Financial Services in the Eye of the Storm

By Vicki Elliott

Nov. 25, 2008

With industry-altering force, the economic crisis has taken an immediate toll on financial services firms. But while fear and panic may whipsaw the markets, the crisis brings with it a real opportunity—a chance for these troubled firms to fundamentally alter their human-capital management models for long-term advantage.

    Indeed, unlike many other career choices, financial services careers have been all about pay, especially in the investment banking sector. But attraction and retention can no longer be so compensation-centric. As other industries are making clear, attracting talent to financial services needs to be about the total employment value proposition— including training opportunities, career development and flexible working arrangements. These are important levers for companies to use as they walk a fine line of delivering shareholder value while retaining and engaging a talented workforce in an affordable and sustainable way.

    Financial services firms need to identify and retain their best performers and structure their incentive compensation and broader talent management programs to appeal to this population. Career progression and training and development opportunities should be part of the conversation firms have with employees and recruits. Companies will have to be more transparent, not just about compensation, but also about their total vision and the career opportunities they offer.

    Additionally, there are four key areas of potential change in how incentive plans are structured and administered:

  • Greater differentiation of top performers.

  • Longer time horizons for incentive payouts tied to performance.

  • Increased emphasis on risk management and metrics.

  • Incentive payouts based on real earnings rather than on mark-to-market valuations.

    The trend in financial services firms is to strengthen performance management programs to better differentiate strong from average or weak performers. Any available bonus money should go to the top performers. However, if employees receive a reduced bonus, they shouldn’t necessarily interpret that as a directive to look for another job.

    Similarly, companies can no longer afford to provide incentive guarantees to executives without corresponding performance guarantees. Firms that want to better align pay with performance and retain top performers should consider placing less emphasis on annual results and bonuses and more on rewarding performance over a longer period of time. Historically, mandatory bonus deferrals have been linked to service-based vesting, but there should also be a performance component that takes into consideration the profitability of the business generated over time.

The third area of change involves stronger performance metrics around risk management. For example, rather than funding bonus pools based on a percentage of revenue, firms should focus on profitability, after accounting for the cost of capital adjusted to reflect the level of risk incurred in the business. Managing risk with metrics and multiyear periods will help ensure companies are compensating people for sustained, realized performance.

    Finally, the other major design issue that’s highly relevant right now is market-to-market valuations of illiquid securities. Executives have been compensated based on market values that are not actually achieved. Companies should reconsider compensation based only on amounts that have been realized.

The market volatility challenge
    While these strategic design changes make sense, there’s no avoiding the fact that financial services firms are especially affected by the market volatility we see on a daily basis. And the big challenge with market volatility lies in setting performance targets.

    If we agree it will be nearly impossible to predict future performance now or even next year, companies should consider a combination of year-end assessments of key performance indicators (absolute performance) with relative performance comparisons against peers. There needs to be a balance between delivering real profit and sustainable organizational results and acknowledging the challenging reality of today’s market environment.

    How can financial services firms manage some of that volatility? It’s a matter of minimizing incentive guarantees, building in multiyear views of performance, and doing away with direct-drive formulaic incentives and purely discretionary incentives. Achieving balance between clear performance metrics and a discretionary interpretation of results is key.

    In the short term, though, there are likely to be staff cuts for overall affordability and a net reduction in compensation. Firms aren’t likely to cut base pay, and some may even use base pay as a way of balancing the risk in the overall compensation package. But we’ll likely see reduced overall payouts where there are performance issues and a reduction in current cash bonuses with an increase in deferrals. Companies will be moving toward measuring performance over a longer time frame, tying payouts to both service and performance.

Employee communication
    Employees, of course, are most concerned about what this shakeout will mean for them. Direct, clear and timely communication from senior management will help employees move past paralyzing uncertainty to a point where they can be productive and even motivated to effect a positive outcome. Companies should reinforce the overall position of the firm, the value of its offerings and its plans for the future in simple, direct language. It’s important to tell employees what the firm is doing to address the current situation without sugarcoating or hiding the facts. This crisis is not likely to be a short-term cycle, and companies should be clear with employees about what it will take to get through the months ahead.

    The sense of urgency can be overwhelming, but it’s important for corporate leaders to take a step back and apply good diagnostic tools to understand where their human capital priorities should be. A Band-Aid remedy, such as reductions in staff, might stop the bleeding today, but the problems most likely will require major surgery to ensure long-term success.

    The bottom line is that firms need to identify high performers and make retaining them a priority. And they also need to motivate the general workforce. Proven diagnostic tools, such as internal labor market analyses and business impact modeling can help firms identify which human capital levers to pull to get the necessary results while minimizing further damage. If ever there was a time to be thoughtful and focused, it’s now. Decisions made in this time of crisis will have long-lasting effects on financial services companies’ greatest asset: key talent—the talent they’ll rely on for future success.

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