Corporate Governance

Public Offerings and the Disappearance of Investment Banking Firms

By J. Robert Brown

As we have noted many times on this Blog (and in the article, The "Great Fall": The Consequences of Repealing the Glass-Steagall Act), the disappearance of independent investment banking firms will have a harmful effect on US capital markets.  With Lehman bankrupt, Bear Stearns and Merrill Lynch reduced to subsidiaries of commercial banks, and Goldman and Morgan Stanley converting to commercial banks (while struggling to remain independent), investment banks as a separate class of financial institutions have disappeared.

What is a consequence of the disappearance?  Investment banks made their money not from commercial lending but from the capital markets.  They provided M&A advice and acted as underwriters when companies engaged in pubic offerings.  Their unique dependence upon the capital markets meant that they had every incentive to encourage public offerings and to ensure their success once they were underway.  While in a post-Glass Steagall world commercial banks could act as underwriters, they lacked the same dependency and commitment to the capital markets.  Moreover, they operated with a conflict of interest.  Public offerings reduced the need to borrow, the bread and butter profit center for commercial banks.

With independent investment banks essentially gone, the news on the IPO front is predictably dismal. The number of public offerings (IPOs and secondary) declined precipitously in 2008 according to Dealogic. "Just 29 companies went public in the U.S. last year, compared with 215 in 2007 -- an 87% drop. No deals are on the immediate horizon for 2009."

While there are many causes for the drop off, not the least of which is a deep recession and a precipitous loss of investor confidence, the disappearance of independent investment banking firms is likely part of the explanation.  If an aggressive collection of financial intermediaries existed that made most of its money through the capital markets, particularly underwriting, presumably more companies would be convinced to sell stock to the public. 

At a time when commercial banks are not lending, the capital markets represent an alternative source of funding.  Alas, those that promoted deregulation at all costs contributed to the demise of the financial intermediaries that could make this alternative a reality.

Full post as published by The Race to the Bottom on January 09, 2009 (boomark / email).