Does any trader deserve 30% of his P&L?

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Phibro's Andrew Hall caused something of a stir over the weekend.

According to The Wall Street Journal, Hall is demanding that a contract which last year saw him paid $100m, is upheld again this year - despite the fact that the US government's about to become the owner of 34% of the bank.

According to the Journal, Hall is currently allowed to take more risk individually than entire teams of traders are allowed to take elsewhere in the Citigroup empire. His contract is also said to entitle him to a massive 30% of any gains.

Roger Ehrenburg of Information Arbitrage reiterates why Hall's pay arrangements (and those of most traders on Wall Street) are very, very wrong.

"Wall Street traders effectively start at zero P&L each and every year, institutionalizing a short-term mind-set that doesn't create sustainable equity value for the firm. In short, the Wall Street trader compensation model is badly broken, in large part because of the agency effects of risking hundreds of millions to billions of dollars of "other people's money" (OPM) with a grossly asymmetric payout function (e.g., shaped like a call option where the trader's max loss is their base salary, while their max gain is effectively infinite and is a function of gross profits)."

To overcome this, Ehrenburg recommends banks pay traders in the way hedge funds do - namely encouraging traders to invest in their own funds, only allowing them to withdraw small amounts of capital every year, and imposing high water marks for performance over time, below which bonuses can't be paid.

The real issue, however, is not only that Hall's being paid for performance on an annualized basis, it's the fact that he's getting 30% of any upside with no real exposure to any downside. Very few traders at hedge funds get this kind of percentage nowadays, let alone traders at hedge funds which are underpinned by the US taxpayer.

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