For thousands of investment bankers who toiled on Wall Street during the heady days of the mid-2000s, 80% of success, to borrow a line from Woody Allen, was just about showing up. In those precrisis, high-profit times, almost every banker working at a major firm could count on receiving an extra reward in their paycheck come bonus time, largely to compensate for what was viewed as their relatively low fixed salaries.

But no more. Under increased pressure from shareholders, lawmakers, regulators and the public at large, earnings-strapped Wall Street banks are now much more selective about who receives the top rewards -- and what those rewards consist of. These days, there is at least a 30% bonus differential between a bank's best performers and its next level of producers, says Alan Johnson of New York-based compensation consultancy Johnson Associates Inc. There are also fewer bonuses in "the middle and more outliers on both ends," he adds, meaning that some bankers will receive no bonus at all. As one back-office employee at a big investment bank puts it, "This is the first time Wall Street is not the best place to earn money."

To be sure, bonus season, which at most firms begins toward the end of the year when bankers learn what they will receive in their paychecks the following year, is still a highly anticipated time on Wall Street as incentive-based compensation, while now a smaller portion of total pay, still represents a large majority of overall comp. But at the urging of regulators, bonus pay today is more likely to be paid in equity and deferred cash than in the past, and in some cases, it can even be clawed back. Meanwhile, banks have moved to raise base salaries to keep employees happy as their bonuses drop. But that has served only to significantly increase the firms' fixed costs at a time when their earnings are under pressure from a sputtering global economy and from their regulator-mandated exit from high-risk, high-profit businesses, such as proprietary trading.

All of this means that Wall Street's shrunken bonus pool is poised to get even smaller. Russ Gerson, CEO of New York financial services recruiter Gerson Group, says the average managing director bonus at the large investment banks was down 30% to 40% to just over $1 million in 2010 from its 2007 peak of about $1.6 million to $1.7 million.

At the same time, managing director-level salaries at the big firms jumped about 40% from an average of $250,000 to about $400,000, Johnson adds. He says the increase was overdue in an industry that had not grown base salaries for about a decade.

Because compensation costs across the big U.S. investment banks ticked up slightly in the first half of 2011, while profits fell, the bonus pool will likely be even smaller this year than last. Johnson expects a small double-digit percentage salary bump at the end of this year and a corresponding bonus decrease. A financial services compensation report published in August by Johnson Associates projects that the biggest bonus dip will be among fixed-income departments, with declines of 20% to 30% due to high levels of uncertainty and decreased liquidity. The largest bonus increases will take place in M&A and capital markets departments. Bankers in those groups should see their bonuses rise 5% to 10% due to an increase in 2011 deal activity and in initial public offerings industrywide.

If it were up to regulators, Johnson says, bonuses would decline across the board. "Regulators hate bonuses," he says. "They don't understand them and believe they will be drivers of inappropriate behavior."

Indeed, in June 2010 the Federal Reserve published guidance on incentive compensation, strongly advising that bonuses not encourage risk taking beyond a bank's ability to manage the risk and for incentive pay to be compatible with internal risk management. In early 2011 the Securities and Exchange Commission proposed a similar set of rules prohibiting incentive-based pay that encourages inappropriate risk taking or that could lead to a material loss for the financial institution. The SEC proposals added another layer of rules for financial institutions with more than $50 billion in assets, calling for them to defer at least 50% of their executive officers' bonus pay for three-year periods.

"To deal with the optics and regulatory environment in 2008, the banks increased base salaries so that they could pay lesser bonuses," Gerson says. "However, now they are starting to take fixed-cost hits," which are contributing to the widespread layoffs that are now plaguing the Street.

To soften the blow, banks may begin lowering base salaries. "What Goldman Sachs did in London is going to be a trend," Gerson adds. According to media reports, Goldman, Sachs & Co. recently informed hundreds of managing directors and lower-ranked staff members there that the higher salaries granted to them in 2010 would expire beginning in 2012 and would revert back to unspecified levels. The firm had temporarily raised their salaries in response to a public backlash against banker bonuses in the U.K.

When it comes to Wall Street comp, Goldman remains in a class by itself. Its pay arrangement is unique among big investment banks due to its group of approximately 470 partner managing directors, who earn multiples higher than nonpartner managing directors, a source says. The partner managing directors, a group created following Goldman's 1999 initial public offering, own a significant part of the company and share in its profits through dividends, the source explains. "They are by far the highest paid on the Street," the source says. "I don't consider them to be apples to apples" when compared with managing directors at other firms.

In addition to Goldman, other big banks on the high end of the pay scale include J.P. Morgan Chase & Co., Morgan Stanley and Bank of America Merrill Lynch, which paid producing managing directors $1.9 million in salary and bonus on average in 2010. All declined to comment for this story.

At the lower end of the spectrum among big firms is Swiss bank UBS, which in 2010 paid out an average of $1.5 million in salary and bonus to productive U.S. managing directors, the source adds.

UBS' below-average pay might explain the exodus of its high-level talent in recent years. More than 50 investment bankers have left UBS' U.S. operation since 2009, including Cary Kochman, who in June jumped to Citigroup Inc. as head of North American mergers and acquisitions, and Gary Howe, who left in July to head the North American financial institutions advisory group at Lazard.

A UBS spokeswoman declined to comment.

But for most of the larger banks, the biggest change in their pay plans has been the increased proportion of deferred, incentive-based compensation. "The majority of managing directors at large banks were paid 25% to 40% of their total compensation in [deferred] noncash three to four years ago, which in some cases has since doubled," says Sandy McLane, co-head of the global banking and markets practice at recruiting firm Spencer Stuart. Today most large U.S. firms, including Goldman, J.P. Morgan, BofA and Citigroup, offer between 60% and 70% of their executive officers' incentive pay in equity and deferred cash.

Morgan Stanley underwent one of the more dramatic compensation shifts in 2009, paying 72% of its executive officers' bonuses in equity and deferred cash, up from 36% in 2008, according to its proxy filing. In 2010 the firm increased the deferred portion of its executive officers' compensation to more than 80%. Also beginning in 2010, all other employees received an average of 60% of their bonus in equity and deferred cash and 40% in cash up front, up from 60% in cash up front and 40% deferred cash and equity in 2009.

Goldman is just behind Morgan, paying 70% of its executive officers' bonuses in equity beginning in 2010.

Morgan Stanley was the first of the big U.S. investment banks to pay a portion of executive officers' and senior managers' year-end bonuses in performance-based stock units, or PSUs, a practice it instituted in 2009. These PSUs are paid out only if the company meets certain returns on average equity metrics and established stock price performance thresholds within a three-year vesting period.

From a risk-reducing standpoint, it is easier to withhold deferred compensation from bankers who acted in a manner damaging to their institutions than trying to "hunt them down to get back a clawback," says Johnson. Prior to this shift, "if the banker and the bank had a great year, the banker would get a $5 million bonus, and in year two, if the banker had a bad year but the bank had a good year, he might get zero. There is something inherently wrong with that because zero is not enough of a penalty," says Peter Miterko, managing director at New York compensation consultant Pearl Meyer & Partners LLC. Deferring bonus pay allows the banks "to measure and encourage performance over a longer period of time," he adds.

Deferred compensation can also serve as a retention tool -- especially at a time when senior-level investment bankers might be tempted to move to firms that are not putting the same squeeze on bonuses, such as boutique and midmarket banks and private equity firms. Because deferred bonuses tend to vest over three to four years, it is more expensive to recruit a banker who has not completed that vesting period. In many cases, second-tier firms that do not want to have to buy out a new hire's deferred pay will wait for big-bank talent to get laid off. The newly unemployed can sometimes negotiate exits with their deferred pay intact, says Gary Goldstein, co-founder and president of New York recruiter Whitney Partners.

The higher a banker is on the ladder, the more challenging it may be to recruit him or her because "the higher your pay, the heavier the equity component," says Johnson. For the higher-paid bankers, "five years ago, equity peaked at about 45% to 50% of compensation; now it's peaking at 60%, 70% or 80%," he adds.

Whether these changes are actually mitigating risk may be too early to call given that they have only been in place for about two years, says Spencer Stuart's McLane. But according to Goldstein, the sole component of the compensation changes that may directly prevent risky behavior are clawback clauses. In February 2010 UBS was the first bank to implement a wide-scale clawback, recalling cash bonuses worth Sfr300 million ($379.9 million) from its top bankers after the bank failed to post a net profit for 2009. But all of the big Wall Street firms have instituted clawback provisions in recent years, allowing incentive-based compensation to be canceled or recovered if an employee's actions result in significant financial or legal harm to the firm, if he or she is deemed responsible for a financial loss within a division or, in some cases, if a bonus was based on inaccurate performance metrics.

While not necessarily arguing against risk-aversion measures, Kevin Petrasic, a partner in Paul Hastings LLP's global banking practice, says that a fine balance must be struck. "The challenge for the largest banks is, to a certain extent, you want to discourage inappropriate risk taking, but you want to have a healthy degree of incentives to encourage appropriate risks," he explains.

Some recruiters argue that those on the advisory side of investment banks are being subjected to rules seemingly designed to curtail risky behavior in sales and trading departments, which use significant leverage. Despite the advisory business being less risky by nature, the rules, including clawbacks, are being applied across the board. "Advisers are not taking risks, but the shareholders want to know that all members of the bank are held accountable -- your company has to do well for you to do well," says Daniel Ryan, partner and sector leader of the financial services practice at Chicago-based recruiting firm Heidrick & Struggles International Inc.

Altered compensation models, coupled with the shuttering of proprietary trading desks under the Volcker Rule, have reduced risk taking within the big banks' sales and trading departments. And with less risk comes less reward. "These groups were making an enormous amount of money because they were taking substantial risks with the banks' capital -- proprietary trading was where the big compensation packages were," says a recruiter requesting anonymity. Since the Volcker Rule, sales and trading pay has "balanced out" with that of M&A and capital markets departments, he adds.

While traders' compensation is no longer at astronomic levels, the "guys running these groups are still getting paid well because they are managing risk -- heads of fixed income and equity can be making north of $10 million," the source adds.

But fewer and fewer earn north of $10 million at the major firms these days, and in attempts to satisfy their appetites for a more bonus-weighted, less risk-averse Wall Street, some investment bankers are increasingly looking for employment elsewhere. Among Street veterans, there are "those that remember the good old days" when compensation wasn't under a regulatory vise, says Goldstein.

These bankers may be contemplating a complete change of lifestyle such as teaching or working with a foundation, he adds. However, he notes, "a lot of that is talk -- I don't think many people are making that move."

More likely is a shift to private equity firms or hedge funds. While the base salary and bonus "flatten out" at private equity firms at about $1 million to $2 million a year, the upside for management is unlimited due to their ownership in the firm's investments and the carried interest they receive on these investments, Goldstein says.

Another option for bankers disgruntled with lower bonuses -- and with an atmosphere less suited to cultivating or catering to individual stars -- are small and midmarket advisory shops, which are paying "up-front bonuses, sign-ons and all-cash compensation without any deferred equity," says Jeanne Brant­hover, head of New York-based Boyden World Corp.'s financial services practice. Those recruiting "tricks of the trade" are "harder [for the large banks] to give than they used to be" adds an in-house recruiter at a large investment bank. While not necessarily prohibited by regulators, a guarantee or signing bonus without a performance metric may be viewed as inconsistent with a bank's risk goals and risk management.

One midmarket investment bank profiting from the big firms' changing pay policies is Houlihan Lokey Inc. in Los Angeles. Its 70% compensation-to-revenue ratio is "one of the highest I've seen anywhere," says Jeff Werbalowsky, co-CEO and global co-head of financial restructuring at the firm. (Most larger banks have comp-to-revenue ratios in the high 40s to low 50s.) Over the past two years, Houlihan has added 30 bankers to its debt capital markets, equity capital markets and M&A businesses, adds Scott Adelson, senior managing director and global co-head of corporate finance.

New York's Jefferies & Co. has also been recruiting bulge-bracket bankers in droves, aided by its attractive pay packages as well as its place removed from the more highly regulated bank holding company spotlight, say recruiters (see story, page 10). And midmarket New York bank Oppenheimer & Co. has also been able to entice bankers due to its all-cash bonus payments, says Marshall Heinberg, managing director and head of investment banking at the firm. "I've seen the trend in which lower bonuses and more stock causes bankers pause and makes the alternative to move to smaller firms more attractive," Heinberg says. "We've had conversations with a few bulge-bracket bankers -- it's a recruiting pool we can take advantage of."

But not everyone at the big banks is looking to jump ship. With the aftershocks of the financial crisis not fully worn off and looming fears of the next shoe to drop, bankers and traders remain "cautious and nervous about going to another firm -- the voluntary movement of people has been depressed," says Johnson. Some of the bankers who fled big firms in 2008 and 2009 for richer rewards at boutiques are now returning. As Gerson says, "It takes a special kind of capability to be successful at a boutique -- you need to be able to work without products." And for some, even the promise of a big cash bonus may not be enough to compensate for that.

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