Wall Street, Baseball Salaries See Post-Steroid Austerity

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Baseball and Wall Street have a lot in common these days – and not just because both games are followed by guys who speak with more confidence than insight about how they’re played.
 
Both Big Finance and Major League baseball teams are adjusting to new realities following an era of overstated results achieved through unnatural performance enhancers, leading them to pay too much for talent that was not as valuable as it appeared. In each case, leaders are trying to impose more rational pay schemes, stronger performance measurement, and better data and technology to hone smarter decision making.
 
And both baseball and Big Finance are proving to be better, more resilient businesses for those still around to deploy the lessons of the bubble-and-bust years.
 
In baseball, player performance was juiced by steroids and growth hormones, which inflated hitters’ statistical exploits and allowed many players to extend their careers. While strength-building drugs were presumed to be distorting the game from the mid-1990s into the mid-2000s, many were not explicitly prohibited and, it now appears, were more pervasive than was generally believed at the time.
 
The unnatural juicer
 
On Wall Street, the unnatural juicer of profits was a recipe of excessive financial leverage abetted by ultra-low interest rates and lax credit standards. While neither illegal nor secret, banks’ enormous and often-hidden leverage was largely responsible for lush profits and enormous bonus inflation, especially from 2004 to 2007.
 
Now the major investment banks and most baseball teams are working to rationalize how much and on what basis they pay their people. Despite the stock market’s four-year rally toward a new high and a long-running boom in the bond business, New York Stock Exchange member firms last year paid out total compensation that was more than 5% below the industry peak in 2006. (Granted, banks and brokers now employ fewer people on their rosters -- an option unavailable to baseball team owners.)
 
Salary inflation in baseball has eased substantially, too. After rising 15% from 2007 to 2011, the total payroll of the 30 Major League teams barely inched higher in 2012 even as league-wide revenues rose an estimated 7% from 2011 (according to MLB).
 
To sharpen the comparison, consider the recent money maneuvers of Goldman Sachs Group (GS), the New York Yankees of finance, and the Yankees, the Goldman Sachs of sports. (Goldman is an investor in the Yankees’ sports-cable network and an advisor to the team, but these connections are immaterial to this exercise.)
 
In the credit-bubble years, Goldman’s financial leverage – assets divided by shareholders’ equity – exceeded 25, and the firm traded that capital aggressively to generate returns on equity above 30% a year. The firm paid its people well out of those leverage-enhanced profits, bestowing $20.1 billion in cash and benefits in 2007. That amounted to 43.9% of net revenue and an average $660,000 per employee.
 
Last year Goldman ran with a leverage ratio closer to 12, was targeting a low-teens return on equity and paid out $12.9 billion, or 39.7% of revenue, to employees, who earned an average of $397,000 each, or 40% below 2007 levels. The 30 MLB teams in aggregate last year also paid just over 39% of revenues in salaries, down similarly from above 41% in the late 2000s.
 
Regulation, credit-agency scrutiny and competitive factors have combined to keep Goldman’s leverage, profitability and compensation at lower levels. But the firm has also tried to fine-tune how it pays its people, for example charging traders a punitive financing rate for stale investment bets and tying individual compensation to risk-adjusted performance of entire teams.
 
The Yankees are undergoing their own version of slightly tighter purse strings. The team routinely was the most valuable and freest-spending under longtime owner George Steinbrenner, and its untamed budgets helped the team make the playoffs every year from 1995 through 2008. Payroll peaked at $209 million in the 2008 season. Since Steinbrenner’s death in 2010, management has tried to reduce its contract obligations at the margins, last year dipping its payroll below $200 million despite still-rising league and team revenues aided by a new stadium in 2009.
 
A fragile advantage
 
Regulation of a sort is imposing some spending discipline here, as it has on Goldman. The rules governing the “luxury tax” paid by high-revenue teams to poorer ones are giving the Yankees a powerful incentive to get its 2014 payroll under $189 million. Team management has vowed to undercut this limit, even as it joins other clubs in using more advanced statistical tools to evaluate players and handicap their long-term value. As this season begins, the apparent on-field advantage of the richest teams appears more fragile than it has in years.
 
Here is Goldman COO Gary Cohn in Davos this year, discussing the firm’s pay practices: “The asset that we have, like all our competitors have, is human capital. There is a very clear market for human capital. We hire people during the year. People hire people away from us. We know where people transact. We know what the market is. We think relative to the competitive landscape that we operate in, our people got paid relatively fair relative to the contribution they made to the firm and to our share price.”
 
And here is Yankees general manager Brian Cashman, when asked this winter about how he will navigate the team’s need to replenish talent at key positions, in part due to injuries: “We will try to accomplish upgrades where practical. But if people want to try and take advantage of the circumstances and have us pay twice the price, then we’re not going to do anything there. We’ll just deal with what we’ve got and wait it out.”
 
Clearly, these guys are no longer interested in letting their checkbooks do their thinking for them.
 
Naturally, no one is weeping for the privations visited upon pro ballplayers or senior bankers, even under the relative cost-consciousness of their employers. Just last week, the Detroit Tigers gave dominant pitcher Justin Verlander a five-year, $140 million contract extension and the San Francisco Giants bestowed a nine-year, $167 million deal on star catcher Buster Posey.
 
A new pattern
 
Yet the pattern with recent lucrative long-term baseball packages is that the players are young, proven performers who could otherwise be lost to the highest bidder under free agency within a few years. Contrast this with the indulgent 10-year, $275 million gift the Yankees gave steroid-tainted infielder Alex Rodriguez in 2009 when he was already 34 years old.
 
Less prominently, Goldman this year hired Morgan Stanley’s (MS) Asia investment-banking chief Kate Richdale as a partner, which puts her in line for one of the richest annual paydays on Wall Street. Yet the calculation clearly was made that her connections to clients in a critical region and value to Goldman’s banking franchise make her more than worth the money.
 
Meantime, bankers and traders today are increasingly paid in restricted stock that vests over a number of years, to tie them to the firm and dissuade them from taking outsized short-term risks that could undermine the bank’s health in future years. Sort of like a long-term, incentive-laden player contract.
 
Incidentally, at the risk of carrying the analogy too far, those looking for an opportunistic competitor bucking the New Austerity trend can look to Jefferies Group (JEF.F) as today’s Toronto Blue Jays of Wall Street. Less storied than their bullying division-mates the Yankees and Red Sox, the Jays this year have gone all-in trading and bidding for expensive stars from teams looking to economize, including shortstop Jose Reyes, allowing its payroll to surge 45% to $120 million.
 
Jefferies, the mid-market investment bank, has been in growth mode as global banks have retrenched, boosting head count by almost 50% since 2007 and paying producers as generously as any other firm in a bid for market share. The firm, run by a tight group of veteran trader-executives led by Richard Handler, is now set to merge with financial conglomerate Leucadia Group (LUK), in a gambit to become a more formidable merchant bank in the old style.
 
Just because the leading organizations in baseball and finance are now adopting a more sober tone about pay-for-performance and more prudent talent evaluation methods doesn’t mean it will last. Competitive pressures and a potential new episode of overly generous credit conditions on Wall Street could drive risk-taking and bonus inflation back toward reckless levels. And after the Yankees get under that $189 million payroll threshold for a year, the team could well go back to setting the market on coveted veteran players.
 
For now, though, it appears both games have become more chastened in their performance expectations and careful with a buck. Play ball.

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