Macquarie Group pays its staff too much, says rival investment bank UBS

It may be a case of people in glass towers throwing stones, but Australia's only listed investment bank, Macquarie Group, has been told it pays its staff about $800 million over the odds by another investment bank, UBS.

In a research note to clients, UBS's highly rated team of bank analysts said the Macquarie remuneration structure had not changed much in the past 20 years, despite a massive change in the group's businesses model.

On UBS's figures, if Macquarie re-jigged its compensation model so each of its divisions paid staff at around the top 25 per cent level of its global peers, annual costs would be cut by $809 million and earnings-per-share (EPS) would jump 32 per cent.

Further belt-tightening down to middle-of-pack pay would cut staff costs by more than $1 billion and boost EPS by almost 50 per cent.

UBS said that given Macquarie was now a globally diversified financial services company, a staff expense-to-income ratio of 35 to 38 per cent was appropriate.

"This compares to 46 per cent today using MQG's (Macquarie Group's) outdated investment banking structure," UBS noted.

Macquarie listed as a public company in 1996 with 1,500 employees and $400 million in capital, specialising in equities and corporate finance with only about 8 per cent of revenue coming from overseas.

These days, it is a diversified financial giant with 14,000 staff, $12 billion in capital, $450 billion assets under management, and about 70 per cent of its revenue generated offshore.

Pay structure 'outdated', says analysts

UBS told its clients that Macquarie's cost base is too high and its cost-to-income ratio is where it was when it first listed.

"We believe that the main reason for Macquarie's lack of improvement in efficiency is its remuneration structure which remains tied to its investment banking legacy," UBS analysts said.

UBS argued that while Macquarie's purely "investment banking-style activities" have fallen from around 80 per cent of earnings to less than 20 per cent, its "outdated" remuneration model was benchmarked against investment banking divisions of its global peers.

UBS noted only Macquarie's actual investment banking and equities divisions — Macquarie Capital and Macquarie Securities — operate around the mid-point of their direct global competitors with a staff cost-to revenue ratio of 47 per cent, coincidently about the same as UBS investment bank itself.

However on UBS's figures, Macquarie's asset management, corporate finance, and banking and financial services businesses all had substantially higher staff cost-to-revenue ratios than their peers.

While comparisons are difficult given the opaque nature of such operations, the UBS report found Macquarie's Institutional Banking division had a remuneration-to-revenue ratio of 46 per cent compared to 30 per cent for its Australian peers.

In the global asset-management game, Macquarie's 46 per cent remuneration-to-revenue ratio was substantially higher than the 36 per cent quoted for its much larger rivals Blackrock and State Street.

Macquarie staff bonuses from 'profit pool'

However Martin Lawrence, a corporate governance analyst with institutional investment advisory firm Ownership Matters, said Macquarie handled pay better than many of its rivals over the years.

"They started the revolutionary concept where staff get paid out of profit, rather than the model where management got what they thought they were worth," Mr Lawrence noted.

Under the Macquarie model, staff get paid bonuses out of a "profit pool" once the company's cost of capital is met.

While Macquarie does not discuss specifics of its remuneration structure, it is generally understood that once the cost of capital target is met — a return-on-equity (ROE) of around 11 or 12 per cent — increasingly large portions of the profit pool is paid to staff.

Since the global financial crisis, Macquarie's ROE has roughly halved from above 20 per cent to around 10 to 12 per cent, and the bonuses have shrunk as well.

UBS argued that a change in remuneration structure could see Macquarie's ROE jump back up towards 20 per cent and its valuation rise from $68 per share to $95 per share.

"We believe such changes are inevitable despite a likely pushback from Macquarie management for obvious reasons," UBS analysts said.

"However, we believe it is becoming increasingly difficult for Macquarie's board to justify holding onto its antiquated bonus calculation."

Mr Lawrence said there had always been a core contest between shareholders, who supply the capital, and staff, who invest it, about the division of profits. "Of course shareholders would like a bigger share," he said.

"However, the important question is that if you radically change the ratio, would you keep the staff?"

Macquarie was not available for comment, but some clue to the company's thinking on the matter can be found in its annual report.

"Macquarie's consistent approach to remuneration has served it well over the long-term, evolving incrementally over time," the company told its shareholders.