Morgan Stanley investors will have to wait for their payday. Chief executive officer James Gorman set aside more for bankers in the third quarter after railing earlier this month against Wall Street's "heads I win, tails you lose" compensation culture. Revenue rebounded, but not enough for owners to get the share of the spoils Mr. Gorman says they deserve. His model for Morgan Stanley needs to catch up to his message.
The Wall Street firm didn't have a bad summer. Clients and shareholders breathed a sigh of relief when a Moody's downgrade wasn't as harsh as originally feared. That helped the market view of Morgan Stanley's credit improve considerably. Ignore the related accounting effect, and the firm generated $7.6-billion (U.S.) of revenue in the period – 18 per cent more than a year earlier. Even so, the bank eked out a profit that equates to a paltry annualized return on equity of about 3.5 per cent. Strip out some other one-off costs and the figure sputters to more than 6 per cent.
While the top and bottom lines lagged those of Goldman Sachs, compensation didn't. Of that $7.6-billion of adjusted revenue in the quarter, Morgan Stanley set aside about 44 per cent for bankers and traders, just as its rival did. In total dollar terms, Mr. Gorman's bank has reserved nearly a tenth less so far this year than in the first nine months of 2011. The third-quarter pay, however, was higher than a year earlier and in the prior quarter.
The overall picture seems at odds with the CEO's recent comments that pay in the industry is too high. But his broader point is that when revenue falls, the percentage of it doled out to employees often goes up, but when revenue rises, investors don't typically get their fair share.
Mr. Gorman ultimately wants to see compensation absorb a smaller proportion of revenue. Part of that involves limiting individual pay and judiciously culling the ranks of bankers. More important, though, is bringing in more revenue. Shareholders need to believe that an institution with reduced risk tolerance, a big Japanese stakeholder and a growing focus on asset management will be able to ramp up its fee income in a far from gung-ho market. That requires a leap of faith – or at least a lot of patience.