Sauce for the gander

April 16, 2013 | Banks, Compensation, Incentives, Innovations, Pay, Subprime, US News



By:David A. Smith



Time for you to reform too, padre


Too soon old, too late smart – is that how it runs?  Or was it a case of being smart but helpless, feeling under pressure to pay huge bonuses in cash based on non-cash estimates of earnings? 


Before the crisis, Wall Street firms often paid millions of dollars in cash bonuses to traders, creating the incentive for riskier deals, even if it put the firm on shaky ground over the long haul.


What could possibly have gone wrong with that?



What could possibly go wrong with this?


It was common for traders to collect about 70% of their overall pay in the form of immediate cash bonuses.


That question lies behind a recent article in the Wall Street Journal (January 16, 2013) highlighting a better-late-than-never change in executive compensation:


Several thousand Morgan Stanley traders, investment bankers and other employees will get IOUs instead of cash when bonus day arrives Thursday, a fundamental change in Wall Street pay triggered by the financial crisis.


The bonus-deferral plan combines two elements, of which the first is requiring the investments to prove themselves out:



I’ll give you proof!


The New York company will pay its bonuses in four equal installments, according to people briefed on the plan, with the first chunk coming in May and the last in January 2016.


Financial advisers aren’t included in the new compensation plan, [our sources] said.


Financial advisors aren’t traders, so their incentives differ – as does their ability to put the entire firm at risk.



Leverage, baby, it’s all about leverage


Secondly, bonus deferrals act as a form of golden handcuffs:


Employees who quit or are laid off before the payments stand to lose their deferred compensation –


Whoa – laid off?  How’d that get into the documents?


That adds a whole new element, one that were I a trader I’d vociferously protest:


– unless they negotiate a separate deal with the company.


Damn right they’ll negotiate the layoff clause.  It’s one thing to ask me to defer getting paid until the investment does what I projected it would do; it’s quite another for you to gain the right to pocket my bonus because you’ve decided I’m no longer net-profitably-valuable to the firm.


“I don’t think there will be a lot of cheers on the trading floors of Morgan Stanley,” said Mark Williams, a former Federal Reserve bank examiner who now teaches at Boston University. “Bonuses were used to buy houses and cars.”


No hedge fund trading in class, students: Mark Williams, BU


Gratification deferred, gentlemen and ladies – get used to it.  Investors have.



Spoken like a banker!

(Found at the hilarious Savage Chickens.)


The new plan, he said, is “likely to irritate many employees … especially those who believe they’ve performed well in 2012 and now have very little to show for it.”


Irritation subsides.  The acid test is, will they leave?


Morgan Stanley Chairman and Chief Executive James Gorman has been a strong proponent of deferred pay, an approach favored by regulators and risk-management experts.



No, I didn’t get the job because my last name is an anagram of the firm’s name


I’m sure Mr. Gorman is far from alone in his desire to defer large pay packets; he’s just the one who decided to put his traders’ money where their mouths were.



If their transactions do as well as they say, then they’ll get paid that way … and not before


Mr. Gorman, a plain-spoken Australian, has increased deferrals and lowered bonuses since taking over in 2010, saying in one interview that employees who didn’t like the new pay structure should look for other work. He also has said that compensation would rise as revenue and returns on equity increase in the economy’s recovery.


Good for him.  Taking a stance for the good of the entire firm is what a chief executive should do.


When asked about the new bonus plan, a Morgan Stanley spokesman referred to comments last year by Mr. Gorman to employees. “Shareholders need to make money,” the chief executive said. “We can’t just make it ourselves.”


Somewhere Karl Marx is spinning in his grave – a firm’s CEO commenting that the workers have been scooping all the profits, and the shareholders gone none.  Worse for old restless Karl, Mr. Gorman is right.



Still spinning?


Evidently Mr. Gorman is not alone in his reforming of the system:


Pay deferrals have already become commonplace across Wall Street. About 40% of fixed income traders, 15% of equity traders and 10% of staff in investment banking units had roughly half to 75% of their 2011 bonuses deferred, according to Options Group, a New York executive search and consulting firm, which publishes a widely read compensation report.


At some point, the revamping of payment becomes a cultural shift that will survive the inevitable revival of bank profitability.


“This is huge,” said Jonathan Macey, a law professor at Yale University. “It’s going to help Morgan Stanley’s reputation. If I were a counterparty, I’d rather do business with them because of it. I can’t believe it’s taken so long.”



What took them so long?


Actually, nor can I.  On second thought, having known many bankers, I can.



“Those are my principles, and if you don’t like them … well, I have others.”


Executives in recent days told managers about the changes, which mean that most employees making more than $350,000 a year will learn their “number”—Wall Street shorthand for bonus—this week [January 20, 2013 – Ed.] but won’t collect the full amount over the next few weeks, which has been the traditional practice. This year’s deferral plan will affect about 20% of bonus-eligible employees.


The highly paid ones, that is.  As it should be.


As word of the new bonus plan swirled through the company on Tuesday, some employees face postponing purchases, dipping into savings or tempering their lifestyles.


Tempering my lifestyle?  Aux barricades!



Yachts for everyone!  Private jets for all!


The deferred payments apply only to bonuses of $50,000 or more, which will be paid half in cash and half in shares.


Shares – meaning equity in the firm?  Or notes? – meaning debt instruments repayable out of future profits?  Obviously, the two create different incentives.


The bonus plan’s immediate impact will be softened somewhat because Morgan Stanley is due to pay deferred compensation earned in 2011 and earlier. Last year, Morgan Stanley capped immediate cash bonuses at $125,000 for its best-paid employees and deferred the rest.


Thus the real story of this article is less about Mr. Gorman’s break with tradition, and more about his adhering to a strategy he announced and launched a year ago.


In setting the bonus plan, Morgan Stanley executives have said they were trying to strike a balance between the demands of investors and the cash-flow needs of well-heeled bankers and traders.


I shall refrain from spluttering at the concept of ‘well-heeled’ (loaded term) bankers having cash flow needs.  Though Parkinson was right that expenditure always rises to meet income in an organization, that need not be the case with individuals.



I was right about other things too, young man


Through the first nine months of 2012, Morgan Stanley’s average compensation expense per employee was $207,757, up 3.1% from $201,542, a year earlier. Analysts and compensation consultants expect total pay to be flat or up slightly, on average, for employees at the firm.


Total pay, of which the deferrals are a rising portion.


Morgan Stanley officials have said they moved quickly to reform their compensation after the financial crisis. John Mack, their chief executive at the time, took no bonus for three consecutive years, starting in early 2008.


Character is when you do what is right, even if it hurts, even if you need not have done it.



My character is strong


The firm issued a so-called clawback plan after the crisis, so that employees could be liable if trades blew up after their bonuses were cashed. Morgan Stanley was particularly sensitive after it lost about $9 billion on a mortgage trade in 2007 and was unable to recover any significant portion of the compensation paid to the traders and risk officers involved.


Yes, I’d say losing nine billion will concentrate your focus.



Nine billion isn’t the end of the world … is it?


Now [the cash bonus payout fraction] has dropped to zero, something that hasn’t happened before on Wall Street for such an array of employees.


Before the crisis, bankers sold investors complex instruments and pitched them that the bankers should be paid cash up front, even though the instrument would perform over time and still needed to be proven out.  Now it’s sauce for the goose, sauce for the gander.


Mr. Williams said these kinds of bonus deferrals were leading talented banking workers to jump to the “shadow banking system” of hedge funds and private-equity firms. “Are you pushing the best talent away?”


Certainly you are pushing away some talent – and probably some of the most highly recruited talent.  But are they your best talent?  Ay, there’s the rub.


Others counter that the deferrals allow Mr. Gorman to keep employees who follow his vision, as well as those who are confident they can repeat their success in future years.


Precisely – those who believe in the firm will co-invest in the firm, and they will become eyes and ears for the firm’s risk management culture.



Bad friendship, but good corporate governance?