Do Bankers Earn Their Bonus?

Afternoon monkeys,

A couple weeks ago an article from the Harvard Business Review was brought to my attention as it concerned a regularly discussed aspect of banking, appropriate compensation. As is often discussed in the media, the question of whether bankers truly generate value commensurate with the paychecks they receive, is examined by those at HBR in a rather unique way: by actually looking at the data. I know, "performing analysis" shouldn't be a terribly unique way of figuring this sort of thing out, but in my experience, all you see in the typical discussion of banker pay is the average salary compared with another average salary, which leaves something to be desired. Luckily, HBR did some good analysis, and you may be surprised by their conclusions.

HBR accomplishes their analysis through the inspection of two metrics, Return on Invested Talent, and Total Earning Assets per Head, and then compares them to an average airline employee. I'm not exactly sure why they chose to compare them to an airline employee, but the results are interesting nonetheless. To begin, HBR explains their metric, Return on Invested Talent:

To judge whether this outrageous looking sum is fair or not I apply a metric I call the Return on Invested Talent (or ROIT). Like Return on Invested Capital (ROIC), which reflects what a company earns, how much capital it needs to earn it and the ratio between the two, ROIT reveals what the company earns, how much it has to spend on its talent to earn it, and what the ratio is between the two. In short, we divide the (financial) outputs by the major (talent) inputs.

They then go on to compare the ROIT of the typical GS employee with that of a airline employee:

At face value, a GS banker on average generates $3.05 of revenues for every $1 spent on his or her salary. Examining profits before tax and solving for the ROIT equation described above reveals the return on investment to GS's talent generates a rate of $1.44 of profit for every dollar expended on the typical GS employee.

To put this in context, using the same equation, the average employee in a low cost airline generates a profit before tax of $1.94. On that basis, the average banker is arguably about 25% less profitable than the average airline employee — but that 25% difference certainly doesn't account for the huge gap between the average take-home pay of the banker ($367,000 in 2011) and the pay check for the average low-cost airline employee ($67,000).

Upon review of the GS annual statement, it appears that the author is looking at GS as a whole enterprise, certainly a reasonable approach, but you may be asking yourself, "what about their investment banking division by itself?" This changes things rather dramatically. Sadly, the company appears to only disclose their total headcount, which is not broken down by division, but, they do disclose operating expenses by division. Holding compensation as a percentage of operating expenses constant, their investment banking division appears to generate $2.72 in net revenue for every $1 spent on talent, more than 40% higher than the low cost airline in their example (as opposed to 25% lower). But, nevertheless, HBR goes on to examine another metric, total earning assets per head:

So what does explain that differential? Another metric, total earning assets per head, provides a possible answer. According to this measure, in the year ending 2011, each GS banker was handling roughly nineteen times the value of the corresponding figure of assets as a typical low cost airline employee ($27.7m to $1.4m). On this basis, the GS banker is arguably under-compensated, since his or her salary is about six times that of the airline employee.

This is certainly an interesting result and a tremendously stark difference between the two, which adds some credibility to the pay that the bankers at GS receive, with HBR adding:

The point is that we cannot all be paid at the same rate as a banker because most of us are not dealing directly with the same volumes of capital. It is perhaps this financial reality alone, not the alternative arguments over the technically demanding and complex instruments in need of the highest levels of human capital that has become twenty first century financial market making, which justifies the differential.

Bottom line, when facts rather than emotion are applied, bankers on average might apparently deserve their bonuses. Which rather makes one wonder whether the European Union's plans to cap them isn't just an act of political petulance.

What do you monkeys think? Does this line of reasoning make sense? How do you think banking on the whole does (or your firm in particular) in terms of compensation given the results of GS?

 

Comparing banking to an asset heavy, capital intensive business like an airline, makes no sense. Why not compare it to other professional services firms - accounting, consulting, food services, janitorial, whatever...companies where their primary asset is their people.

The direction they take is interesting, but they could have found better comps.

 
TechBanking:
Comparing banking to an asset heavy, capital intensive business like an airline, makes no sense. Why not compare it to other professional services firms - accounting, consulting, food services, janitorial, whatever...companies where their primary asset is their people.

The direction they take is interesting, but they could have found better comps.

It does make sense.

 
Best Response

"Main street" as people call it, is still completely clueless to the fact that wall street “Bonuses” are not actual bonuses per se. Its largely a misnomer and what everyone refers to as a bonus is mostly accrued salary. No analyst is going to work 100 hrs a week for 50-70K a year. And no Senior banker is going to work for 300K where they could actually be making a multiple of that if they were working in another capacity, such as a C-level executive of a major corporation. Part of the bonus is in fact a bonus. But to be up in arms because someone made a “Bonus” in a non-profitable year is demonstrative of a lack of understanding of the industry. There has been an uproar about bonuses even before the financial crisis. It made the front cover of the news papers 2 or 3 years ago when GS had record bonuses. Yet I do agree that there are serious flaws in the system and share concern in some of the criticisms going around.

Wall Street compensation is what it is for a few reasons in particular:

1- it’s a very competitive field with only the most accomplished (i.e. best schools, best grades, best experience) being hired

2- you make a significant lifestyle sacrifice, at ALL levels Analyst to MD

3- it’s a high pressure job; most of the people on this forum don’t realize the full magnitude of this because we are tuned to work in this type of field. Most people go through the motions expending minimal effort at work, it is IMPOSSIBLE to do that in this field.

4- There is a huge amount of risk to working in this field. There is a huge degree of volatility in hiring/firing, NOTHING is guaranteed. You have the least job security of any other professional field hands down. Even in an ideal economy from the day you start working, its only a 2 year program, then you’re jobless again. Then you land another gig, but guess what thats 2 year program also, then you’re jobless again. At a more senior level, obviously the finite programs aren’t the case, but the lack of job security surely is.

The public sees Wall Streeter’s making bank and they don’t want to hear any of the above reasons. They bitch and complain when their boss asks them to stick around past 5:30 but they somehow see big Wall Street bonuses and feel like they’re being had… like someone is taking THEIR piece of the pie."

  • Marcus_Halberstram
 
BTbanker:
"Main street" as people call it, is still completely clueless to the fact that wall street “Bonuses” are not actual bonuses per se. Its largely a misnomer and what everyone refers to as a bonus is mostly accrued salary. No analyst is going to work 100 hrs a week for 50-70K a year. And no Senior banker is going to work for 300K where they could actually be making a multiple of that if they were working in another capacity, such as a C-level executive of a major corporation. Part of the bonus is in fact a bonus. But to be up in arms because someone made a “Bonus” in a non-profitable year is demonstrative of a lack of understanding of the industry. There has been an uproar about bonuses even before the financial crisis. It made the front cover of the news papers 2 or 3 years ago when GS had record bonuses. Yet I do agree that there are serious flaws in the system and share concern in some of the criticisms going around.

Wall Street compensation is what it is for a few reasons in particular:

1- it’s a very competitive field with only the most accomplished (i.e. best schools, best grades, best experience) being hired

2- you make a significant lifestyle sacrifice, at ALL levels Analyst to MD

3- it’s a high pressure job; most of the people on this forum don’t realize the full magnitude of this because we are tuned to work in this type of field. Most people go through the motions expending minimal effort at work, it is IMPOSSIBLE to do that in this field.

4- There is a huge amount of risk to working in this field. There is a huge degree of volatility in hiring/firing, NOTHING is guaranteed. You have the least job security of any other professional field hands down. Even in an ideal economy from the day you start working, its only a 2 year program, then you’re jobless again. Then you land another gig, but guess what thats 2 year program also, then you’re jobless again. At a more senior level, obviously the finite programs aren’t the case, but the lack of job security surely is.

The public sees Wall Streeter’s making bank and they don’t want to hear any of the above reasons. They bitch and complain when their boss asks them to stick around past 5:30 but they somehow see big Wall Street bonuses and feel like they’re being had… like someone is taking THEIR piece of the pie."

  • Marcus_Halberstram

Bonus is a discretionary bonus. It's not guaranteed. It it is truly accrued salary in an accounting sense, then it should be carried on the B/S as a liability. If I were a shareholder of the bank, I don't care how hard you work. Work 144 hours a week if you like, I'm only going to compensate you for your results.

This is a ridiculous entitlement attitude. A truly "free enterprise" / "capitalist" point of view would not care at all about the 1. competition to get in, 2. lifestyle sacrifices, 3. pressure of the job, 4. huge amount of risk when it comes to incentive compensation. Incentive comp is for results. If you don't generate results, you don't get paid the bonus. To feel "entitled" to a bonus in a non-profitable year is just ridiculous.

 
freeloader:
BTbanker:
"Main street" as people call it, is still completely clueless to the fact that wall street “Bonuses” are not actual bonuses per se. Its largely a misnomer and what everyone refers to as a bonus is mostly accrued salary. No analyst is going to work 100 hrs a week for 50-70K a year. And no Senior banker is going to work for 300K where they could actually be making a multiple of that if they were working in another capacity, such as a C-level executive of a major corporation. Part of the bonus is in fact a bonus. But to be up in arms because someone made a “Bonus” in a non-profitable year is demonstrative of a lack of understanding of the industry. There has been an uproar about bonuses even before the financial crisis. It made the front cover of the news papers 2 or 3 years ago when GS had record bonuses. Yet I do agree that there are serious flaws in the system and share concern in some of the criticisms going around.

Wall Street compensation is what it is for a few reasons in particular:

1- it’s a very competitive field with only the most accomplished (i.e. best schools, best grades, best experience) being hired

2- you make a significant lifestyle sacrifice, at ALL levels Analyst to MD

3- it’s a high pressure job; most of the people on this forum don’t realize the full magnitude of this because we are tuned to work in this type of field. Most people go through the motions expending minimal effort at work, it is IMPOSSIBLE to do that in this field.

4- There is a huge amount of risk to working in this field. There is a huge degree of volatility in hiring/firing, NOTHING is guaranteed. You have the least job security of any other professional field hands down. Even in an ideal economy from the day you start working, its only a 2 year program, then you’re jobless again. Then you land another gig, but guess what thats 2 year program also, then you’re jobless again. At a more senior level, obviously the finite programs aren’t the case, but the lack of job security surely is.

The public sees Wall Streeter’s making bank and they don’t want to hear any of the above reasons. They bitch and complain when their boss asks them to stick around past 5:30 but they somehow see big Wall Street bonuses and feel like they’re being had… like someone is taking THEIR piece of the pie."

  • Marcus_Halberstram

Bonus is a discretionary bonus. It's not guaranteed. It it is truly accrued salary in an accounting sense, then it should be carried on the B/S as a liability. If I were a shareholder of the bank, I don't care how hard you work. Work 144 hours a week if you like, I'm only going to compensate you for your results.

This is a ridiculous entitlement attitude. A truly "free enterprise" / "capitalist" point of view would not care at all about the 1. competition to get in, 2. lifestyle sacrifices, 3. pressure of the job, 4. huge amount of risk when it comes to incentive compensation. Incentive comp is for results. If you don't generate results, you don't get paid the bonus. To feel "entitled" to a bonus in a non-profitable year is just ridiculous.

I have mixed emotions about this. On the one hand, results matter and people should be compensated for their results. On the other hand, if the company at large isn't profitable or is having a down year and that is reflected in the compensation of the best performers and/or the guys who work the longest hours with high career volatility then you are going to have a very difficult task obtaining talent to fill those roles going forward if your organization gets that reputation.

A principle of accounting is to determine if your company is a going concern--if it is, then your compensation doesn't necessarily reflect a quarterly or annual outlook; rather, it reflects a long-term investment in a product. Even the best companies have down years.

 
freeloader:
Incentive comp is for results.
No, it's not. It's there to keep you around next year. Naturally, if someone performed very well this year, you expect them to perform well next year. So, you pay them so they don't test the waters with your competitors.

The only positions that truly pay for results are commission based or revenue share positions. All salary and bonus employees are paid to retain them next year.

One question you may ask is: what about those Analysts who are in 2 year programs? They don't have to pay them to retain them. That's true, but everyone knows what they earn, so if some firm got cute and decided not to pay 2nd year Analysts bonuses, they wouldn't be able to recruit anyone next year.

The reason the bonus component has been such a large percentage of total comp is because it's easier to reduce it.

 
freeloader:
This is a ridiculous entitlement attitude. A truly "free enterprise" / "capitalist" point of view would not care at all about the 1. competition to get in, 2. lifestyle sacrifices, 3. pressure of the job, 4. huge amount of risk when it comes to incentive compensation. Incentive comp is for results. If you don't generate results, you don't get paid the bonus. To feel "entitled" to a bonus in a non-profitable year is just ridiculous.
You're only thinking of this from one end. If you are the buyer in the market for labor (employers), I agree that you only want to pay for results. However, the sellers in the market for labor (employees) also want to maximize their expected utility. To the extent their expected utility is diminished by #1-4, employees are going to require higher compensation. If the employees are not compensated for these, they will simply sell their labor elsewhere.

Also, remember that there are a number of ways to measure "results." While you might just look at current year profit, employers often are (and should) willing to pay for other forms of results that are harder to measure, such as decreasing risk, strengthening/protecting the firm's brand, etc. Therefore, one could argue that it is very reasonable to award high compensation even in an unprofitable year.

 
freeloader:
Bonus is a discretionary bonus. It's not guaranteed. It it is truly accrued salary in an accounting sense, then it should be carried on the B/S as a liability. If I were a shareholder of the bank, I don't care how hard you work. Work 144 hours a week if you like, I'm only going to compensate you for your results.

This is a ridiculous entitlement attitude. A truly "free enterprise" / "capitalist" point of view would not care at all about the 1. competition to get in, 2. lifestyle sacrifices, 3. pressure of the job, 4. huge amount of risk when it comes to incentive compensation. Incentive comp is for results. If you don't generate results, you don't get paid the bonus. To feel "entitled" to a bonus in a non-profitable year is just ridiculous.

For professional services firms, analysts adjust quarterly results for comp accruals (at least the good ones do). The low base/bonus structure is a reasonable response to giant earnings swings, but there are compelling reasons why the rate of passthrough shouldn't be 100%.

Bank earnings are pretty volatile and there is no good reason why an M&A banker's compensation should depend largely on the skill of his firm's bond traders and the diligence of risk managers? Advisory bankers are salespeople (with the junior ones being sales support), and sales commissions are generally paid as % of top line. Paying based on group revenue generation is the right way to go considering labor an input. This also minimizes the retention problem, you will keep your top teams as they are getting paid, and over time will shrink the under-performers via attrition.

 
BTbanker:
"Main street" as people call it, is still completely clueless to the fact that wall street “Bonuses” are not actual bonuses per se. Its largely a misnomer and what everyone refers to as a bonus is mostly accrued salary. No analyst is going to work 100 hrs a week for 50-70K a year.

To play devils advocate, I would disagree with this claim. Assuming 100 hours/week over a 50 week year, that works out to 5,000 hours/year, or $10-$14 an hour. I would imagine that the line of analysts willing (although, possibly less able) to take the job at such a payrate is very long, and I would argue that it not be difficult to fill the entire analyst ranks at rates under $15 an hour in the current economic environment.

I mean, what else are they going to do? If we learned nothing from the economic collapse that Nancy Pelosi caused, it's that by God do investment bankers work hard, but sadly, they have no marketable skills.

(Paraphrased from a quote by Mr. Jack Donaghy, obviously. Also, I think a couple people have this as their sig line and I laugh everytime I read it.)

Note: I'm not advocating this approach by any stretch of the imagination.

BTbanker:
Wall Street compensation is what it is for a few reasons in particular:

1- it’s a very competitive field with only the most accomplished (i.e. best schools, best grades, best experience) being hired

2- you make a significant lifestyle sacrifice, at ALL levels Analyst to MD

3- it’s a high pressure job; most of the people on this forum don’t realize the full magnitude of this because we are tuned to work in this type of field. Most people go through the motions expending minimal effort at work, it is IMPOSSIBLE to do that in this field.

4- There is a huge amount of risk to working in this field. There is a huge degree of volatility in hiring/firing, NOTHING is guaranteed. You have the least job security of any other professional field hands down. Even in an ideal economy from the day you start working, its only a 2 year program, then you’re jobless again. Then you land another gig, but guess what thats 2 year program also, then you’re jobless again. At a more senior level, obviously the finite programs aren’t the case, but the lack of job security surely is.

I think you may have the causality backwards in #1, the field attracts such accomplished candidates because the compensation is high, but I would agree (based on what I've seen) with you on #3 & #4.

"My caddie's chauffeur informs me that a bank is a place where people put money that isn't properly invested."
 

There are tens of billions a year in fees for all of investment banking but only ~15K(?) people globally capable of winning/attracting meaningful amounts of IBD business.

If one wants to decrease the salary of bankers then one merely has to legislate the fee structure of investment banks. Profits are reduced and therefore salaries are reduced.

 

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