Monday, March 27, 2006

IDD on Wall Street Bonuses

The Investment Dealers' Digest, often referred to as IDD, had a nice article on the state of the investment banking bonus.

Here is the link. IDD keeps the article up for a few weeks before it removes it for people who aren't registered for the site, so I have pasted the article below as well.


After several years of working in the shadow of traders and fixed-income professionals, investment bankers in the US are finally getting some respect. Bolstered by a sparkling year in M&A, which logged its highest volume since 2000, Wall Street firms boosted the compensation they paid to investment bankers by some 20% in 2005, roughly double the 10% increase paid to traders and debt professionals, according to Johnson Associates, a compensation consultancy.

This turn of events has many investment bankers smiling-some wider than others. Since the market bust in early 2000, fixed income and trading have carried the day for Street firms, and as a result, bankers often had to suffer through flattish pay, not to mention the indignity of being subsidized by other groups. But in 2005, investment banking made a dramatic re-entry, as Street firms collected $53.1 billion in fees from M&A advisory and underwriting activities, a 25% increase over 2004, according to Bloomberg. That is not to say that investment banking is suddenly driving Street profits. Fixed income and trading still bring in the lion's share of the stuff. But 2005 was the year when $2.7 trillion in global M&A volume, not to mention other ancillary activity gleaned from cash-rich financial sponsors, greased Wall Street's fee machine and got it humming.

Indeed, the Street set a compensation record in 2005 with $21.5 billion in bonuses, obliterating the prior record of $19.5 billion set in 2000, according to New York State Comptroller Alan Hevesi The largesse was widespread, reaching many. And bankers can take heart: The cheery earnings scenario for investment banking is expected to continue in 2006 (Goldman Sachs led the quarterly earnings parade last week with a performance so spectacular that at least one analyst was left gasping for a descriptive adjective).

But bankers got a dose of reality in their paychecks as well. No longer will Wall Street indiscriminately pass out the booty in the good times, having learned bitter lessons from past booms. It fine-tuned its pay practices in 2005 and inserted a good measure of discipline-carefully monitoring revenues as well as the capital and risk involved in making a deal happen, and going to great lengths to figure out exactly who brought in the business. It rewarded rainmakers with an outsize portion of the bounty, gave token raises to workhorses who played minor roles, and sent unmistakable messages to underperformers that they should consider other employment.

A good year, therefore, meant different things to different people. A top-producing managing director at a bulge-bracket investment bank, for example, could have gotten a package of $10 million or more, while a low-producing one might have seen his or her pay remain flat or edge up only 5% to $1.1 million, recruiters say (see accompanying tables).

"There was a lot more talk about tying pay to merit in the past few years," says Francisco Paret, head of the US investment banking practice at executive search firm Egon Zehnder International. "But in 2005, there has been a much more focused effort to link pay and performance."

Indeed, the lack of a raise in 2005 was more meaningful than ever. "If your pay didn't go up, you probably were not going to be working there long," says another recruiter.

Street firms are old hands at communicating with money, and they know just how small to make a bonus to insult someone into leaving. And bankers, while not considered exactly the most introspective of professionals, also have a fine ear for messages when money is involved. Thus does the industry use bonus season to tell its bottom 15% of performers to leave. Executive search pros say this practice helps banks upgrade their talent pool.

"Banks are finally being intelligent about compensation," says Laura Lofaro, president of Sterling Resources International. "They are running a business, and they realize that in order to incentivize and motivate people, they have to pay for performance."

Lofaro calls it a move towards a meritocracy. It is also a survival technique, as banks are having to work harder in areas such as trading, where commissions have taken a years-long beating, to generate profits. They are seeing revenues shrink in many areas, such as trading, and have to find new, higher margin businesses. Shareholder activism at the same time is putting pressure on firms to carefully husband their resources.

That is why banks, even in a good year like 2005, are hiring less than they would have in the boom years of 1998-2000, says Alan Johnson of Johnson Associates. They realize they can increase productivity with the team they have, add junior people as needed and put the big money into hiring and keeping stars. "The business is very competitive," Johnson says. "To really make a difference, you need a real star to add the edge."

But top junior people are not easy to come by, either. They are the foot soldiers who work killer hours doing everything from providing support to senior bankers in pitching new business to actually processing the deals, and they are invaluable. The best and brightest are now courted by hedge funds and private equity firms as well as Street firms-a dynamic that won't change anytime soon, says Brian Korb, a partner at executive search firm Glocap Search who specializes in private equity. "Demand for top talent among junior hires has shown no sign of waning," Korb says.

Banks are acutely aware of the importance of junior bankers, and they generally took good care of them in 2005-as they did in 2004. Some VPs got increases of as much as 25%, according to compensation experts. Demand is expected to continue to be high this year, especially if the industry activity level continues as strong as forecast. "There is still a dearth of talent on that level, and I think they were exceptionally taken care of," says John Rogan, global head of financial services at Russell Reynolds.

Happy days

In a good year such as 2005, the increased profits soothe some of the fault lines between what one recruiter calls "the stars and the worker bees."

Compensation experts surveyed by IDD estimate that firms paid investment bankers 20% more in 2005 than in 2004, the best increase since 2000. But bankers were not the only ones paid well. Wall Street pay was up 10% on average in 2005 over 2004, with trading and fixed income up 10% and commercial banking up 5%, according to Johnson Associates. That, of course, means some got a 40% hike and others got zilch. Still, the bounty reached many.

"On average, people are happier than I have seen in recent memory," says Andrea de Cholnoky, co-head of the investment banking practice at executive search firm Spencer Stuart. "I don't have a lot of people calling and saying, I've been treated badly.'"

Compensation experts say that most investment bankers got an increase in 2005 in the 5% to 15% range, while stars got much more. Because there was so much money available this year, non-star workhorses who may have gotten no raise in the recent past got some increase as well. "There was less of the haves and have-nots," says Rogan. "Even the have-nots did better than the year before."

Among the banks, there was significant variation in compensation. As usual, big investment banks typically paid the most. Among them: Lehman Brothers, which had a record year; Morgan Stanley, which paid some very well but also pruned heavily among its managing directors; Goldman Sachs, which continued to benefit from the M&A boom; Bank of America, which paid selectively well, and Deutsche Bank, which had disappointed bankers in years past but came through in 2005 with packages that pleased many.

Top-producing individuals in some of the hottest areas such as financial sponsors or M&A saw their pay soar. Many more managing directors reportedly broke the $5 million barrier this year, which in years past was reserved for the chosen few. Top producers were rewarded to the point that in some cases their pay eclipsed that of their group head.

Guarantees-both as a hiring and retention tool-were also used more frequently in 2005 than in the recent past. Banks didn't hesitate to use them in a counteroffer when a top banker was being wooed by another firm. The guarantees varied in length from one to three years, depending on the banker's caliber and position, with two- to three-year guarantees usually given to group heads. "Pay guarantees are now back," says Richard Lipstein, managing director at Boyden Global Executive Search. "If you are doing well and a competitor wants to hire you, they have to pay up for you."

Still, some habits that became ingrained during the lean days of investment banking endure. Despite the brisk hiring environment, bankers still think twice before moving, and they take into account factors other than money, notes Paret of Egon Zehnder. "People are cautious in making a move," he says.

Focus of complaints

In years past, bankers frequently complained that they were wronged on pay, but not in 2005. "If I step back and think of a theme I have been hearing from people who were unhappy and why that is, the most common complaint has been that they got looked over for a promotion," says de Cholnoky.

With pay so much improved, the slow road to promotions is more noticeable. Much of it stems from banks' tougher standards and their reluctance to award, for instance, a managing director title, which also entails a raise. Sometimes the raise can be substantial. At Goldman, for example, a promotion to partner can literally means tens of millions of dollars in stock and other emoluments over a career.

Another reason: fewer top slots. As deals have picked up, firms have shrewdly added more junior people to process deals, but they have not expanded with a proportional number of senior slots such as managing directors. "Firms have added a lot of people, but they have not added a lot of MD or director slots," says Johnson Associates' Johnson. He says that firms are also trying to avoid overhiring, having tired of painful large-scale layoffs in the recent past.

Hiring: supply and demand

While deals and fees have been gushing in, most banks have tuned their hiring practices with almost as much fervor as their pay practices. But even with this caution, the end result is that banks have ramped up their staffing levels, and indeed, recruiters say they are busier than ever looking for candidates pretty much across the board. Lehman Brothers grew its ranks by 8% in 2005 and plans a similar increase in 2006. Goldman plans to add 2-3% more employees in 2006. Meanwhile, executive search firms are licking their chops, waiting for Morgan Stanley, which axed numerous managing directors near the end of 2005 and in early 2006, to start hiring replacements.

Investment banking and equities are expected to be strong in 2006, according to the Securities Industry Association. Thus banks will likely continue to look for talented bankers in those broad categories, especially in hot sectors such as financial sponsors, FIG, energy, consumer products, and portions of technology.

Despite all the resumes that pour in, top Wall Street banks tend to hire among a known pool of people who usually work for rivals. "It's like playing musical chairs pretty much among those [already] in the game," says Murari Rajan, co-head of the US investment-banking practice at Egon Zehnder.

As 2006 has gotten under way, business remains brisk. M&A volumes are already at $606 billion, up from $422 billion in the same period last year, according to Thomson Financial, and equity underwriting is showing signs of a comeback. Fixed income and trading are expected to be strong, but at a more muted level than in the past. Meanwhile, the SIA is predicting an even a bigger bonus pool in 2006.

But there is an inescapable reality hovering over bankers. While they got paid well in 2005, their rebound year, their comp is still nowhere near the pay accorded to star traders, who help rake in the Street's bigger profits. "Investment banking doesn't drive these firms anymore," Johnson says. "It may not drive it again."

(c) 2006 Investment Dealers' Digest Magazine and SourceMedia, Inc. All Rights Reserved.


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