Certain professional roles allow individuals to directly and measurably contribute to the success of a commercial enterprise and, in so doing, to generate profits (and losses) on a vastly greater scale than is possible in the roles in which the majority of people work. As a consequence, these individuals are often in a position to attract outsized (and at times, outlandish) compensation for their effort. It can be tempting to attribute this earning power to unusual individual skill, education, work ethic, or the like, but these attributes are rarely sufficient and may not even be necessary (certainly not on Wall Street, at least).
On some level, it’s just a matter of being in the right seat at the right time. An investment banker’s career is heavily influenced by the robustness of the sectors in which she specializes. An institutional salesman or relationship manager may print money in buoyant markets, but may find himself out of business if a few key clients defect. A trader who generates profits is progressively given more capital and more opportunity (in dollar terms) to generate future profits, and to capture a share of that increasing pie for himself. Wall Street is not alone in this regard: how important is the “big break” in a performer’s career, or the opportunity to appear in front of the right talent scouts (and avoid injury) in an athlete’s? It is extremely competitive to even have a chance at ending up in that right seat at that right time, and it is not guaranteed by any amount of skill or hard work. I believe this dynamic contributes to the difficulty “Wall Street” and “Main Street” have in understanding each other when it comes to compensation (with continued apologies for the oversimplification and caricature). Main Street looks at how much those people in those chairs make, and thinks it’s indecent. Wall Street looks at how bitter the struggle is to even get in those chairs, and thinks it’s justified.
One might think that investors and paymasters would attempt to diagnose to what extent skill, luck, momentum, and ‘beta’ (i.e., general market direction), among other possible factors, contribute to the success of a line of business or to the returns on an investment. In reality, they do make an attempt, but this is a pretty hard exercise, and it’s a more pleasant and convenient practice for all parties to attribute as much as possible to ‘skill’ – this makes employers look sophisticated and makes their investors happy to believe their capital is in the best hands. Nassim Taleb is one of several scholars who have explored this topic in illuminating detail (Fooled By Randomness is more on point than The Black Swan for my discussion here).
Is it ‘fair’ that equally skilled, knowledgeable, and hard-working traders can have vastly discrepant career trajectories just as a result of small differences in their initial conditions (e.g., how much opportunity were they initially given to take risk, and how did those trades go over the time-horizon of their manager’s patience)? On an intuitive level, probably not; but nobody really cares. Within the Wall Street bubble, there’s the gambler’s mentality that imagines beating the odds and hitting it big, so there are few tears shed for those who weren’t so fortunate. Outside of Wall Street, people don’t even understand why these people should be making so much money in the first place, so the search for gradations of fairness seems pretty silly.
That all being said, attempting to control for randomness in promotion and compensation seems like a generally good practice for any professional organization, but it doesn’t really tell us how to balance this with the organization’s need to “attract and retain top talent” (howsoever defined). In my view, the conceptual problem has nothing to do with attracting and retaining top talent, but everything to do with the problem of running an organization where everyone wants to believe that he or she is top talent. In organizations (not to mention entire industries) with such an orientation, pay expectations will always be anchored to the very top of the spectrum – and as long as the cost of meeting those expectations can be passed through to clients and investors, it will be possible to do so. What does this mean, in practical terms, for ‘reforming’ Wall Street compensation? I’ll return to this question some other time.