Stealing savings and penalizing pay for performance

Posted by Marc Hodak on November 2, 2008 under Executive compensation | Read the First Comment

There is a growing outrage about the possibility that Wall Street employees might get paid anything this year. This outrage is translating into a demand to rob bankers of their legitimate savings, and the elimination of pay-for-performance in the banking sector.

To begin with, critics are complaining that banks “owe billions to their executives.” But the vast majority of those billions represent past compensation that executives have chosen to save inside the company. And those critics are further outraged that these savings are accruing interest. Imagine that? And they are further clucking about the fact that these deferrals are mainly for the purpose of deferring taxes. Can you believe that anyone would actually try to structure their affairs to delay paying taxes? Goodness, how greedy can one get? How…unpatriotic?

So, imagine for a moment that one of those bad, bad people decides to defer some of their compensation, essentially saving it within the firm. Under what conception of fairness or justice would one accept the company, reacting to government pressure, confiscating those savings? That is precisely what the ‘companies-owe-executives-billions’ crowd is implicitly advocating. Why else would this particular form of savings register as a front page headline?

Next, the scolds are complaining about new bonuses that many of bankers are set to get for 2008–upwards of $20 billion. New bonuses in a year like this? How dare they?

Well, consider that most top-paid bankers, the ones getting millions each year, have relatively low salaries. Upwards of 90 percent of their total pay comes in the form of variable compensation that the media calls “bonuses.” But bonus is kind of a misnomer for this kind of pay. “Bonus” implies “extra amounts” for good work, or above-average performance. That’s how most Americans think of bonuses because that’s what they look like in their lives. In the context of traders or bankers, most of their compensation is better thought of as commission–a share of the revenues they help to bring in.

So in a year as bad as this, how much should such “bonuses” be reduced? Well, if your bank failed, you’re likely to get an anemic bonus for the revenue you helped bring in roughly up to the date you were laid off. And you’ve probably lost about 90 percent of your net worth in deferred compensation, most of which is typically in the stock of the firm. This hardly feels like a pat on the back.

If your bank survived, things might look a little better, but still not like happy days. Consider that the average surviving banks has seen a 20 percent revenue decline. If the pay of their managers were, in fact, more like commissions for revenue than bonuses for profits (which are now losses), then how much should their “bonus” drop? Reason would say, something like 20 percent. In fact the more senior managers who are typically paid based on a combination of revenues and profits are expecting to see their bonuses drop by 30 to 50 percent. That seems sensible in the context of how their variable pay is expected to vary.

But the fevered critics who benefit from inflaming the passions of ordinary Americans are saying that the banks preparing to pay their managers their greatly reduced commissions are “getting ready to reward themselves for a job well done.” And these banks are getting government investment, so how dare they pay their managers anything at all?

The implicit argument is that if the government becomes your partner, your revenue-based commissions ought to be retroactively scrapped. You wouldn’t likely to that to your own company, but that may be a reason you’d want to think hard about making the government your partner. Unless, of course, you had no choice.

The political pressure is now intense enough that the banks are having to confront it. They’re dealing with the fact that “some politicians contend that executives and employees responsible for fueling the credit crisis should now pay a steep penalty,” and these politicians don’t seem to think that a 30 to 50 percent decline in one’s pay is steep enough.

Naturally, I don’t see any of the politicians who significantly contributed to this crisis seeing a steep decline in their pay, or losing significant chunks of their net worth. But it’s easy for them complain, especially when the press is both egging on amplifying their complaints. The only business that congressmen need to run is the vote-getting business of channeling economic ignorance.