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Financial Times, August 30, 2008 article


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Time is ripe to rebalance pay scales in the banking sector

By Francesco Guerrera
Published: August 30 2008 03:00 | Last updated: August 30 2008 03:00

Here is your starter for 10. Spot the odd one out in the following triad of management gurus: Peter Drucker, Jim Collins, Jerry Colangelo. Jerry who?

Mr Colangelo, head of the US national basketball team, may not have the bibliography of the late Mr Drucker or boast Mr Collins' corporate kudos. But Wall Street executives navigating the current crisis ought to look up from their copies of The Practice of Management and Good to Great and learn from him.

A recap for non-hoops fans. Mr Colangelo took charge of a number of spoilt superstars who had been humiliatingly defeated at the 2004 Athens Olympics and turned them into the finely tuned team that picked up gold in Beijing.

Mr Colangelo's transformation of the hitherto ball-hogging prima donnas into a well-oiled winning machine came down to a crucial factor. He taught them the simple but powerful concept of "united we stand, divided we fall", demanding that all players train together for three years before the Olympics.

Wall Street should copy Mr Colangelo's game plan.

Financial services groups have long been prisoners of a pay structure that contains the seeds of their own destruction.

There are few, if any, industries where companies siphon off some 50 per cent of their annual revenues into the pockets of the people who produce them.

Investment banks have compounded the folly with a bonus structure that encourages short-term bets and excessive risk-taking.

In theory, the Street's bonuses are the ultimate incentive-based awards. Traders and bankers who make a lot of money for the firm get a bigger portion of its profits.

Reality is more complicated. "Producers" and "rainmakers" - isn't it telling that the industry parlance spotlights people who "make" stuff happen rather than those who "do" things? - are largely paid according to the performance of their businesses, not the entire company. They have zero reason to co-operate with other departments while they have millions of dollars of incentives to go it alone with high-risk, high-return strategies.

Ask Vikram Pandit, Citigroup's chief executive, who is trying to awaken the bank from its slumber by getting its disparate parts to sing from the same hymn-sheet.

The "lone wolf" syndrome is augmented by the fact that traders tend to be paid on paper, rather than real, profits. So if in December their trades are in the black, they get the big bucks even though those bets could be bleeding money by January.

Many groups only look at the quantity, rather than the quality, of the paper gains. By omitting to take into account the risks involved and the amount of capital used, Wall Street allows a reckless risk-taking mentality to take hold.

The "pay now, think later" strategy prompted the seven largest US groups to pay their bankers $95bn in compensation between 2005 and 2007, according to the consultancy Accenture.

No firm asked for the money back when the credit bubble that had inflated those pay checks burst in mid-2007, causing $500bn in writedowns and sending share prices crashing down.

It is true that many of those bankers have been, or will be, fired. But is it desirable or logical to have a system that dispenses riches in fat years and creates a class of wealthy unemployed in lean ones?

When confronted with these arguments, bankers retort that Wall Street will never change its bonus system because no company will want to run the risk of mass defections to less enlightened rivals.

This view is not convincing. With tens of thousands of bankers and traders looking for jobs, this is the time to bring method to the industry's pay madness.

Changes need not be radical. Tying part of a bonus to firm-wide performance, linking another portion to long-term gains and risk-weighting the whole sum would be a decent and reasonable start.

A bit like asking a basketball god to pass the ball.




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