October 3rd, 2012
More than most professions, the pay of financial service professionals is or should be tied to their performance. It is easy to quantify the returns the investments they recommend return and easy to compare their performance to other financial service professionals. When executives perform well they frequently receive large bonuses. However, should they receive large bonuses when they fail to meet their own internal targets and consistently underperform the market over many years?
Over the past few years Temasek Holdings senior management has awarded itself bonuses for consistently underperforming the market and even failing to meet its own internal hurdle rates.
A hurdle rate is the rate of return an investment manager must exceed before collecting a bonus. Temasek states on its website that its risk adjusted hurdle rate ranges from 8-9% over the last few years. They further state in the Temasek Review 2012 that:
“When we deliver returns above our risk-adjusted hurdle, we have a positive bonus pool to distribute, part of which is deferred to future years. When we deliver returns below our risk-adjusted hurdle, we share a negative bonus pool….the average risk-adjusted hurdle rates for Temasek were about 9% through the years.”
So now that we understand what the Temasek hurdle rate is and why it is important, let’s look at how often they have met the hurdle rate over the past few years. Here is the total shareholder return as calculated by Temasek:
According to Temasek’s own numbers, since 2008 they have only beaten their own one year hurdle rate 1 out of the past 5 years. Their 5 year total shareholder return is a paltry 3% while their hurdle rate is 9%. This is not a good record. Finally, the one year that Temasek beat its hurdle rate of through March 31, 2010 with a return of 43% the first full year after the financial crisis, the Strait Times Index returned 55%. Not only is Temasek not beating its own hurdle rate, when it does beat its hurdle rate it isn’t beating the market.
Surely given this record of performance failing to meet its own internally established hurdle rates, Temasek should not be awarding senior managers bonuses especially given their statement above on how the creation of the bonus pool. According to the Temasek annual report since 2006 every year included cash bonuses for the prior years work; bonuses in six of seven years for “wealth added” even though “wealth added” was negative in 4 of the 7 years according to Temasek; co-investment investment units awarded in 5 years out of 7 comprising a major portion of compensation which appear behave similar to a stock option.
In other words, senior management is given an ownership stake in Temasek Holdings for failing to meet their own hurdle rate, follow their own policy, and not beating the market the one year they do beat their hurdle rate! The average Singaporean though gets 2.5% through their CPF account to fund Temasek. Who is getting the better deal?
To try and get an idea of how big a bonus Temasek senior management is awarding itself for not beating its own internal hurdle rate, let’s compare the Temasek management costs to that of other investors that disclose their costs. Temasek lists its operating expenses in its group income statements. To make a fair comparison, I add up their Selling & Distribution, Administrative, and Other Operating Expenses but exclude their Finance costs. You can see a simple comparison to other well known investment firms in USD below in Table 1.
Even though Goldman Sachs manages $762 billion USD more than Temasek while employing 31,900 more people its non-financial operating costs are only 34% higher. To put this in perspective, the average operating cost of employing someone at Goldman Sachs is $864,181 SGD. The average operating cost of employing those 400 employees at Temasek: $52,141,276 per employee! It is 60 times more expensive to employ someone at Temasek Holdings than Goldman Sachs and 94 times more expensive than Morgan Stanley.
The enormous discrepancy in operating costs between Temasek and firms like Goldman Sachs matters for two very important reasons. First, as financial firms primary non-financial cost is operational and administrative costs like employee compensation, office space, and overhead, this implies that Temasek is paying its employees well above industry norms. According to the Wall Street Journal, the average salary at Goldman Sachs was $367,057 in 2011. Unless Temasek is buying enormous amounts of printer cartridges and paper clips, these operational costs represent compensation costs.
Second, the excessive non-financial operating costs at Temasek represent an enormous drain on Singaporean public finances. Temasek currently pays $21 billion SGD in non-financial operational costs. If Temasek operational costs per employee were equal to Goldman Sachs, they would only spend $345 million SGD. In other words, if Temasek spent money like Goldman Sachs rather than Temasek, total operational costs would fall by 98.3%!! To put it another way, the difference between the amount of money Temasek would spend if it averaged Goldman Sachs cost per employee is equal to 34% of Singaporean government expenditure. The excessive spending is directly taking money out of the Singaporean budget.
Maybe the discrepancies and costs at Temasek should become part of the National Conversation?
*The writer is a professor of business and economics at the HSBC Business School at the Peking University Graduate School. An expert in sovereign wealth funds, he has published in such leading journals as the Review of International Economics, the Journal of Public Economic Theory, and the International Finance Review on such diverse topics as CDS pricing, the WTO, and the economics of adoption and abortion. His work as been cited by a variety of media outlets including the Wall Street Journal and the Financial Times. Prof Balding received his Phd from the University of California, Irvine and worked in private equity prior to entering academia. He blogs at http://www.facebook.com/baldingsworld.