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Is Compensation a Villain Of the Credit Crisis is the title of a recent post on the US Banker website.
“While compensation was not THE cause of the current credit crises it certainly can be viewed as a significant contributor.”
The idea is that today, bank’s incentive compensation plans are mostly based on the current year’s revenues. However, most trading profits are from revenue streams spanning multiple years.
The authors recommendation is to audit incentive plans to identify and remove features that incent short-term behavior. He also makes several other recommendations including:
- Executives should have significant personal capital at risk
- Current cash and long-term reinvestment in the firm should match the firms’ lines of businesses generating its profit
- Take back incentives if deals do not go through (only incent when actual profit is made)
- Ensure executives understand and take risk ownership
- Measure performance for the entire firm
- Develop talent from within and build a long-term culture.
Not bad ideas, but I’m sure financial institutions have many very smart people considering this as well.
When I read this article, I was wondering, could compensation really have a significant role in the credit crisis?
Investment bankers earn a lot of money… A lot of people in the financial sector receive (received?) huge bonuses. But let’s take for example Lehman Brothers. In 2006, along with many other investment banks, Lehman Brothers had a stellar year: it paid its average employee $335,441 and reported a fourth-quarter profit of 1 billion. This is after of course, paying 8.87 billion in salary to its 26,000 employees. Goldman Sachs has even more ridiculous figures; it paid its 26,400 staff an average of $622,000. Two years later, Lehman files for bankruptcy.
So, how much can we blame “crazy” compensation versus bad risk management? I’m not a financial analyst, and I’m not pretending to understand the entire issue… However it seems logical that a firm such as Goldman Sachs, who paid almost twice as much in average compensation in 2006, should be hit equally hard by the credit crisis as another firm such as Lehman Brothers, if compensation was such a major factor.
Goldman Sachs Performance
It turns out that while Goldman Sachs was affected by the credit crisis, it is not in such a bad shape… despite having paid its employees more. And this proves that… the credit crisis is a very complex problem, and that maybe, maybe compensation is not such a “significant” contributor to the credit crisis.
Before Bear Stearns went down but after it was apparent the housing bubble had burst, one of various CNBC programs was debating how these bad collections of mortgages could be sold in the first place. “Who would sell them?”, they asked. Everyone was of the opinion that it must have been because nobody really understood that what they were selling (that is, packages of mortgages with variable rates of risks built into them) were actually bad products.
Jim Cramer was the lone voice of dissent. He said these guys knew exactly what they were selling, and that “It’s all about the commish [commission].”
Just thought it was an interesting conversation.
Very relevant and thanks for sharing! I have another post on the topic coming up soon. I won’t give everything away just yet, but I had a very interesting conversation regarding the credit crisis with Steven Apfelberg, Senior Vice President, Marketing and Business Development at Callidus Software.
At the end of the conversation I (jokingly) concluded that Callidus was to be blamed for the credit crisis because it did a *too* good job at encouraging certain behaviors (selling mortgages at all cost) in many financial institutions. I’m not sure he thought it was as funny as I did :-)
That’s pretty funny. (I’m currently a PM at Callidus, btw - I came over with the Comp Tech acquisition).
Truly these are tough times across the board for all businesses. I spent 4 years in investment banking prior to moving into SPM at a high tech, then Callidus for nearly 6 years and now Xactly for 3. I have two comments. Investment banking is highly regulated. I couldn’t sneeze without some officer asking me if I had pre-authorization for that action. The funny thing is that when Mr. Greenspan, and I am a fan of his, deregulated banking he did not line up the compliance process with that change. Bankers are in this game to make money. SPM software is about motivating behavior to drive business initiatives. Like any sales rep, when you find a way to ‘jog’ the system and make more money most people will use that advantage. I guess its time, actually past time, to review the rules of the banking game? On a high note, SPM initiatives, especially those that are SaaS based, are in a keen position to help companies navigate these times by identifying where a business can cut costs, drive margin, add market share, align their sales resources, and all of it is done at a low cost of entry. We should all get that message out.