The Wall Street Example: Bringing Excessive Executive Compensation into Line

Article excerpt

The market is up, and the CEO is rewarded with a huge compensation package. The market is down, and the CEO is rewarded with a huge compensation package. There's plenty wrong with this picture, not the least of which is the lack of any link between pay and performance, and the absence of any long-term performance measures. This author, a recognized expert in executive compensation, has several excellent suggestions for changing the picture.

Executive compensation at Wall Street investment houses encapsulates most of the problems surrounding excessive pay, as well as contributing a few of its very own. In this article, I will attempt to identify the key problems with executive compensation in firms both on Wall Street and in corporate America, as well as offer several solutions.

The three key problems this article will address are:

* excessive pay levels

* poor links between incentives and company performance

* total lack of long-term performance measures.

1. Excessive compensation

The classic justification for high pay anywhere is that compensation is driven by the market: How can one company pay its executives less than its peers without incurring recruiting and retention problems? This too is the mantra on Wall Street, where pay peer groups range from the 50 largest U.S. companies (Goldman Sachs) to a small group of other investment banking and financial services companies (Merrill Lynch). The pressure on pay levels is pretty strong from both of these groups and the results of that pressure can easily be seen (see Table 1). But in the case of the investment banks, internal differentials - pressure from highly paid employees below senior management levels can drive executive pay even higher.

While base salaries are generally low, they comprise a very small proportion of total compensation. As the Merrill Lynch 2004 proxy indicates: "Under the Merrill Lynch approach, like that of many investment banking/financial services firms, base salaries by design represent a relatively small portion of an executive officer's total compensation." Most of a Wall Street executive's pay consists of incentive payments of one kind or another. Similarly, this is where the pressure arises from internal differentials, as the level of bonuses for many Wall Street employees, not just executives, can be substantial. According to the office of the New York City Comptroller, an estimated $10.7 billion in bonuses was paid out to securities employees in 2003. While this was divided among more than 160,000 employees, it is safe to say that some of those employees received bonuses that put their annual compensation close behind that of their bosses. Given these undoubted pressures, it is only fair that the CEOs of the six securities firms that have reported so far this year should have earned between $21 million and $54 million in 2003.

Fair from what perspective, exactly?

In the last two years, these six firms have been fined a total of $1.4 billion for publishing allegedly biased research; the grandson of Sanford Weill, the former CEO of Citigroup, was admitted to the 92nd Street Y preschool in exchange for a more favorable analyst report on AT&T, and several of the firms were involved in at least two of the biggest financial collapses ever, Enron and WorldCom (now MCI). None of the executives admitted any personal liability, and any and all fines were paid ultimately by the companies' stockholders or the stockholders of the relevant insurance companies. Yet, by the end of 2003, the CEOs of the six largest brokerage houses that have reported so far are among the top 25 highest-paid CEOs in the S&P 500. Indeed, three of the banks - Citigroup, Lehman Brothers and Bear Stearns have CEOs who are among the top 10 highest paid.

What justifies these levels of pay? The two most commonly reached for excuses are size and market. But evidence does not bear this out. With respect to size, only two of the banks are in the top 25 of the S&P 500 when measured by market capitalization. …

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