No One Gets Fired for Hiring Goldman Sachs

I came across a research article in Knowledge@Wharton titled "Show Me the Money: Aura of Top M&A Banks Often Obscures Low Returns for Clients" about how the league tables ranking investment banks don't necessarily correspond to post-M&A performance of the banks' clients. In fact, the study finds that there's actually a negative correlation between the league tables and post-M&A performance. That's obviously counter-intuitive. One possible reason is as follows:

Banks are simply responding sensibly to industry practices. "Since clients ignore the very measures that do predict future performance [i.e. past performance] and instead focus on market share, it is entirely logical for banks to maximize their league table position -- in particular, by accepting even value-destructive mandates," he and Bao write. "Not only will the mandate boost fee income today, but it will also increase market share and the ability to generate income in the future."

Once market share becomes entrenched as the standard for evaluation and thus a signal of reputation, it can undermine efforts by corporate managers to use other measures. "Remember the old saying, 'No one gets fired for buying IBM,'" Edmans says. "Goldman Sachs is often number one in the league tables and it's the same with them. No one gets fired for choosing Goldman Sachs as their investment banker."

This is not to say that the quality of these banks is not high. It's simply to say that the incentives in the industry are counter-intuitive -- banks take on business that may actually destroy value rather than create it in an attempt to maintain their league table ranking. One question that comes to mind, then, is if (and how) you change the incentives?

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