Bankers, Bonuses And Baseball

Over on his Reuters blog, Felix Salmon has a post today about why he believes banks should not poach talent. He says that, even if you look beyond the claim that social ills might follow bankers getting huge guaranteed bonuses, the practice fails miserably anyway from a business strategy standpoint. I see where he's coming from, but I think we might as well broaden the question in order to look for an alternative.

First, I don't want to get into the debate of whether or not there are social problems with large guaranteed bonuses. Instead, I'll just say in passing that I don't think there necessarily are so long as firms are allowed to fail. The problem we're having related to giant guaranteed bonuses really stems from the government protecting firms that take part in this practice.

What I would like to get into has to do with an interesting quote from Jeffrey Pfeffer, via Salmon:

When a company hires a star away from another firm, the star's performance falls (46 percent of the research analysts did poorly in the year they switched jobs and their performance remained lower even after five years), there is a decline in the performance of the group the star joins, the market value of the company hiring the star falls, and the star doesn't stay with the new employer for very long...

Having worked at a bank, I've certainly seen this phenomenon in action. There are several poached bankers I witnessed who stayed as long as their gigantic guarantees lasted for, made the bank tragically little money, and then went elsewhere. In my experience, however, they were the exception and not the rule.

I wonder if there could be a sort of adverse selection going on in Pfeffer's 46% statistic. For example, maybe some analysts who are more apt to flee to another firm for a new big contract are actually not that talented after all. If they were truly brilliant, surely their prior bank would not have let them leave, and given them a lofty counter offer. Their current firm certainly would be a better judge of their talent than the hiring firm. That they wouldn't want to retain these employees seems suspicious.

The solution, says Salmon and Pfeffer, must be to grow talent organically, rather than try to buy it from outside. I think that's definitely a better alternative for the reason I just explained. You might be hiring a lazy guy who interviews well. But in reality, his resume may have been built up more by smart, hardworking people around him than his own efforts. We've all seen that guy in action around the office. We cheer when a competitor ignorantly lures him away. But if you have an organically grown superstar, then you know you're dealing with real talent.

Yet can banking, or really any industry, really ignore talent and not bother trying to acquire it from competitors?

When thinking about this question, I can't help but relate it to my favorite sport: baseball. I also can't help but think of my favorite team: The New York Yankees. They show why Salmon and Pfeffer are both right and wrong. The Yankees serve as the prototypical example of buying talent. They're often criticized for it by their opponents. (But I should add that those opponents often fail to realize that the Yankees also have a very strong farm system to produce organic growth.)

First, baseball shows why Pfeffer is right: free agents often fail to meet the huge expectations placed on them after signing fat contracts. Just ask the Yankee's Alex Rodriguez.

But it also shows why Pfeffer is wrong: find me a team out there who would not like to have Rodriguez or other high-priced Yankees talent on its roster. Maybe not a the price the Yankees pay, but virtually any team waking up after dreaming they had the Yankees' talent would characterize the dream as a pleasant one -- not a nightmare. After all, the Yankees win an awful lot of games with their poached talent. Even though the talent doesn't always measure up to what the team hoped, even watered down it often creates a very strong team. Perhaps that's because Pfeffer's 46% statistic is still the minority -- the other 54% don't perform worse than expected.

I still think guaranteed contracts are a problem, however. Because baseball shapes my view when it comes to big contracts for talent, I have a similar view of how banks should handle contracts to how I wish baseball teams would: make them merit-based. Put enormous performance-based incentives in place to attract talent, rather than guaranteed payouts. I think that's against the players' union rules, but there is no investment bankers' union to my knowledge. Yet.

Let's apply this to Alex Rodriguez. I think he makes around $28 million per year. Let's say the Yankees want him to hit 50 home runs every season. They could instead structure his contract to pay him $500,000 for every home run he hits. That way, he'll be motivated to exceed even his team's expectations, but still potentially make a lot more than he would on any other team if he just plays like he always has. This is a simplistic example, but I'm sure you get the point.

Any truly talented individual who plans on working hard should love the idea of an incentive-based contract like this, and that includes bankers or traders. It should also be enough to lure them away from their current firms, if by meeting reasonable expectations, that banker makes whatever the guaranteed contract would have been.

In his blog post, Salmon broadly asserts that it's a bad idea for banks to poach talent. I disagree. While growing organic talent may be ideal, the idea that talent should be irrelevant in the labor market seems too bizarre to comprehend. The trick, as I explained, is to poach talent in such a way that forces new workers to produce at or above the new firm's expectations. I completely agree with Salmon that guaranteed bonuses fail to do that, but for firms to ignore talent entirely would throw a wrench in our capitalist system.