Bucking the Trend

Originally posted February 2010 

In the February 2, 2010 article by Joe Bel Bruno (Dow Jones News Wire) in The Wall Street Journal (Lazard Posts 4Q Loss On Compensation Costs) tell us that “Lazard Ltd. reported an unexpected fourth-quarter loss Wednesday, hurt by charges triggered from the death of its former chief executive and a major overhaul of its compensation program.” 

In part the reason for this loss is that Lazard has made a decision to buck the Wall Street trend (embraced by competitors like Goldman and Morgan Stanley), by deciding to “get rid of deferred cash compensation that pays workers over a number of years, a move that could attract top talent from bigger Wall Street firms saddled by tougher pay restrictions.” 

This change to “all cash” compensation is justified by Lazard because they, unlike their competitors, “…largely avoided mortgage-backed securities and other complex instruments that felled bigger rivals, doesn't take on risk like the major Wall Street banks.”  Quoting Michael J. Castellano, Lazard CFO, the article goes on to say: “The changes in its pay structure will eliminate deferred cash payments and align compensation expenses with annual revenue…”

We believe that the practice of concentrating a CEO’s and other executives’ personal wealth in the form of his own company’s stock is poor compensation strategy and worse business strategy. It can force the executives to change their approach from “offense” to "defense” and that might puts the shareholders’ total capital at risk.  

Let’s look at an example of a CEO.  The average CEO holds that job from about age 55 to 62 and has already been with the company for perhaps 10 to 15 years.  He has achieved the top rank only by showing business acumen and aggressiveness throughout his pre-CEO career.  As CEO, Boards layer more and more shares on the CEO in the hopes that this will create a super-alignment with the goals of shareholders (that being stock appreciation).  Pretty soon the CEO is in a position where most of his wealth is in the value of the company’s shares. 

Perhaps this works well for a few years because the CEO remains aggressive and stock prices rise, but one day closer to his retirement, he might awake and realize that unless he hunkers down and moves cautiously, a large portion of his personal wealth could be at risk. He may adopt a  “take no risks” behavior, and although that might be aligned with the CEO’s personal goals, it may not be aligned with that of the shareholders.  Although the CEO’s change in perspective could have a dramatic impact on business results, other executives in similar situations with important impacts could become misaligned with shareholders interests as well. 

But the fundamental question is “Does this Lazard decision make sense?”  Clearly the shareholders are, at least in the short term, adversely impacted by a drag on the stock price. But that maybe a gamble worth to attract key talent they might not otherwise tempt away from competitors who are weakened by the hue and cry of the media, public and government over executive pay and risk management. 

Here is the really compelling reason why this could be a good move for Lazard: in our research we found that in an “IQ” based business like banking (vs. process based) the top decile performers (the 90th percentile and above) are shown to produce 250% more profits for the firm than the average (50th percentile) performer.  So it makes sense to staff your key positions with top decile performers because it puts the company in a great economic position even if these top performers demand pay that is 50% or even 100% more than the average performer.    

The risk to Lazard is in execution.  Lazard must be able to identify these high talent people, get them hired, and then these top performers have to bring business to Lazard. 

A secondary risk that we hope Lazard is very cognizant of is the cultural compatibility of these new hires with the Lazard organization.  To avoid finding themselves as possibly the next Wall Street bailout, Lazard must have people and organizational strategies that will allow them to absorb these new hires without shattering the core tenets of their business and fundamental culture of their company.