Updated: June 6, 2010 10:57 IST

Corrosive camaraderie in capital markets

D. Murali
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If the axiom that you can’t legislate behaviour is true, then you really can’t legislate behaviour in financial markets, observes Peter Firestein in ‘Crisis of Character: Building corporate reputation in the age of skepticism’ (

He foresees that certain segments of a population of smart, motivated people who gravitate to large amounts of capital will, in the long term, find ways around the scope of existing legislation, which is often decades old and out of date. “But, more immediately, they will easily rebuff the regulatory enforcement bureaucracy. Some will be found out and indicted, but by the time this occurs, the problem will generally have become so pervasive as to rock an entire industry.”

The author recounts how, during the market bubble of the mid- and late 1990s, a curious camaraderie between the executives and the equity analysts was evident in the discussion of quarterly financial results over conference calls. The job of an analyst, he reminds, is to scrutinise companies for the benefit of the analyst’s clients – institutional money managers entrusted with the investments of mutual funds, pension assets, and other reservoirs of capital important to the retirement and well-being of millions.

“The ingratiating attitude these analysts typically adopted toward management was therefore curious in the extreme. ‘Nice quarter, guys,’ was often the phrase that introduced a supposedly neutral analyst’s conversation with management.”

Excessive executive compensation

Devoting attention to the sensitive area of executive compensation, which has become a source of heated contention for being wildly out of proportion with the pay of others in the workforce, Firestein notes that excessive compensation levels don’t present much of a problem for those CEOs whose philosophy is to get rich and get out. “But for leaders who are builders, the manner in which executive compensation is established across the business landscape can exert a pernicious effect on the atmosphere in which they work.”

A significant layer of potential corruption, he cautions, can be in the form of compensation consultants involved in the establishing of CEO pay levels. “Boards, who must answer to their shareholders over executive pay, generally retain these specialised consultants to render opinions. Doing so enables a board to show that it has impartially vetted the CEO’s awards and that those awards reflect the norm.”

Watch out, the same consultant may be getting hired for various other services, thus dwarfing the fee for advising on executive pay. Examples of such services mentioned in the book include actuarial work used by HR departments, and administration of pension and other employee benefit programmes. “These are highly lucrative propositions, often involving the company’s purchase of expensive expertise and sophisticated software.”

The IPO game

Live music, giant video screens, and banners heralding the new listing stretched the entire length of the exchange’s façade – these are some of the rock-concert-like glimpses of the big IPO days that the author reminisces. Executives of the IPO company du jour were generally given the honour of joining the NYSE chairman on the balcony overlooking the trading floor to ring the opening bell, he adds.

“As the trading day began, the financial media beamed images around the world of grinning executives celebrating with bear hugs and waves. They tossed baseball caps bearing the company’s logo to the traders below.” While some of this joy was visible on camera, much intense satisfaction occurred behind the scenes among the investment bankers and brokerages that had brought the company public, informs Firestein.

In the ‘Byzantine game’ that played out, each IPO was an advertisement to the companies who were candidates for the next deal, and to the investors who would pay commission to own these buoyant shares, critically depending though on price performance after the stock began trading.

To help assure that the price would rise after issuance, banks and brokerages carefully monitored their order books, which told them who had committed to buy and therefore gave them a forecast of the demand for the shares of each IPO company, the author describes. “They used this information to price shares at issuance. More accurately, they underpriced them so they would rise in open-market trading.”

A different vocabulary

The ‘structural corruption’ explained in the book introduces readers to a few of the words and phrases that rolled out of the tongues of the key players in the financial markets during the rollercoaster days.

‘New paradigm,’ for instance, conveyed the sense that the traditional standards of value no longer applied. A ‘liquidity event,’ that the bankers were willing to facilitate, meant taking a large part of management’s ownership, registering it as equity, and selling the same into the market at a price.

‘Laddering’ refers to the practice of extracting commitments from investors to buy shares at ever-higher levels, even before receiving their first allocations at the IPO issuance price, Firestein instructs. “So bankers knew beforehand that buyers would appear at those higher prices, an advantage that has not often occurred in the history of financial markets.”

‘Spinning’ may appear to be a cricket term, but in the banking circles it was ‘the technique of promising IPO shares to executives of companies who wanted to bring their companies to market.’ These allocations, as the author elaborates, generally consisted of unrestricted shares, which meant executives could resell them immediately, without the usual holding period that forced them to retain the shares for a time to ensure that they would continue to act in the company’s interest.

Thus, an executive who received shares in the morning at the IPO issuance price could ‘flip’ them – that is, sell them – in the afternoon for a substantial profit. By offering this deal, as Firestein outlines, a bank could provide an executive with a considerable incentive to give it the underwriting mandate. “In some cases, it could make his fortune in a day.”

Educative and thought-provoking study.


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