Tuesday, August 11, 2009

On Compensation After the Demise of the Gilded Age....

This story about the hurdles catching the heels of anyone interested in reining in Wall Street pay had me thinking about compensation.

According to that story in yesterday's NY Times, Wall Street has not long endured life without the reward of the "guaranteed bonus." (In fact, I doubt it's endured even a second without such a perk.)

Though unemployment has grown exponentially in the last year, though the recovery is looking to be a "jobless" one for those outside of Wall Street, the investment bankers who've been propped up and well-fed at the trough of TARP are planning a lot of "ironclad, multimillion-dollar payouts – guaranteed no matter how an employee performs."

Guaranteed no matter how the economy performs.

And, as we saw last winter, guaranteed by the feds no matter how the company performs.

And when I was thinking about compensation, I starting thinking about something a very wise man said not too long ago about Wall Street compensation:

"...We should apply basic standards to how we compensate people in our industry. The percentage of the discretionary bonus awarded in equity should increase significantly as an employee’s total compensation increases. An individual’s performance should be evaluated over time so as to avoid excessive risk-taking. To ensure this, all equity awards need to be subject to future delivery and/or deferred exercise. Senior executive officers should be required to retain most of the equity they receive at least until they retire, while equity delivery schedules should continue to apply after the individual has left the firm."

Can you guess who dropped these pearls about applying "basic standards" to how Wall Street compensates people in the biz?

Lloyd Blankfein, CEO of Goldman Sachs, in an op-ed piece that appeared in the Financial Times last February.

I have to say that I like developing Wall Street compensation models that take into consideration an employee's performance over time - I like the idea of the "deferred exercise" of a bonus. The idea of the "guaranteed bonus" seems to go against the grain of what Blankfein recommended last winter.

So in light of Blankfein's views on applying "basic standards" to compensation, the fact that Goldman is on track for passing out record bonuses this year, the year of the bailout, is a plot twist I did not expect this narrative to take. The Wall Street Journal describes the current backdrop against which these bonuses are displayed:

"The resurgence [of Goldman Sachs] has been the topic of much banter. It comes at a sensitive time as lawmakers scrutinize Wall Street pay packages in the wake of the financial crisis. The bonuses for bankers and traders are blamed for encouraging the kind of risk taking that led to the financial crisis. As a result, the government was forced to pony up billions of dollars in aid for the country's financial firms, including Goldman."

Of course, salaries are traditionally negotiated within the privacy of the company that is paying the salaries. It is an expense for the company, a hefty one at that.

But when compensation takes place at companies receiving "two or more federal bailouts," the public has been inserted into the process. Like most people, I wish the public had not been inserted into the business of finance - I wish the financiers had managed their businesses significantly better in the last decade so that the federal government wouldn't have felt compelled to rescue the sector last fall.

But what's done is done - the financial sector (and Goldman Sachs) received any number of different bailout options - the direct TARP loan, the indirect AIG payment, the loan guarantees and the warrants and TALF, that "lifeline to the asset-backed securities market, in which consumer loans, commercial-real-estate loans and other debt are bundled into securities and sold to investors" (as defined by the WSJ.)

Thus, we care far more about these bonuses this year than at any other time. So are these Goldman bonuses going to conform to the ideas Blankfein recommended last winter?

Doesn't really seem like it. Seems like Goldman's bonuses are to be paid out as swiftly as Paulson was able to shovel TARP funds out the door last fall. (A "land-speed record," he called it.)

For a company so recently the recipient of one of the most massive federal welfare programs in decades to award such bonuses to its employees - in a time of high unemployment and continuing economic uncertainty, there's nothing long-term about handing out such rewards. They're getting bonuses based on their ability to maximize profit last quarter, which they did by continuing to risk big in an environment that is now openly propped up and supported by the feds.

Last February, it appeared Lloyd Blankfein was passing on wisdom he'd learned from the crash - the idea that how Wall Street compensates employees could be improved.

In April, 2009, he made further refinements to his ideas in a speech he gave to the Council of Institutional Investors' spring meeting:

"Compensation should encourage real teamwork and discourage selfish behavior, including excessive risk taking, which hurts the longer-term interests of the firm and its shareholders.

We also believe it is important to set forth specific guidelines on how we compensate in our industry.

– Compensation should include an annual salary plus deferred compensation, which is appropriately discretionary because it is based on performance over the entire year.

– The percentage of compensation awarded in equity should increase significantly as an employee's total compensation increases.

– For senior people, most of the compensation should be in deferred equity. Only the firm's junior people should receive the majority of their compensation in cash.

– As I mentioned earlier, an individual's performance should be evaluated over time so as to avoid excessive risk taking and allow for a "clawback" effect. To ensure this, all equity awards should be subject to future delivery and/or deferred exercise over at least a three-year period.

– And, senior executive officers should be required to retain the bulk of the equity they receive until they retire. In addition, equity delivery schedules should continue to apply after the individual has left the firm.

At Goldman Sachs we believe attracting and retaining the best people is vital to our effectiveness and that incentives are an important element in that process. But we also recognize that, misapplied, they can also encourage excess. As an industry, we need to do a better job of understanding when incentives begin to work against the social good rather than for it and take action to redress the balance."

In July, Goldman Sachs notified the nation that they've set aside more than $11 billion for bonuses this year.

Lloyd Blankfein talks a good talk. Clearly, he knows that misapplied incentives can encourage excessive risk taking that can topple the economy.

But when it's all said and done, his actions show he favors rewarding risk far more than acting on behalf of "the social good." Because paying out billions in bonuses as a reward for the profits made during one quarter by a firm that has been the beneficiary of some of the most extraordinary corporate welfare programs in American history is simply a continuation of the risky business as usual that destroyed our economy.

And even Lloyd Blankfein at one point saw the error of continuing down that road.... but not today. Goldman's gilded age continues, even as the country continues its rot.

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