Get ready to defend your business model again, Goldman Sachs (NYSE:GS). But this time it isn't to regulators. And it isn't to a pitchfork-wielding public. It's to your own shareholders.
On Monday, the Security Police and Fire Professionals of America Retirement Fund, a public pension fund, sued Goldman for paying its employees too much money. No joke. According to the pension fund's attorney, "The plaintiffs accuse Goldman's board of directors of breaching their fiduciary duties by failing to administer the company's compensation plans in the best interests of the company and its shareholders."
Begin a long, slow clap
Bravo. This is how say on pay is supposed to work.
Business should be simple -- the employees work for the shareholders. But on Wall Street, that's claptrap. Business is a money pot for the employees, while shareholders are just the chumps that prime the pump. As famed investor Leon Cooperman once said, "I determined many years ago that if you want to make money on Wall Street, you work there; you don't invest there. They just pay themselves too well."
Just how well?
Most of Wall Street determines pay by a simple formula: 50% of net revenue. Going back several years shows Goldman rarely diverges from this rule. In 2008, compensation as a percentage of net revenue was 49.2%. In 2007 and 2006, it was 44%. Morgan Stanley (NYSE:MS) is typically about the same, if not slightly higher. This year won't likely be any different.
This might seem absurd when compared with compensation ratios at Coca-Cola (NYSE:KO), Wal-Mart (NYSE:WMT), or Ford (NYSE:F). But remember, investment banking is an industry that (in theory) only sells the labor and knowledge of its employees, not a tangible product. An investment bank's compensation, then, effectively counts as its cost of goods sold, which is why it can get away with shuttling so much revenue straight into employees' pockets.
The same goes for a management consultancy like Accenture (NYSE:ACN). Accenture routinely pays out over 70% of its revenue as compensation. Most law firms and accounting firms can likely say the same.
Yet no one spits and screams at them. Why?
Because they actually earn it
What's admirable about this lawsuit, and where the pension fund nails it on the head, is that it doesn't criticize the amount of Goldman's compensation (likely over $800,000 per employee this year), or even the percentage of revenue. It attacks how compensation is earned. As the attorneys note, Goldman determines compensation "without regard to whether its results were attributable to the productivity and performance of the company's employees."
Bingo. Goldman and other banks like JPMorgan Chase (NYSE:JPM) are having record years. But how much of the success is the result of brilliant management, intense research, and innovative strategies? Something close to zero, I'd say.
At Goldman, fixed-income, currency, and commodity trading revenue for the nine months ended Sept. 30 increased almost threefold over the year before. That alone accounts for most of Goldman's notorious success this year. And it happened for one of two reasons:
- Its traders suddenly stumbled upon newfound brilliance and financial acumen.
- Traders are effortlessly riding the steepest yield curve since 1992, meaning they can borrow money at 0% and invest it in riskless securities at 3% to 4%, courtesy of Ben Bernanke. Plus, there's FDIC-backed debt, and other publicly financed goodies that subsidize trading results.
I'll let you guess which one it is. When the yield curve is in your favor, the amount of grey matter you need in your head to make huge sums of money is negligible. To quote Charlie Munger, "Any idiot can do it. And, as a matter of fact, many idiots do do it."
Keep screaming at Wall Street, Fools
What's infuriating about banker compensation isn't that employees suck up undue amounts of revenue. It's that banks have absurd advantages that allow them to earn undue amounts of revenue to begin with. If you want to fix Wall Street, don't tweak the pay structure. Tweak the profit structure.
