The Compensation Correction Posted on: September 30th, 2008

For
the past several years, financial industry compensation has been
cycling upward, but we all knew that it couldn’t continue indefinitely.
Every year, base salaries trended up, bonuses were all but guaranteed
and were often multiples of base salaries without regard to personal or
firm performance — and firms were paying sign-on bonuses, moving
packages and sometimes making candidates whole on anticipated bonuses
they were leaving behind to make the move. Candidates sought their next
career in banking, private equity or hedge funds because it was the
“hot” sector and they could make a handsome living, but few could
articulate precisely what they loved about the work other than the
money. Those easy to grab rewards are rapidly fading into memory. There
is a compensation backlash whipsawing through the industry and we all
need to be prepared to be realists about what “market compensation”
means for the foreseeable future.

There
is a heavy flow of talented candidates into the job market right now.
It means that to be a survivor in this new recruiting market,
candidates need to be realistic and be ready to retool (more about
retooling in my next post). It also means that candidates will need to
be prepared to demonstrate what value they can add to their current
firm, in to keep their jobs. There just won’t be enough seats at the
table to absorb all of the candidates coming into the market and that
means an inevitable change in how compensation has been doled out to
date. A WSJ article on Monday touted the new breed of CEO’s who are
willing to agree to have their bonuses and comp packages adjusted
downward if the company’s performance isn’t up to par. Expect the same
thing to begin happening in our industry.

Last
year several clients decided that bonuses were nothing more than a
fiction, that there were no tangible standards upon which bonus amounts
were awarded and that candidates had begun to expect them as part of
their reliable compensation, not as a reward for superior performance
or returns. These clients began turning to a reasonable base salary,
and carry as the measure of reward in their firms (even at the mid and
junior levels), all but doing away with bonuses and making long-term
performance of employees and the fund intimately tied together.

Given
that investment cycles are predicted to last longer, that exits will be
tougher and that firms will likely have to be tightening their belts
with fundraises coming further apart than before (meaning less
overlapping management fees), and the competition for a place at the
table in firms will be greater, expect compensation to begin cycling
downward in this year and throughout 2009. We could very well see firms
saying, in effect, this year’s bonus is that you get to keep your job.

Take
note, this is not a suggestion that firms should have a free license to
take advantage of candidates and not reward them for jobs well done.
But, to a certain extent, expect that firms will return to the basics
of compensation in this industry – your salary is your compensation for
doing the basic requirements of your job, your carry is your reward for
the long term performance in the fund. Traditionally, private equity
has been about the long view and to see results meant putting in the
effort and trusting in the result at the end of the game when an
investment exited.  The past several years of
bonus compensation have had little to do with employees’ performance
and more with private equity trying to attract talent by competing with
high salaries and year end bonuses offered by the investment banks. The
bulge bracket investment banking compensation model is changing
dramatically before our eyes and boutique banking firms and private
equity and hedge funds will look to follow suit, returning to their
roots of reward for performance.

Some
candidates have been quoting to me their “market value” by telling me
what they made last year. Market compensation is determined by the
current market, just like the value of your house.  The
industry we all work in is cyclical and that means that it isn’t always
increasing. It also means that we all need to take a good hard look at
what the market is paying based on current conditions and adjust our
expectations accordingly.  You don’t have to do a job if you can’t accept that salary, but you should also be aware of what the market is
willing to pay before you get yourself hung up on compensation issues.
There are lots of jobs out there, it just so happens that this industry
is experiencing a compensation correction, so last year’s going rate
may not be indicative of the current rate. Those who can be flexible on
compensation, geography and sector will have more opportunities than
those who cannot.

Recently,
a candidate from one of the failing banks was offered a position at
another firm. He replied, “That’s a 25% pay cut from what I made last
year! I’m worth more than that!” Don’t confuse your “worth” with what
you are being paid for the work you do. The two are never the same and
you’ll be a much happier person if you are doing work you enjoy and not
just for the money.

I’d
love to hear from you. How is compensation changing at your firm these
days? How are you coping with changes in compensation as the market
corrects? Email me at dpalmieri@pinnaclegroup.com