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Goldman Sachs Saves Quarter by Slashing Pay


Goldman Sachs (GS) cut compensation costs more than expected in the fourth quarter, helping the investment bank beat analyst expectations by a wide margin.

Compensation as a percentage of revenues rose to 36.5% in the fourth quarter compared to 26% in the corresponding quarter of the previous year. Goldman has historically had a fourth-quarter compensation "true-up", a practice where it adjusts its compensation relative to revenues in the final quarter to boost overall profits.

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Although the ratio rose in the fourth quarter, it appears Goldman has managed compensation expenses better than what analysts were expecting.

Analysts had predicted that Goldman might have far less flexibility to make major adjustments to compensation, given a challenging revenue environment and amid competitive pressures. Wells Fargo analyst Matt Burnell, for instance, had expected the compensation to revenue ratio to stay at 44% in the fourth quarter.

Still, for the entire year, compensation to revenues stood at 42.4%, up from 39% in 2010. The 21% decline in overall compensation expenses could not offset the decline in trading and capital markets revenues. Total revenue declined 26% in 2011, leading to a 47% drop in profits for the entire year to $2.5 billion.

The investment bank's 34,700 employees (includes staff at consolidated entities) earned an average compensation of about $352,248 in 2011. That is down 11% from 2010, when the firm's 38,700 employees earned an average salary of $397,312.

The average compensation is computed by dividing total compensation expenses by the number of employees on staff at the end of the year on a consolidated basis. The averages are, of course, skewed by eye-popping bonuses paid out to the company's partners.

But in the last year, Goldman has lost 50 or so partners, according to press reports. Last week, the firm saw the exit of two members of its management committee, including trading co-heads Edward Eisler and David Heller.

Observers have interpreted the departures as a sign that Goldman is looking to contain the hefty payouts it has to make to its partners.

Goldman Sachs CEO and Chairman Lloyd Blankfein

Bonus cuts and layoffs have been widely anticipated on Wall Street as banks grapple with a challenging capital markets environment.

The headwinds for Goldman Sachs and Morgan Stanley (MS) are particularly intense in 2012. The European crisis remains a major overhang for capital market activity heading into the first quarter, usually a seasonally strong one for investment banks.

Of greater concern is the impact the Volcker rule, expected to be implemented in July, will have on traditional investment banking business models.

The draft of the rules has raised concerns that the high degree of monitoring and compliance will increase the cost of trading. Worse, some fear that the narrow definitions of traditional functions of traders such as market-making might impact liquidity, particularly in fixed-income markets.

So far, banks have remained cautious in their commentary about the impact of Volcker, as regulators continue to seek industry input on a range of issues. But the uncertainty has made it difficult to make long-term decisions on capital allocation and staffing.

Goldman Sachs has, so far, maintained that the current weakness in the environment is purely cyclical and it would take sustained weakness for more than two years for it to make sizeable cuts to its workforce. Still, 2011, Goldman laid off about 2,100 jobs across entities, bringing its total workforce to 34,700 on a consolidated basis.

At Goldman's smaller rival Morgan Stanley, plans are underway to lay off 1600 employees by the first quarter of 2012. Because of its substantial wealth management operation, Morgan has a slightly different compensation structure relative to investment banking peers, with compensation often taking up as much as 50% of revenues.

The investment bank may cap cash bonuses for senior management for 2011 at $125,000 and defer as much as 75% of their compensation, up from about 65% in recent years, according to a Wall Street Journal report.

The same report suggested that Goldman Sachs may have cut the bonuses of its 400 partners by half.

Earlier this week, JPMorgan Chase (JPM), reported a 36% drop in compensation expenses, lowering the average compensation per employee by 8% to $341,552.

The bank laid off more than 300 employees in the investment banking division over the year. That is lower than most rivals, reflecting JPMorgan's inherent strengths and continuing focus on expansion.

Citigroup (C) does not break out employee details by division but said that it would lay off as many as 4,500 employees; over a quarter of the cuts will come from the investment banking division.

More long-term changes could be in store for Goldman and Morgan Stanley employees. Bernstein analyst Brad Hintz expects Goldman to respond to Volcker by automating market making activities; reduce staffing on trading floors and shrink overhead to enhance business margins. "We foresee a "'new"' Goldman Sachs that will remain a powerful global securities house and investment bank, but with a much more tightly limited balance sheet and a much changed fixed income business model," the analyst wrote in a recent report.

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