Sense on Cents

I have little patience for dealing with thin-skinned people. In a similar fashion, I have little regard for those who would care to generate benefits and rewards without putting ‘skin’ in the game. I respect individuals who are willing to expend the effort, the values, and the capital to grow an ownership stake in an enterprise. Wall Street boards and management need to take a full and honest accounting of their firms on these fronts.

Any business enterprise can be chock full of tremendous effort, pristine values, and employee capital but still fail. Other enterprises can have an abundance of some of these qualities and still fail. For example, the employees of both Bear Stearns and Lehman owned in excess of 30% of their respective firms. Despite those ownership stakes, the excessive greed of senior management within those institutions along with outsized risks brought those once proud firms to their knees. All this said, any enterprise which puts more ‘skin in the game’ has added incentive to more aggressively and prudently manage franchise risk. To this end, welcome to the debate centering on Wall Street compensation practices.

I am not in favor of the government dictating compensation practices. However, if boards willfully neglect their corporate governance responsibilities then those institutions should be subject to aggressive capital regulations and restrictions. I do not pretend to think these compensation issues are easily addressed, but they are part and parcel of the Uncle Sam economy.

I addressed this topic on August 21st in writing “Will Goldman Sachs Be Bulls, Bears, or Pigs?” In that post, I wrote specifically of Goldman’s compensation, but my premise would hold for all Wall Street banks. I continue to maintain;

The fact is the public sees Goldman specifically and Wall Street in general benefitting from taxpayer dollars injected into the system along with a host of Fed and Treasury programs. While Goldman has paid back its TARP funds, they have still benefitted from financing backed by the FDIC. Moreso than direct benefits to the firm, Goldman has clearly benefitted indirectly from the gamut of Uncle Sam’s largesse.

Uncle Sam clearly has a large amount of ’skin in the game.’ Goldman can address its image and burgeoning reputation problem by increasing its own ’skin in the game.’ How can they achieve this? They should compensate employees in stock to a much greater extent and have that stock vest over a longer time period.

Typically, senior executives, traders, and bankers are paid approximately 35% in stock and the stock would vest over a three year time frame. As such, individuals would typically have one year’s worth of compensation tied up in the firm.

Let’s see Goldman pay people 65-70% in stock and have it vest over a 5 to 6 year time frame. If Goldman is concerned about losing people, that pay structure would serve as a real disincentive for other firms to hire Goldman people. Make no mistake, Goldman employees would NOT be happy to be paid in this format . . . BUT there would be plenty of people on Wall Street who would take that pay structure right now to work at Goldman Sachs.

Goldman has the opportunity through this bonus cycle to display whether they are bulls, bears, or pigs.

Holding this position, I was pleased to read this morning Wall Street Needs More Skin In the Game by Peter Weinberg, a founding partner of Perella Weinberg and former Goldman Sachs partner. Weinberg writes:

The debate about bonuses and Wall Street pay rages on, and for good reason. Compensation is a complex issue that is essential to managing systemic risk. The asymmetrical structure of pay packages—a “heads I win, tails I win less” approach—was wrong. But overly prescriptive government intervention to solve the problem poses its own challenges and might not help us get the incentives right, either. So what can we do?

Here are two ideas that could help us replicate the discipline instilled by the old pay packages of private partnerships:

First, institute what is called a “10/20/30/40” plan. Under such a plan, junior employees would receive regular competitive pay, but senior employees would be paid as follows: 10% of annual compensation in cash now; 20% of annual compensation in cash later; 30% of annual compensation in stock now (with a required holding period); and 40% of annual compensation in stock later.

“Now” means paid immediately at the end of a compensation period. “Later” means after a period during which a cycle can be evaluated. During that evaluation, the firm’s compensation committee would perform a “look back” in which it can adjust the award or leave it at a predetermined level. This function should not be used to micromanage past bonuses but simply to make sure success in a specific year was still viewed to be success in hindsight.

Under this program, 60% of the compensation would vest over a longer time frame. As much as I would not have personally liked this system when I worked on Wall Street, people need to accept that the industry has changed. Weinberg continues:

Second, create a “Skin in the Game” plan. When an executive or a senior employee manages a trading or asset-management business which can be measured by its own profit and loss statement, those executives or employees should invest a significant amount of their own capital in that business or fund. The compensation committee of the company’s board would determine who qualifies for this plan and the definition of a material commitment.

Well done, Mr. Weinberg. I commend you. Where are your Wall Street colleagues to implement these recommendations?

LD