Today, Senator Claire McCaskill of Missouri introduced legislation that would limit salary, bonus, and stock options for executives as financial firm recipients of bailout funds be limited to the President’s level of pay, currently $400,000.
McCaskill’s proposal is likely to go all of nowhere. She is not a member of the Finance or Appropriations committee, so her proposal is more a shot across the bow than a serious initiative. And given that “executive” is generally defined as the five most highly paid corporate officers, the ones whose remuneration is listed in the proxy statement, it covers only a trivial number of employees.
But her bill is getting a lot of media coverage, which means it could serve as a starting point for negotiations. It has become a benchmark as far as the public is concerned.
So how reasonable is it? The problem is that too few people in the industry have any memory of what bad times were like, and the last few years were so grotesquely rich (in terms of pay, not risk adjusted performance) as to have distorted industry participants’ sense of reality. The pretext for the largess was that the really good people would decamp to hedge funds, so pay had to be ratcheted up to those levels (John Whitehead, former co-chairman of Goldman, dismissed that idea when the bubble was at its peak).
Bear in mind: the bonuses paid in 2008 in New York, when all the big domestic players and most of the large foreign firms (who constitute the bulk of employment) were on government life support, were the roughly the same as in 2004, which was a good but not stellar year. I’m not certain of the headcount differences then versus now; with the loss of Bear, Lehman, and a lot of headcount cuts industry-wide, I doubt that employment is much above 2004 levels.
Since people are generally not too open about pay (and tend to exaggerate to boot), I have only a couple of datapoints, but I think they are germane. Anyone with relevant info from the last downturn is encouraged to speak up.
The dot bomb bust was bad on Wall Street. To give an idea: I went to see a friend in the search business in 2002 to get his insights about a company he knew. He had two neat stacks of unopened letters on a credenza behind his desk, each roughly 2 feet high. I asked about them. He explained he was getting an enormous amount of letters from job-seekers (and mind you, his was a very small firm). He didn’t bother opening them, since he knew or could find plenty of good people and employers preferred to hire the employed over the unemployed. The letters were from unknown quantities and there was no reason for him to try to weed through them.
So why did he keep them? In case someone connected called him to ask him if he had received the resume of his good buddy. Then he would dig through the pile and give it a (usually obligatory) look.
One of the hard hit businesses was mergers and acquisitions. Keep in mind that M&A is a fee business; the professionals do have overhead (salaries, travel, secretarial, computers and software, access to databases) but they don’t use capital and they require less infrastructure than trading operations (which have trading stations, data feeds, lots of software and valuation modes, risk management, sales forces, back office). Now admittedly, in boom cycles (the late 1980s and the last few years) Wall Street messes up this nice model and decides to try to gain a leg up in M&A by risking its balance sheet (committing to lend to fund deals). That always leads to ruin. But that gets reined in during bad times, so let’s think of the traditional, high wits, low overhead version of the business.
I’d welcome any other inputs, but the people I knew in M&A (senior MDs running what had been high profit industry groups, so the top of the food chain in that business) were cut back to $400,000. And they were unhappy but not disappointed, if you can appreciate the distinction. They of course hated that they had to keep trying to do business when there was no business to be had. Tilling a field during a drought is not pleasant. But they were grateful to still have a job, to not have been demoted, and knew intellectually that their pay was fair in light of current conditions.
Assume 3% inflation. Compound $400,000 forward to 2009. You get roughly $500,000.
M&A is a talent business. You need pretty highly developed skills to master the technical aspects and be credible with CEOs. The top people can and do set up or join boutiques (although some recent ones overlarded with talent, like Perella Weinberg, haven’t done as well as the older boutiques, like Greenhill & Company).
Traders will argue that level is too low, that if they make $30 million for someone, they deserve a bigger cut.
No dice, Unless you are willing to pay back your share of losses, I don’t accept the logic that you are entitled to a asymmetrical pay deal. You may have been lucky enough to extract that, but what you can get in good times (or from chumps) and what you deserve in a more abstract sense are two different things. You are playing with other people’s money, and that carries with it substantial responsibilities (or at least it should, but management heretofore has been complicit in pretending that it doesn’t).
Warren Buffet, in his reinsurance business, had a simple formula: his execs got a pool of 15% of the profits on deals written 5 years earlier, ex any losses on the same pool. Five years was long enough for the vast majority of deals to prove themselves out.
I could see a variant of that formula for traders. Say you do make $30 million in profits in year one. You get a salary and only 1/10 of your cut that year in cash. The rest is deferred. Any losses in years 2-5 get deducted (the deferred portion can be invested in a high or low risk manner at the choosing of the trader, so there would be some income on the deferred amount) Any remainder is paid out.
Now that would take some tweaking (t creates an incentive for a trader having a super year to change firms, for instance), and there may be better ways to achieve the same end, but you get the drift: you can’t have people who take serious risks with capital enjoying “head’s I win, tails you lose” arrangements. Either they rewards have to be reined in substantially so they have less reason to take big gambles, or they need to share more in the downside.
The threat to contain pay is serious enough that Wall Street may have to find a way to deny its reflexes and exercise restraint. This is going to make for some interesting theater.
Babe's Ghost 
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now what, pray tell, would that do to GDP?