What is Obscene About Goldman’s Compensation?

There has been quite a bit of hubbub lately over the end-of-year bonuses paid by Goldman Sachs. It even provoked an op-ed piece in the venerable New York Times. Totaling some $16.5 billion, and averaging $623,000 per employee, the payouts have set off a firestorm of shock, awe, envy, and more than a few cries of “That’s obscene!” It’s really funny to see how people react when things not only work as intended, but work perhaps too well.

The more serious people question whether the pay was justified, or was prudent for the company. With the average employee getting more than $200 an hour, and some reaching into the tens of thousands an hour, it seems inevitable that there would be sour grapes but the real question should be: is it right?

In a word: yes. It’s fine, and even exemplary. I think there are three key measures by which to judge a compensation system:

  • Is it based on, and does it reinforce, the organization’s goals and objectives?
  • Is it applied according to some reasonable, and preferably transparent, methodology?
  • Is it fiscally prudent for the organization?

That’s it. Forget about providing a living wage, or some sense of social fairness, or even public perceptions of the system. If it meets these three measures, I think it is great. Let’s look at each of these measurements, and reflect on Goldman’s application of them.

Reinforcing goals and objectives

This is number one for a reason: it is by far the most important. I’ve said it here on these pages a hundred times, but the key to success in an organization is defining a clear vision followed by consistent daily application of that vision. There are many ways to apply the vision, but few are more effective than to base compensation on it. I have built compensation systems that are directly based on the company vision, and the results are astounding. [ed: more on this later]

The compensation system should reward those who exceeded those objectives so dramatically.

Does the system at Goldman Sachs meet this test? Well, from a distance it’s hard to tell. But I can say that, from what I know of the company, the goal is to make deals and trades that benefit the buyers, the sellers, and Goldman Sachs. And by all reasonable measures, they hit a home run there. Pre-tax profit (that’s net, not gross) even with these salaries included was over a half-million per head. That’s twice the Wall Street average, and 5 times what we so proudly got when I was at Microsoft.

So, even without knowledge of the specific goals and objectives that Goldman set for itself, it’s clear that from a strictly financial perspective, they scored big. And the compensation system should reward those who exceeded those objectives so dramatically.

Reasonable and transparent methodology

This is the point that catches up so many companies. Many firms have their compensation set extremely top-heavy, with those who control the purse strings, taking the most out of the purse. I like to see a compensation system that is based on some simple, clear, and preferably public, metrics. Typically it’s something like gross sales, or gross profit, or even something like regularly measured customer satisfaction. Whatever it is, it should be simple, directly correlated to things people actual have some influence over, and difficult to “game”.

Those who control the purse strings, taking the most out of the purse.

Another key component of this is that the compensation system should be very broadly based. Not just a perk for those at the top, but dipping deep down into the organization, so that all people who have a part in creating the success can share in it. When I was at Microsoft, virtually all full-time employees were eligible for stock options. That’s the kind of example I’m stressing here.

From what I can see, Goldman’s scheme meets these objectives. There are stories of most employees seeing twice to three times their peers at other firms, and this is in line with their company performance against their competition. Yes there are reports of some secretaries complaining they only got $120k when others saw millions, but that melts when you point out that’s 2x the going rate. So what this all means is that the system is implicitly broad-based and relatively effective.

Fiscally prudent

This is where Goldman has me completely won over. You see, they pay compensation in arrears. They wait until the end of the year, and then, once all the numbers are in, they divvy up the spoils. This has many great effects, a key one being that they never have to worry about paying for performance they might achieve. They know both how well the person has performed, and how much they can afford to reward them. How clean is that?

In addition, they have the benefit of drawing the bonuses not from pending revenue, but from cash on hand. And they’ve had the better part of a year to invest that money wisely, before they have to pay it out. I think every small firm that has had to scrape to make bonus payments would do well to consider a scheme like this.

I think Goldman has it just about right.

So, in summary, I think Goldman has it just about right. They pay people from their profits, they do it in a manner that rewards for definitive past performance, and in line with their corporate objectives. The fact that the company was enormously profitable isn’t something people should resent. Envy, maybe. Emulate, probably.