STRATEGIC DIRECTIONS IN INVESTMENT BANKING—A RETROSPECTIVE ANALYSIS

The last two decades of the 20th century were extraordinary ones for the investment banking industry. For most of this period, the value of financial services transactions grew at approximately twice the rate of the real economy, creating unprecedented boom times for investment banks. Several firms emerged among the world's most powerful financial service institutions. Yet these years also included one of the most destructive times that investment banks have ever endured. Dozens of firms disappeared—some failing outright, but most by merger into larger competitors, after failing to measure up to the expectations of regulators or of their shareholders. Certainly operating conditions changed greatly from the fairly simple, comparatively sleepy environment of the 1970s. The banking and S&L crisis created many opportunities for investment banks as financial assets migrated from the balance sheets of thrift organizations to the trading arenas of the marketplace. A merger and restructuring boom created additional opportunities for creating new client relationships and for dealmaking. The burgeoning fiscal deficit of the late 1980s also fostered a new emphasis on trading and principal investing. And there was a series of almost uninterrupted booms in one specialized product or another—REITs, junk bonds, emerging market securities, high tech and Internet stocks, among others. Deregulation and technology improvements broke down many regulatory and special barriers to competition and, by the end of the 1990s, wholesale financial markets had become fully globalized and highly competitive. This, of course, meant significant reductions in commissions and spreads, and in the value and exclusivity of banking relationships generally. This article examines the strategic choices of the major surviving investment banks and finds that those firms striving to be major global players have had to meet essential tests of gaining market share and market capitalization. To do this, the firms selected one (or more) of four basic approaches to achieve their goals. Several (Drexel Burnham, Salomon Bros., Bankers Trust) focused on growth through dominance of one or more key trading markets. Several others (Citigroup, JP Morgan Chase, UBS) were caught up in a strategy of growth through continuous acquisition. A few others opted for a show-stopping “truly” strategic merger (Credit Suisse, Morgan Stanley-Dean Witter). Only a handful (Goldman Sachs, Merrill Lynch) stuck to a simple strategy of steady internal growth. Those firms that came to dominate their markets through aggressive trading practices have now all disappeared or been folded into others—perhaps because their trading culture became too aggressive for their managers to contain. The multiple-merger firms have continued to grow by acquiring the customers of their rivals and discarding excess personnel, but in so doing have become enormous organizations that are threatened by the mediocrity of conglomeration. To be successful following a truly strategic deal depends on the underlying strategy being a constant in a highly changeable marketplace—and if “bigger” indeed turns out to be “better,” then the devotees of steady internal growth may be in danger of falling behind. There are pros and cons to each approach, but the article makes the case that the ability to execute strategy is what really counts, and this is increasingly difficult in markets in which commanding market shares have already been established by a few top firms. The final question, however, is whether any of these approaches can be sustained indefinitely. As firms become more diversified across product lines to lower their volatility, they become less specialized and in time perhaps less effective at delivering the market's best and most recent ideas to clients. Such firms also presume that investors choose to own their stocks (they are all public now) because of their market capitalization, liquidity, and steady, market-indexed growth. But, in fact, sophisticated institutional investors may prefer more specialized, less diversified, more exposed positions with greater upside potential. If so, the industry may find itself coming apart, with firms throwing off talent, divisions, and product lines in an effort to deconglomerate themselves back into something like the lean competitive machines that investment banks were when structured as small partnerships.