Compensation

Hey, so, if you work at a bank, you may have heard about this, not sure, but your comp will be down. Just a bit. Unless you’re a junior mistmaker Chez Dimon. But otherwise, yeah. Down.

Another thing you may be less aware of is that some people are actually not so unhappy about that. A few of them even think that it’s possible that your pay should be down some more. And they think someone should really look into that:

Giant firms are expected to cut executive pay by some 30% from 2010 levels, consultants say. And since the financial crisis of 2008, firms have reduced cash bonuses, increased their use of company stock and added clauses that allow them to recoup—or “claw back”—pay in certain circumstances.

Even so, some investors want more changes. In December, the Nathan Cummings Foundation—a private charitable organization and institutional shareholder—filed proposals asking that directors at Goldman Sachs Group Inc. and J.P. Morgan Chase & Co. address potential reputational damage that big pay packages could bring to the banks, said Laura Campos, director of shareholder activities at the foundation. The proposals also request that they study how such awards could reduce banks’ ability to spend money on other areas, and report those findings to shareholders.

Shareholder resolution activists (not to be confused with, like, real activists) are mostly pretty silly creatures and this is a pretty good example of why. The Journal tries valiantly to make the efforts of Nathan Cummings and his eponymous foundation relevant to the hot-button issue of how much bankers get paid, but it’s pretty clear that the NCF is focused on a thing called “executive pay.” Executive pay is sort of an irrelevancy for investment banks, mostly, since it makes up a relatively small fraction of comp, and since lots of people at banks get paid executive amounts of money without being a named executive officer. And as long as the Nathan Cummingseses of the world are focusing on how much the Lloyds/Jamies/James-not-Jamies of the world are getting, they will probably stay away from your now-30%-paltrier comp.

Other fearless crusaders for shareholders have noticed this, however, and are more interested in going directly after your money, though they have yet to resort to the rather infra dig expedient of shareholder resolutions. Instead they do things like complain to Andrew Ross Sorkin, who earlier this week said: Read more »

As you may have heard, bonus season this year is going to be a bit tricky, on account of the fact that Wall Street banks didn’t make much in the way of cash in 2011. While paying some seniors staff zero dollars is being considered, it still may not be enough to pick up the slack. There is one idea that’s been floated among firms but shot down, so far, for fear of being too risky, so risky that it’s probably not even safe to mention it here but I’m gonna– freezing pay for junior staff. (Oh god, shhh, don’t say it aloud, we don’t want to start a run on the banks!) Everyone wants to do it but no one’s got the cojones, fearing the backlash that would come from angering “future stars” whose names will be learned in 5-7 years when they graduate from second class citizen status. No, the consequences would be dire. Unless…unless everyone put up a united front against these incredibly powerful and intimidating people? Read more »

A story that is told about banks is this: Bankers are paid to maximize short-term results and screw the risks. All they care about is this-period earnings. They dance until the music stops. (Then they sue.) In this story, banker pay drives risk and volatility and other terrible things.

A counter-narrative that sometimes floats around is this: there’s no particular evidence that bankers are paid in line with short-term risks. The jury is sort of out on this one because the data isn’t really there one way or the other; see this post from the Epicurean Dealmaker for why you shouldn’t take seriously claims that bank executive comp (who cares about executives?) doesn’t closely track stock prices (who cares about stock prices?). He tentatively endorses a form of the traditional view:

My industry’s pay practices and culture were built over decades when the vast majority of business investment banks conducted was agency business. Business like M&A, where you earn a fee for helping a client buy or sell a company, or security underwriting, where you earn a fee for placing client securities with outside investors, or securities market making, where you earn a spread for standing between buy- and sell-side investors as a middleman and temporary warehouser. None of these businesses entailed any material amount of persistent or hidden financial risk to investment banks …

The problem arose when investment banks (and their bastard cousins and often ultimate owners, commercial or universal banks) began conducting business as principals, either explicitly and in full knowledge, or—most dangerously—in total ignorance. Mouthwateringly profitable leveraged lending, structured products, complex derivatives, and proprietary investing of all kinds meant that investment banks no longer conducted business as short-term conduits of temporary risk, but began accumulating long-term financial risks on or off their balance sheet, often without their own knowledge. But when this happens, the old view that Joe in Structured Products should get a massive bonus in February because he brought in $100 million of fee revenue to the firm this year cannot cope with the fact that Joe’s fabulous trades expose the firm to $1 billion in potential losses over the next five years.

Lest you reply “but you get paid in stock so ooh long-term incentives ooh,” ED has an answer to that that is I think irrefutable. And he ends up calling for an empirical study of line-trader-and-banker pay that determines how much risk-taking is and is not incentivized by comp.

Maybe we’ll do that when we get an intern. Until then, a data point you might look at is this paper that Oliver Faltin-Traeger of Blackrock and Christopher Mayer of Columbia Business School presented this weekend at a fancy soirée in Chicago. It is not at all about banker comp. It is about the fact that CDOs were shit, pure shit, basically. I know, you knew that already, but really: Read more »

We’ve talked before about the theory that paying investment bankers in stock gives them an incentive to maximize the volatility of their businesses, which is a thing that some people don’t want so much. This starts from the notion that in a 10 or 20 or 30:1 levered bank or broker-dealer or futures merchant, the bulk of the money at risk belongs to the creditors, whether unsecured or depositors or repo or ex-wives or whatever. So it’s plausible to think of the equity as an at-the-money option to buy the assets from the creditors. And as any Level I CFA test completer could tell you with approximately 70% probability, the value of an option increases with volatility. If you own the equity in a bank with $29 billion in debt and $1 billion in equity market value, then you’ll prefer equally likely payoffs of [$25, $35 billion] to payoffs of [$29.99, $30.01 billion], because the higher volatility payoff increases the expected value of the equity (which, after all, can’t go below zero). If, however, you are a creditor of that firm, your preferences are the opposite.

This is all pretty straightforward and orthodox, and it probably ought to inform how you think about the incentives to bankers from owning their bank’s equity, and if you think that way then maybe you come up with ideas like “pay them in CDS” or whatever. On the other hand this theory shouldn’t be taken too seriously. When your entire net worth is in Jefferies stock, “the equity can’t go below zero” isn’t all that comforting.

But it’s worth remembering that incentives from owning equity are not exactly the same as incentives from being paid in equity: people who have a lot of stock feel different from people who stand to one day get a lot of stock. That’s the interesting takeaway from this weekend’s DealBook piece about the fact that bank stocks sometimes go up. (And sometimes they don’t.) For example:
Read more »

The Fed has three basic functions: central banking, bank regulation, and calling down police brutality on Occupy Wall Street protesters. While the first function is getting all the attention today, the New York Fed’s blog is spending some time on the second. Specifically, they’re trying to figure out how bankers should get paid.

Optimal design of banker compensation is a thing that people like to think about, and that regulators like to regulate. We’ve talked about it before, and I’ve suggested that the right way to reward bankers is not to give them mostly equity or extra-levered equity, which encourages asymmetric risk-taking, but rather to give them exposure to their firm that roughly matches that of their main stakeholders. Which, for a bank, means basically various flavors of creditors. So a bank CEO whose net worth consists 20% of equity of his firm and 80% of unsecured debt of his firm, like Brian Moynihan, in theory has better incentives to do the right thing by bondholders, depositors and the financial system than someone who’s 100% in out-of-the-money stock options. And a banker who is paid in structured credit products that can’t be foisted on to clients has incentives … well, he’s an interesting case study at least.

I like the NY Fed researcher-bloggers because they’re pretty sober people who want to optimize banking regulation but don’t spend their time freaking out about stupid popular things like how CDS will kill us all, banning short selling, or just generally hating on bankers. So I’m pleased to see NY Fed researcher Hamid Mehran is with me on this whole comp thing: Read more »

Remember Dennis Kozlowski? Bald guy, about yay* high? Actually kind of cherubic-looking, in that you could see him playing Cupid in the school play? Used to run this company called Tyco until he was sentenced to 8 1/3 to 25 years in prison? Anyway, quick story about Big D is that the reasons he’s in jail include but are not limited to: 1) paying himself $105 million in 2000 when maybe he should’ve taken a bit less, 2) outfitting the bathroom in his company-funded apartment with a $6,000 shower curtain that even John Thain said no to when it came to decorating his executive washroom, 3) throwing his wife a birthday party in Sardinia that cost (Tyco) $2 million, on account of the performance by Jimmy Buffett, the togas for the guests, the “ice sculpture of Michelangelo’s David spewing vodka from his penis and a birthday cake in the shape of a woman’s breasts with sparklers mounted on top,” the latter of which do not come cheap, this much we promise you. For all of that and more, D-Koz was found guilty on counts of grand larceny, conspiracy and securities fraud. Anyway, the joint has provided a lot of reflection time for DK, and recently, he sat down to share what’s on his mind. Read more »

Goldman Sachs International has triggered a clause inserted into the employment contracts of a group of its London-based investment bankers in mid-2009 that will result in them having to take a pay cut, Financial News has learned. A number of staff across the investment bank’s European division, which is based in London, have been told this summer that their base salaries will be cut, a source with knowledge of the situation told Financial News. [FN/WSJ]