Wall Street Executive Payments

Washington Post business columnist Steven Pearlstein was online Wednesday, Dec. 20 at 11 a.m. ET excessive executive pay on Wall Street.

Read the column: Wall Street's Season of Excess (Post, Dec. 20).

A transcript follows.

About Pearlstein: Steven Pearlstein writes about business and the economy for The Washington Post. His journalism career includes editing roles at The Post and Inc. magazine. He was founding publisher and editor of The Boston Observer, a monthly journal of liberal opinion. He got his start in journalism reporting for two New Hampshire newspapers -- the Concord Monitor and the Foster's Daily Democrat. Pearlstein has also worked as a television news reporter and a congressional staffer.

His column archive is online here.

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Lovell, Maine: Do you consider the efforts of the federal government (SEC, etc.) to ensure that citizens and shareholders are told the true costs of corporate executives, including direct remuneration, options, retirement, bonuses, housing, private jet priviledges, health clubs, etc., adequate? If so, how so? If not, what are your suggestions and the feelings of those whom you are talking to these days?

Steven Pearlstein: The extra disclosure, and the rules that will allow us all to compare apples to apples, is a great idea. The SEC ought to be commended, including Chairman Cox. And this, by the way, includes more disclosure about post retirement pay and benefits. The next step along this path, however, is to have the shareholders get a vote on executive pay and bonus plans, and to insure that directors can be removed if they don't win a majority vote in the Soviet-style "elections" that are the rule in corporate America.

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Annandale, Va.: Without going into too great a detail, could you tell us what a company like Goldman Sachs and other Wall Street firms actually do to earn the kinds of profits the companies reported reported this year and the amount of bonuses it paid to its employees especially the higher executives. Isn't greed great!

Steven Pearlstein: We need first to say that Wall Street firms have been incredibly innovative in recent years, creating all sorts of new products that allow big companies and institutional investors to raise money, lay off risk, price risk, etc. This has made all sorts of markets more liquid, more stable, more efficient, better able to price things, etc. And among the firms, Goldman is reputedly the best, particularly when it comes to making the right bets about which way interest rates will go, or what is the probability of a credit default, or whether oil prices will go up or down. These are smart folks who work incredibly hard, and they deserve to make more than the rest of us, at least in an economic sense.

But not that much more. And that's my point in today's column. It is one thing to say you want pay for performance, which we have. But you also have to ask whether the level is reasonable and necessary, and I would say it is neither reasonable or necessary. The people on Wall Street have got so used to these numbers that they have lost all perspective, and actually think they deserve these sums. They point to all the value they create, all the profits they earned for themselves and their clients, etc.

Funny that.

I never hear about when a merger that has been pushed by one set of investment bankers, and blessed in a fairness opinion by another set of bankers, goes bad, that anyone gives back the fees.

You never hear about the fund manager who loses money for clients dipping into his fees to make them whole.

The problem with this "deserve" thing is that it is a one-way ratchet -- a form of heads we win together, tails you lose kind of proposition. The big upsides would be "deserved" if they were matched with equally big downsides. But they are not. And that's the con game.

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Any more on why the oligopoly stays?:"Clients are less focused on price than on the reputation of the firm and its key employees. Nobody ever lost their job hiring Goldman Sachs. Because of this reality, it is difficult for new firms to enter."

Just seems like there's so much money at stake and new financial instruments that more of this advantage should get competed away. Especially when some of the investment bank advice is so fad-driven: mergers and synergy are in one year, breakups and 'focus' are in the next. But despite poor results, the investment banks still make money on all the churn.

Steven Pearlstein: Precisely. As to why the oligopoly stays, it is a fascinating question that we could ask about lots of industries that are imperfectly competitive. In this case, the most important factor is that corporate clients are probably loath to take a chance on a lower-cost entrant because the savings are overwhelmed by what would happen if the deal turns out badly and the person who makes the decision gets second-guessed for going with a cut rate firm. And because everyone knows that, the investment banks don't worry about their pricing getting undercut. In fact, I suspect they compete to see who can charge more, on the theory that the higher price will send a signal that they are the quality player. And the corporate clients are suckers for that kind of thing.

This is also a market that has some scale economies and probably can support only a handful of key players. In that it is not unique. But it is the difficulty of entry, and the client insensitivity to price, that creates the oligopoly pricing and profits.

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Oxford, Ohio: Steven - thanks for the thought-provoking column. Some of the things Teddy Roosevelt said still ring true today. Do you think the government should be doing something about the issues you raised today? Could shareholder activists change things? Or is it more of a social issue - i.e. if such excesses were regarded as evidence of "greed" rather than "success", maybe they would moderate their behavior to earn the esteem of others?

Steven Pearlstein: You notice I don't use the word greed. I don't think that is useful in an economic conversation. Why do I want a raise? Because I'm greedy. Why do you want a lower price on that flat screen TV. Because you're greedy. Calling someone greedy in a capitalist country doesn't really illuminate things very much.

As to what the government should do, I've already said making corporations more responsive to shareholders is probably as far as I would go. Then I'd hope that some major mutual funds and pension funds would get together and devise a set of standards that would govern their voting, which would set some real limits on pay programs -- not just in terms of how they are structured, to link pay to longterm value creation, but also by setting some absolute limits, so that we can lower overall levels. The shareholders ought to be the drivers of reform here, not the government -- the government should just make it easier for them to do so, individually and collectively.

In the end, however, this is largely a cultural issue. In Europe, nobody would dare pay themselves these sums because it would bring social disapproval down on them. And the press, the academic community, the religious community all have a role here, in discussing openly the moral and ethical dimensions of a market economy that is allowing the very top to pull away from everyone else. So far, the corporate community has been able to ignore that conversation, despite overwhelming disapproval of their pay schemes. But we have to keep at it, because I think we are finally gaining some traction.

In the end, this will break when more and more chief executives of visible companies declare they aren't going to play the old game, are going to set reasonable limits, and speak the truth about how corrupt the old system has become, with the directors and compensation consultants all scratching each other's backs.

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Washington, D.C.: How much was your bonus this year?

Steven Pearlstein: Unfortunately, non-managers in the newsroom aren't really eligible for bonuses. I think that is wrong -- I'd be in favor of lower base pay with a fairly sizeable bonus pool. But I"m not sure most of my colleagues would agree.

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Brightwood, D.C.: Fannie Mae told most of its non-trading-floor workforce to take annual or leave without pay for two weeks over the holidays, including 2,000 consultants on Catch-up and Get Current projects (earnings 2005 and 2006.) Apparently now Morgan Stanley has also furloughed most of its employees for a holiday spell. What is it with trillion-dollar piles of investment money trying to cut expenses on the backs of non-executive employees? Even Scrooge took the same half-day off he gave Bob Cratchit...

Steven Pearlstein: Is this just a game for the companies to raid the unemployment insurance pool>

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Danvers, Mass.: Charlie Munger also says it's envy. Wall Streeters manage other people's money. Corporate executives manage their ownership of capital assets. Are these service worth a percentage of the assets' value? of their income? In aggregate, how should the managers' compensation compare to something like GDP over time? constant, rising, declining?

Steven Pearlstein: You would think that people who are constantly justifying corporate consolidation on the basis of economies of scale would have the intellectual honesty to admit that managers share of profits should be going down, not up. But my main point here is that this is not a proper way to think about compensation. The right way is to think about what a human being needs and can spend, and work up from there. Why is it that the person at the top of a huge organization is entitlted to any percent of the profit? If the company doubles in size, can he work any more than the 12 hours a day he now works? Or any smarter? Will he have any more direct reports? I don't think so.

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Houston, Texas hello steven: Can you explain how these wall street xmas bonuses are determined? How do i get a job there?

Steven Pearlstein: Get born to prosperous parents. Go to Yale and Harvard Business School and get a summer internship at Goldman. And then work your way up the greasy pole.

The bonuses are determined on the basis of how much profit you or your group generated. Its a fairly elaborate process, with all the trappings of being objective and rational and market driven. But it still begs the question of how big the bonus pool should be in the first place.

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Washington, D.C.: Why don't competitive forces reduce revenues at the big investment banks? I.e., if Bank X will do a major deal for a 1% fee, why doesn't Bank Y offer to do it for a .50% fee? Is there collusion? Or are the companies that use investment banks simply so big that it is not worth their time to trigger these competitive forces by inducing bidding?

Steven Pearlstein: Well, as I said, the banks are smart enough not to get in a price war with each other, because they know that, in the end, they will all be losers and nobody will gain any market share because of it. And it is a small enough club that they can pull off this kind of collusive behavior without actually have to have a meeting and collude. The real problem comes from the fact that it is almost impossible for a new firm to enter and try to get a foothold by offering lower prices. And the reason, as I said, is that the market is rather price insensitive.

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Dayton, Ohio: My college roommate worked for Goldman out of college. He probably makes three times what I make, but I work many fewer hours, have a shorter commute, drive a nicer car and live in a much nicer home. Why? Because I live in flyover country.

I harbor no envy for bankers whose only perk is high salary. Money is just a number.

Steven Pearlstein: Yes, it is a mistake to equate pay packages with happiness, at least above a certain level. There is a diminishing return to income on the happiness scale.

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Woodbridge, Va:"Funny that. I never hear about when a merger that has been pushed by one set of investment bankers, and blessed in a fairness opinion by another set of bankers, goes bad, that anyone gives back the fees.

You never hear about the fund manager who loses money for clients dipping into his fees to make them whole."

Yeah, whatever happened to the concept of suing for breach of fiduciary responsibility? Why don't these advisers face at least some liability when they push highly risky ventures that go south? Admitedly the final decision remains with the investor but the system does seem to be stacked in favor of the middlemen.

Steven Pearlstein: You got that right. They get you coming and going -- on the way up as well as on the way down.

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Washington, D.C.: I'm a buy and hold index fund investor. There's a lot of wasted money in the financial and business world, but from a personal level, I'm not affected by a lot of it. For example, high mutual fund fees come out of the pockets of people who are dumb enough to pay them. Overly inflated corporate pay, however, affects my bottom line, since that means corporate profits are lower. Hedge fund salaries seem like they would, like mutual fund fees, come out of the hedge fund investors' pockets (other than the indirect effect you mentioned). But I'm not sure about how to think about the money going to investment banks like Goldman Sachs, a lot of which seems to come from mergers. Can you enlighten me?

Steven Pearlstein: Well, their biggest source of profit these days is trading for their own account -- in other words, they make money buying and selling financial instruments. The advisory business is smaller, less profitable but growing nicely. And there are fees for executing trades or coming up with new financial instruments for clients. In the end, all of these are paid, ultimately, by owners of capital, which could be individual investors or beneficiaries of pension funds or beneficiaries of university endowments.

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Twincities: I agree with the central premise of your article that the executive compensation market is imperfect. But is it imperfect because the skill/expertise of these executives is rare and therefore rewarded disproportinately or is it a sort of collusion where the executives are artificially creating a supply-demand mis-match (not sure how they would though... after all no one stops me or anyone else from trying to be an executive)? Appreciate your thoughts. Thank you.

Steven Pearlstein: It is not because the skill is rare -- there are lots of people who are coming out of business schools and consulting firms who would love to get into the game. Potential supply is much larger than the demand. But this is a winner-take-all type market, in which all the clients want to deal with the top performers. If I told you I could get you a good deal on the services of the 20th best investment bank to handle your corporate merger, I suspect you'd pass up the opportunity. And that understandable caution on your part leads to the winner-take-all dynamic. In truth, the 20th best is probably good enough, and only increases the risk of the deal very little, if at all. But people don't know it or, if they were shown evidence, don't believe it. Again, its a defensive mechanism: If things go wrong, you don't want to be in the situation of explaining why you decided not to go with Goldman Sach.

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D.C.: Also -- to Houston, TX -- make sure that you have the appropriate (i.e., required) gender apparatus. That is to say: no girls allowed in this clubhouse.

-sigh-

Steven Pearlstein: they're allowed, if they're willing to act and think like the boys.

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Arlington, Va.: For the most part, I agree with your contention that investment bankers in the U.S. are overpaid, but how is that any different from real estate agents (getting 6 or 7% commissions on real estate that has doubled in value or more in ten years) compared to the rest of the world, or auto workers making $25 to $30 an hour for the Big Three while Nissan and Toyota workers in the U.S. make roughly half that amount? It's easy to pick on Wall Street, but there are many places in our economy where I suspect compensation will be competed downward.

Europeans may not be paying themselves the same pay packages in private industry, but some of that is due to the best and brightest going into government and then getting sweetheart deals on housing, living allowances and other luxuries. The pursuit of self and self interest is not unique to the U.S.

Steven Pearlstein: We can argue about whether some autoworkers are overpaid (I've written that) or real estate agents (I've written that, too). But the degree to which they may be overpaid pales in comparison to Wall Street and executive salaries. Not necessarily in percentage terms, but in absolute terms. and my point is that percentages shouldn't be the way we think about these things. We can have a big argument about whether investment bankers should earn two or three million a year. But I don't think there is any excuse for paying them 25 million routinely.

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Annandale, Va.: Steven,

I take great comfort in knowing, for a fact, that every single one of these greedy, immoral people are going to die. Their money can't buy them out of that. Of course, if they die sooner, rather than later, that just make my day a bit brighter.

Steven Pearlstein: Now, now. Let's not get into that.

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"Get born to prosperous parents.": And isn't that the problem right there? Social mobility in the US is dying (even that notable left-wing rag, "The Economist" now is saying that). Meanwhile those at the top take an ever increasing amount of national wealth.

At a certain point, this tends to breed a leeeetle bit of violence.

Steven Pearlstein: Yes, at some point the losers will decide the system doesn't satisfy their needs and wants and will use the political system to redistribute income in some fashion. We don't need to have a Russian-style revolution to do that. We can do it the European way, through high taxes and government run health care, restrictive labor laws, that have the effect of lowering corporate profits, lowering returns to holders of assets and increasing the incomes and economic security of those at the bottom. Which is why the corporate leaders need to start thinking of ways to restrain themselves -- because if they don't, pretty soon somebody is going to do it for them.

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Houston, Texas: Have observed over the years that when the U.S. government has a probe with these these wall street firms; i.e. Merril Lynch et all the rest, an out of court settlement is reached, the various firms admit nothing, deny nothing. They pay huge fines to the gov and then the federales keep the monies and we who have been harmed get more salt on our wounds. The fox is not guarding the hen house.

Steven Pearlstein: Not sure what your point is exactly. Most of those settlements have to do with wrongdoing. We're not talking about that today. This is about perfectly legal ways of setting pay for executives and top performers in financial firms.

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Washington, D.C.: There's similar price snobbery when it comes to corporate law firms, too.

Steven Pearlstein: I'm sure there is. Too bad there isn't when it comes to newspapers!

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"Now, now. Let's not get into that.": Why not? Our govt is for hire to the highest bidder, and we can't even get the most minor of ethical reform passed. The top 1% are pocketing 80% of economic growth. Social mobility is dying fast.

If all other options are closed, and a new de-facto aristocracy is forming, they should be deal with the way we dealt with the last aristocracy.

Steven Pearlstein: This is how we get into a bad political dynamic.

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Washington, D.C.: This just sounds like a bunch of people who are bitter. Investment bankers work harder than anyone else in business. They routinely work 18-20 hours a day in thankless jobs, and the only thing they have to look forward to is their future earnings.

College grads who go into I-Banking basically spend all their time working for 2-4 years non-stop, whereas everyone else works normal hours and has a more laid-back life.

Don't be bitter just becuase you made the wrong decision or didn't work hard enough when you were young...

Steven Pearlstein: If you think there is some rational relationship between working very hard for four years, and earning $20 million a year every year from the age of 30 to 55, then we have problem. Deferred gratification is worth something, but not that much.

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"bad political dynamic": Uh...if all options are closed, isn't using terms like "bad political dynamic" just a sop?

It's sort of like when the big dumb bruiser expects the scrawny guy he picked a fight with to follow Marquis of Queensbury rules, and berates him when he "cheats". Why should the rules be set by those who gain by them?

Steven Pearlstein: Because if you let these kinds of disagreements get raised to the level of wishing your enemies dead, then you are in Bagdad. Let's try to keep things more civil than that, even on line.

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Steven Pearlstein: Good discussion. There won't be any chat next week. Wishing all of you a happy holidays and a great new year. See you in January.

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