Explaining Guaranteed Bonuses

The New York Times today has yet another article about the troubles of President Obama's pay czar, Kenneth Feinberg. In it, the Times explains more of the same: that he is going to have an uphill battle in dealing with guaranteed bonuses at the large banks. I've already written several times about Feinberg's challenges in dealing with this problem. I thought it might be helpful, however, to explain guaranteed bonuses, and what banks are thinking in promising enormous sums of money to employees before performance has occurred.

Before delving into a comment about the Times' piece in particular, I think it's important to begin with an understanding of what a bonus means for those on Wall Street. It's not like a Christmas bonus, or other occasional bonuses, that most Americans might be fortunate enough to receive. Imagine, for example, if your Christmas bonus were 50% to 80% of your annual pay. So if you currently make $50,000, that bonus would be $25,000 to $40,000, where your salary would only be $10,000 to $25,000.

The term "bonus" is something of a misnomer on Wall Street. The bonus culture there began as a way in which to encourage people to work their hardest. Linking compensation to performance is certainly not a novel concept, but on Wall Street, they took it to the extreme. Over the past few years, however, it has become clear that bonuses are not nearly so linked to performance. As I pointed out a few weeks ago, 2008 showed healthy bonus levels even though the banks almost all failed.

The reality is that Wall Street jobs have become so competitive that sort of minimum total compensation levels (salary plus bonus) have gotten much higher, but base salaries have not. As a result, sort of minimum bonuses are now generally accepted to be well above zero, despite the counterintuitive result, given the widespread connotation of "bonus."

Consequently, it should not be surprising that so many banks have begun increasing their base salaries. First, it more realistically captures minimum compensation levels in the banking job market. Second, it quells public outcry, as bonus numbers will proportionally decrease. The problem, of course, is that it completely fails to address the problem that bothers so many Americans: that bankers can make millions of dollars despite terrible bank performance.

Up to now, I've been talking more about bonuses in general than guaranteed bonuses, which is what I set out to do. I think that introduction was necessary, however. So now let's go to the Times' lead paragraph, which includes a common misconception:

A guaranteed bonus might strike many people as a contradiction in terms. But on Wall Street, banks have become so eager to lure and keep top deal makers and traders that they are reviving the practice of offering ironclad, multimillion-dollar payouts -- guaranteed, no matter how an employee performs.

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.

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