Published: October 23, 2009 11:13 am      

The hired help deserve to skim off $100 million a year?

"Nobody who is hired help and who plays with other people's money "deserves" to earn $100 million," gripes the brilliant Steven Pearlstein in an outstanding article for the Washington Post. "That's certainly true in a moral sense. But it is also true economically.... Let's look at the fundamental asymmetry of risk in the investment business. If you were putting your own money at risk," Pearlstein continues, "there's the possibility of making lots more, but there's also the possibility you could lose it all. The same, however, can't be said if you are an investment banker, a hedge fund manager or a trader in credit default swaps. In that case, if you do well, you get a percentage of the winnings or the value of the deal. But if you do poorly and your clients lose money, the worst that happens is that your bonus is zero. You never have to give back anything from the bonus you earned last year. And, you still get a base salary comfortable enough to keep up payments on the Upper East Side townhouse, the summer place on Nantucket and the tuitions at Brearley. "No one cares about over-the-top compensation schemes when business is booming ... and when share prices are rising. But on the downside, everyone cares. During the "Great Bull Market" of the late 1990s, almost no one bothered to question the exorbitant option grants that Silicon Valley companies lavished on their employees (and on their board members!).
But once the "Great Bull Market" ended, and the NASDAQ imploded, a new bull market in recrimination and litigation began. Class-action shareholder lawsuits erupted from the smoldering remains of former Wall Street darlings, as desperate shareholders tried to recover some small fraction of their losses.
Would it not have been much better for these abused shareholders to sell when the selling was good? Would it not have been better to have raised a skeptical eyebrow toward the questionable corporate practices of the era and headed the other way..., even though questionable corporate practices were producing rising share prices?
"Excess compensation in one area leads to excess compensation in others," Pearlstein concludes. "And that, in the end, is how this arms race in executive pay comes about. It's more about envy than economics. The corporate executives complain they should make as much as the investment bankers, the bankers are upset if they don't make as much as the private-equity guys, the private-equity guys demand to make as much as the traders, and the traders won't sit still until they are paid like hedge fund managers.” Excess compensation also leads to sub-optimal shareholder returns. Greed and capital preservation just don't seem to mix very well, especially when the greed belongs to someone else and the capital belongs to you. The big brokerage firms make most of their money by speculating with capital that does not belong to them, or by levying fees and commissions on capital that their clients put at risk in the financial markets. In other words, shareholders and clients bear most of the risks. Yet, whenever any form of success arrives, Wall Street's elite always garner an outsized share of the rewards. That's asymmetry. And in this case, asymmetry might just be another word for "greed."

Bob Tonachio, CEO of Robert James & Associates, Inc., may be contacted at 1-800-530-5700 His firm charges no fees for advice and consultations are always free of charge. Clients, that followed his firm’s recommendations did not suffer losses in the recent bear market.