The Wrong Way to Easy Street

Despite the rocky road they've left for the rest of the economy, Wall Street firms still seem determined to take the express lane to Easy Street. Recent data show that these big banks still haven't aligned their compensation structures with actual long-term performance goals. And since the rest of corporate America often follows Wall Street's lead, this could be a one-way street toward value destruction for shareholders.

The primrose path to risk
The Corporate Library studied Wall Street pay practices both before and after the financial crisis. A new white paper (PDF file) released by the Council of Institutional Investors sums up its findings, comparing Wall Street pay to large non-financial companies in the U.S. as well as international financial institutions.

The Wall Street companies studied included majors like Bank of America (NYSE: BAC  ) , Citigroup (NYSE: C  ) , Goldman Sachs (NYSE: GS  ) , JPMorgan Chase (NYSE: JPM  ) , Wells Fargo (NYSE: WFC  ) , and Morgan Stanley (NYSE: MS  ) , as well as financial companies that are no longer with us, such as Merrill Lynch, Lehman Brothers, and Bear Stearns.

Not surprisingly, the data include several disturbing revelations. Between 2003 and 2007, Wall Street CEOs received two to three times as much compensation as head honchos in the remainder of the Fortune 50. As co-author Paul Hodgson noted in a subsequent blog post, that latter bunch isn't exactly renowned for its prudent pay policies.

In addition, Wall Street CEOs' higher pay largely stemmed from huge gifts of restricted stock, which weren't tied to any future performance benchmarks at all.

Before and after
After studying the data both pre- and post-crisis, the report blames several elements of pay policy for ultimately harming shareholders during the financial crisis:

  • Excessive cash bonuses.
  • Too much emphasis on short-term, yearly growth metrics.
  • Skyrocketing pay levels, which "effectively insured executives against failure."

As the report dismally relates, "little or no Wall Street compensation was linked to long-term performance measures." Leaders who never experience the consequences of failure have no reason to avoid excessive risk, or even do a particularly good job at all.

There's at least one silver lining in the report. Post-crisis, Wall Street companies have improved some of their pay policies, including tougher clawback provisions and longer deferral periods before executives can pocket their compensation.

Sadly, even this glimmer of hope has a bit of tarnish. According to the study: "None of the banks in the study has addressed adequately the importance of tying compensation to long-term value growth. Some banks have increased fixed pay excessively."

Last but not least, the study noted that leading international financial institutions had long-term performance targets in place even before the global financial crisis, making Wall Street's freewheeling pay structure look even more irresponsible and embarrassing.

Forget Easy Street -- take the high road!
I'm not sure why so many investors give Wall Street's bad behavior a free pass -- or bother to invest in these companies at all. We've all seen ample proof that too many of these firms demand arrogant, undeserved rewards, damaging their own shareholders, their customers, and eventually society at large. Despite what should have been the harrowing lessons of the financial crisis, and the lingering pain of our own still-limping economy, it seems that not enough has changed in the financial industry.

For big banks, huge pay packages without regard for performance might sound like a ticket to Easy Street. But they leave huge potholes in their wake, tripping up the rest of the marketplace. If shareholders don't take the wheel and steer these companies back onto the right path, we could all find ourselves once again on the road to ruin.

Check back at Fool.com every Wednesday and Friday for Alyce Lomax's columns on corporate governance.

The Fool owns shares of Bank of America and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days.

Alyce Lomax does not own shares of any of the companies mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On December 01, 2010, at 6:48 PM, mshawcfp wrote:

    I'm surprised we don't all revolt against how banking is done these days!

  • Report this Comment On December 02, 2010, at 11:38 AM, pghwrites wrote:

    Thanks, Alyce, for this thoughtful and perceptive column. When I set out to research this white paper I was sincerely hoping that lessons had been learned, and to find that pay practices on Wall St were fundamentally business as usual, but with higher base salaries, was a great disappointment. Especially as non-US pay practices - already ahead - showed signs of even further improvement. Some company spokesman, from Goldman, I think, claimed that major improvements had been made because pay was more deferred. As you know from reading the report, such practices were already widespread and did nothing to deter risk. Thanks again.

  • Report this Comment On December 03, 2010, at 3:13 PM, stan8331 wrote:

    Not surprising, but reprehensible nevertheless. The big investment banks aren't going to change their ways without a fight. As has been pointed out in other recent Fool articles, one thing that really makes this an uphill battle is the populace's abject lack of financial knowledge. Investment banks gleefully exploit the fact that most Americans have no clue about even basic finance, much less the cloistered, arcane world in which they operate.

    Hopefully, over time there will be more and more sunshine directed at these practices by respected entities such as TMF. I'm not sure much is likely to change until investors begin to avoid companies that employ these sorts of practices.

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