Killing it like a hooker in Hong Kong

The banker’s comp uproar

The FT, this morning has another  op-ed, this by William Cohan, the author of the Lazard history, arguing that regulators should step in to regulate banker’s pay. This is the same line of attack that Raghuram Rajan has been taking.

The reasons given are the following:

1. Bankers take risks with shareholder money, are rewarded when things go right, but don’t pay a price when things go wrong.

2. Pay should be contingent on longer term outcomes of deals and loans.

3. If all the banks do it, then the big fear that they will lose top talent to competitors is unfounded. Where else would banker’s earn what they do?

Underlying all of this is a belief that bankers are paid more than they are worth anyway, and the industry is due for a correction in wages.
While I do think banker’s are overpaid, and I do agree than long term comp should be tied to results of deals, I doubt that the regulation remedy will be effective.

Firstly, bankers already do have downside when things go badly. Base pay at a bank for a director is about US$150k. Bonus for the average MD is about US$1 mil. In a bad year, when an MD is not paid a bonus, he bears the opportunity cost of not working somewhere else where he would have been paid that bonus. And US$150k does not go far in most financial capitals.

Secondly, bankers are currently underpaid. That’s right. A survey of graduates at any business school will tell you that everyone wants to work at a hedge fund. Guys who stay long term at banks these days consciously make a decision to give up the opportunity to make more money in return for a more stable career. This is a risk return decision. If you look at the job opportunities available to intelligent, highly educated A-type personalities it would read:

Private equity, hedge fund, investment banking, management consulting followed by a senior corporate position, Senior corporate position, entrepreneurship

Each of those professions has a different risk return curve, but all of them have high absolute levels of compensation. Pay bankers less, and they would move to professions where they would be paid more.

Longer term compensation structures may end up costing more to shareholders than the current system.  If you pay someone a percentage of profit on a deal, and it’s written into a contract instead of being discretionary, then you may end up getting some truly amazing comp structures especially for the outperformers. Are you really ready for billion dollar payouts to individuals? Because that is what will happen with deferred payouts. A single guy in a bank who made the right decision at the right time may walk away with more than the entire 10,000 employee pool. The employee pool at a bank is like a store of out of the money call options. You pay the option premium with the hope than a few of those options convert in any one year and massively pay you. But the guys who are always in the money will demand and get more and more of that premium.

Finally, regulation will bring with it both transparency on pay and better protection for employees. This is going to be horrible for bank shareholders. Opacity rewards those in possession of better information, and currently bank HR departments have much better information than their counterparties: the bankers. Better protection for employees will result from them being able to take banks to court if they are not in line with regulation, which is different from the current arbitration system where a panel of people with vested interests in keeping payouts low adjudicates. This will be horrible for bank shareholders, as the amount of dirty laundy to be washed in court will be immense.

At the end of the day, only junior bankers really need banks to gain experience and build reputation. Senior bankers can usually bide their time till they can write their own ticket somewhere else. And people hate getting insulted by being paid less than they think they’re worth on an order of magnitude.  See Mark McGoldrick

May 2, 2008 Posted by | Uncategorized | , , | Leave a comment