Investment Banking and Corporate Finance

H.Keiding: Economics of Banking (Prel.version:August 10) Chapter 9, page 1 Chapter 9 Investment Banking and Corporate Finance 1. Introduction: investment banking In this chapter, we discuss the particular field of activity of a financial intermediary known as investment banking. As mentioned in Chapter 2, investment banking as a specific activity is concerned with the setting up and changing the capital structure of private corporations, dealing with matters of arranging loans, issue of securities, buying or selling of firms. There is a tradition in the US that investment banking should be separated from ordinary (“com- mercial”) banking, going back to the Glass-Seagall act from 1933 but eventually abandoned in 1999. In Europe, investment and commercial banking has traditionally been coexisting in

the financial enterprises. The traditional business of an investment bank is to assist their costumers in raising funds in capital markets and advice them in cases of mergers and acquisitions. Also, the investment bank takes an active part in attracting investors in connection with issuance of securities and possibly negotiating with other firms which may have been singled out for fu- ture mergers. Investment banks often contact potential clients for mergers and acquisitions, and if they are met with interest, carry out the deal for the client. Among other important activities of the investment bank one should mention trading se- curities as well as asset management, and perhaps even more important in recent years, sales of new products in the form of securities created on the basis of other financial assets (cf. the discussion of securitization in Chapter 10). Also, the investment bank o ers consultancy services for costumers who want to invest either directly or in securities, and in connection with this activity, they maintain a department doing financial analysis. Since most of these activities have been or will be commented upon in other contexts, so that we concentrate on those aspects of investment banking that involve direct contact with costumers in connection with capital structure of the firm. In the present chapter as well as the following one, we look closer into corporate finance, which is the field giving rise to business for the investment bank. The subject of this study is capital structure of the firm, ways of attracting capital and types of contracts needed to regulate the behavior of entrepreneurs and investors, and the role of the investment bank in this context. In this chapter, we outline the celebrated Modigliani-Miller theorem about the irrelevance of capital structure; then we turn to some discussion of financial contracting and H.Keiding: Economics of Banking (Prel.version:August 10) Chapter 9, page 2 discuss a simple model of mergers and acquisitions. We then proceed in Chapter 12 with a short treatment of the decision about going public and its implementation. It should be pointed out that in most of what is discussed here, the financial intermediary plays a remote role if any at all; we are dealing in most cases with a non-financial firm which attracts outside capital, not in the form of bank loans but as risk capital. However, the investment bank is not only advising but also assisting in carrying...

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