The Downside Of “Deferred Comp”

GS had a bad quarter, but still accrued some decent compensation costs. This from the one firm on the street that is not only willing to pay ZERO bonuses to those who “earned” it, but who could still retain talent. So why the big compensation accrual?

A part is salaries. Salaries have increased, so all else being equal, the accrual for salaries is much higher than it used to be. It is less flexible, but that is only a fraction of what is going on.

If you are going to pay an employee $2 million at the end of the year, but 1/3 will be paid that year, and 1/3 at the end of the following 2 years, you only have to account for $666k.

If the next year, you want to pay that employee $2 million with the same terms, you have accrue $1.33 million – $666k for this year’s comp, and $666k for last years comp. By the third year if that employee is still getting $2 million, then you have to accrue the full $2 million. $666k for this year, and $666k for the prior year, and $666k from 2 years ago (I know it doesn’t exactly add up, but I couldn’t resist using 666).

So, in a bad year, even if you plan on paying a zero bonus, you still have compensation costs for prior year’s deferred comp, and current year’s salary.

Since most deferred comp is tied to stock performance, it isn’t quite exact, and deferrals in the current quarter will reflect changes in stock price and what has already been accrued, but the point is the same. In order to continue to get benefits from deferred comp, the bank has to make future deferrals more onerous – cliff vesting with longer terms. Or, and this is really scary, actually enact clawbacks. Clawbacks would allow them not only to avoid recognizing that deferred comp, but booking back into P&L the portion that had already been accrued.

It’s still a relatively minor issue, but for a bank with big deferred comp and future earnings difficulties, this could cause real problems – either for investors or for employees.