to be, and although I'm not curing cancer, I may be contributing to the process that gets the money to the person who does. And this is the second big point. Investment banking let's people invest. My team is tasked with lining up good ideas that need money, with money that needs good ideas.
I may not be producing energy efficient solar cells, rice bags for the poor, or biomedical advances, but I am part of a system that lets those things happen, and without that system, none of those things would be possible. The catch is every once in a while, I may inadvertently (or maybe even knowingly) help line up capital for an idea that is not a net good for society. My defense is that these idea's need demand, and people don't pay for what hurts them. Sometimes they do, but they do it unknowingly. I argue for the system to work, these bad idea's, bad mergers, bad companies, must be few and far between, because if they were common consumers would lose trust. When you lose trust, you lose consumption, which leads to layoffs, which leads to depression. We all work around the principle that everyone is contributing to society, not taking away from it. It's a sound principle and it guarantees virtue in every profession if it holds.
Why so much money?
I haven't developed a good explanation to this yet. I'd still pursue finance if it paid a fraction of what it does; I'm made for the trade, what is more fun than predicting the future! Finance is my plan A,professor B, and helicopter pilot plan C. After that I would start thinking about professions that were "jobs" that could pay for other things in life I enjoy, but for now I'm looking for a career that is the life I enjoy. Chris Rock explained it this way.
So why the money. Well economically it should be because supply of the job is much higher than demand. But this isn't true, thousands of people apply to 1 opening, statistically each applicant has 0% of getting in, the wage should be dead low, because if you don't want it the firm can just give it to the next applicant. Before we ditch economics lets drop the assumption that every applicant is the same. Maybe out of the 1000 applicants, there are only 50 that could do the job? I don't know the answer to this one, but I'm sure it plays a part of the story, there are 4 rounds of interviews after all.
The hours need to be factored in as well. If you are working 90 hour weeks for 51 weeks a year, you are making under $22.00 an hour. Averaging a 90 hour a week is a bit steep, but I'd wager most i-bankers are making less than $30.00 an hour before bonuses in their first 2 years.
And let's not forget what employers are asking for here. Quants with presentation skills. It's not that hard to find a very well spoken university grad from a liberal arts degree. It's not that hard to find a quantitatively sharp university math major. It is hard to find someone who has both. Many business students are good speakers, decent on the business skills but lack the fundamentals in statistics. I-banking is high powered sales, you need the best of both worlds if you are going to solve and explain business combination investment problems.
The Image
I'll admit, I've read the blogs (for example the leveraged sellout), and seen the movies (Wall Street... the first one), and I can concede that those with less than admirable intentions may flock to the profession of i-banking. But I will say that I plan on leading a life of virtue (maybe a bit on the Ayn Rand side of the definition sure), and after speaking to my to-be team in the interview rounds I'm left with the impression that they do as well. It's never like the movies anyways...
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