Taunter Media

So it seems there is some sort of movement to try to permanently alter finance comp.

New York Times

Wall Street Journal

Great.  But it seems folks are after two diametrically opposed goals:

• Longer term vesting/evaluation cycle.  Instead of an annual bonus, tie the bonus to performance over several years, presumably because one year is too short a period of time to judge multi-year assets/transactions.
• Closer tie with firm performance.  No more failing firms paying tens of millions of dollars to employees.  When the business is struggling, everyone should take a hit.

Let’s think about time cycle.  “Bonus” is a word that means something very different in finance from common usage (sort of like “bankruptcy”).  In general, we think of a “bonus” as a “gift;” something you are not obligated to pay but do out of good feeling.  When a guy makes $10mm a year, $200,000 of which comes from his base salary and $9.8mm in one lump sum at Christmas, however, that goes out the window.  He expects the $10mm, or some substantial portion of it; if he didn’t, he would be willing to jump ship midyear to a firm that offered $500,000 base and no bonus.

Wall Street is fairly unique in that the managers of Wall Street firms are simply employees who stuck around; they are exactly the same social class as all of their “professional” employees.  It’s pretty odd – the best welder on an assembly line does not end up running the company, the best maid does not get the keys to the hotel, the best actor is not put in charge of the studio – but it means that there is a fairly strong implicit bond between the levels of the workforce.  Assembly line workers would not allow management to determine their compensation in one fell swoop at the end of the year; they simply don’t trust management not to screw them.  And with good reason; management would screw the employees if the UAW were not there (and it still might).  Same for even well-paid trades, such as professional sports – the folks on the Detroit Lions got every dollar they expected, even though the team did not win a game.

Finance does not have unions in part because most professional expect their peers who are deciding their comp to be somewhere between fair and generous.  The objection from the political class that is stepping into the breach is that management has been far too generous.  Perhaps.

But bear in mind that as the deferral period stretches out – and a bonus is simply deferred compensation – the amount of trust has to increase. If I am asked to do work today for money a week from Friday, only so many things can happen to get in the way.  If I am asked to do work today for money three Christmases from now, a lot more can go wrong.  Things I thought I did well – things everyone thought I did well – may, with the advantage of several years’ hindsight, turn out to have been done poorly.  Incidentally, it could also happen that I did something far better than originally thought – if I make the firm hundreds of millions of dollars, is the firm really going to cut me a check for the full amount?  Managers will come and go.  If it previously took me a certain amount of money to get me to work, I am now going to need more – or greater confidence that the previous amount of money will be paid.

This is incompatible with paying me based on the performance of the firm.  If, for example, my pay period is stretched to three years, there is now a lot more time for someone in a completely different part of the business to screw something up.  The company may be in entirely different lines of business by then.  I am going to insist ever more that my money be segregated from his; since the other guy’s pay cannot become negative, any effort to balance a firmwide bonus pool has to fall on me (assuming I was profitable).  So the firm is now a less trustworthy counterparty – at the same time that it is asking me to trust it more.

Hopefully the incompatibility of these two goals will reverse the consolidation trend; banks will go back to their sleepy 3-6-3 model (borrow at 3%, loan at 6%, hit the golf course by 3pm), broker-dealers will be smaller and more numerous, a per-share tax on trades will slow hedge funds, more securities will be exchange-traded.  But even this model, it should be noted, will increase aggregate finance compensation – every one of the finance mergers of the past decade was predicated on the cost savings of eliminating overlapping jobs, and undoing them will require staffing up again.

Finance is – most of the time – a profitable business with incredible opportunities for return on equity.  The only debate in compensation is who should receive those outsized returns – the shareholders who stump up the capital, or the professionals they hire to do the work.  Not sure why any allocation within that is more moral than any other.