http://www.businessweek.com/news/2012-02-01/morgan-stanley-s-expanded-bonus-deferrals-may-haunt-shareholders.html

Bloomberg News

Morgan Stanley’s Expanded Bonus Deferrals May Haunt Shareholders

February 01, 2012

Jan. 23 (Bloomberg) -- Morgan Stanley’s new deferred bonus plan will reward patience, at least for its top employees. For shareholders of the investment bank, the costs may linger for at least three years.

While Morgan Stanley improved profit by cutting 2011 pay packages for senior investment bankers and traders, the bottom line got another boost from deferring an average of 75 percent of those payouts, up from 40 percent two years earlier, people with knowledge of the matter said. Those costs may instead be borne this year or beyond.

“It will improve the current profit picture, but it will be an overhang on the stock,” said Robert Willens, a former Lehman Brothers Holdings Inc. analyst who’s now a tax consultant in New York. “People will realize that over a relatively short period of time, these expenses are going to be recorded and will depress future profits.”

Wall Street firms are under pressure from lawmakers and regulators to defer more pay after upfront bonuses were blamed for fueling the financial crisis. The overseers, including the Federal Reserve, say the change will discourage employees from taking risks that pump up their current pay while hurting the company later. The new danger is that firms in lean times will promise packages that are hard to afford when the bill comes due.

Morgan Stanley is following firms including UBS AG and Credit Suisse Group AG in adopting pay practices that will push fixed-compensation costs to future years. Banks typically don’t disclose the percentage of deferred pay.

Morgan Stanley felt some of those effects from previous deferrals last year. Chief Executive Officer James Gorman said during a Jan. 19 conference call that the $16.4 billion of compensation recorded in 2011 was bloated by deferred awards from prior years.

‘Acutely Aware’

“We are acutely aware of the impact of deferral decisions on future periods,” Gorman, 53, told analysts on the call. Mark Lake, a Morgan Stanley spokesman, declined to say how much the firm saved in 2011 from deferrals or how it affected net income.

On a per-employee basis, Morgan Stanley’s reported compensation costs for 2011 averaged $264,996, more than the $254,596 set aside the previous year. Gorman’s own pay for last year fell 25 percent from 2010 to $10.5 million, 92 percent of which was deferred, a person with knowledge of the matter said last week.

Morgan Stanley, the sixth biggest U.S. bank by assets, employed 61,899 people as of Dec. 31. Last year represented “a high-water mark” as the firm had to make good on an unusually high number of deferrals from previous years, Gorman said. “We will have more flexibility in the years to come.”

Wall Street Rivals

The firm’s net income last year tumbled 13 percent to $4.11 billion, as the stock fell 44 percent. While revenue climbed 3.2 percent, the pay deferrals helped hold compensation expenses to a 3 percent increase.

In 2009, the ratio of compensation to revenue was 62 percent. Gorman arrived in 2010, vowing to reduce the figure, which dropped to 51 percent that year. It held steady in 2011, helped by the deferrals. The firm’s ratio is higher than at any of its Wall Street rivals, partly because it has a higher proportion of retail brokers, who typically pocket about 60 percent of revenue.

Gorman told staff at a meeting in London this month that he wouldn’t pay so much that it would drive the firm to a loss, said people briefed about the remarks, who spoke on condition of anonymity because the session was private.

‘Extend Vesting’

Multiple goals may go into the design of a compensation plan, such as curbing risk-taking or providing incentives for employees to stick around, said Joseph Sorrentino, managing director at Steven Hall & Partners. Still, managers understand the benefit of the savings that come from deferred compensation, said Sorrentino, whose New York-based firm advises companies and executives on pay plans.

“Companies choose to extend vesting, and therefore they’re taking a smaller hit in the near term,” said Sorrentino, who doesn’t count Morgan Stanley among its clients. “But it just pushes everything out. Eventually it catches up.”

An effort by Credit Suisse and UBS, Switzerland’s biggest lenders, to defer more compensation and increase salaries, attracted the attention of JPMorgan Chase & Co.’s bank analysts in London, who said in a June note that the firms might be less able to cut costs if the deferred pay comes due during years when profits are slim.

Discretionary Compensation

Goldman Sachs Group Inc. cut its 2011 compensation costs 21 percent from 2010. Chief Financial Officer David Viniar said last week that costs of previous deferrals were unchanged and discretionary compensation fell “significantly more” than revenue, which dropped 26 percent.

Morgan Stanley capped the portion of 2011 cash bonuses to be paid out early this year at $125,000 and cut pay packages for senior investment bankers and traders by 20 percent to 30 percent, people briefed on the plans said last week.

The decision increased the average amount of pay deferred to about 75 percent, up from an average of 60 percent in 2010 and 40 percent in 2009, the person said. Employees were notified of their total bonuses last week.

The remainder of cash bonuses for 2011 will be paid out in two equal installments in the final month of 2012 and 2013, a change from the previous deferral plan that paid out in thirds over 18 months, the person with knowledge of the plan said. Spreading the payments over a longer time may reduce the costs that hit in any given year. It typically takes three years for restricted stock to fully vest.

‘Makes Economic Sense’

The firm may be anticipating that revenue will climb faster in coming years, making it easier to absorb the compensation costs deferred from 2011, said Brad Hintz, a former Morgan Stanley treasurer who’s now an analyst at Sanford C. Bernstein & Co. in New York.

“It makes economic sense to defer if management anticipates a rebound in revenue, which allows the expenses to catch up and deferred and current costs to be paid off without damaging earnings and thus the share price,” Hintz said.

Deferred compensation costs in coming years will be less than those taken in 2011, Morgan Stanley CFO Ruth Porat said in an interview.

“That gives us more flexibility,” said Porat, 54. “Obviously, we’ve taken out headcount, and we’re doing other things that further create compensation capacity or flexibility.”

Morgan Stanley’s deferral program may help to bind employees to the firm, and there’s a chance competitors will follow suit, Sorrentino said.

‘More Glue’

“It gets some more glue on the employees, because if they leave they’re going to leave those deferred amounts on the table,” he said. “If they go to work for a competitor, they’re going to forfeit those awards.”

There’s also a chance that the plan may backfire.

“It can be a recruiting tool on the other side,” Sorrentino said. “A competitor could go to Morgan Stanley’s employees and say, ‘Look, you only got a certain percentage of your bonus paid out this year. All this other stuff doesn’t pay out until later. Come join us, and we’ll make that up.’

Any departures might free Morgan Stanley from promised payouts, said Frank Suozzo, a former head of growth financial- services research at AllianceBernstein LP.

“There are going to be people who leave, and leave that cash on the table,” said Suozzo, now president of advisory firm FXS Capital LLC in Goldens Bridge, New York. In that case, Morgan Stanley “would not be paying out as much in the future as they would have had they paid it all in cash today.”

--With reporting by Christine Harper in New York and Ambereen Choudhury in London. Editors: Rick Green, Peter Eichenbaum

To contact the reporters on this story: Bradley Keoun in New York at bkeoun@bloomberg.net; Michael J. Moore in New York at mmoore55@bloomberg.net.

To contact the editors responsible for this story: David Scheer at dscheer@bloomberg.net; Rick Green in New York at rgreen18@bloomberg.net.


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