Investment bankers have long lived by the maxim that, when it comes to M&A advisers, big is beautiful. Now there is academic research to support their claim that the top-tier banks really do deliver the best returns for their clients.
Working on large transactions - and winning league table credit for them - brings prestige, fees and an ill-defined sense of "quality" that in turn generates a momentum of its own in winning future business. That's why nine of them fought to advise on the proposed $45 billion merger of the commodities giant Glencore and the international mining group Xstrata. And yet academic research has, in the past, failed to establish a clear link between the biggest advisers on the largest deals and the benefits to clients of their expensive work.
Instead, research has pointed to a negative correlation between size and performance. But a new study by Dr Andrey Golubov, Lecturer in Finance at Cass; Dimitris Petmezas, Professor of Finance at the University of Surrey; and Nickolaos Travlos, Professor of Finance at the ALBA Graduate Business School in Athens, suggests that top-tier advisers do indeed generate higher shareholder returns for publicly listed bidders - but not for obvious reasons and only when they are advising on the acquisition of other public companies.
Their paper, When It Pays To Pay Your Investment Banker, examined more than 4,800 transactions between 1996 and 2009 by publicly listed companies in the US, separating them into the acquisition of public and private companies. It measured the shareholder returns on these deals by means of the "cumulative abnormal returns" to investors in the five-day period around the announcement of a transaction.

$65 million benefit
It found that the perceived quality of top-tier advisers (the eight largest investment banks by the value of deals advised over the period) had no discernible impact on returns across the sample. But when it came to acquisitions of other public companies, bidders who employed top-tier advisers generated excess returns to their shareholders that were 1.01% higher than on deals advised by less prestigious banks.
This effect - which translates into an average benefit to shareholders of $65.8 million per deal - more than offsets the fee premium of almost 40% charged by top-tier advisers.
At first glance, as one senior M&A banker at a boutique advisory firm said, this might be down to the fact that the large corporates most likely to engage bigger investment banks are also more likely to be serial acquirers and therefore be "better" at M&A. But research in 2011 by the Boston Consulting Group found that so-called serial acquirers generated lower returns than other types of buyers. Further, the study's elaborate methodology takes care of any such potential confounding effects.
Dr Golubov's research found that the distinguishing factor was the ability of top-tier advisers to identify and structure mergers with higher synergy gains, to negotiate harder on price, and to extract a higher proportion of the synergies for the bidder.

Media spotlight
In turn, the fact that the halo effect of hiring a top-tier bank is evident only on public transactions- which attract a harsher media and shareholder spotlight - suggests that top-tier banks work harder to extract better outcomes for their clients and to protect their own reputations.
The top-tier banks in the study were Goldman Sachs, Merrill Lynch (now Bank of America Merrill Lynch), Morgan Stanley, JP Morgan, Citi/Salomon Smith Barney, Credit Suisse First Boston, Lehman Brothers (now Barclays Capital) and Lazard. Echoing the conclusions of the study, the Co-Head of global M&A at one of them said: "I and many of my colleagues have worked in this business for more than two decades. The cumulative value of that experience is not something that a smaller firm can match or that a new entrant can replicate any time soon."
Dr Golubov said: "We were puzzled by the earlier evidence that top-tier advisers could seemingly get away with charging premium fees and not delivering better outcomes, so we decided to re-examine this issue. It turned out that superior performance of top-tier investment banks was hidden within the sub-sample of public firm acquisitions [in fact, the largest deals], where advisers' reputations are truly exposed and on the line."
This new study will, for the time being, reaffirm the banks' obsession with their "big is beautiful" approach to league tables.

When It Pays to Pay Your Investment Bankerby Andrey Golubov, Dimitris Petmezas and Nickolaos Travlos, Journal of Finance, February 2012.

William Wright is an Investment Banking Columnist at Financial News. He can be contacted at wwright@efinancialnews.com