Reference no: EM132002032

During the financial crisis at the end of the last decade, Merrill Lynch was acquired by Bank of America for $50 billion. The reason for the acquisition was that Merrill Lynch was unsure it could survive the crisis on its own. Bank of America received government assistance during the financial crisis from (and was thus covered by) TARP (the Troubled Asset Relief Program). So too then was Merrill Lynch. One initial consequence of TARP coverage was that some employees, including some high-level, high-revenue generating employees, began to leave larger financial institutions like Merrill Lynch/Bank of America to go to so-called “boutique” financial services firms, which had not received TARP money and thus were not covered by TARP restrictions on compensation. Another initial reaction was an increase in base salary levels and a decrease in bonus levels, apparently in response to all of the negative publicity bonuses had received and as a way to get around TARP restrictions. One senior executive at a company receiving TARP money and now paying smaller bonuses and bigger salaries, however, questioned whether the TARP-induced greater emphasis on base pay made sense: So, “You’re going to overpay them regularly, instead of just sometimes?” However, now that some time has passed, the economy has recovered (somewhat), and the stock market has bounced back, Merrill Lynch (as we saw earlier) and other financial services companies are making money again. At Merrill Lynch, there is always a lot of action and discussion around compensation strategy. Merrill introduced a plan to expand its number of financial advisors by 8% (about 1,200 people). Where would they come from? Other firms? How would Merrill get them to move? By offering unusually high up-front signing bonuses and decentralizing authority to make such offers. Traditionally, top brokers from other firms can receive 1.5 times their pay at the firm they are leaving. Merrill was not the only firm looking to add top brokers. Indeed, what was described as a “bidding war” broke out, and signing bonuses were reported to have gone as high as three to four times previous pay in some cases. Why the bidding war? “Wealth management firms make the bulk of their profits on the top 10 percent of their producers” according to compensation attorney Katten Muchin. And, very wealthy clients tend to be more loyal to their advisors than to the advisors’ firms. At Merrill, there are some concerns among financial advisors. First, in the non-Merrill part of Bank of America, brokers are under a discretionary bonus system rather than an (objective) incentive system where pay is based on a formula. Merrill financial advisors fear that Bank of America wants to extend that system to cover them. Second, and likely related, non-Merrill brokers at B of A are expected to cross-sell—in other words, to push products sold by other parts of the bank. The opportunities for such synergies are typically seen as a source of competitive advantage for a large, diversified financial intsitution such as B of A. However, cross-selling performance (and cooperation) is difficult to assess objectively. Thus, subjective evaluations are likely necessary. Merrill brokers appear to be opposed to cross-selling, both because they are concerned it could undermine their relationships with their clients and they prefer to have their pay determined by objective measures.

Answer the following questions

What is the likely result of bidding wars of this type for top brokers? Will most firms benefit? Who will be the winners and losers? What about the brokers?

Explain why there is such a strong relationship between pay and performance for brokers. Why isn’t this true of many other jobs?

Should Bank of America change its compensation strategy to include more subjective assessments of performance and a greater emphasis on cross-selling? What effect might this have on its success in the bidding war for top brokers?

In chapter 1, we talked about incentive and sorting effects of pay strategies. Describe the incentive and sorting effects at Merrill Lynch and how changes to the compensation strategy might affect them.