Did someone say “Greed is Good”?

Posted by Marc Hodak on February 8, 2009 under Executive compensation | Read the First Comment

Man, I bet NYU colleague Roy Smith is stewing about that one.  He wrote a terrific article explaining that you can’t argue in favor of pay-for-performance on Wall Street, then scrap its bonus system altogether, if only for senior managers.  Roy doesn’t use the word “greed” anywhere in the article, yet the WSJ editors entitled his piece “Greed is Good.”  Unfortunately, us writers have no say in the inflammatory headlines they give to our articles in order to sell their papers.

Anyway, here is a great insight offered by Roy, who himself was once a Goldman partner:

Henry Paulson, when he was CEO of Goldman Sachs, once remarked that Wall Street was like other businesses, where 80% of the profits were provided by 20% of the people, but the 20% changed a lot from year to year and market to market. You had to pay everyone well because you never knew what next year would bring, and because there was always someone trying to poach your best trained people, whom you didn’t want to lose even if they were not superstars.

In other words, if you have someone very talented working for you, someone who can make your firm tens or millions or hundreds of millions (or more) in a good year, then even if this wasn’t a good year for them, you may still want to pay to keep them around.  It might not look good to a casual outsider, but you’d be a fool not to.

This insight is followed by my favorite line in his piece:

Warren Buffett, when he was an investor in Salomon Brothers in the late 1980s, once noted that he wasn’t sure why anyone wanted to be an investor in a business where management took out half the revenues before shareholders got anything. But he recently invested $5 billion in Goldman Sachs, so he must have gotten over the problem.

The point being that when smart people see what’s really going on, they understand how and why the situation has evolved the way it has, and can better appreciate how radical remedies may cause far more problems than they solve.  Maybe that’s why the closer one gets to a subject, the more conservatively they tend to view it.  I have seen this transformation many times (including with myself).