Bank Executive Compensation: Payback

Bankers’ pay is a complex subject that arouses simple emotions.

“The villagers are at the gates of the castle with burning torches,” says one compensation consultant. The sheer amount that bankers are paid riles people at the best of times. When the economy is ravaged and the source of the trouble is banks themselves, the pitchforks come out. Politicians on both sides of the Atlantic are gleefully grilling bankers on pay. New York state’s attorney-general has reportedly issued a subpoena to Bank of America demanding data on its most well-rewarded employees. A penitent Peter Wuffli, ousted as UBS’s chief executive in July 2007, has returned SFr12m ($10m) in bonus entitlements to the Swiss bank.

Bankers are desperately trying to placate their critics. On November 16th Goldman Sachs, which kicks off the bonus round when it reports its full-year results next month, announced that its top executives would forgo their bonuses this year. Executives at Barclays, Deutsche Bank and UBS have done the same, even though the first two have avoided government injections of capital. Others will follow.

Reining in the pay of senior management is arguably the easiest problem for banks to solve, however. The real headache, politically and commercially, is how to compensate people below the management suite. These employees absorb the bulk of the bonus pool. Goldman’s top brass may go without this year’s payout, but the bank had still reserved $11.4 billion in the first nine months of its fiscal year for total compensation.

Never mind that this number was roughly one-third down on last year’s equivalent totals, and that headhunters expect most banks’; bonus pools to shrink by around 50 percent. Never mind that these employees have little control over the overall direction of the bank, or that the people who took the most calamitous bets in areas like subprime mortgages cleared their desks last year. Nor that bankers’ base salaries are low relative to other professions and that they have suffered heavy losses by holding shares in their employers. Paying out billions in bonuses will still look awful. Worse, many expect the ratio of compensation to income, which normally hovers just below 50 percent, to balloon in 2008 as banks’ revenues fall faster than their pay bills. Banks may also end up giving out more cash than expected: so far have share prices fallen that firms will have to issue many more shares this year to reward people with equity, risking yet more dilution of bruised investors.

Not unreasonably, some ask why bankers should get a bonus at all after a rotten year like this. In truth, many will not. The distribution of bonuses will be skewed towards top performers, leaving little or no money for those in the lower quartiles. That will be difficult for the banks to communicate, says Vicki Elliott of Mercer, a consultancy. In normal times, missing out on a bonus serves as code for “brush up your cv.” But that will not necessarily be the case this year.

Bonuses will also be unevenly distributed between different parts of the banks (see chart). Lots of divisions are still delivering decent results. Bankers in high-volume, low-risk “flow businesses,” such as foreign-exchange trading, are reporting record demand, for example. Others, such as prime brokerage, may have fallen away steeply in the past two months but brought in plenty in the early part of the year.

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