(FT - William Cohan): Wall Street financial incentives must change

[Ghost Dog]

One hates to prejudge, but it seems highly unlikely that Stan O'Neal and Chuck Prince will share the real reason for the financial crisis when the former Wall Street chief executives testify on Thursday before US Congressman Henry Waxman and his committee on oversight. Both men were deposed last autumn, from Merrill Lynch and Citigroup (NYSE:C) respectively, in the wake of billions of dollars in losses while they were in control. Nevertheless, they still leftwith tens of millions of dollars in compensation.

"I request that you be prepared to provide your perspective on this reported pay package," Mr Waxman wrote to Mr O'Neal, "how it aligns with the interests of Merrill Lynch shareholders and whether this level of compensation is justified in light of your company's recent performance and its role in the national mortgage crisis." A similar letter went to Mr Prince.

The truth is that Mr O'Neal's $161m and Mr Prince's $42m exit packages are in no way justified by their performance either as executives or as fiduciaries for their shareholders. These vast overpayments - contractual though they may be in part - for mediocre performance are the latest examples of how irretrievably broken Wall Street's compensation system is.

It is no exaggeration to lay the blame for the financial crisis and a host of others - among them, the internet bubble (1999) and the telecommunications bust (2001) - on Wall Street's compensation system. Ignoring that somewhere between 50 and 60 cents in every dollar of revenue that Wall Street receives is paid out in compensating its employees, is it any wonder that when you reward bankers with absurd sums to generate innovative securities - collateralised debt obligations or mortgage-backed securities - they react the same as one of Pavlov's dogs? Or, since mergers and acquisitions bankers get paid and promoted only if deals close, is there any surprise that their agenda is to push deals to close, not to offer unbiased advice?

These perverse incentives are exacerbated by Wall Street's lack of accountability. Huge bonuses are deposited and consumed long before the bad deals that generated them can slam investors. If Bruce Wasserstein's "dare to be great" advice to Robert Campeau in the late 1980s on his acquisitions of Allied Stores and Federated Department Stores ended up being more than a little off the mark, should Mr Wasserstein be held responsible? Or arebondholders, shareholders and employees left to bear the brunt of bad advice?

Of course Mr Wasserstein should have been held accountable. But he was not. By the time the deal cost investors billions, he had leftFirst Boston for his eponymous firm. As chief executive of Lazard - where the stock price declined 14 per cent in 2007 - he is now lionised and overcompensated. Mr Wasserstein is not alone. He is joined by countless other masters of the universe who provided the rationale for such flops as AOL-TimeWarner, DaimlerChrysler and Alcatel-Lucent.

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