What Should an Investment Banker Do to Ensure Due Diligence?
Investment bankers should always perform due diligence on the companies they’re working with. There are often time pressures to complete analyses and make decisions, and mistakes are most often made under duress. In addition to looking for the specific accounting manipulations presented in these case studies, investment bankers should heed a few timeworn axioms:
Trust but verify. Just because an accounting firm has signed off on the financial statements, it doesn’t mean that these statements accurately reflect the realities of the business or that the financial statements were constructed with conservative accounting assumptions in mind.
If it looks too good to be true, it probably is. Exceptional financial performance is to be applauded, but an investment banker should figure out why a particular firm is outperforming other firms in its industry, or is thriving despite a lackluster economy. The corporate world is highly competitive, and a firm whose performance is truly a positive outlier is rare.
Make sure that the performance of the firm is truly exceptional and not the result of “exceptional” accounting.
Don’t invest in anything you don’t understand. One of the most basic tenets of investing is to understand what you’re investing in. The world’s greatest investor, Warren Buffett, has stayed away from technology companies because he says he doesn’t understand them.
Sometimes it’s difficult to admit that you don’t understand something, but many investment bankers would be well served to emulate Mr. Buffett and realize when they’re outside their circle of competence. It isn’t how big your circle of competence is, but how well you define and operate within the perimeter.