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The case for an industry credential in investment banking

The time is right for the establishment of an industry credential in the investment banking profession.  In this paper, we will:

  • Assess the prevalence and adverse impact of competency gaps on the profession
  • Identify core competencies that lead to career success in investment banking, how they evolve over time and how they differ from "buy side" skills
  • Propose that the profession as a whole will benefit from an industry credential that requires professionals to demonstrate mastery over a codified body of knowledge

Before we present our case for establishing standards and an industry examination, it is worth noting that the IBP Institute benefits from a unique vantage point: The IBP Institute was founded in 2015 as a joint venture of Wall Street education firms Wall Street Prep, Financial Edge and Wall Street Oasis. Together, the founding firms train over 20,000 students and professionals annually on technical investment banking skills considered necessary for success on the job.

For nearly two decades, we have been at the center of how applicants pursuing investment banking develop the skills necessary to become a valuable employee.

Over 60 investment banks, including two of the three largest investment banks globally1, hire us to run their formal analyst training programs. For nearly two decades, we have been at the center of how applicants pursuing investment banking develop the skills necessary to become a valuable employee.

Our advisory board includes industry leaders like Greg Fleming, former President of Morgan Stanley, who brokered the sale of Merrill Lynch to create BAML, and David Resnick, who was Head of Global Advisory for Rothschild’s Investment Bank.

The adverse impact of competency gaps on the profession

Why create an industry credential and why now? A case can certainly be made that the investment banking industry has done fine over decades without formally recognized professional standards or a recognized credential. The short answer: Many investment bankers lack the skills and traits to effectively do their job and it's getting worse.

For example, The IBP Institute reviewed 20 valuation models that were used to support transactions for three significant implementation errors common in investment banking. Fig 1, Appendix 1 Over half the models reviewed had errors resulting in a significant impact on the analysis' conclusions.

There is an understandable temptation to attribute poor practice to the delicate conflicts investment bankers must navigate. While investment banks market their finance and valuation expertise, firms only earn fees upon successful completion of a transaction.  This means, for example, that an investment bank retained by a corporate seller will naturally skew the valuation towards the seller’s goals, regardless of the underlying finance theory.  That said, it is critical to distinguish between commercially necessary biases and mistakes simply due to poor practice.

Such errors pose reputational risks in an industry characterized by a hyper competitive client services orientation. Poor practice also create costly inefficiencies in workflow: Less competent bankers require more oversight, diverting senior bankers from revenue generating, client facing work.  These issues won’t go away on their own. Exacerbating the problem is the confluence of three related trends:

  • Recruiting and retention is getting more competitive. A 2017 Wall Street Journal article2 reported that analysts and associates who left their positions at a dozen investment banks in 2015 stayed an average of 17 months, compared with a 26-month average for those departing the same positions a decade earlier. Back in 1995, the average tenure was 30 months. Given the steep learning curve in investment banking, the period of time during which new hires are productive is shorter than ever.
  • Training programs have shortened. Expense reduction initiatives have contributed to shorter training programs, particularly at large “bulge bracket” investment banks. The IBP Institute estimates that the average training programs have been shortened from 8 weeks in 1998 to 3 weeks in 2015. "Liberal arts majors often feel unprepared for the initial  training at bulge brackets and can be  passed over by smaller firms due to their lack of relevant knowledge,” according to Louise Pitt, Managing Director at Goldman Sachs.
  • Automation threatens on-the-job skill development. Data services like Capital IQ have automated traditionally analyst labor intensive tasks such as calculating a company’s financial ratios. “What junior bankers gain in time saved, they’re losing in skill development. Analyzing financial reports is a critical aspect of this growth that is going away,” according to David Connal, former Head of Global Learning at BMO Capital Markets.

What makes a good investment banker?

Virtually all firms provide new-hire orientation, which introduces new hires to company specific values, mission, brand and other processes. The amount of time allocated to orientation ranges widely, but on average covers just under 20% of classroom time.

First, it is worth a review of what defines success in investment banking, and whether there actually is a discrete and identifiable investment banking “skill set.”  It is also worth exploring, to the extent that such a skill set can be identified, how it overlaps with, or might be different from, the body of knowledge recognized by related professions.

Technical Skills

Based on a review of 28 representative new-hire training programs ranging from large “bulge bracket” firms to small “boutique” firms, we can gain insight into the investment banking skill set at the analyst and associate ranks.

Virtually all firms provide new-hire orientation, which introduces new hires to company-specific values, mission, brand and other processes. The amount of time allocated to orientation ranges widely, but on average covers just under 20% of classroom time. The remainder of training time is devoted to both technical and firm-specific processes. Fig 2

The majority of training – 58% on average – is dedicated to technical training. This was the case at nearly every firm surveyed. The material covered during the technical portion of training is largely the same across all firms surveyed. With only a few exceptions, topics covered in technical training have significant overlap even across firms with niche sector, geographic and product focuses.

There is clearly a discrete, identifiable investment banking skill set upon which a body of knowledge and examination can be developed.

Well respected industry credentials like the CFA, FRM and CIMA are inappropriate as a gauge of investment banking skills for several reasons: First, the technical skill set for banking is far more weighted towards transactional knowledge and equity valuation than are these programs. “Bankers really need to understand the deal process and how to analyze transactions,” said Joseph Marren, former Managing Director at Credit Suisse and author of Mergers & Acquisitions, A Valuation Handbook.

Second, financial modeling and the ability to effectively communicate financial insights are other distinguishing factors of a foundational banking skill set. According to Marren, “Investment bankers have a very different job than investment managers, and this makes the majority of what’s covered in programs like the CFA irrelevant to them.”

Lastly, “soft skills” are perceived to be critically important in investment banking: To better understand the industry’s own perceptions of the investment banking skill set and what makes for a “good investment banker," The IBP Institute conducted a survey3 of both current and former mid-level to senior investment banking professionals with representation across experience levels ranging from VP to group heads, from banks across the size spectrum based predominantly in New York and London.

Survey participants were asked to rank a variety of attributes that they believed predict success in investment banking. In the table below, we list the most common attributes identified at all levels, organized into three categories: Technical Skills, Soft Skills, and Project Management/Operational Skills.

Technical SkillsSoft SkillsProject Management Skills
1. Accounting and Finance1. Work ethic ("grit," "drive")1. Attention to Detail
2. Excel and Modeling2. Likability ("agreeableness," "team orientation")2. Project Management
3. Understanding Deal Processes3. Communication3. Time Management
4. PowerPoint4. Common Sense4. Organizational Skills

Figure 3Fig 3 shows the perceived relative importance of these skills at specific positions.

Soft skills and project management skills

Despite the emphasis on technical training at the junior level, the survey suggests that harder-to-quantify “soft skills” factor considerably in the ability for an individual to have a successful career in investment banking. This is not surprising, due to the commercial/client-services nature of the industry.

“Bankers must be both knowledgeable in finance and skilled at relationship-building, project management, and communication. At the junior level, we reward technical mastery but to successfully climb the ranks, the relationship-building starts to trump everything else,” according to Ben Sopranzetti, Professor of Finance at Rutgers University.

 While communication skills and attention to detail can be assessed, there is debate around the reliability of screening for harder-to-quantify attributes like grit and agreeableness.

The importance of non-technical skills in IB represents another distinction from the “buy side” that an industry examination must consider. While communication skills and attention to detail can be assessed, there is debate around the reliability of screening for harder-to-quantify attributes like "grit" and "agreeableness." In 2016, Deutsch Bank’s investment banking division instituted a behavioral test to “level the playing field for a new pool of talent from colleges that banks previously ignored.”4 Goldman Sachs plans to pilot a similar personality test on U.S. summer interns in 2018.5

Diana Giddon, ex-head of Talent Development at Morgan Stanley and co-author of “Unequalled: Tips for Building a Successful Career Through Emotional intelligence” said that “gauging a candidate’s emotional intelligence is invaluable,” but cautioned that “firms are concerned about whether these tests can be gamed, whether they are fair. Ultimately, more work needs to be done to determine whether the traits we think we want are the ones we actually need.”

The IBP Program

An exam specifically developed with the needs of the investment banking profession in mind can address many of the shortcomings in the current model for identifying and developing junior investment banking talent. The amount of time spent on formal training is insufficient to develop even the most basic skills for most new hires, and the volume of preventable mistakes found in investment banking analyses strongly suggests that these skills are also not being sufficiently developed on the job.

Retention of top performers is declining at even the most prestigious firms. An industry exam will create a broader, more qualified pool of junior talent for banks from which they can identify and develop their future leaders.

Banks that ignore these trends — assuming they can follow the old model of simply retaining their best performers and letting the under-performers go — do so at their own risk. Retention of top performers is declining at even the most prestigious firms6. An industry exam will create a broader, more qualified pool of junior talent for banks from which they can identify and develop their future leaders. At the very least, a standardized exam will enable firms to better benchmark their own recruiting and development efforts against their peers.

The IBP Program was developed for these reasons, and the IBP Institute believes the program should be adopted by the industry and used as a key factor in recruiting and employee training. To develop the body of knowledge for the IBP Program, the IBP Institute worked with practitioners, learning and development professionals, academia and training providers to ensure that the IBP Credential represents a body of knowledge that addresses topics and concepts most applicable to the investment banking profession. Figure 4Fig 4 shows the curriculum overview and Figure 5Fig 5 contrasts the IBP curriculum outline with the CFA curriculum.

Figure 4: IBP Curriculum (Level 1 & 2)
  1. Financial analysis:
    • Accounting
    • Financial Statement Analysis
    • Financial Reporting
  2. Corporate Finance and Valuation
  3. Transactional analysis:
    • Capital Markets
    • Mergers and Acquisitions and Recapitalizations
    • Divestitures, Restructuring and Other Investment Banking Products
  4. Excel and Financial modeling
    • Financial Statement Forecasting
    • Valuation Modeling
    • M&A and LBO Modeling
    • Using Excel and PowerPoint to Communicate and Sensitize Conclusions from Financial Analysis
  5. The commercial role of the investment banker
    • What is the role and responsibility of the banker towards the client
    • How does the client relationship inform the technical work-product
    • What are the key tension points between responsibilities to clients and other stakeholders
  6. Qualitative considerations
  7. Ethics
Figure 5: Comparison of the IBP and CFA curriculum
IBP Curriculum, Levels I and II)CFA Curriculum, Levels 1-3
  1. Financial analysis
  2. Corporate Finance and valuation
  3. Transactional analysis
  4. Excel and Financial modeling
  5. The commercial role of the investment banker
  6. Qualitative considerations
  7. Ethics
  1. Quantitative methods
  2. Economics
  3. Corporate finance
  4. Financial reporting and analysis
  5. Security analysis
  6. Portfolio management
  7. Ethics

To earn the IBP Credential, candidates must meet professional requirements and pass two 4-hour exams (Level I and Level II). Each level requires 200-250 hours of study. Candidates are required to work through Excel models and filings as they would on the job.

The IBP Program is rigorous. There is no way to earn the IBP Credential without demonstrated comprehensive mastery over the material.

The program is rigorous; designed so there is no way to earn the IBP Credential without comprehensive mastery over the material. In the summer of 2016, a pilot of the IBP Exam was administered to new hires by 5 investment banks who also agreed to share full-time analyst bonus tiers after the 1-year mark to help gauge the effectiveness of the exam.Appendix 2

The results were remarkable: The analysts who passed the exam (27% of the group) were nearly four times as likely to receive a top-tier bonus than the group that did not pass, and nearly two times less likely to receive the low tier bonus. The results, albeit with a small data set and over a short horizon, illustrate the potential of the IBP Program: It is predictive of success on the job. In 2017, the pilot was expanded to 8 firms, and we look forward to publishing results in 2018 with a larger population.

In Q3 2017, registration for the IBP Program will open to the public with the first public administration of the exam to take place in June 2018. The IBP Program presents an opportunity for the industry to rethink traditional approaches for skill development and better align them with current trends. As with the CFA and FRM programs, once the IBP Program gains wide adoption, the industry will not only reap the benefits of improved professional standards, but will benefit from more qualified candidates and greater returns on training investment.


Appendix 1: A survey of 20 investment banking models for significant misvaluationA1-1 due to common implementation error
Relationship between fundamental value drivers not internally consistentOnly 1 model explicitly and accurately linked growth, returns on capital and reinvestment. All 19 remaining models were vulnerable to significant error, and 7 of the models did contain significant valuation error due to growth forecasts unconstrained by reinvestment.A company’s growth is defined (and thus constrained) by the firm’s returns on capital and reinvestments.7 While most investment banking valuation models make explicit assumptions for growth (FCF, earnings and dividends) and reinvestment (capital expenditures and working capital), very few models constrain growth by the reinvestment assumption, leading to an often-unreasonable change in the implied return on capital (or equity). Because the relationship between these tree drivers are not well understood, the lack of linkage between the value drivers models often output leads to valuation results that are conceptually flawed (often significantly).
Mismatch of cash flows and value8Of the 20 models, 8 had cash flow/value mismatches that carried a less than 20% impact on valuation. 4 models had mismatches with a 20% or greater impact on valuation.A basic tenet of valuation is that the value of an asset (or collection of assets) is a function of the cash flows it will generate. The prevalent approach for valuing businesses in investment banking is called the unlevered approach. This approach, for all its benefits, requires that analysts effectively untangle operating from non-operating assets as well as financial from operating liabilities. The value of operating assets and liabilities should be derived from a cash flow forecast, while all other assets and liabilities should be valued separately. This process is challenging - absent a thorough understanding of the valuation process and the nature of the assets and liabilities being valued, double counting the value of certain assets and liabilities in valuation (or not counting at all) happens more often than not.
Incorrect calculation of firm capitalizationOf the 20 models 4 had significant valuation error attributable to valuing the benefits of stock based compensation but ignoring the cost.When determining a company's market capitalization, decisions must be made about how to account for potentially dilutive securities that have been issued in the past as well as those that are expected to be issued in the future. There is inconsistency around the treatment of already-issued restricted stock, options, convertible securities and warrants. The issue of future dilutive share issuances is even more troubling, as a significant portion of valuations systematically overvalue businesses by completely ignoring the impact of future dilution.9
A1-1 We define the impact of the implementation error as “significant” if the error led to a valuation error greater than 20%, all else equal.
Appendix 2: Results of the 2016 IBP Program Pilot
Full-time analystsNumberTop Bonus: Tier 1Middle Bonus: Tier 2Low Bonus: Tier 3
Passed IBP149 (69%)2 (15%)2 (15%)
Failed IBP386 (18%)19 (56%)9 (26%)

Five investment banks participated in the 2016 pilot.  Participants from firms without explicit bonus tiers were allocated based on bonus size. One participant who passed and four who failed the IBP Exam were no longer with the firm at bonus time.  Percentages based off of participants still with the firm at bonus time (n=47), not total participants at the start of the pilot (n=52).

Article Footnotes

1 Based on Thomson’s 2016 League Table ranking for deal fees across all investment banking functions. Data here.

2 Wall Street Journal: “Millennial Employees Confound Big Banks” Article here.

3 IBP Institute survey conducted among 127 current investment banking professionals with seniority of VP and higher.

4 Financial Times: “Bank hiring: Wall St turns to machines to find better-behaved bankers." Article here.

5 Reuters: "Goldman to use 'personality test' for hiring decisions." Article here.

6 New York Times: "Private equity is top choice of young Wall St. bankers." Article here.

7 Tim Koller, Marc Goedhart, and David Wessels, Valuation: Measuring and Managing the Value of Companies, 5th ed., (New York: John Wiley & Sons, 2010).

8 Aswath Damodaran, Investment Valuation: Tools and Techniques for Determining the Value of Any Asset, 3rd ed. (New York: John Wiley & Sons, 2012)

9 www.wallstreetprep.com/blog/stock-based-compensation-treatment-dcf-almost-always-wrong/