Tuesday, March 6, 2012

For the Fortunate Few: Comp Packages

Bonus season at financial institutions has come and gone. Yet for the month or two afterwards, there is the inevitable aftermath, the ruminating over what happened and the pondering over whether lucrative payouts in years past will ever reappear.

In the post-crisis financial industry, where many just feel fortunate to be employed, there will still be some degree of anger, frustration, or disappointment in payouts. Many yearn for the times of the 1990s or the early 2000s.  Most know the industry is still enduring a shake-out or a re-engineering of sorts, and compensation is a candidate for shake-out, too. 

Handsome compensation packages still exist in certain segments, perhaps most prominently at venture-capital firms, private-equity companies and hedge funds.  Even in 2012, you can read about insane, mind-boggling bonuses, likely because someone made an insane, mind-boggling hedge-fund trade.  Payouts at banks, investment managers and other financial institutions (or in general finance roles) still appear to be attractive to some, even if they have slipped to pre-2000 levels.

Financial institutions, however, are trying to be more creative. More than ever, they are tweaking the structure of compensation packages--more stock, less cash, some options, and even some distressed debt or arrangements with "claw back" features (where employees are required to return promised payouts if individual or institutional performance reverses itself).

In this post-bonus season in 2012, reports are widespread about the reduction in payouts or the clever structures of packages.  Morgan Stanley, for example, capped cash payments at $125,000. Credit Suisse and others transferred certain structured bonds or mortgage securities from their spruced-up balance sheets into the pockets of some senior managers.

The structure of comp packages depend on market and peer practice and institutional performance, but they also depend on experience levels and individual performance.  Accounting rules, impact on overall ROE and long-term corporate issues are also factors.

Senior bankers and traders are more likely to be awarded packages that include restricted stock, deferred compensation and/or options.  More junior personnel (analysts and MBA associates, e.g.), still with little leverage, will have less say-so and may be awarded all cash or some stock--whatever is rationalized by senior management at the time.

If you are a finance professional and if you are lucky enough to receive a comp package, what would you prefer? From the list below, what is the optimal structure for the firm and for you, no matter whether times are good, bad or so-so?

1.  Cash
2.  Cash and options
3.  Cash, options, and restricted stock
4.  Cash and deferred compensation
5.  Cash and debt securities

 Over the past two decades, there have been variations.  Recall the dot-com era, the explosion of Internet businesses and stocks.  In the late 1990s and early 2000s, some financial institutions awarded bankers and traders stakes in venture funds, start-up companies or leveraged investments.  More firms today are exploring debt compensation.

Two Wharton researchers argue comp packages should include debt securities issued by employees' companies. (See Wharton Research:  Alex Edmans, Qi Liu)  They argue that senior managers should behave like owners to maximize returns, but also behave like debt-holders who, because they aren't promised high returns, are more careful about managing and controlling risk.

As debt-holders, managers at financial institutions will be more apt to manage businesses within more comfortable risk bands. A payout, for example, of 80-percent stock and 20-percent debt makes sense.

Younger professionals usually prefer cash, partly because they need it.  Experienced bankers, traders and managers sometimes prefer cash, because they contend they can manage the cash better and more suitably for themselves than the employer.

In the dot-com era, younger professionals (including analysts and MBA associates at prominent firms) actually demanded it, or they threatened to leave finance for opportunities in technology.  And the bulge-bracket firms at the time obliged.  This same segment has less leverage today, but will likely still be paid minimally in stock holdings.

All the world knows, if the company is expanding and growing and has a bright horizon, then packages adorned with options and stock are welcome.  If the company has stumbled or is struggling, employees will shirk equity that will likely decline, although a cash-strapped company will tend to award just that because cash is necessary to stay viable.

Deferred compensation and options are unattractive when the company's prospects are failing. Options over time can expire worthless. And institutions sometimes go bankrupt (Lehman, e.g.), at which time deferred comp becomes just another debt claim.

For the newer MBA associate or first-year vice president at stable institutions in stable industry segments, non-cash compensation is not as bad as it sounds when managers hand over the envelope with "the number."  Non-cash comp comes with restrictions and requires patience, but there are advantages (although sometimes hard to see when you are just starting out):

(a) The upside tends to be greater in the long term.
(b) And yes, it can be a disciplined savings plan for those who haven't yet begun to appreciate the values of long-term investing.

Tracy Williams

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