1 Introduction................................................................. 1
2 Prologue:PracticesandProcessesinInvestmentBanking............. 7
2.1 MergersandAcquisitionsAdvice................................... 8
2.2 SecuritiesUnderwriting.............................................. 12
2.3 FinancialAnalystResearch.......................................... 18
2.4 TradingandSales .................................................... 21
2.5 ManagingInvestmentBanks......................................... 24
PartI InvestmentBanksasIntermediaries
3 SellingInformation......................................................... 31
4 InformedIntermediaries................................................... 37
4.1 ReducingAdverseSelection......................................... 37
4.2 QualityofSecuritiesIssued.......................................... 42
Conclusions .................................................................. 48
5 IndependentFinancialAdvice ............................................ 51
ReviewofPartI
PartII CorporateFinance
6 MergersandAcquisitionsAdvisory...................................... 63
6.1 ContingentFeeContracts............................................ 65
6.1.1 EliminatingMoralHazardinMergerAdvice.............. 65
6.1.2 MergerAdvicewithAdverseSelection.................... 68
6.2 AcceptingMergerOffers ............................................ 71
6.3 Break-upfees......................................................... 75
Conclusions .................................................................. 78
7 SecuritiesUnderwriting.................................................... 81
7.1 UnderwritingContracts.............................................. 82
7.1.1 FirmCommitmentandBestEffortsContracts............. 83
7.1.2 Book-Building............................................... 87
7.2 AppointingUnderwriters ............................................ 96
xi
xii Contents
7.2.1 UnderwriterSelection....................................... 96
7.2.2 UnderwritingSyndicates.................................... 101
7.3 Underpricing.......................................................... 107
7.3.1 PreventingAdverseSelection............................... 108
7.3.2 RelationshipBuilding....................................... 110
7.3.3 LitigationRisk............................................... 114
7.3.4 SecurityFlipping............................................ 116
7.3.5 MonitoringofIssuingCompany............................ 117
7.4 GreenshoeOption.................................................... 123
7.5 ChoiceofUnderwrittenSecurities .................................. 125
7.6 UnderwritingbyUniversalBanks................................... 128
Conclusions .................................................................. 131
ReviewofPartII
PartIII Research
8 BiasedAnalystRecommendations........................................ 137
8.1 FinancialAnalystAccesstoCompanyInformation................ 138
8.2 ObtainingFutureInvestmentBankingBusiness.................... 140
Conclusions .................................................................. 144
9 AnalystReputation......................................................... 145
10 RegulationofFinancialAnalysts ......................................... 153
ReviewofPartIII
PartIV TradingandSales
11 FinancialInnovation....................................................... 163
11.1 IncentivestoInnovate................................................ 164
11.2 IntroductiontoInnovations.......................................... 167
11.3 AdoptionofInnovations ............................................. 172
Conclusions .................................................................. 176
12 AssetManagement ......................................................... 177
13 BrokerageServices ......................................................... 183
14 MarketMaking............................................................. 189
14.1 InventoryControl..................................................... 190
14.2 AdverseSelection.................................................... 195
Conclusions .................................................................. 198
Contents xiii
15 ProprietaryTrading........................................................ 201
15.1 InvestmentinExpertise.............................................. 202
15.2 RemunerationofTraders............................................. 205
15.3 MisrepresentationofTradingOutcomes............................ 213
15.4 DualCapacity ........................................................ 216
Conclusions .................................................................. 229
ReviewofPartIV
PartV ConductingInvestmentBankingBusiness
16 EmploymentPolicies....................................................... 235
16.1 OptimalRemuneration............................................... 236
16.2 PromotionPractices.................................................. 242
Conclusions .................................................................. 249
17 Partnerships................................................................. 251
17.1 ViabilityofPartnerships ............................................. 252
17.2 TheImpactonServiceQuality...................................... 256
Conclusions .................................................................. 261
18 TheDecision-MakingProcess ............................................ 263
18.1 TheImpactoftheOrganisationalStructure......................... 263
18.2 DelegationofDecision-Making..................................... 268
Conclusions .................................................................. 272
19 RelationshipBanking...................................................... 273
20 OptimalInvestmentBanks ................................................ 279
20.1 SpecialisationofInvestmentBanks ................................. 279
20.2 MatchingBanksandClients......................................... 286
Conclusions .................................................................. 288
ReviewofPartV
Epilogue:EthicalConsiderations .............................................. 293
FinalReflections.................................................................. 301
ProblemSets...................................................................... 305
ProblemsSetsforPartI...................................................... 305
ProblemsSetsforPartII..................................................... 309
ProblemsSetsforPartIII.................................................... 322
ProblemsSetsforPartIV.................................................... 326
ProblemsSetsforPartV.................................................... 336
ProblemSetsforthePrologueandEpilogue............................... 347
xiv Contents
A MathematicalTools......................................................... 353
A.1 ImplicitFunctions.................................................... 353
A.2 ConstrainedOptimisation............................................ 354
A.2.1 LagrangeMultiplier......................................... 354
A.2.2 Karush-Kuhn-TuckerConditions........................... 355
A.3 BayesianLearning.................................................... 357
A.4 LeibnizIntegralRule................................................. 358
A.5 StatisticalTools....................................................... 359
A.5.1 ConditionalMoments....................................... 359
A.5.2 OrderStatistics .............................................. 360
B EconomicModels........................................................... 361
B.1 NashBargaining...................................................... 361
B.2 TacitCollusion ....................................................... 362
B.3 RiskAversion......................................................... 364
B.4 MonopolisticCompetition........................................... 365
B.4.1 HotellingModel............................................. 367
B.4.2 SalopCircle.................................................. 368
C CreditRiskAssessment.................................................... 371
C.1 TheMertonModel ................................................... 372
C.2 TheKMVModel..................................................... 373
C.3 TheVasicekModel................................................... 373
D SecurityValuation.......................................................... 377
D.1 DiscountedCashFlow............................................... 377
D.2 ComparableCompaniesAnalysis ................................... 378
D.3 PrecedentsTransactionsAnalysis................................... 379
D.4 DerivativesPricing................................................... 379
Glossary........................................................................... 381
References......................................................................... 389
Index............................................................................... 393