AS WALL STREET prepares for its annual ritual of handing out year-end bonuses, let's hope that most if not all of the major firms demonstrate a measure of self-discipline by keeping tight reins on executive compensation.
While all employees who do their jobs well should be paid competitively, pay structures that encourage overly rich compensation particularly plans intended mainly to benefit an elite group of senior executives undermine shareholders' faith in Wall Street and, ultimately, in the financial markets.
First and foremost, boards must make sure that top executives have plenty of skin in the game. They can do this by requiring senior executives to hold stakes in their companies for an extended period of time say, a minimum of five years. That would align the executives' long-term financial interests with those of shareholders and discourage excessive risk taking.
At a time when investor confidence needs to be buttressed, Wall Street also must make sure that shareholders receive full and complete disclosure of executive pay.
Firms would be wise to follow the example expected to be set by James Gorman, chief executive of Morgan Stanley. In recent weeks, it has been widely reported that he has told some executives at his firm to brace for double-digit declines in bonuses this year.
In an effort to rein in compensation in the upper-management ranks, Mr. Gorman reportedly plans to dole out competitive bonuses to employees in divisions that have done well, such as those involved in stock trading and investment banking. However, employees in less successful divisions, such as fixed-income trading, can expect to see their bonus checks shrink.
In the annals of Morgan Stanley's storied history, 2010 will go down as the year of differentiation, Mr. Gorman is telling employees, according to a story that appeared in The Wall Street Journal.
Mr. Gorman, of course, found himself in hot water with shareholders in early 2010 for paying hefty bonuses to employees in 2009. In that year, the firm paid out a record 62% of its net revenue in compensation and benefits, far exceeding the industry norm of 40% to 45%.
Failure to apply some semblance of fairness and rationality to compensation practices inevitably will lead to direct intervention from legislators and regulators a cure that no doubt will be far worse than the disease.
Already, the newly enacted Dodd-Frank Act requires public companies to report how executive pay compares with compensation for the rest of the work force and give shareholders a non-binding say on pay that is, a positive or negative vote of confidence in a company's pay practices.
And let's not forget the failed attempt by Sen. Barbara Boxer, D-Calif., and Sen. Jim Webb, D-Va., early this year to offer legislation that would have imposed a one-time 50% tax on bonuses of more than $400,000 for employees at financial firms that received funds under the $700 billion Troubled Asset Relief Program.
The possibility of outside intervention grows in tandem with rising investor resentment about pay practices on Wall Street.
More than 70% of Americans believe that big bonuses should be banned this year at Wall Street firms that received TARP funds, according to a survey released by Bloomberg last week. Another 17% believe that bonuses exceeding $400,000 should be taxed at 50%, the survey found.
Investor resentment is understandable. With the nation's unemployment rate hovering just below 10% and about 2 million mortgage loans in foreclosure and another 2.4 million loans past due by 90 days or more excessive compensation on Wall Street seems dreadfully out of sync with life on Main Street.
As financial stewards, financial planners and investment advisers have an important role to play in the battle for rational compensation practices on Wall Street. They can, and should, encourage clients to take advantage of the new say-on-pay rules by voting their proxies.
Advisers also should make their own opinions heard by voting their proxies and by demanding that corporate boards provide some rational explanation for executive salaries and bonuses.
Finally, advisers should be willing to refrain from doing business with, or investing in, companies that fail to provide such an explanation.