The financial services industry has been pulling in solid profits lately, but experts say firms should be mindful about how they dole out year-end bonuses and to keep the focus on rewarding long-term performance.
Taxpayers were nearly ready to bring out "le guillotine" in March after the American International Group awarded the top executives in its financial products unit $165 million in bonuses just months after the firm received $173 billion in government bailouts.
Kenneth Feinberg, the Treasury Department's special master for executive compensation, is determining the appropriate executive pay packages for the top 100 employees at the seven most heavily bailed out companies-AIG, Bank of America, Citigroup, General Motors, GMAC, Chrysler, and Chrysler Financial -but the "pay czar" has no jurisdiction outside these companies.
Nevertheless, many executives are worried that their year-end bonuses and salary levels could be slashed at the last minute for the sake of appearances. Like professional athletes, these top performers often switch firms and go to the highest bidder, and firms that don't pony up lose out.
A recent report from the New York State Comptroller's office found that broker/dealer operations of the New York Stock Exchange's member firms earned a record $35.7 billion in the first half of this year. Net revenues totaled $91.4 billion for the first half of the year, nearly three times the $35 billion for the same period a year ago.
"Profitability is on track to exceed 2006 levels, which was a banner year for the industry," said Comptroller Thomas DiNapoli. "Compensation is also increasing faster than expected, leading to expectations of higher bonuses."
The report found improved profitability at each of the four securities firms it examined: Goldman Sachs, Merrill Lynch, Morgan Stanley and JPMorgan Chase. Compensation has improved at each of the four firms, with both Goldman Sachs and JPMorgan "on track to pay out more compensation in 2009 than in 2007," and Merrill Lynch and Morgan Stanley showing compensation declines slowing.
Bonuses paid to employees in the New York securities industry, including deferred compensation, "could be higher than last year based on current compensation trends," the report said. "Compensation reform, however, will restrict the amount paid this year in cash and will increase the amount deferred to future years."
The Securities and Exchange Commission is working to improve its Sarbanes-Oxley mandated examination of executive compensation at financial services firms, and recently indicated that companies shouldn't wait for a formal request to brush up on their disclosure practices.
"It is in a company's best interest to communicate clearly and effectively about its executive compensation," said Shelley Parratt, deputy director of the SEC's Division of Corporation Finance, at a recent conference on proxy disclosures. "The SEC's role in this area is not to regulate how companies compensate their executives, but rather to see that investors have the critical disclosure they need to make informed investment and voting decisions."
"The compensation discussion and analysis should not be so technical and process-oriented that it obscures the explanation of what the compensation is designed to reward," she continued. "A company's analysis of its compensation decisions should present shareholders with meaningful insight into its compensation policies and decisions, including the reasons behind them. Where analysis is lacking, shareholders are often left with a pages-long discussion that is heavy on process but does not explain the reasons why the named executive officers were compensated as they were."
There are a number of creative ways to compensate executives for strong performance without awarding year-end bonuses, such as through the use of stock options, employee stock purchase plans, restricted stock purchases and performance shares. Each of the options can be profitable or not, depending on when the stock is offered and when the offer is exercised.
A new study by Charles Schwab found that most of the companies it surveyed say they offer benefits in order to motivate their employees and support the future success of their companies. The 200 firms Schwab surveyed had an average of $1 billion or greater in annual revenue.
"A few years ago, they would have said it was a recruitment tool, but now these options are a motivational and employee-retention tool," said Larry Bohrer, vice president of Charles Schwab Stock Plan Services. "Performance-based rewards are becoming a more prevalent tool for recognizing performance."
Bohrer said many of these options will allow the purchase of company stock at a certain price for a set amount of time. If the market price falls, employees are unlikely to buy the stock at a higher price than the market, but if the market price rises, as most stocks have this year, the employee can purchase the company stock at a steep discount.
"Performance-based plans often have a time component and list specific criteria that must be achieved in order to realize the value of the reward, such as hitting a target level of earnings per share," Bohrer said.
A cashless exercise option allows employees to borrow up to a maximum amount from a brokerage firm, purchase the company stock at a low, fixed price and immediately sell the stock at the current, higher price for a net gain. Many companies discourage this practice, as they want the employee to hold onto the stock so they'll have an ongoing stake in the business.
All equity rewards create a current taxable income, but there are no taxes when they are granted, he said, only when the rewards are taken advantage of. They are not tied to 401(k) plans.
Bohrer said the No. 1 challenge administrative plans face is educating employees about the features and benefits of these rewards.
The study found that 55% of executives were worthy of an "A" grade for their level of understanding of these options, while about half of non-executives scored a "C" grade in their understanding. In addition to providing employees with informational packets and online resources, employers can offer on-site seminars and one-on-one consultations to improve employee education, but few make this extra effort.
"There seems to be a big gap between the challenges these companies face and the actions they take to solve them," Bohrer said.
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