Compensation

Discount Broker Charles Schwab leads off his book of advice by describing an "eager-beaver stock salesman" he says he knew who took a prospect to look at the boats in the harbor. "As they surveyed the various luxury craft floating before them," Schwab writes, "the salesman pointed out all the yachts owned by successful brokers. 'But where are the customers' yachts?' the prospect innocently inquired."

It's odd that Schwab would appropriate this famous bit of Wall Street lore as his own--the story was considered old even in 1940, when it was recounted in a wonderful book called Where Are the Customers' Yachts'?--but it's a telling little legend nonetheless. An awful lot of money gets made in the investment world; but the exciting returns, by and large, are raked in by the croupiers.

I know a 23-year-old, first job out of college, who makes six figures trading foreign securities for a top-of-the-line New York firm. ("My job is to bullshit the customers," he says.)

I know an only slightly older fellow who makes seven figures trading bonds.

"Whoa," I said when he first revealed the number--seven figures is a lot of money for a kid, even on Wall Street--"let me see the pay stub."

Maybe this isn't the sort of challenge one is supposed to pose in polite society ("My, my, Mrs. Partridge, what stunning jewels--are they real?"), but Truth is my job objective, bluster my bête noire--and what connection have Wall Street trading desks ever had to polite society? Anyway, I wanted to see what a seven-figure pay stub looked like--if, in fact, this young man could produce it.

He could; he did. One million six hundred seventy-two thousand dollars. It was his bonus. (Otherwise, it looked pretty much like any other pay stub.) The problem was, he said, it wasn't enough. He'd been promised a percentage of profits on his trades--he is a very smart trader--and now they were trying to get off with a lousy $1,672,000.

It was the Richie Isaacs thing all over again. Richie--I can call him Richie because everyone else does--was trading G.N.M.A.s for Lehman Brothers Kuhn Loeb and quit in a huff when his bonus check came through for just $2,000,000. He went to Donaldson, Lufkin & Jenrette, where he says he's much happier.

Of course, these aren't your average Wall Street traders. Your average Wall Street traders these days make--what, I don't know--$200,000, $300,000 a year.

But for the good ones, you gotta expect to pay up. Here was this one kid at Hutton (or was it Shearson or Salomon? My lips are sealed), again 23, making--well, it couldn't have been more than $70,000 or $80,000, one of his colleagues told me, but the entire G.N.M.A. desk at Merrill Lynch had up and left one day, en masse, for another firm, and now Merrill was, quick like a bunny, trying to regroup. (A G.N.M.A. desk is a bunch of guys connected to telephones and video screens, trading millions of dollars of Government National Mortgage Association bonds and related securities.) So Merrill hired some senior fellow and charged him with putting together a new team. Which is how it came to pass that one morning, a year out of Princeton (or was it Yale?), the 23-year-old I'm thinking of went in to work to say he was leaving. He felt really bad, he said, but Merrill Lynch had made him an offer he couldn't refuse.

Now, you're thinking, How much of a bump would Merrill have had to offer a young guy like this to renege allegiance? Double what he'd been getting? Triple?

Merrill Lynch offered $600,000. But the kid didn't jump after all. You know why? His employer matched it.

"Hi, honey, I'm home!"

"How'd it go today?"

"Not bad. I got a $530,000 raise."

•

This column is about making money the old-fashioned way. If by the time you read it, things have already collapsed, perhaps this will help explain why. If they're still flying high, maybe it's time to take cover.

Not that the mid-to-late Eighties bear much resemblance to the mid-to-late Sixties, the last time we had some really good old-fashioned excess on Wall Street. Back then--The Go-Go Years, if you want to read John Brooks's fine account of them--champagne was flowing much as it is today. And then, as now, the Dow was not far from all-time record highs. But then you had daily merger-and-acquisition headlines, as financial wizards like Jimmy Ling used "funny money"--inflated stock--to build industrial enterprises of questionable long-term viability (L.T.V. for short). Today there are daily mergers, true. But with advisory fees to the investment bankers running routinely into the millions and very often the tens of millions--$100,000,000, in the case of Pantry Pride's acquisition of Revlon--you can be sure these deals are much more solidly grounded. (This time, instead of shaky stock, they're using shaky bonds.)

Then you had the much-publicized money-manager "gunslingers," like Fred Alger and Jerry Tsai; today, merely the much-publicized arbitragers (and, well, Fred Alger and Jerry Tsai back again, the latter most recently on the cover of Business Week).

Mutual-fund sales were booming back in the Sixties (remember Bernie Cornfeld?); today they're booming again, but--and here's the critical difference--this time, investors won't get hurt.

Finally, today you've got a much saner new-issues market. Back then, you had a company like National Student Marketing Corporation (my first job out of college) going public at six dollars a share and rising in the first day of trading to $14 (and then to $143). Today you've got Home Shopping Network going public at $18, rising to $42 that same day and hitting $133. But--and here's the critical difference--Home Shopping Network, unlike National Student Marketing (whose stock slid from $143 to $3.50), is no temporary marketing phenomenon. Students graduate, but there will always be shut-ins with money to burn watching TV.

So the differences between that era and this are stark. No more have we a guns-and-butter policy in Vietnam sowing the seeds of inflation; today our military and domestic spending is well within our means (give or take 200 billion dollars).

But I digress. (And actually, there really are enough differences to allow some hope; anyway, we'll scrape through.) What I mean to be talking about here is compensation--specifically, the hint of unreality that has crept into pay at the apex. Has greed run amuck? There was investment banker Dennis Levine earning more than $1,000,000 a year, yet looking to supplement his wage with some really serious money from insider trading.

"It's crazy, isn't it?" a young partner of what was once Lehman Brothers asked a group of us at an investment-community dinner party. He was marveling at how much everyone, himself included, was making. Not that pay stubs were being passed around the room. But you had to figure that average compensation for those in the circle was $500,000 to $1,000,000, if not higher. And this fellow, as he neared his 40th birthday, having built up a net worth of $5,000,000 or so by going to the right schools and plugging away honorably and conscientiously for his firm, lo these dozen years, thought it was all a little crazy. "Isn't it?" he asked again. Apart from my own head, nodding like a piston, the rest of the heads in the circle seemed not to grasp exactly what he meant.

I sat next to a classmate at a similar dinner who had helped develop a financial-planning program for households, like his own, earning $250,000 a year and up. "Gee," I said, "that can't be a very big market. How many households have that kind of income?" Oh, I'd be surprised, he said, sipping the $50 wine that had been brought to our table. He didn't have the figures right with him, but it was several million--something like one household in 11.

One in 11 American households with an income of $250,000 or more!

In fact, of course, the number, though hard to ascertain exactly, is more like one household in 500. It's just that a preponderance of those happy households are clustered in this fellow's neighborhood.

And speaking of households, I asked this classmate and the others at the table, just to see if they would be as surprised as I had been when I ran across the figure, what proportion of American homeowners they thought had mortgage debt of $75,000 or more. I was relying on 1983 data, I confessed--home prices and, presumably, mortgage amounts have risen some since then--but this was the data I had, so this was the quiz. What did they think?

The consensus was around 30 percent.

What proportion of homeowners, I persisted, was $50,000 or more in mortgage debt?

The consensus grew to 50 percent.

Yet the answers, according to a Government survey published by the Federal Reserve at the end of 1984, were two percent and eight percent. Only two percent of American homeowners in 1983 owed $75,000 or more on their homes; only eight percent owed $50,000 or more.

This is hard for investment bankers to imagine, because investment bankers live in Manhattan. In Manhattan, a three-bedroom apartment costs $800,000.

They're making so much money on Wall Street these days that even the lawyers are "Leaving the Law for Wall Street," as the New York Times Sunday magazine titled a recent cover story. In it, the senior partner of one top-paying New York law firm complained, "We are simply unable to pay the kind of money that a good man with two, three, four years of experience can get. The $200,000-to-$500,000 range just isn't possible."

Average American household income is in the $20,000-to-$30,000 range. Basically, it breaks down this way: Poor folks make four figures, most folks make five figures, rich folks make six figures, celebrities and a select few plastic surgeons and business types make seven figures, Victor Posner and a very few others make eight.

Just what (continued on page 203)Compensation(continued from page 147) Victor Posner contributed to society to make him worth the $12,700,000 salary and bonus he took from his financially troubled D.W.G. holding company in 1985, theoretically with his shareholders' approval (D.W.G. owns such companies as National Propane, Royal Crown Cola and Arby's), is open to question--though he did once contribute land to Miami Christian College that he valued so highly on his tax return it led to his conviction (subject to retrial) this past July on ten counts of tax-related offenses.

But don't get me wrong. When Steve Jobs makes half a billion inventing the personal computer, that bothers me not a whit--all the less so, in fact, because making a bundle was not his primary goal. Invention and entrepreneurship are the internal combustion that drives the American dream. More power to them both. As for Johnny Carson and his N.F.L. equivalents--more power to them, too.

Nor have I a beef with the first-year associates at Cravath Swaine & Moore. ("When he landed a job with Cravath Swaine & Moore, one of the nation's most prestigious law firms," reported The Wall Street Journal, "the 25-year-old law student could hardly believe his luck. Then he got even luckier: The firm raised his starting salary by $12,000 to $65,000 a year--two months before he was expected to start work.") While it's undeniable we have too many lawyers and hard not to wonder whether some, such as the gentleman who charged me $200 an hour to get a swimming-pool permit, are overpaid, I have no beef with the starting pay at Cravath. First off, $65,000 in New York is $45,000 anywhere else; second, associates earn that working 80 hours a week, which is simply two normal $22,500 40-hour jobs back to back. (Cry not, however, for Cravath's 56 partners, who averaged in 1985 a reported $770,000 apiece and, one fervently hopes, a little more in 1986.)

I just feel uneasy when I hear that more than 20 employees of Merrill Lynch in 1985, and probably again in 1986, made more than $1,000,000, even though Merrill Lynch's profitability has been suffering of late (could this be one reason why?); or when I read that to elbow your way onto Financial World's list of the 100 highest-paid Wall Streeters in 1985, you had to pull down a minimum of $3,000,000; or when I hear that a neighbor of mine, an arbitrager, made $40,000,000 that year and may double it for 1986; or when I hear that junk-bond emperor Mike Milken will make about $100,000,000 in 1986. They've earned it; it's theirs; I'm not trying to take it away from them--fair's fair. But could things in some sense be getting a little toppy? Could a bit of froth have bubbled into the market?

I feel uneasy, too, when I read that top-executive pay outside Wall Street keeps climbing faster than everyday wages--as if the contribution of the C.E.O. grows steadily more important relative to that of the other 30,000 employees of the firm, or as if it's just damn hard to attract chief-executive talent at $650,000 a year nowadays, so you've got to sweeten the pot. For it's not just on Wall Street that the deal makers, the guys with the leverage, reside.

Coopers & Lybrand compensation expert Edmund Schwesinger worries we may be creating a corporate royalty in this country, with such luxurious perks and such obsequious entourages that morale down the line could suffer. "It's an inappropriate thing for a democratic society," he says, thinking not about the C.E.O.s making hundreds of thousands a year but about some of those who make millions. "We shouldn't have a corporate royalty, or certainly not one fed by shareholders--especially when the shareholders are so largely pension funds."

In the past couple of years, he believes, things have really gotten out of hand. C.E.O.s are rarely stars singlehandedly responsible for the success of the enterprise; they're team captains. Yet instead of being paid that way, they're paid like Joan Rivers.

There are ratchet effects at work here. Rather than base executive compensation on meaningful measures of performance (admittedly easier said than done), Schwesinger says, there is a natural tendency to focus solely on what's "competitive." What's the competition paying its guys? Typically, an executive-compensation study is commissioned and presented to the board. The board is then asked to approve pay at least equal to the industry average, to stay competitive. That pushes below-average companies up toward the average--and, thus, raises the average. (As you might expect, there's little downward pressure from above-average firms recommending to the board their pay be cut.) Ratchet.

The president and chairman don't recommend their own compensation, but if the board has just approved increases averaging 10.7 percent for the rest of top management, can it do much less for the C.E.O.? Ratchet.

There's also the tendency for the lower-paying industries to compare themselves with higher-paying ones, with little enthusiasm for doing the opposite. Ratchet.

And there's this pressure on the board members: If they let a valued key executive leave--like the C.E.O.--they do a real disservice to the company (and saddle themselves with a major chore). It's more prudent to err by overpaying a little than to err by underpaying. Ratchet.

If the opulence gets too showy, Schwesinger fears, Congress may pass an excise tax--70 percent, say, of executive compensation over $2,000,000--which would effectively kill the golden goose.

Fortunately, corporate lawyers generally have the good taste to put the really big numbers near the back of the proxy statement, not in that little table that shows shareholders what the directors and officers of their company earn.

It was clear to the shareholders of little National Bank and Trust in Norwich, New York, that its chairman earned $182,308 in 1985; but how many noticed the footnote on page 38 that disclosed his half-million-dollar retirement bonus? Some gold watch!

Nor is cash any longer the really meaningful factor in top-executive pay. John Byrne, lured from Geico to run Fireman's Fund Corporation, earned just $283,333 there in 1985. But there's also the matter of his right to buy 2,500,000 shares of Fireman's Fund stock at $26 a share after four years' stewardship. That right's already worth $20,000,000 if the stock holds it's current level for the next three years. Should it climb ten percent a year to boot--not impossible--his four-year bonus would be $50,000,000.

So here I am, myself poised to make truly obscene sums (is ten cents a reader really asking all that much for a sexy column like this one? I ask the 15,000,000 of you), and I can't say I'm entirely sure what to make of all this excess--except, perhaps, that when things get so dizzy, they eventually fall.

I'll tell you what not to make of it, though. First is not to try to pass a law against it or levy some special tax on it--the free market has a way of correcting excess. (You might, however, if you're a shareholder, vote against some of it, especially if you're the shareholder who controls 1,000,000 shares in a pension fund.)

And second is not to lose too much sleep envying it. I know that's easy to say, but I spent an evening with yet another investment-banker classmate. This one has locked in a nice annual income for the next few years by setting up for his firm a profitable (well, OK, a very profitable) long-term hedge. (The idea with a hedge is that no matter which way things go, you make money.) He thought it up, he spends an hour or so a day overseeing it, to keep its ratios nicely balanced, and he gets his own little piece of it--$2,000,000 a year. And do you know what? He's bored.

He makes 100 times as much money as you do (or maybe just 20 times as much if you've really turned out to be the hotshot your mom told me you'd be) but gets to see only the same movies and TV shows you do, sleeps in a bed very much like your own, eats and drinks only marginally tastier food and wine and spends a good part of each waking day trying to figure out what to do with his life. He's not sure what he wants. That, at least, is no problem for you: You want what he has.

"The problem was, he said, it wasn't enough. He'd been promised a percentage of profits on his trades--and now they were trying to get off with a lousy $1,672,000."