Sense on Cents

The biggest secret in the money game is the manner in which people are compensated. Why is this compensation process such a secret? Very simply, if the general public understood the compensation process they could then understand the motivations of those managing their money. 

At the institutional level, Wall Street typically pays people on a salary plus bonus format. The salary often would represent only 20% of the overall compensation. The bonus would be tied to individual, group, division, and company performance. The bonus would typically be paid 2/3rds in cash and 1/3rd in stock. That stock component would typically be paid out over a three to five year time frame, thus tying the individual to the firm. That lockup is known as “the golden handcuffs.”

Under this format, people are motivated to maximize profits in order to maximize compensation. In maximizing profits, however, inordinate residual risks have often been left on the banks’ books. Thus, the risk/reward model has been skewed. Expect the Wall Street compensation model to change to address this issue going forward. (more…)