Be Careful What You Wish For . . .
Posted by Larry Doyle on February 3, 2009 2:47 PM |
In the midst of the current economic turmoil, nobody in our country has gone unscathed. With rising unemployment and falling 401-K valuations, everybody is looking for scapegoats. Prior to my passing judgment on any situation, I prefer to investigate fully the details and circumstances rather than shooting from the hip. President Obama’s gunslinger approach may resonate with his constituency, but for those who care to understand the details, let’s probe further. Without a full review of compensation practices, a blanket condemnation, in my opinion, is the height of pandering and akin to a fan heckling an umpire without reviewing the videotape. Over and above that, widespread government intervention into compensation practices is a VERY dangerous precedent; be careful what you wish for!!
Let’s go into the world of Wall Street compensation. Any executive on Wall Street will readily admit that their assets walk out the door every night and back in the door every morning. Managing those assets is the crux to managing a business. In my opinion, the same could be said of any business. While there are a handful of smaller brokerage houses on Wall Street, the bulk of the business is executed with the larger shops. The compensation at all of these shops (Goldman Sachs, JP Morgan, Morgan Stanley, Bank America, Credit Suisse, UBS, Citigroup) is structured as salary plus bonus. The bonus can run upwards of 90% of the total compensation for revenue producers. Over and above the simple salary plus bonus structure, anywhere from 25-75% of the bonus will typically come in the form of company stock which is paid out over the course of three to five years. That stock component and delayed payout are known as the “golden handcuffs” because it restricts the ability of an employee to leave a firm. How and why? If an employee leaves a firm, he or she walks out without that portion of his compensation. Additionally, Wall Street firms further restrict a wide swath of senior executives by imposing non-compete agreements. How do these work? At many shops, if a senior executive decides that he wants to leave the firm, he can only receive his “delayed payout” if he chooses to work for a not-for-profit or in the field of education. If an individual is let go, he will receive his “delayed payout” on its’ schedule.
Bonuses are totally at the discretion of management. The paradox for any manager is how to grow revenues and the business within the confines of a budget and the environment. While it is easy for Obama or anybody outside of Wall Street to paste a blanket vote of “no confidence” on Wall Street and the compensation formula, I would expect a little better from our nation’s leader. Why??
— Did every firm request to take government money? No! More than a few firms were required to take money against their wishes.
— For those who care, there are a lot of divisions within firms that generated significant revenue. Are the individuals who drove those revenues, often times in the multiple millions of dollars, supposed to receive no bonus. If so, you will see a wave of departures and along with that a serious decline in revenues going forward.
— If people received no bonus, would firms relax the “golden handcuffs” that restrict employee movement? I have already asked this question and the answer was a resounding “NO.”
— As I responded to a loyal reader in a prior thread, Wall Street should implement a system that establishes reserves against positions that reside on the firms’ books against potential losses. As positions are liquidated and revenues recognized, then people can receive compensation accordingly. For individuals who generate revenue and positions are sold and risk eliminated, a fair compensation should be paid.
— I am not saying there are not abusive compensation practices that should be rooted out. For these areas, management should be held accountable for implementing them. Any shareholder who does not agree with the compensation paid and formula used should SELL his stock. Management should be held acccountable by regulators and rating agencies. Remember them??
— “Be careful what you wish for!” I make this statement because if government is actively involved in establishing compensation practices throughout an industry, then do not be surprised if they look to use that precedent across other industries and other situations. Some may view that as unlikely, but I have already been hearing about situations that would question the validity of contracts, the belief in private business, and results of corporate negotiations. If government intervenes in areas they deem as in the public interest, where does one draw the line?
In summary, some may view my points as overly aggressive and presumptuous in light of the massive government injection of capital. I would respond that with increased government intervention, private capital becomes increasingly reluctant to invest. Obama should not pander to his constituency, but take the measured approach of true leadership and remark that “abusive compensation practices will not be tolerated.”
Jamie Dimon of JP Morgan weighs in on these topics: Dimon Says Not Every Company Responsible for Wall Street Pay