Money Stuff: Goldman Won’t Underwrite Just Anyone

One theory is that investment banks are the gatekeepers of the capital markets. Private companies that want to go public come to the investment banks for help, and the investment banks screen those companies and take public only the ones that they can vouch for. Big prestigious investment banks will be choosy with their endorsements; their endorsements will mean something. The stamp of approval of a Morgan Stanley or a Goldman Sachs signifies that a private company is good, and the banks carefully guard their reputation for underwriting good companies.

The other theory is that initial public offerings pay large fees and the investment banks are in the business of collecting large fees. If a company wants to go public, it will interview banks, and the banks will compete to win the business by telling the company how great and valuable it is. Then the banks who win the business will advise the company on its IPO, and send the company’s prospectus to potential investors, and set up meetings with those investors on a roadshow, and take orders from investors who want to buy stock. And then banks will tell the company how much stock the investors want to buy and at what price, and the company will sell that stock. The banks are middlemen; they are managers of a process; they serve a coordinating and centralizing function. They don’t tell you that the company is good; they certainly don’t tell you how much it is worth. They are hired by the company to work for it. The people deciding how much the company is worth are the investors, large sophisticated professional money managers who decide to invest after reading a detailed prospectus and meeting with the company’s managers; they are free to put in orders at whatever price they like, or not to put in orders if the deal seems too rich. It is a free market, and if the market thinks the company is worth a lot of money then it is irrelevant what the bank thinks.