Corner of Bay Street and Adelaide streets in Toronto.Gloria Nieto/The Globe and Mail
The first two weeks of December are a treacherous time on Bay Street. For many people, a full year's worth of work is given a value in one short meeting when their annual bonus is disclosed, which means anxiety levels are typically through the roof.
The chatter afterward usually centres on how high or low the bonus pools are. Friends start calling friends at other shops to let them know how it all shook out, then stories are written about who's getting paid what.
This annual game misses the point. The quantum of pay certainly matters, but the way in which compensation is calculated is even more important. And it's rarely discussed.
Coming out of the 2008 crisis, when the global financial system nearly collapsed, lawmakers and regulators around the world took great pains to install compensation systems that would prevent a few groups of employees from literally betting their firms on a small number of trades. Risk management became all the rage, and new features – such as pay clawbacks – were instituted to hold people accountable.
But the new rules stomp out only the most nefarious behaviour. Under Canadian law, bonus clawbacks aren't mandatory, and they only apply if there's been an accounting irregularity. It takes something like fraud to get the money back.
And as good as intentions are, many initiatives miss the mark. The explosion of restricted share units (RSUs) is one example.
Many capital markets employees are now paid a significant percentage of their annual compensation in RSUs that vest over three years. The thinking is that people should benefit or suffer in line with the share price of their employer. But while these shares might deter people from blowing up their own firms, they do little to discourage offering bad advice to clients.
That's because underlying incentives are still out of whack. Bonuses are still paid like commissions on new car sales, with little regard to how investors ultimately fare. That matters in a year like this one when global mergers and acquisitions topped $4-trillion (U.S.) for only the second time since 1980, according to Thomson Reuters.
The capitulation of Canada's energy sector illustrates the problem. The sector has seen many major deals over the past two years, but these transactions have largely been train wrecks for investors. The advisers, though, were still paid well.
It is unfair to point fingers solely at investment bankers, who are the typical targets of compensation scorn. The current incentive system is skewed across capital markets. Fixed-income origination desks, for one, are profiting handsomely from low interest rates that have spurred the non-stop issuance of provincial debt – even while the governments raising this money are digging themselves into deep holes.
And somehow retail advisers evade any scrutiny even though they can make piles of money with little downside risk. In Hydro One's $1.8-billion (Canadian) privatization, they were paid the highest commission – 3 per cent of any share sold versus 1 per cent for institutional sales – which matters because 40 per cent of the deal was sold to retail buyers. These advisers collectively made $55-million up front -- though that sum was split between the individual brokers and their respective firms.
Fixing these systemic flaws isn't easy, which is probably why they've stayed this way. These incentives help deals get sold.
There is also misinformation. Even though investment banks have made boatloads for underwriting equity financings this year – nine were worth $1-billion or more – this hasn't been "free" money. Almost all of these large share sales were sold by way of bought deals, which means the banks absorb any risk if the deals don't sell.
That isn't enough to justify the status quo. The current system not only divorces pay from long-term results, it also pushes pay higher at corporations, something detailed in The Globe's recent stories on the rise of executive pay.
The trouble is knowing where to start. So many managers are worried they'll lose employees to rival firms if they adjust pay.
On this front, one anecdote stands out more than any other.
In 2009, Ken Feinberg was tapped by the Obama administration to determine how much executives at bailed-out companies should be paid. Many people "look at it as a populist issue – that these officials in these companies are getting too much money, and as a material matter, they don't need it," he told an audience at Princeton University shortly after he wrapped up his duties. Activists, he added, often ask questions about how many cars, houses and vacations these executives need.
What he found, though, was that was pay is often a "surrogate for worth." This is particularly true in capital markets, when very little performance feedback is provided.
If more praise or constructive criticism is provided over the 12-month window, employees are less likely to act irrationally if they get a bad number. At the very least, it should lower anxiety levels leading into the excruciating December sit-downs.
Tim Kiladze