Bonus Derangement Syndrome

Posted by Marc Hodak on January 30, 2009 under Executive compensation, Politics | Read the First Comment

OK,  Wall Street collectively earned $18 billion in bonuses.

After the NY Comptroller’s report yesterday, BDS has come into full swing.  President Obama gave a wag of his finger.  Many in our anti-business media are piling on with psychobabble dressed up as analysis.  Now, the Davos clique, striving for relevance, is chiming in.  And check out how hot “b” can sound when enunciated by the babe in the MSNBC video.

The comptroller’s report itself did not contain the outrage it provoked.  In fact, it noted that the lack of these bonuses had a material impact on the ability of the state and city to finance public services, reinforcing the truth of what P. J. O’Rourke once said about the value of the undeserving rich:

The worst leech of a M&A lawyer making $500,000 (he wrote this in 1992) will, even if he cheats on his taxes, put $100,000 into the public coffers.  That’s $100,000 worth of education, charity or U.S. Marines.

What is shameful, I think, is the PR problem Wall Street has created for itself by mislabeling what it pays its producers as “bonuses.”  Wall Street, like any other enterprise, depends on its talent, such as it is.  And, like any other enterprise, the famous 80/20 rule applies–about 20 percent of its talent generates about 80 percent of its revenue.  Rather than pay all its talent equally, they give these people base salaries that would barely keep them in a small Manhattan apartment.  These folks need to earn up to their competitive level of pay through “bonuses” based on their production.  So, whereas most people in the country think of a bonus as something “extra” awarded for very good performance, on Wall Street most of these bonuses resemble commissions earned by a modestly salaried salesperson.  The I-banks like to call them bonuses because it sounds better to the employees they wish to attract and retain.

Unfortunately, it sounds the same way to everyone else.  The point is, no one familiar with how sales people get paid  would seriously think that paying them zero commission in a bad year makes sense (except, perhaps, Barney Frank).  Hey, the guy sold only half of what he sold last year, but he didn’t sell nothing.  He deserves his commission, which will add up to less than he could have made in a less risky compensation structure of mostly salary.

But all this outrage leaves out the most important point of any discussion of bonuses:  as long as someone has a their compensation at stake via a commission, bonus, whatever, they will perform better at the margin.  Wall Street had a miserable year.  Believe it or not, it could have been worse.  How much worse we won’t know until we eliminate all remaining incentives to preserve, if not earn, as much revenue as possible.  When you take someone off the incentive curve, however it’s labeled, they cease to care how many more billions go out the door and down the drain.

They become like congressmen.