On Bonuses

A quick primer on Wall Street bonuses:

1. Normal 'bonus'

For revenue generators, primarily sales and trading, the bonus is the prize for which folks work. Wall Street base salaries typically run from $100,000 to $250,000 but the bonuses can be, well, zero to multiples and sometimes many multiples of that. These bonuses are DISCRETIONARY and PERFORMANCE BASED. Depending on the specific market, e.g., interest rates, equities and specific products, e.g., cash, derivatives the bonus is typically a percentage of what you produce for the firm. A 5-10% payout would be typical so revenue production of $1 million would net the employee $50,000-$100,000. $20 million in production would beget $1-2 million.

Remember that these bonuses are DISCRETIONARY which means that number is decided by the firm and the number will be affected by how well the group, the section and the overall institution performs. This is generally a tax, i.e., subtractive.

2. 'Guaranteed' bonus

Guaranteed bonuses are typically offered to entice the employees of a competitor to come work for you. These are often guaranteed for one to two years and is likely a premium over what the target had been earning at his previous job. For instance if a trader had a total compensation of $500,000 the previous year and was considered a strong producer a competing firm may offer $750,000 guaranteed for one or two years. There are two important things to note about these types of guarantees:

i. they are typically paid in the same way the firm pays the rest of its bonuses- specifically if the firm decided that 60% of payout would be in cash and 40% in deferred shares over 3 years, unless it is otherwise written, the guaranteed would be paid this way.

ii. the bonuses are not paid if the employee is fired FOR CAUSE which would include going over risk limits, leaking information, sexual harassment etc.

Why guaranteed bonuses? Generally guarantees pay for the risk of moving firms AND must make up for FOREGONE DEFERRED BONUSES from the previous firm. Let's treat each in turn. Firms typically pay bonuses between January 15 and March 15. Assume February 15, assume also a minimum of 30 days of gardening leave (during which the departing employee cannot work for the new firm while he is being paid base salary by the old firm) so essentially at the minimum the transferring employee has lost three months of the year. In practice a transferee loses 3-6 months and would want to be guaranteed compensation for that. Not to mention the additional risk of going to a new shop.

Secondly, any deferred compensation not yet vested will be lost and is typically repaid either in cash or equivalent value in shares by the new firm.

Finally, if the new firm goes bankrupt, e.g., Bear Stearns or Lehman Brothers the employee becomes simply AN UNSECURED CREDITOR OF THE BANKRUPT FIRM. Oops.

3. 'Retention' bonus

These tend to be quite a bit more infrequent than the first two and are typically given to keep key employees after a merger or as a counter to an employee who is about to leave to join a competitor. These can be paid upfront (now more valuable than ever) with a clawback provision should the employee leave before the covered period.

I don't know the details of the bonuses that were paid out to employees of AIG Financial Products but it is very likely that they involved contracts that were previously agreed and perhaps spanned more than one year. If any of the employees were involved in a fraud they should be terminated for cause and not be eligible. However in most of these cases this comes down to the sanctity of the contract. If you do not honor contracts, you do not honor property rights and without property rights we are finished as a functioning free society.

On a smaller scale any firm that doesn't honor contracts will find it very difficult to hire good talent in the future without ever larger more airtight contracts.

The fact that [mostly] Democrats and Republicans are trying to legislate a gigantic surtax on bonuses > $10,000 at AIG FP is truly a joke. It's the same lack of understanding that bemoans that a lot of the bailout money [WHICH ARE LOANS CONVERTIBLE INTO EQUITY NOT GRANTS] went to other banks. AIG sold insurance to those banks and is bound to honor those 'contracts'. If AIG defaults to its counterparties then we negate the value of the entire bailout to begin with.

Congress will legislate punitive surtaxes on AIG and others. And the Obama administration will only be too happy to sign it.

It was a great Republic while it lasted.