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9-902-168
JANUARY 16, 2002

ASHISH NANDA
THOMAS DELONG
LYNN VILLADOLID ROY

History of Investment Banking
“The investment banker was a breed apart, a member of a master race of deal makers. He possessed vast, almost unimaginable talent and ambition. If he had a dog, it snarled. He had two little red sports cars yet wanted four.”

– Excerpt from Liar’s Poker, Michael Lewis, 1984

Introduction
This note focuses on the evolution over the past 100 years of investment banking in the U.S. and describes the scope of products and services offered by investment banks.1

Activities of Investment Banks
Functions Performed by Financial Institutions
Investment banks perform a subset of the activities that fall under the umbrella of banking. Lord Rothschild (1910-1990) of the famed European banking dynasty, explained that banking “consists essentially of facilitating the movement of money from Point A, where it is, to Point B, where it is a

needed”. More formally, Bodie and Merton (2000) identify the six functions performed by financial b
institutions as:
1.

transfer of economic resources through time, across borders, and among industries;

2.

risk management;

3.

clearing and settling payments to facilitate trade;

4.

resource pooling and the subdividing of ownership in enterprises;

1 The terms “investment banking firms,” “investment banks,” and “banks” are used interchangeably in this note.

________________________________________________________________________________________________________________ Lynn Villadolid Roy, HBS MBA 2001, and Professors Ashish Nanda and Thomas DeLong prepared this note as the basis for class discussion. Copyright © 2002 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.

This document is authorized for use by Calvin Nguyen, from 1/13/2011 to 4/21/2011, in the course: BUS 428: Investment Banking - Crowley (Spring 2011), Emory University. Any unauthorized use or reproduction of this document is strictly prohibited.

902-168

History of Investment Banking

5.

providing reliable price information on securities to help decentralized decision making in securities markets; and

6.

mitigating the impact of asymmetric information on interactions among parties, i.e. overcoming the problems of hidden information (adverse selection) and hidden action (moral hazard).

Role of Investment Banks
Investment banks perform these six functions in their role as intermediary between issuers of securities and investors in securities. Their role as intermediaries implies that investment banks serve two clients in every deal – issuers and investors. An issuer can be a public or private company, or any other entity that sells financial assets in the form of stocks or bonds (i.e., securities). An investor can be a company, an institution, or a person who buys these assets. Alternatively, an issuer can be viewed as a buyer of capital (i.e., it issues securities because it needs externally-generated funds) and an investor can be viewed as a provider of capital.

Although it is possible for issuers to bypass the services of an investment bank by accessing the capital markets directly, the large number and wide dispersion of potential issuers and investors makes the market for securities trade fragmented. Fragmented markets can function well if the characteristics of items being exchanged are easily observable to market participants. But securities are complex, partial financial claims on running enterprises. The securities market suffers information...
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