Finance: SECURITIES FIRMS
CAN BEAR STEARNS TRADE UP?
A visit to James E. Cayne at his office at Bear, Stearns & Co.'s Manhattan headquarters is never dull. An animated storyteller and natural salesman, the 61-year-old chief executive likes to regale visitors with tales about his travels, philosophy, competitors--and deals. Next to his desk is an oversized deal momento: a shiny red motorcycle, a gift from Ek Chor China Motorcycle Co., a Chinese company that he helped win an underwriting assignment from in 1993.
Cayne, known as Jimmy, is feeling pretty good these days. Bear Stearns has long been one of the most profitable firms on Wall Street, with one of the highest returns on equity--pretax ROE was 21.6% in the year ending June, 1995. Its biggest business, mortgage-backed securities, has been weak, causing 1995 earnings to fall 38%. But the firm rebounded with strong results from other areas in the quarter ended in September. And after over a decade of building its investment bank, the firm is making considerable progress. Cayne is convinced that Bear Stearns is on the cusp of greatness. "No firm ever felt the way we feel about ourselves," he says. "The right word is passion."
Bear Stearns is an anomaly on Wall Street. Its major competitors have become highly structured, multilayered, and broadly diversified. But though it is a public company with over 7,400 employees, "the Bear" retains the feeling of an informal, old-fashioned partnership run by partners who take a visceral interest in their trading positions. Its culture stresses entrepreneurship, thriftiness, and performance--and rich rewards to those employees who excel in these virtues. The firm is adept not only at mining opportunities but in sidestepping disasters. While many firms took big hits in mortgage-backed securities in 1994, Bear Stearns avoided losses.
For all the firm's success, Cayne faces tough challenges. He knows that parts of the culture need retooling. He wants to build investment banking to replace dwindling revenues from mortgage-backed securities, which was hit with a mass exit of five of its senior employees this fall. But the firm is still at heart a street-smart, every-man-for-himself trading house. Investment banking, by contrast, is antithetical to a trading culture, stressing collaboration and long-term relationships. It has a long way to go to reach its goal of becoming a classy investment bank that serves blue-chip corporations with an integrated team of employees. "Bear Stearns as an investment bank is still in its infancy," concedes one employee.
CULTURE CLASH. This is especially true in fast-growing overseas markets, where Bear Stearns is a mid-size domestic firm surrounded by global giants. Only 6.7% of its revenues come from abroad, vs. 27% for Merrill Lynch & Co. Instead of making massive investments to span the globe, Bear Stearns is spending cautiously in select emerging markets. "They can succeed as a specialty player in niche markets," says Guy Moszkowski, an analyst at Sanford C. Bernstein & Co. But "they are certainly too small to be a major global powerhouse."
Moving to a more collaborative culture would clash with Bear's compensation system, which stresses strict pay for performance. The system also includes an unusual--and sometimes divisive--two-tier pay policy. The six members of the executive committee divvy up a bonus pool tied to the firm's overall ROE. The 276 senior managing directors get paid mostly based on their own and their individual unit's results. But generally the top executives make much more than the senior managing directors. In fiscal 1995, the top executives got rich bonuses--Cayne got $8.8 million and Greenberg got $8.2 million--while many senior managing directors took huge cuts. Cayne says the top executives still took a 50% pay cut in 1995, adding that if the firm's profits are flat, they get just $200,000.
Finally, Cayne must prove that he is a worthy successor to the legendary Alan C. Greenberg, age 68, known as Ace. Cayne became CEO in 1993. He actually runs the firm and chairs the all-important committee that determines what everyone but the executive committee is paid. But Greenberg, who chairs the executive committee, still personifies the firm's identity.
If Cayne can't meet these challenges, Bear Stearns might have to sell out, most likely to a big European bank. Any bid would have to be attractive to employees, though, because the firm is 37% employee-owned. "People here don't want to sell, but we know we're being looked at," says Warren J. Spector, head of fixed income at Bear Stearns.
Any buyer would have to live with Bear Stearns's renowned quirkiness. It has the largest board of directors in the U.S., with 38 members. Greenberg sends internal memos that quote a fictitious character named Haimchinkel Malintz Anaynikal, who spouts aphorisms. And employees earn big rewards for ratting on their bosses for mismarking trading positions.
HORATIO ALGER. Bear Stearns has a knack for seizing opportunities overlooked by others, hiring top people, and building strong franchises. Examples: Latin American investment banking, run by Stephen M. Cunningham, and mortgage-backed securities, now run by Spector.
The firm's most coveted franchise is clearing and settling securities trades for institutions and money managers. This provides about one-third of its income and is the steadiest part of its earnings, says Smith Barney Inc. analyst Alison Deans. It accounts for a huge 12% of the New York Stock Exchange volume. The unit also makes margin loans and borrows stock so clients can sell short. "Bear plays from its strength, which is financing and clearing," says Long Term Capital Management partner Eric Rosenfeld, a client.
Bear Stearns's scrappy culture is a clear reflection of Jimmy and Ace. Greenberg started at the firm 46 years ago, making $32.50 a week as a clerk, and became CEO 14 years later. An amateur magician and yo-yo aficionado, he is known for his superb trading skills, philanthropy, quick decision-making, and for harshly berating employees, then forgetting about it 20 minutes later. He sits on the equity trading floor and remains an active broker, with an impressive client list. "I spend all my time trying to bring in business," says Greenberg.
Cayne has his own Horatio Alger story. He went to Purdue University to study engineering, but dropped out after three and a half years when he learned a failing grade in French meant he'd have to stay another year. After a stint in the Army, he worked for six years as a scrap-iron salesman in his wife's family business in Chicago.
Moving to New York in 1964, he earned his living as a bridge player on the "rubber-bridge" circuit, where games are played for money. At age 35, he joined Bear Stearns as a broker. When he interviewed with Greenberg for the job, Greenberg discovered Cayne, a world-class pro, shared his fascination with bridge. Bridge was also Cayne's ticket to his first client, Laurence A. Tisch, one of Cayne's bridge buddies. Cayne was in demand as a partner. "I was like a toy--the bridge toy," says Cayne. "If I was their bridge partner, they would win."
Cayne has a street-savvy air. He uses profanities and reads the New York tabloids. He sits on the same floor as the firm's retail brokers in the New York headquarters. One recent accomplishment was personally recruiting 31 top brokers from competitors.
Individual enterprise, of course, is a Bear Stearns hallmark. But achieving its investment banking aspirations will require teamwork--and a compensation system that rewards it. Investment bankers must develop long-term relationships and cooperate with colleagues with no immediate payoff. "The elevation of the individual is not a good strategy for cooperative tasks," says a former employee. "There is a lot of bitterness each year because some get paid a lot and others who helped get paid a little." Not so, says William J. Montgoris, Bear Stearns's chief operating officer. "The comp system is a great strength of the firm."
Under investment banking head Alan D. Schwartz, Bear Stearns has made major progress. This year, it assisted Walt Disney Co. when it bought Capital Cities/ABC Inc. and worked for Time Warner Inc. behind Morgan Stanley when Time Warner bought Turner Broadcasting System Inc. These two huge deals pushed it into the No.5 spot in mergers and acquisitions through Nov. 13, up from 34th in 1990. "Everyone says they are in it for the long-term relationship, but Alan [actually] conducts himself that way," says Richard Bressler, chief financial officer of Time Warner.
Overseas, though, Bear Stearns has stepped on some landmines that show it still has a few things to learn about Asia and investment banking. In 1993, it won the mandate for a $770 million equity underwriting for Consolidated Electric Power of Asia. CEPA was spun off from Hopewell Holdings Ltd., the Hong Kong-based real estate developer owned by Gordon Wu. Bear's bankers worked for months preparing the CEPA prospectus.
CANNY FRANCHISER. But a few days before the prospectus was to be issued, says Cayne, Wu insisted that the deal price be fixed well in advance, which is how deals are done in Hong Kong. In the U.S., deals are priced very close to the sale date. Committing early under the Hong Kong way, Bear Stearns could suffer potentially huge losses on the $770 million issue if the market fell in the interim.
Bear Stearns's credit committee then vetoed the issue as too risky, subjecting the firm to a major embarrassment. Wu awarded the deal to two local houses. Bear was ultimately given a minor role, but only after Cayne threatened to delay the release of a regulatory filing that would permit the stock to be sold in the U.S. Wu declined comment. Cayne says Bear didn't lose any money and that he is still friendly with Wu.
Schwartz insists he remains as committed as ever to overseas investment banking. "We've always built franchises," he says. "We've just never said, build a franchise at any cost." That may seem shortsighted, given its long-term goals. But with its impressive record of franchise building, it wouldn't be wise to bet against the Bear.By Leah Nathans Spiro in New York, with Pete Engardio in Hong Kong