Is the culture of Wall Street bonuses changing for good?
Once upon a time, Wall Street investment bankers and traders spent all year looking forward to December and January; for most of them, these were the months when they learned the details of their bonus payments, which in some cases accounted for 90 percent of their total compensation for the year. The rest of the New York City economy also waited with bated breath, as Wall Streeters used their annual windfalls to put down payments on new homes, buy the latest cars and generally spend lavishly.
Even in the tough times that followed the financial crisis, a lot of those on Wall Street eyed the decline in bonuses as something they would just have to get through. At banks that remained reasonably solid but had taken TARP money, even executives heading up businesses that stayed profitable were cautioned that they would have to be patient; it wouldn't look good to dole out lavish paydays at a time when taxpayers were bailing out the financial system.
But it has been harder than most of these Wall Streeters expected to get back to what was once "normal" — and we're now seeing more signs that it won't ever happen. Indeed, just as the economy is settling in for a "new normal," so too, it seems is compensation on Wall Street, at least within many big banks.
The evidence of that has been pouring out of the investment banks banks lately. Morgan Stanley reportedly plans to cut 1,600 jobs, and will pay out bonuses to high-earnings employees (and there are still plenty of those) over three years. Goldman Sachs and JPMorgan Chase confirmed the industry trend on Wednesday when they released details of their compensation plans alongside their fourth-quarter profits.
Goldman announced unexpectedly impressive earnings, partly thanks to a big surge in bond underwriting (those low interest rates are good for something, even if it doesn't help the firm's trading revenues). Its net income soared to $2.83 billion from $1.01 billion in the fourth quarter of 2011. But the average compensation for its employees rose a relatively meager 9 percent to about $400,000, and fewer of them will benefit from the bonus pool. Even more intriguingly, Goldman Sachs slashed the size of that bonus pool, paying out only 37.9 percent of its revenue to employees, compared to 42.4 percent in 2011.
According to a Goldman study, the compensation ratio averaged 46 percent from 1999 to 2010, and the 2012 ratio is the lowest since 2009, when payouts plunged as the company struggled to reposition itself in the wake of the financial crisis.
Over at JPMorgan Chase, where net income jumped 53 percent in 2012 and earnings per share came in 20 percent higher than analysts had expected, the average compensation package actually declined, to $216,928 from $217,600 in 2011. The compensation ratio dipped to 33 percent from 34 percent. Of course, CEO Jamie Dimon's London Whale-sized personal loss affected that bottom line. Dimon's pay was cut by from $23.1 million to a mere $11.5 million as a result of the trading losses from what he eventually acknowledged was a "flawed, complex, poorly reviewed, poorly executed, and poorly monitored" trading strategy in the bank's London offices.
True, the compensation ratios are also affected by improving operating results and shrinking employee headcounts. When revenues and profits rise, there's more money to distribute to employees and shareholders, or to be held on the books as retained earnings. And if the banks have also cut their staff — as both Goldman and JP Morgan Chase did, to the tune of 3 percent each — there are fewer employees around to collect bonuses. That adds up to a reduction in the compensation ratio.
But there has been intermittent and quiet grumbling among some institutional investors about Wall Street compensation, especially as the return on equity at many of these financial institutions has remained well below pre-crisis levels. The pressure may have eased somewhat this year, given the performance of some of the banking shares: Goldman's stock has rallied 44 percent over the last 12 months, while JPMorgan Chase's shares are 34 percent higher. But it wouldn't take much for the grumbling to resurface, and JPMorgan, at least, must have been aware that the release of its internal report about the London Whale losses would provoke wariness on the part of investors fearful of another such mishap.
Morgan Stanley, which has struggled far more than arch-rival Goldman Sachs to recover from the financial crisis, has already allowed it leak out that it's taking a much tougher stance when it comes to compensation. James Gorman, who took over as CEO in 2010, has showed himself to be tough not just on cost-cutting — the bank also is axing thousands of workers — but when it comes to compensation. "There's way too much capacity and compensation is way too high," he said in an interview with the Financial Times in October. "I'm sort of sympathetic to the shareholder view that the industry is still overpaid."
Now Gorman is backing up those words with action. Even though Morgan Stanley's stock price did outperform the S&P 500 last year, it still lagged many of its peers, so the pressure from shareholders to pay out a smaller portion of revenues in compensation likely is commensurately larger. And Gorman is listening: This year's bonuses will be paid out in installments between May of this year and January 2016, and anyone who chooses to quit in irritation won't be taking any unreceived portion of that bonus payment with him.
Gorman's approach, clearly, is that he doesn't want to retain anyone within the ranks of his investment banking team or on his trading desk whose focus is solely on how to maximize that annual bonus check. If disgruntled employees want to go to hedge funds instead, so be it. It's an intriguing tactic that could resonate well with investors as long as it isn't seen to cripple the bank's ability to generate profits, offer a respectable return on equity or curtail any future growth in its share price.
It's another step in the ongoing efforts of Wall Street to find a better model for this new era. Outside critics and internal forces will continue to try to better align the incentives of the institutions, the workforce that ultimately generates the profits and the financial system overall. Don't expect to see an end to this Great Compensation Debate any time soon.
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