Jefferies Bankers Are Happy To Pay Jefferies Shareholders $6mm For The Privilege Of Not Being Jefferies Shareholders

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What is the best thing about these Jefferies bonuses? For me it's this:

For 2011, we offered our employees the option to receive the stock portion of their year-end compensation in the form of either shares or cash, with the cash amount being equal to 75% of the grant-date amount of the stock that an employee would otherwise receive. The election resulted in a decrease to share-based compensation expense of approximately $23.3 million, as certain employees elected to receive reduced cash awards lieu of the full grant-date amount of the shares. This offset increased cash compensation expense by approximately $17.5 million. The net effect of this election on total compensation and benefits expense was a reduction of approximately $5.8 million. While these cash awards were fully expensed in 2011, they will legally vest in future periods.

When I first skimmed the headline I thought, okay, paying a 25% discount for liquidity makes sense. I, anyway, would be a lot wealthier had I gotten ... really almost any percentage of my stock-based comp in cash rather than vaporizing most of it and leaving a small stub subject to a nondisparagement agreement when I left (I love you guys!), but that is neither here nor there. Because that's not actually what the Jeffererers got. The people taking the "cash" got no more liquidity or vestedness or, um, cash, than the people taking the shares. They got ... at a first approximation, they got an illiquid JEF bond. If they're around, and Jefferies is around, and the cash is around, in three years or whenever this stuff vests, then they get a fixed amount of money. If not, not.

So the only thing that the Jeffers got for giving up 25% of their stock-based comp was ... avoiding the risk that Jefferies stock would decline by more than 25%. Here's a silly coincidence:

In fact, if you go use Bloomberg JEF <equity> OV <go> and price a 3-year, down 25% put option without monkeying with default inputs, it costs ... 24% of spot. Which means that, in a free country, the Jeffers could have spent 24% of their stock bonuses to protect their downside below 75%, while keeping all the upside and not having credit exposure to Jefferies for 3 (?) years.*

So this deal doesn't look like a screaming win for the people who took it, and the fact that one in seven** of them said yes does not seem to make all that strong a bull case for JEF. People go around freaking out when insiders sell stock. These insiders were lining up to sell down 25%.

But once you get beyond that nasty vote of no confidence, this looks like a good deal for Jefferies. Two things to think about. First, as a pure trade, it's great for shareholders. They get to buy stock down 25% from people who are thrilled to sell it to them there. Jefferies shareholders picked up $6mm in absolutely free money just by shifting the currency with which they paid employees - employees who, by definition (since it was their choice), think that this is a better deal than keeping the $6mm. And just like BofA, Jefferies is using its comp structure to optimize capital. Unlike BAC, which is happy to get $1bn of underpriced capital by stuffing it to its bankers, Jefferies is in the position of reducing capital - it has a share buyback program in place and was buying several million shares in late 2011. Buying stock at a 25% discount, and with probably less bad regulatory mojo versus open market buying, is a no-brainer.

Second, it's actually good for incentives. I mean, sure, it takes away some of the bankers' incentives to make the stock price go up. (And it sure makes them look like they're not expecting that.) But we've talked ad nauseam about the benefits of paying bankers in debt or CDS or whatever. Jefferies is a particularly good case for that. You may remember that some people are concerned about its creditworthiness, and other people are really completely freaked out about its creditworthiness. Shifting some comp from equity to debt - and, particularly, shifting that comp for the people who are most nervous about Jefferies' prospects - reduces the risk of a bet-the-farm event, and increases the likelihood that Jefferies will actually keep plugging along (with its slightly reduced capital). In effect this structure is a tiny levered recap, where the sellers of the shares are also the buyers of the debt - and are also Jefferies's employees. That's probably a good position for them to be in.

Jefferies Lets Bonus Recipients Swap Stock for Cash at 25% Cut [Bloomberg]


* Yeah, I mean, this doesn't really work, because at the worst case you're down 25% twice, which is worse than you do in the actual scheme. Still. The point is that, if you could actually trade options on your Jefferies shares, you could build yourself a better mousetrap than you were actually offered. But your RSU agreement probably doesn't allow that.

** Weighted by value. It seems $23.3mm of stock was sacrificed versus $136mm in remaining share-based comp.

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