eFinancialCareers

Bankers are accustomed to uncertain full-year compensation. For most global institutions, however, part of this year's uncertainty reflects the challenges of unwinding an uneasy marriage with public authorities playing the unfamiliar roles of lender and equity partner.

Compensation consultant Johnson Associates, in its just-released quarterly outlook, lays out the dilemma in stark terms.

This past February, Congress enacted punitive strictures on TARP bankers' compensation that aim to turn Wall Street into a clone of Washington (just as eFinancialCareers News had warned three months earlier). Johnson calls the legislated caps "unworkable" and says that's why the administration has yet to issue guidelines for implementing them. Elected officials probably couldn't force the genie back in the bottle even if they wanted to. Notes Johnson: "Public scrutiny makes it difficult for politicians to oppose drastic pay restrictions."

Unscrambling the Eggs

For both U.S. and European institutions that received bailout aid, the ability to pay employees at year-end rests crucially on the ability to repay their respective governments. "Firms have until September at the latest to have (a) workable program communicated to employees," Johnson says. Groups comprised of traders, brokers and others whose bonuses are calculated like commissions are already up against the gun. Aware of just how much revenue or profit they bring in, these producers are keeping tabs on the compensation their contracts promise. Should they get stiffed, their ace in the hole isn't legal action but mass defection. Because financial advisors and some trading groups "typically operate like an affiliate with less company association," Johnson calls it "easy to move (the) group elsewhere."

Meanwhile, other institutions are rolling out the red carpet. The New York Times reported Thursday that Barclays Capital has drawn more than 450 researchers, traders and dealmakers in Europe and Asia from rivals like Goldman Sachs and Morgan Stanley in the last three months alone. It plans to add at least 300 more by year-end. Barclays didn't take any bailout money. Boutiques continue hiring too - most recently Perella Weinberg with two additions in London.

Johnson envisions three possible outcomes by September. Banks that repay TARP funds will enjoy stability and be positioned to attract top talent. If full compensation limits remain and TARP funds can't be repaid, employees will flee to institutions not subject to government pay caps. This scenario means "destruction of value for shareholders/taxpayers," Johnson observes. A middle scenario involves less-stringent pay rules and partial repayment of government aid. That's essentially a stopgap, offering stability for just a year.

Adverse Selection

Where do things stand now? A dozen smaller institutions already have reached agreement on returning TARP money. Others, including JPMorgan, Goldman Sachs and Morgan Stanley, have formally applied to repay, but it isn't clear when or if the government will let them. Less-robust institutions need to reach some accommodation with Washington and have only four months left to do so, based on Johnson's timeline.

In a separate but related trend, institutions are boosting the fixed (base) portion of many employees' compensation. This too is driven by political calculus. Leaders hope to pre-empt public chants of "four legs good, two legs bad!" that would otherwise erupt with deafening force during what's quaintly called "bonus season."

"While the new compensation plans are great for those in fee-based businesses, they’re lousy for anyone running performance divisions such as sales and trading," remarks Daniel M. Harrison on BNET.

Raising base salaries while curtailing bonus potential creates a problem of adverse selection. Fixed pay appeals most to those individuals who produce less than their colleagues. Meanwhile, those confident of their ability to produce will decamp for boutiques, foreign firms or other less-constrained venues. "That trend will end up culminating in big banks such as Morgan Stanley increasingly resembling the slow, lumbering Tokyo-based megabanks of the 1990s," Harrison warns.

That's also in line with arguments introduced in this column last autumn.