New York Times, February 19, 1994

On Wall Street, Masters of Innovation

by Susan Webber

Imagine an industry that is chock-full of risk and keen competition. Customers are fickle. Markets are volatile. There's no patent protection. New product designs are publicly disclosed. Now imagine that to survive in this rough-and-tumble industry, companies have developed hundreds of new products, some of which have grown into major businesses.

Wouldn't corporate America be eager to study this industry, to see how it came upon its innovative ways?

Welcome to Wall Street.

Although most executives may be skeptical, Wall Street beats Main Street hands down when it comes to innovation. Consider wrap accounts, an investment product that gives wealthy individual investors access to money managers who normally handle only institutional accounts. Started in 1985, this inventive financial product has attracted $90 billion in assets; with fees of 3 percent a year, the wraps represent $3 billion in revenues for Wall Street.

Or consider asset-backed commercial paper. Devised as a financing tool for companies with low credit ratings, these instruments now account for $45 billion outstanding. There are many inventions Wall Street has devised—credit swaps, inverse floaters, down-and-out options, synthetic securities. The names are Wall Streetese, but, in any language, they satisfy the criteria for innovations. They identify unmet needs, create novel ways to satisfy them and then pay off handsomely.

These products are not accidents. Wall Street is simply highly innovative. Compare the very model of an innovative industrial company, 3M, with a like-minded Wall Street aspirant, Bankers Trust. 3M tries to earn 20 percent of its revenue from products developed in the last five years. But Bankers Trust takes this goal one better. It has a policy of abandoning products as they mature in order to focus on young, highly profitable ones.

What is Wall Street's secret? How does it innovate at a pace that makes the biotechnology industry look Model T by comparison? There are several reasons:

On Wall Street, making money takes precedence over all else; there are no sacred cows or secure fiefs. Elsewhere, vested interests often come before profits. For example, Citibank pioneered swaps, a lucrative financial product, in 1981. But even though Citibank is undeniably a hungry and profit-minded bank, it wouldn't pay its swaps sellers in proportion to what they generated. Why? Because then they might earn more than top Citibank executives. Predictably, the swaps talent left for firms with more enlightened pay policies—on Wall Street.

In most industries, interdepartmental efforts are either infrequent or low-level. They're also politically charged events, avoided by the astute. But not on Wall Street, where several major activities — underwritings, mergers and acquisitions and real estate financings — require interdepartmental cooperation. On Wall Street, egos and politics don't stand in the way of business.

Even the most senior executives on Wall Street work regularly with clients. This means that top managers know customers and market conditions, and can evaluate new business opportunities.

Can we say the same of any other industry? One thinks of General Electric's Jack Welch as a skilled executive who sets goals and supervises his top managers—not as someone who meets with customers. But one thinks of Felix Rohatyn as a premier dealmaker who lavishes attention on clients—not as someone who manages the Lazard Freres mergers and acquisitions department.

Wall Street is Darwinian. Very often, even for higher-ups, pay depends not on seniority or title but on performance. Internal competition is intense, and no one can live on past success. To compensate for this institutionalized insecurity, top performers can earn huge sums — Michael Miliken is the most famous but not the only example of this. Take Lawrence Hillibrand, head of the Salomon Brothers bond arbitrage unit, who earned $23 million in 1991. Before Mr. Hillibrand's boss, John Gutfreund, left Salomon in August of that year, he was paid only $1.2 million.

As American companies study team dynamics, Oriental philosophy and Silicon Valley entrepreneurs in the search for innovation's secrets, they should look closer to home as well. Insecurity and opportunity—also known as fear and greed—on Wall Street may hold the answers they seek.