Compensation 11th Edition by George Milkovich,Jerry Newman,Barry Gerhart

Exercise 12

During the financial crisis at the end of the last decade, Merrill Lynch was acquired by Bank of America for $50 billion. The reason for the acquisition was that Merrill Lynch was unsure it could survive the crisis on its own. What really made headlines, however, was the disclosure that Merrill Lynch had paid out $3.6 billion in bonuses just before being taken over by Bank of America. 64 These bonuses were paid while the federal government was spending hundreds of billions of dollars to bail out financial institutions like Merrill Lynch and/or intervening to persuade firms like Bank of America to do acquisitions to save firms like Merrill Lynch. Indeed, Merrill Lynch lost $27 billion in 2008. So, the "$3.6 billion question" one might say was: WHY President Obama saw no good answer and blasted such bonuses as "the height of irresponsibility." The U.S. House of Representatives looked for a way to get the bonus money back. It passed legislation by a 328-93 vote to impose a 90% tax on the bonuses of anyone at a bank receiving $5 billion or more from the federal government (via TARP-the Troubled Asset Relief Program) and earning more than $250,000 a year. The Administration signaled a lack of support and the legislation subsequently died in the Senate. However, TARP includes restrictions on compensation for firms that have taken a certain level of TARP money. These restrictions are designed to discourage executives from taking "unnecessary and excessive risks."
One initial consequence of TARP was that some employees, including some high-level, high-revenue generating employees, began to leave larger financial institutions like Merrill Lynch/Bank of America to go to so-called "boutique" financial services firms, which had not received TARP money and thus were not covered by TARP restrictions on compensation. Another initial reaction was an increase in base salary levels and a decrease in bonus levels, apparently in response to all of the negative publicity bonuses had received and as a way to get around TARP restrictions. One senior executive at a company receiving TARP money and now paying smaller bonuses and bigger salaries, however, questioned whether the TARPinduced greater emphasis on base pay made sense: So, "You're going to overpay them regularly, instead of just sometimes " 65
However, now that some time has passed, the economy has recovered (somewhat), and the stock market has bounced back, Merrill Lynch (as we saw earlier) and other financial services companies are making money again. At Merrill Lynch, there is always a lot of action and discussion around compensation strategy. Merrill introduced a plan to expand its number of financial advisors by 8% (about 1,200 people). Where would they come from Other firms How would Merrill get them to move By offering unusually high up-front signing bonuses and decentralizing authority to make such offers. Top brokers from other firms can receive 150% of their pay at the firm they are leaving. 66 Merrill is not the only firm looking to add top brokers. Indeed, what is described as a "bidding war" has broken out, and signing bonuses have been reported to be moving in some cases to three to four times previous pay in some cases. Why the bidding war "Wealth management firms make the bulk of their profits on the top 10 percent of their producers" according to compensation attorney Katten Muchin. 67 And, very wealthy clients tend to be more loyal to their advisors than to the advisors' firms.
At Merrill, there are some concerns among financial advisors. First, in the non-Merrill part of Bank of America, brokers are under a discretionary bonus system rather than an (objective) incentive system where pay is based on a formula. Merrill financial advisors fear that Bank of America wants to extend that system to cover them. Second, and likely related, non-Merrill brokers at B of A are expected to cross-sell-in other words, to push products sold by other parts of the bank. The opportunities for such synergies are typically seen as a source of competitive advantage for a large, diversified financial intsitution such as B of A. However, cross-selling performance (and cooperation) is difficult to assess objectively. Thus, subjective evaluations are likely necessary. Merrill brokers appear to be opposed to cross-selling, both because they are concerned it could undermine their relationships with their clients and they prefer to have their pay determined by objective measures. 68
In chapter 1, we talked about incentive and sorting effects of pay strategies. Describe the incentive and sorting effects at Merrill Lynch and how changes to the compensation strategy might affect them.