No quick pay fix for Wall Street

Bankers may no longer enjoy absurdly lavish bonuses. But what's really the best way to align compensation and performance?

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By David Ellis, CNNMoney.com staff writer

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Overwhelming discontent with Wall Street pay practices by both the American public and lawmakers is forcing many firms to rethink how they reward employees and executives.

NEW YORK (CNNMoney.com) -- Few would argue that the lavish paydays enjoyed by Wall Street executives in recent years need to end.

With the financial industry in such turmoil, it's difficult to justify huge salaries, bonuses and other perks. But are politicians taking the best approach to end the culture of excess?

A key measure of the massive stimulus package signed into law Tuesday afternoon by President Obama would effectively rein in outsized bonuses for senior executives and top earners at firms that got money under the Troubled Asset Relief Program, or TARP.

Still, compensation experts said there are a lot of questions about this provision, including what kind of bonus payments would be restricted as well as how to identify which employees reported the biggest haul for the year.

"There are a lot of details that need to be filled in about how this would operate," said Tim Bartl, senior vice president and general counsel at the Washington, D.C.-based Center on Executive Compensation.

One potential unintended consequence of the plan, notes Bartl, is that the pay restrictions could steadily work their way down the employee ranks.

Under the amendment, last year's top performers at financial institutions that accepted TARP funds would feel the squeeze in 2009.

But with their compensation capped this year, the measure could arguably impact the next tier of highest-paid workers in following years.

Street solutions

While the financial industry takes a beating in court of public opinion, some Wall Street firms are attempting to come up with some new ideas about compensation as well.

Leaders at both Goldman Sachs (GS, Fortune 500) and Morgan Stanley (MS, Fortune 500) - two companies that have become synonymous with multi-million dollar pay packages - told Congress last week they planned to do a better job of tying an employee's compensation to the success of the firm by making a larger portion of annual bonuses in the form of equity.

Another proposal that has gained momentum recently is so-called "clawback" provisions which would reclaim pay from workers whose actions may damage the firm's long-term financial health.

But even those remedies may be fraught with problems, according to some experts.

Alan Johnson of compensation consultancy firm Johnson Associates said clawback provisions are good in theory but difficult to put into practice.

A trader who made a bad bet on a stock and subsequently left the firm could be required to return money many years after leaving. In such a scenario, it may be tough to prove that one individual was responsible for the loss, resulting in lawsuits, arbitration and plenty of other legal headaches.

"At some big firm, in a year in which you have thousands of people lose you money, you would really have a witch hunt going on," said Johnson.

One performance-based plan unveiled late last year by the Swiss banking giant UBS (UBS) is showing signs of promise as a model for the rest of Wall Street to follow.

In the UBS plan, senior executives, lower-level management and other so-called "risk takers" would receive a fixed salary as well as variable compensation in the form of both cash and equity. The variable portion would be held in reserve and paid out or reduced accordingly depending on how the firm performs in the future.

Bartl said a similar plan adopted by Bank of America earlier this year suggests this type of approach could work. "It shows the direction things are heading - back to this more balanced view," he said.

Blame the bonus

In recent years, some compensation experts have endorsed the idea of greater equity stakes and higher salaries for workers, instead of relying so heavily on incentive pay programs like the annual bonus.

While common throughout corporate America, bonuses are widely viewed as a cornerstone of Wall Street's compensation structure.

A throwback to the days when many of these firms were private partnerships, annual bonuses became a lightning rod of criticism after it was revealed last month that banks and securities firms' doled out more than $18 billion in payments at a time when these companies were getting billions of dollars in taxpayer assistance.

One problematic aspect of Wall Street's bonus culture is that many industry employees had come to expect, and even rely, on this windfall. So that has made some banks unwilling to eliminate them entirely.

Another is the fact that the potential payoffs were so large and rewarded risk taking. That encouraged bankers to make bets they probably would have avoided had they been investing their own money.

"That's where the rub is," said James Reda, the founder and managing director of the compensation consultancy James F. Reda & Associates. "These incentive amount needs to be brought down to earth."

Risk of changing the status quo

Of course, some claim that a severe crackdown on bonuses could cause a so-called "brain drain" on Wall Street, with the best minds fleeing banks to work somewhere where they could earn more money.

There is also the risk that if pay caps are limited to a certain group of firms, top dealmakers could take flight for competitors that don't have to abide by the compensation restrictions.

Morgan Stanley CEO John Mack testified at last week's hearing before Congress on banks' spending of TARP funds, that this is already happening. He said some European firms are dangling large pay packages in front of his bankers.

With that in mind, some banks, such as Goldman Sachs and JPMorgan Chase (JPM, Fortune 500), have indicated they may try to pay back TARP funds early so they can escape the government's restrictions.

But don't expect that to diminish the scrutiny over how top executives are paid.

After all, they still have plenty of upset shareholders to deal with, who will be sure to voice their concerns during the upcoming proxy season. To top of page

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