Figure 3. Source: www.unhcr.org/innovation/grassroots-organizations-are-just-as-important-as-seed-money-for-innovation/

This article will discuss Investment Banks (IBs) and Management of IBs in the context of respective management practices.

These practices hold in middle-market merchant banks but even more so in large investment banks. In this article, we'll explore why.

In 1988, Professors Robert G. Eccles and Dwight B. Crane of Harvard Business School wrote a book called Doing Deals: Investment Banks at Work, expanding thoroughly on Investment Banking Management Practices.

This article piece is based on their respective research, extensive interview case studies, and the final conclusions/ findings drawn from the aforementioned.

Then, now, let's begin.

Introduction

Effectively, Investment Banks serve a primary function as a mediator between issuers (sellers of assets) and investors (buyers of assets). In other words, they mediate and navigate substantial asset flows.

IBs do so by creating a complex network of external ties between themselves, and their two types of customers (i.e. issuers and investors).

So, naturally, investment banks collaborate on deals, especially security offerings.

One of the nuances of investment banking is that the value provided is often decoupled from fees earned by the firm (we will use "IB" and "firm" interchangeably in this article). So, while IBs might provide consistent information, advice, and studies - ultimately, they get paid when a deal is done. By extension, lower-margin products are often used as a way to maintain relationships and, again, provide value to customers in order to get the information that will make it possible for the firm to sell higher-margin products as well.

Needless to say, there is a variety of product lines with low margins and high margins in the firms.

This all necessitates a network of ties between the people of the firm when they work together on different products, to serve customers and create value for them respectively.

But, how do these networks work and look like? Let's find out.

The Investment Banking "Pentagram"

Because investment banks serve different customers and have loose linkages between lower margin products and value received, this necessitates often complex ties inside the firm, and holistic adaptation to constantly changing market conditions. By extension, prudent and functional organization management is very needed.

So, the firm's management is composed of 5 interconnected parts:

Strategy

Investment banks are a form of grassroots/ bottom-up firms. This comes about from the individuality, if you will, of every deal, the need to coordinate internal ties between colleagues and departments, different customers and their needs, and as mentioned, market conditions that seldom stay the same.

It would be virtually impossible for top management to engage in all details of dealmaking, all while leading such large organizations. Hence the grassroots strategy.

This leads us to how firms design their organizational structure.

Design of the Organizational Structure

A modern merchant/ investment bank is a self-designing organization. It's self-designing in a way that it gives a great deal of autonomy to its investment bankers below the top or better yet, middle management.

By delegating autonomy and allowing for a great degree of authority on deals, the firm frees up time and resources for top management to take a "bird's-eye view" of the processes. On the other hand, investment bankers below or in middle management positions learn to make informed and prudent decisions through their everyday tasks and contribute to the value creation of the firm.

However, every autonomy needs a degree of checks and balances.

This is where Management Control Systems come into play.

Although investment bankers enjoy a high degree of autonomy, strict checks and systems are needed to balance out the final output in a desirable manner.

Management Control Systems

Control systems exist to establish individual and unit accountability, regarding the quality and quantity of external ties with customers as well as the performance of ties within the firm.

Management exerts this influence and coordination because individuals seldom focus 100% of the time on one thing, and the role of management, or top management if you will, is to redirect that focus back to the right and appropriate concerns.

Systems, however, are based on metrics and figures, which can be manipulated on their own end. Bonuses are delivered to individuals and units through system grading, and if the aforementioned metrics are manipulated, then the results will be not as optimal for the firm as a whole.

Let's see how top management overcomes this problem.

Bonus Determination System

The faults of quantitative and qualitative measures are not easy to notice and overcome but top management employs a nuanced approach to this problem.

Executives or top managers utilize an approach whereby individuals' and units' contributions to value creation are analyzed. A firm's value as a whole is measured and how it changes, rather than individual systemic numbers.

This approach is very subjective and can be deemed "unfair" by some.

In order to fix this problem, top managers use all of the data created by the control systems, and then the information-processing capabilities of bottom flat network structures, to deduce a fair and rational solution to the subjective bias challenge.

In effect, the problem is solved and bonus determination becomes more neutral and, well, objective.

To summarize the first four parts of the firm "pentagram," a) Structure which encapsulates Strategy and Self-Defining Organization, b) System Measures, and c) Bonus Determination Process, form a triad of interconnected and moving parts that compensate for each other's weaknesses.

Relationship Managers

Who are and what do Relationship Managers (RMs) do?

They are individuals, often high-ranking, within the firm who act as "agents" of the CEO. To put it more metaphorically, they are the "eyes and ears" of the Chief Executive Officer who wants them to undertake, well, a firm-wide perspective in serving customers.

If organizational parts inhibit the provision of products by product specialists (such as asset classes, financial products, equities/ fixed income, derivatives, FOREX, commodities, or structured products) to specific customer needs, then RMs intervene to reconfigure the firm's "moving parts."

They are the "correction managers" of the firm who likewise maintain firm connections with the investment bank's clients in order to recognize and deliver on the needs of the aforementioned customers.

Concluding Thoughts

These are the 4 "pillars" of investment banking management practice, relevant today more than ever.

In essence, organizational structure, as with every firm, but even more so in larger complex organizations, is subject to change when the stakeholders: individuals, units, top management, their customers (investors and/ or issuers), and market conditions change.

Effectively then, investment banks change all the time, albeit in a more lowkey manner to maintain relationships, internal networks, and their comparative strengths in creating value.

Redmount is a middle-market-oriented merchant bank with an advisory and investment platform built to serve the distinct needs of successful entrepreneurs, business leaders, and stewards of family wealth who value having a direct relationship with an experienced partner.