Goldman chips away at fixed cost problem

August 25, 2011

By Quentin Webb
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

LONDON — Trimming base pay for London bankers gives Goldman Sachs back a bit of pre-crisis flexibility. A 2009 agreement to increase some senior staff’s fixed pay was, like moves by many rivals, a somewhat slippery response to political pressure over bonuses. But the Wall Street giant was smart to ensure the rise had a limited lifespan.

The public and regulatory scrutiny of bonuses was understandable at the time, given the banking industry’s huge pay packets and its starring role in wrecking the world economy. But to many non-bankers, the main result has been perverse: not a huge plunge in overall payouts, but a shift towards fixed pay. At Credit Suisse, for example, JPMorgan estimates that fixed costs will account for 82 percent of compensation in investment banking this year, up from 66 percent in 2009.

This setup may have been convenient for the past year or two, but it looks unsustainable. With the economic picture darkening and markets floundering, revenue is falling faster than banks can trim costs. Even Goldman is not immune, logging a puny 6.1 percent annualised return on equity in the second quarter along with net income far below analysts’ forecasts.

To be sure, badly structured bonuses can encourage bankers to make risky bets that undermine the stability of the financial system if they go wrong. But a soundly structured bonus system can offer the right incentives. And at least it has the benefit of being adaptable. Higher levels of fixed costs leave banks with fewer options. They may end up firing more staff, rather than just shrinking everyone’s pay cheques. The alternative — keeping pay and staff levels up as revenue falls — is hardly investor-friendly.

Goldman hasn’t said how much it will save by ratcheting down base pay. Nor is it clear whether any other banks have also moved to turn back the clock. Goldman at least seems to have been clever enough to write the reversal into its employees’ contracts. If others didn’t have that foresight, making it happen could prove contentious. But it’s one more Goldman lead that rivals would do well to follow, if they can.

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