[Mb-civic] Bankers' pay (FT)

[Alexander Harper]

Poor things - one's heart bleeds for them. I look forward to seeing Cheeseburger springing to their defence.

Al Baraka

A serious question for all the overpaid bankers 
>By Frank Partnoy
>Published: August 3 2005 20:41 | Last updated: August 3 2005 20:41
August brings the annual running of Wall Street bankers to the Hamptons and southern France. Historians will record how these pillars of society – just like the Medicis and Morgans of yore – gathered in happy flocks for recuperative play, and to contemplate the grand questions of our time.

Well, maybe not. At least there will be flocking, and epic play, just as there was when I worked on Wall Street a decade ago. But the grandest topic most bankers will discuss this month – even as their companies face lay-offs, lawsuits and a less friendly US Federal Reserve – is how much money they should make this year.

So, in the interest of stimulating at least a few high-minded conversations at the beach, I would like to put a serious question to bankers, one that I frequently asked my former colleagues at Morgan Stanley (but never received a good answer to): why do you make so much money? The most common response might go something like: “I make so much money because I add so much value. I generated $50m for the bank last year, so I deserve at least $5m. If I didn’t get it, I’d quit – a competitor would pay me even more.”

Perhaps. But managers in other industries are more sceptical of employees claiming credit for revenue. A scientist who invents a new drug typically does not receive a share of sales. Nor does an oil executive who negotiates a new contract. Of course, many employees are paid commissions, but banking bonuses are different: they are purely discretionary and come from a pool based on the bank’s revenues.

A more plausible answer is that bankers do so well because they keep money that other companies would give to shareholders. According to the New York Office of the State Deputy Controller, in the past four years, securities firms in the US paid $7bn more in bonuses than they made in profits, $3bn more in 2004 alone. Goldman Sachs paid employees almost $10bn last year. And compensation stays high even when profits are down.

J.P. Morgan last month slashed its net income for the second quarter after admitting to some bad bets. But in the same period, it paid employees more than $4bn, as it has in each of the past four quarters. On average, shareholders got just $1 for every $4 paid to employees.

The battle between shareholders and employees reflects the separation between ownership and control of companies. In general, shareholders, not employees, have the residual claim to a company’s income. But that notion is reversed in banking: employees decide how much shareholders will receive, and then keep the residual. Although bankers generally are a conservative lot, they actually could be poster boys for the left, as well as for the labour movement. No other industry asks shareholders to take on the bulk of risks, while it gives half of all revenues to employees. Indeed, no other industry serves employees better, at the expense of shareholders.

Ironically, a road map for shareholders seeking better returns might be the recent pay scandal at Morgan Stanley. Most people were irate at Morgan Stanley’s board for agreeing to pay Philip Purcell, the outgoing chairman, $62m of deferred compensation plus a year’s pay. And they were even angrier about a deal with Stephen Crawford, the 40-year-old newly anointed president, who secured a contract saying he would be paid $32m even if he quit within a month. (Not surprisingly, he resigned 11 days after signing the deal.)

Was this anger justified? Cosmetically, the numbers seem appalling. No one who does a shoddy job of running a company should be paid $62m. And it could not possibly be worth $32m to pay someone to quit.

Yet as bad as these deals looked, they were good for shareholders. When Morgan Stanley released Mr Purcell’s resignation letter, its shares rose about $1 each; in the same period, other bank stocks were down. On July 11, when Mr Crawford’s resignation was announced, shares rose about 50 cents; at the same time, other bank stocks were mixed. Of course, these increases do not reflect well on these men – the markets obviously thought Morgan Stanley was better off without them. Still, kicking them out increased the value of shares by more than $1bn. If mistakes were made with Mr Purcell or Mr Crawford, it was when they were hired and promoted, not when they were forced out. Their severance deals were in line with Wall Street averages and were scrutinised by top New York lawyers.

The real scandal is not about excessive pay for these two men, but about excessive pay for almost everyone else. Even when banks pay employees in shares, not cash, it dilutes the stakes of non-employee shareholders. If these shareholders thought hard about the business model of banking, they would fight to persuade boards to cut staff or at least pay them less.

Bankers who complained about Mr Purcell might reconsider whether his ouster was part of the problem or part of the solution. They should contemplate what would happen if they were fired and the details made public: would the bank’s share price go up or down?

At least part of the reason bankers make so much money is that they take it from shareholders, who would be better off without so many overpaid banking employees. Most bankers know they are not pillars of society, with grand thoughts or profound answers. Their next-best job, if any, would pay only a fraction of their current compensation.

Banks soon will face the constraints other industries have confronted for decades. In this holiday season, bankers everywhere also should know that as intimidating as the water might look, the real threat is not from sharks, but from shareholders.

The writer, who is currently on holiday in Cape Cod, is a professor of law at the University of San Diego and a former banker at Morgan Stanley. He is author of Infectious Greed: How Deceit and Risk Corrupted the Financial Markets (Henry Holt/Profile)
 
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