Golden Handcuffs: Deferred Compensation as the New Retention Tool

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Think a million-dollar bonus sounds good? How about if you only received $600,000 now with the balance deferred until later?

Perhaps you were given options or restricted stock for that other $400,000 that won't vest or be yours for three years. It would certainly give you an incentive to stay with the firm, at least until the restricted stock or the options were worth something to you. Otherwise, you'd be forgoing about 40% of your bonus.

Well, that's precisely the point. Firms like Lehman Brothers, Goldman Sachs and Merrill Lynch & Co., for instance, are increasingly deferring a percentage of their employees' compensation for as long as three years as a way to get them to stay with the firm. Referred to as "golden handcuffs," the percentage deferred is higher the more the employee earns. For a vice president whose bonus might be $300,000, the firm might hold back 20%. For a senior managing director earning $5 million to $6 million, as much as 40% of their compensation might be deferred.

The employee might be awarded stock that they can't sell - and it can be taken away - if they leave within some period, usually three years. Alternatively, the employee may not even receive the stock for three years.

And the amount forfeited actually grows each year. A managing director may find 30% of his bonus is not available for three years. The following year, another 30% may be withheld. In year three, the same thing would happen, creating what's called a tiering effect. The result: by the third year, some 90% of a year's bonus would be left on the table if the employee left.

"For some of these people, if they left the firm, they'd be leaving millions on the table," says Michael Segal, a partner with Paul, Weiss, Rifkind, Wharton & Garrison LLP.

Firms have turned to deferred pay because employees would simply wait around until, say, March 15 to get their bonus check, and then on March 16, they'd leave. Golden handcuffs inhibit that, Segal says. They're most commonly applied to people with strong client relationships: if they leave clients may follow.

"The concept has been around for a long time. More recently, it's become universal," says Segal. "Every major Wall Street firm now has a program like this, usually up to CEO."

Kenneth Taber, an employment law attorney with Pillsbury Winthrop Shaw Pittman LLP, says firms are trying to make as much of the compensation "future-driven" as they can. It enables them to create so-called claw-back provisions, meaning if the employee leaves, the pay that was deferred is taken back.

"All of this is intended to drive you toward a decision not to leave," Taber says. "It's a rare case when I'm representing someone in senior management who isn't facing this."

The result is that if a new employer wants to hire you, they have to make you whole. And that's made hiring more expensive, he said.

"It's created a world in which there's now a price to be paid for job transition, and my sense is that the price is increasing as employers generally become more focused on using these (deferred-pay) tools," Taber says.

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