Even though financial reform won't create any rules affecting Wall Street compensation, changes are coming. The Federal Reserve will provide rules later this year on how bank practices should better reward their employees based on long-term risk. But the new structure of compensation in anticipation of this guidance is already beginning to form, according to some polling by financial industry career networking firm eFinancialCareers.
First, there's the bad. As expected, many banks are increasing salaries, so to deaden the political consequences of handing out huge bonuses, while leaving total compensation nice and high. The poll found 46% of Wall Streeters have seen pay structures change since the crisis, with the most common novelty being a higher base salary. Of course, this strategy entirely misses the point, as it provides even less of an incentive to worry about long-term risk.
The firm asked financial professionals what changes they would find most palatable:
Financial services professionals spoke out on what is tolerable change in incentive compensation structures, with about one-third saying lack of bonus guarantees and adjusting for risk and capital costs were the two most tolerable changes, followed by bonus vesting over a period of time (20%), and bonus in the form of deferred or equity-related components (11%).
Interestingly, getting rid of one of the most pernicious pay practices according to Wall Street critics, guaranteed bonuses, might evoke the least anger among bankers. Not surprisingly, they don't want to be paid with more of their firm's stock, however. That's understandable for two reasons. First, they likely still have a pretty sour taste in their mouth from the stock they were paid with prior to the crash that hasn't fully recovered. Second, they probably prefer not to be compensated based on other people's work. If the trading group has a bad streak next year, and the firm's stock suffers, should a guy who tore it up in mergers and acquisitions this year be penalized due to a deferred stock award?
Wall Street firms are also anticipating the increased influence that risk managers will have going forward when it comes to compensation. Presumably, the idea would be that a risk manager will consider whether there are any potential future negative repercussions to the revenue associated with each employee's work. For example, if you brought in $5 million in fees for originating subprime mortgage-backed securities, you might not be compensated the same as a guy who generated $5 million in fees by underwriting an equity offering for General Electric. This is a positive development, as not all revenue is attained through activities that produce the same amount of risk for a bank. In the years to come, pay will reflect any disparity.
But perhaps the most amusing statistic was:
And not surprisingly, 70 percent of respondents didn't believe their most recent bonus accurately reflected their contribution to the firm.
If you know much about Wall Street, then this isn't a shock. Banks pay their employees with an upside-down pyramid methodology. The top gets an incredibly huge sum of money, while the bottom gets comparably very little. Meanwhile, the quantity of work is handled on a right-side-up pyramid structure. The lower on the totem pole you are, the more work you do.
To make matter worse, it's no secret how much in fees your group collects. So even if you're a Vice President who gets a million-dollar bonus, you know that your effort helped the firm earn many times that during the course of the year. Your $1 million annual award might have been part of a pot of $25 million in revenue earned through the effort of only a handful of employees. Of course, the bank has an enormous overhead, has to pay for its capital, and must provide income to shareholders. Add to that executives' belief that their client relationships deserve a lot more credit than the underlings' hard work, and it all sort of makes sense. If you're non-client facing support staff in a group like operations or technology, then your compensation is even lower.