The late 1990s saw unprecedented growth in equity values, and a surge of activity on Wall Street. As the markets soared, investors of all stripes entered the stock market hoping to earn quick money on the latest high-tech company. Investment banks, flushed with earnings and needing to expand to meet demand, lured in many college and graduate students with the promise of high salaries and even larger bonuses.

The subsequent fallout of the market brought havoc into investment banking. Stories of wiped-out portfolios, unscrupulously overoptimistic analysts, unethical business practices, and criminal behavior abounded, while other important issues received less attention. And what became of the bankers hired during the 1990s? What would the long-term impact of the crash be on their careers? Would their lifetime earnings suffer? Besides, in a rush to expand their staff, had investment banks taken on less qualified workers?

The paper sets out to address these questions by investigating how the career development of Stanford MBA students who graduated between 1960 and 1995 depended on stock market conditions when they left school. Information on these students comes from a unique dataset compiled using a survey conducted by Stanford University.

Before heading into statistical analysis, the author presents two main scenarios illustrating how the rise and fall of markets might affect worker quality and hiring in investment banks. Both assume that banks hire more staff when stock markets rise. The first hypothesis is that students differ in their banking skills. During lean times, those drawn into banking after school are genuinely productive; however, during bull markets, when banks expand, less talented students enter banking to make money as well.

According to the second hypothesis all students are equally talented. If the stock market rises while students are in school, they can anticipate that more opportunities will be available in finance upon graduation. A larger portion of them will prepare for banking careers while in school, so that during good as well as bad years banks will end up hiring a pool of equally talented workers.

The paper uses the MBA survey along with macroeconomic variables, such as unemployment, to determine which of the two accounts best explains the data. A first result is that stock market increases do lead to greater investment bank hiring: when the return on the S&P 500 index during the final two years of a Stanford MBA class increases by 18.5%, the probability that a student will go into investment banking upon graduating increases by 2% - or by 15% above the average probability of 14%.

Furthermore, graduates who begin their careers in finance are likely to stay in the sector. Someone who starts in banking has an 80% higher probability to still be in banking at a later date than someone who did not. More important is the fact that this probability remains virtually unchanged, irrespective of stock market conditions at graduation. In other words, being hired during a bull market does not increase the likelihood of leaving the industry in later years. In this sense, bull markets create larger pools of investment bankers.

Taken together these empirical findings have important implications. First, relatively short-term movements in stock prices may have long-term impacts on labor market outcomes. A few years of good stock returns attract significant numbers of Stanford MBA students towards Wall Street, and they are likely to stay there not only through the next downturn but for several decades following. Second, the data supports the view that all Stanford MBA students have the potential to become good bankers, and that a greater number direct their studies toward finance when more opportunities in that sector are available. Thus, when banks hire large numbers of students during a boom, the quality of the average candidate does not decline. Having acquired specific finance skills with their degrees and on their jobs, students stay within the industry where they specialized. In fact, even if their qualifications are similar, few MBAs who start a different career during a bear market enter investment banking when the market goes back to being bullish.

The author then explores further consequences MBA students face when starting in an investment bank, in order to uncover authentic causal relationships, and not just statistical correlations between outcomes. To do this, rather advanced statistical techniques are employed, making the technical sections of the paper hard for the general reader. Taking one’s first job on Wall Street decreases the chance of later becoming an entrepreneur by up to 22% and of becoming a consultant by 30%. More strikingly, perhaps, given that investment bankers generally earn more than other professionals, beginning - and thus continuing - a career in banking has a strong effect on lifetime earnings.

Upon graduation, students who begin in finance can expect to earn 64% more than their peers in consulting, and well over double the earnings of others. Fifteen years after graduation, students who began in banking on average earn 90% more than their classmates who began in consulting and three times the amount of others. In monetary terms, starting as investment bankers means an additional two to six million dollars of (discounted) lifetime income. The author interprets this wage premium as a compensation for the longer hours and tough discipline investment banking requires compared to other occupations an MBA student might choose.

The paper demonstrates that an important effect of a bullish stock market is the creation of a class of investment bankers who continue to accumulate wealth long after the high returns have ceased to be. Whether this phenomenon is good, bad, or neutral for society is not clear - certainly it is positive for those lucky MBAs who graduate at the market’s peak. Anyway, an important implication of the paper is that one should consider the effects of stock market conditions on the allocation of managerial skills of the highly educated and on the rewards they can achieve.

Report Source:
"The Making of an Investment Banker: Macroeconomic Shocks, Career Choice, and Lifetime Income", a Working Paper by: Paul Oyer (Graduate School of Business, Stanford University and NBER).
February 2006, pp.33