Wednesday, September 19, 2012

Goldman Tweaks Banking's Ladder

Goldman Sachs leads; everybody else follows. Or most everybody else. So it has been for the past couple of decades in how corporate and investment banks structure themselves and recruit, develop, promote and pay for talent. And so it has been in how banks--from Goldman to regional banks involved in corporate banking and foreign banks that set themselves up on American shores--organize banking units.

Traditionally since the 1980s, most corporate and investment banks (including also their trading, cash-management and processing units) recruit finance professionals into the following "programs," "classes" or "levels":

1. Analysts (those with BA or BS degrees) who join a two-three-year program and who virtually learn from scratch financial analysis, accounting, capital markets and banking on the job, while toiling away long hours doing the dirtiest of work for banking teams (spreadsheets, analysis, projections, document preparation, document printing, research, and, yes, mundane errands for managing directors). They often embark on the role without a clue.  To their credit by the end of the first year, many become somewhat astute about accounting, corporate firm valuation, cash-flow analysis, financial projections and the required regulatory steps to issue new corporate bonds.

2.  Associates (those with MBA degrees or analysts who have been promoted to the associate position) who have substantially more responsibility and more client contact and who are expected to have mastered nuances in corporate finance, capital markets and client industries. They come with experience, maturity and ambition. Some were top-rated analysts at banks before they retreated to Wharton, Darden, or Tuck to polish their understanding of finance and markets. They learn quickly that first year that banking is brutal business, not an academic pursuit.

3.  Vice Presidents who are promoted after spending three-four years as associates and who have more management responsibility and greater access and input to client, deals, transactions, and revenue-generating activity. The pressure builds for them, because performance is tied not necessarily to an in-depth knowledge of markets, financial products and balance sheets, but to their ability to generate revenues and minimize risks.

And depending on the bank, fund, or institution:

4.  Executive Directors/Directors/Principals who have more senior roles in the management of client relationships, trading portfolios, and/or business units.

5.  Managing Directors/Partners who, besides having senior roles and significant decision-making responsibility, have extensive experience and a meaningful ownership stake (or simply own a lot of the stock). They are the ones who have spent practically half a career in the business and are known for their contacts, networks, client relationships, experience through hardships and downturns, and uncanny knowledge of just about anything they touch from day to day.

How and when people are promoted, paid and awarded bonuses have conventionally been determined by "market benchmarks."  But who sets that "benchmark"?

Often it is Goldman Sachs or occasionally one of its peer firms (JPMorgan, Citi, Morgan Stanley, Merrill Lynch, e.g.).  Sometimes it is set by the industry's efforts to ward off other competing finance sectors or industries.  For example, in the technology boom/bust of the early 2000s, banks felt threatened that dot-coms and other start-ups would seize their more talented recruits.  Some big banks even started a brief trend, as an added incentive, of permitting analysts and associates to invest in private-equity deals the bank had been involved in.  Banks regularly have reshaped, rejuggled and revamped development programs to attract analysts and associates who would otherwise be more interested in technology start-ups, hedge funds, venture-capital outfits, consulting or non-profits.

For years, however, banks have shown a tendency to copy or borrow the programs, titles, bonus payouts, perks and promotion standards of other banks.  Often it has been Goldman that started a trend or Goldman that raised the bar for base pay or bonus ranges.  Other banks--with the help of industry compensation experts and professional recruiters--would peek and try to match the "market" (the market set by Goldman) or at least come somewhat close to it.

That would explain, for example, why compensation offers at most of the top banks, funds, and institutions tend to follow similar trends and tend to be quite similar in amount or package content. If Goldman decides, as it has done so in the past, that MBA associates should be paid bonuses partially in common stock. Then others follow suit. If Goldman changes its mind, as it has done in the past (early 2000s), then others do, too.  Some call it copying; others call it competing to stay in the game.

So whenever Goldman makes a move and tweaks some part of the ladder, the industry watches, waits and then reacts.  Last week, it decided to change elements of its analyst program a wee bit.  The change, announced in the Wall Street Journal, will have a trickling effect on other corporate and investment banks.

The change was not major; it was a modification, not an overhaul of the program. But because it was Goldman, it will be discussed, examined and probably duplicated by others.  It decided not to hire analysts on a contract basis for two years and not to guarantee a base level compensation during that period.  Analysts, therefore, can be dismissed for non-performance, and on the way out, they will not be awarded a thanks-for-your-services bonus.  While on paper or in concept this doesn't appear to have any impact on corporate or investment banking, because it's Goldman, it's news.

What does it all mean anyway?

The bigger story may be that Goldman, like all banks, continues to be under burdensome pressure to manage costs when banking activity is annoyingly volatile and the industry is under siege from regulators and the public. One incremental way to manage banking-personnel costs is to start at the bottom:  Don't hand out gobs of cash to under-performing or disinterested financial analysts, some of whom aren't interested in long-term careers at Goldman anyway and have an eye on applying to business school or joining a Greenwich-based hedge fund.

One immediate effect on the young graduates is that the tweaks will make the tough, grinding, difficult role of an analyst even tougher. The life of the banking analyst is one of 80-100-hour work-weeks, a grueling physical existence where one is on call all the time, even on weekend evenings.  But the pay-offs were always an extraordinary bonus payment, a modicum of prestige, and the opportunity to learn massive amounts of corporate finance and capital markets almost overnight. Goldman's tweak adds pressure. Analysts now won't have the luxury of failing or slipping up, as they (right out of school) adjust to deals, markets, spreadsheets, analysis, research, irascible vice presidents, and merely the real world in general.

Another implication is that if banks tweak the analysts program, they could easily tweak the MBA associates program next. Behind closed doors right now, senior bank managers might be huddling to decide how to manage the costs of another class of new associates from top business schools. They could agree to compensate the new bankers and traders handsomely (as they have always done), but they could decide they must reorganize the program (including compensations and performance expectations) to limit overall costs in other ways:  dismiss "under-performing" associates sooner, reduce the number of associates who are on track to become vice presidents, or offer compensation packages of greater portions of restricted stock. The senior bankers could also decide to encourage associates who perform adequately, but whose hearts aren't in it, to leave.

In its lofty role of setting industry standards and setting the "market" for compensation and promotion, Goldman knows by now its incremental steps will probably be copied.  It's not only Morgan Stanley that might follow suit, but the modest-size boutiques, the regional corporate banks, or the West Coast investment-management firm, too, will adjust.

Many say the roles, compensation and lure of corporate and investment bankers have hardly changed in the past several years. But with these kinds of tweaks and revisions, that new day could be dawning.

Tracy Williams

See also:

CFN:  Forced Ranking:  Does it hurt? July-2012
CFN:  The Dreaded Performance Review--2011
CFN:  Becoming a Top Performer--2009
CFN:  Is I-banking still Hot?--2011
CFN:  How Does Goldman Do It?--2010
CFN:  Mastering Technical Skills in Banking--2010

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