Wall Street bonuses- skewed against shareholders?

Goldman Sachs will be handing out huge bonuses even in what is a miserable year for Wall Street. No question, Goldman has done well. It has hedged subprime risks, has reported healthy profit for the third quarter and is expected to do well in the last quarter as well. Enough reason for its CEO to walk away with something in excess of the $54 mn he earned last year.

But people at the top at Goldman know that huge payouts in times such as these are bound to attract hostility. They have sought to preempt it by announcing the creation of a charity, Goldman Gives., to which senior executives will contribute a part of their compensation. Each contributing partner will have his or her own account in the charity and will have say in determining beneficiaries.

In this, Goldman people are doing what the Narayana Murthys and Aziz Premjis have done long back as also Bill Gates and Warren Buffet (although both Gates and Buffet seemed to need some prodding). It helps if you are seen to give back to worthy causes; it also helps if you are seen to have a not very flamboyant lifestyle.

The problem arises with bonuses at firms that have not done well. How do you justify bonuses at firms that have seen an erosion in shareholder value? I address this in my latest ET column, Sorry, you can't touch my bonus.

There are two reasons why Wall Street might think this is justified. The first is that variable pay is a big piece of compensation on Wall Street - and this has to do with individual, not firm performance. If you don't have variable pay, then base pay will have to go up - and Wall Street firms would like to avoid that. The second reason is that performance is easilly measurable unlike in non-financial firms.

Fair enough. However, in financial firms, including banks, there is an issue of rewards not taking into account losses to the firm down the road. Firms pay when the individual performs but don't expect him to pay back when he inflicts losses on the firm. This does seem to be a problem given the scale of bonuses.

True, stock options that vest over a longish period go some way towards addressing the problem. But several problems remain. What if options vest in the third year and the individual
causes a loss in the fourth? What about payments that are made in cash? And what about rival firms taking care of options that are yet to vest when they poach a high performer?

Banks and investment banks are highly leveraged and banks enjoy a security net at the expense of the taxpayer. High leverage can result in high returns to equity and high bonuses when the going is good. It can result in bankruptcies when the going is bad. Incentives in financial firms seem to be skewed in favour of the individual and against the shareholder. The problem needs to be addressed.