Changing Wall Street's ethos as Citigroup looks at alternate compensation

In the face of TARP restrictions on executive pay, Citigroup is considering several ways to generously compensate its highest-earning employees. Ranging from increasing base salaries to offering commissions to spinning off successful divisions, the company's goal is to find ways to retain the most effective employees, many of whom will be lured by other banks that are able to offer more money.

On Wall Street, the question of executive compensation is directly linked to survival, as the brain drain caused by superstar employees running for the hills could delay recovery efforts. Some banks, including Goldman Sachs, are exploring ways to rapidly pay off their TARP debt in order to escape the government's restrictions on executive pay. Most, however, will continue to owe the government for a very, very long time, which means that they will either need to pay their executives less or will have to find alternate forms of compensation.

The problem with executive pay is, at least partly, one of perception. As University of Chicago finance professor Raghuram G. Rajan puts it, the worst case scenario begins with the best employees jumping ship in order to get larger salaries. In this scenario, TARP banks, with their federal dollars and mandated salary caps would have more money to invest, but less talented leaders. Meanwhile, the best financial talents would be working at non-bailout banks, where they will have fewer resources, but much larger salaries. Ultimately, this situation would limit the effectiveness of the most talented money men while maximizing the effectiveness of the most mediocre.

This perspective, which seems to dominate Wall Street thinking, has several shortcomings. The first is historical: if the best money men were really as fantastic as their salaries seem to suggest, then it seems strange that they didn't see the financial meltdown coming. On the other hand, if they did see it coming (which seems more likely), then many of them gamed the system for short-term profit, assuming that they would be long gone when it blew up. This system, which Jonathan A. Knee calls "IBG-YBG," or "I'll be gone, you'll be gone," is unethical at best, and criminal at worst. More to the point, it's basically why Wall Street has crumbled. Any company looking toward its long-term welfare would probably avoid these guys like sushi at McDonald's.

The second problem with the Rajan scenario lies in basic accounting. A company that spends all its profits on gargantuan compensation packages for financial superstars is not putting money into investments, reserves, and other areas that are central to its continued health. A thoughtful investor would probably want to think twice about entrusting his or her financial future to a Wall Street cowboy, particularly when there are safer, more conservative options available.

The biggest problem, however, lies in loyalty. Underlying the IBG-YBG perspective is a larger perception that bank employees are, essentially, independent contractors. This, in turn, suggests that they are obligated to engineer a massive payday and move on to the next job. Ideally, banks and their employees would start to move back toward a model of more long-term loyalty on both sides. If employees viewed their companies as more than pit-stops on the way to billionaire-hood, then they might be inclined to plan for the long term. For that matter, if banks perceived their executives as more than high-paid ringers, then they might be willing to grant them more time and leeway to effectively steward the institutions. This would mean looking past momentary downturns to long-term performance metrics.

The first step toward this is to rearrange compensation so that more of it comes from base salary and less comes from bonuses. In 2008, the median base salary of an S&P CEO increased by 3 percent, suggesting that this process might already be underway. This process would make compensation more transparent, increasing shareholder trust; moreover, it could also push executives to make decisions that benefit the long-term health of the company. After all, if the continued prosperity of an executive is based on the continued health of his company, then he will be far less likely to damage it in the pursuit of a quick payday.

While many on Wall Street view the magnificent paydays of the early 2000's as a basic function of big business, they are actually something of an historic anomaly. With any luck, the next few years will bring a return to the thoughtful, steady business practices that originally made the world of finance such an attractive target for looting.
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