Interesting post. Wouldn't it be possible to design indexed options that would reduce systematic risk and focus on firm-specific risk?

The better solution, I think, is an indirect one: increase shareholder power. If shareholders keep a tighter rein on management, management will be more skeptical of the I-bankers' pitches.

The solution is trivial and already standard practice: the fairness opinion, or what normal people would call a second opinion, from an entirely different IB.

Kip -- interesting solution, but are the same problems inherent in the second opinion? Do investment banks ever not give a favorable second opinion?

Vic -- I will never argue against shareholder power and would welcome it at any turn. I guess the free marketeers would tell us that shareholders already do speak. When mergers are announced, many times the acquirer's stock goes down, reflecting a sell-off by wary shareholders. So, maybe the market already recognizes this conflict and discounts the valuation.

Christine: acquirers' stock often goes down in mergers because acquirers overpay for targets, not because acquirers' shareholders are selling. No reason to sell (especially undersell) if the deal is good for the acquirer. Bidder overpayment in takeovers is a sign of shareholder weakness (vis-a-vis managers), not strength.

I think we're saying the same thing, but maybe I wasn't saying it clearly. When acquirers overpay, the share price of the acquirer goes down because investors are only willing to buy at less than the former price and investors are willing to sell at less than the former price. Overpayment is a sign of shareholder weakness and a result of an agency problem, but shareholders respond by exiting (the only effective shareholder option here because the acquiring shareholders probably don't have to vote on the acquisition).

I had a 90s flashback with the term "ginormous." It reminds me of the mantra Gobogh (go big or go home). Eric.

Real estate brokers are finally facing competition for the % model from fixed-price and other alternate fee schemes. I-banks are a might better disciplined oligopoly.

I’ve been on all three sides of the fence. First, as an investment banker in mergers at Morgan Stanely. Second, as a summer associate at Skadden. And, for the longest period of time, as a member of a senior management teams. My vote goes with Vic – the only way I can understand these incomprehensible investment banking fees is as the result of an agency problem at the firm management level.

Unfortunately, there are many different elements of the legal and institutional milieu that make paying these fees rational for managers (obviously), and one must also note that many firms that do not face large agency problems appear to pay comparable fees. Hmmm. Maybe that’s a researchable empirical question!

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