Sense on Cents

French President Nicolas Sarkozy

How is it that the country that is supposed to be the bastion of capitalism and free enterprise is taking serious direction on the topic of banker compensation from none other than French President Nicolas Sarkozy? The fact that Sarkozy is elevating the banker compensation topic prior to the G-20 meeting in Pittsburgh in September is a clear indication that the powers that be in Washington and on Wall Street have failed miserably on this topic.

There is NO doubt those on Wall Street would like to return to ‘business as usual’ as quickly as possible. Little do the Wall Street wizards appreciate that the ‘usual business’ brought our country to its knees. Let’s address the ultimate motivator, that is, compensation.

Wall Street’s initial response to potential increased oversight of the compensation process has been to increase salaries as an overall percentage of compensation. From a productivity standpoint, I view this maneuver as counterproductive. Increased salaries will increase fixed costs and actually serve as a disincentive. The fact is compensation needs to be viewed in its entirety, both salary and bonus. The entire process should not be gamed by firms to appease regulators.

Bloomberg highlights French President Sarkozy’s approach toward banker compensation in writing, Sarkozy Threat to Shun Banks on Pay Draws U.S. Alarm:

Aug. 26 (Bloomberg) — French President Nicolas Sarkozy’s plan to shun bankers who don’t accept pay limits was met with alarm by analysts and investors in the U.S., where Citigroup Inc. and six other bailed-out companies are being grilled by the government on how they compensate top-paid executives.

I am definitely not for strict government control of private enterprise compensation; however, if the boards of these private enterprises are not performing to protect the industry, the franchises, and the shareholders, then those boards need to be exposed. From my standpoint, the boards are a large part of the problem. Why? The boards are in the pocket of the senior executives. The senior executives have shown themselves to be excessively greedy and disinterested in protecting the industry and, in turn, our country.

Moving right along, I have always maintained that Wall Street banks must be obligated to fully align compensation with returns generated and risks remaining on the books. What do I mean?

A producer (trader, salesperson, banker) generates revenue for the firm but often there is residual risk remaining on the firms’ books. A reserve should be set aside by the business against these residual risks. As the residual risks are eliminated, those reserve funds can be released for compensation purposes. In this process, compensation and risk are much more aligned.

Additionally, the actual bonuses paid should be much more in the form of company stock and vested over a longer time period. What does this mean? Typically, a producer on Wall Street will be paid 1/3 of the bonus in company stock which vests (pays out) over a three year time frame. As such, the employee effectively has one year’s worth of average compensation on the table on a rolling basis. In the process of aligning compensation with firm interests, the boards across Wall Street  should pay a greater percentage in stock and have it vest over a longer time period. The employees will not be happy with this approach, but the fact is the industry was saved by the American taxpayer and at this point the taxpayer must be protected.

Banks will scream that they will lose good people under this more onerous compensation system. Too bad. This compensation system will actually serve as a disincentive for other firms poaching talent because employees will have a larger amount of unvested stock on the line. Will firms pick that up? Sometimes yes, sometimes no depending on the employee.

The industry should undertake these procedures themselves so the government regulators are not compelled to address. Sarkozy is actually doing the U.S. banks a favor by raising the topic. Will Wall Street and Washington lose their selfish motivations and think of the bigger picture? They have shown themselves incapable of being unselfish in the past.

LD

This entry was posted on Wednesday, August 26th, 2009 at 9:26 AM and is filed under Banking Institutions, General, Wall Street, Washington D.C.. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.