CASE STUDY Merrill Lynch During the financial crisis at the end of the first decade of the 2000s, Merrill Lynch was acquired by Bank of America for $50 billion. The reason for the acquisition was that Merrill Lynch was unsure it could survive the crisis on its own. Bank of America received government assistance during the financial crisis from (and was thus covered by) TARP (the Troubled Asset Relief Program). So too then was Merrill Lynch. One initial consequence of TARP coverage was that some employees, including some high-level, highrevenue generating employees, began to leave larger financial institutions like Merrill Lynch/Bank of America to go so-called boutique financial services firms, which had not received TARP money and thus were not covered by TARP restrictions on compensation. Another initial reaction was an increase in base salary levels and a decrease in bonus levels, apparently in response to all of the negative publicity bonuses had received and as a way to get around TARP restrictions. One senior executive at the company receiving TARP money and now paying smaller bonuses and bigger salaries, however, questioned whether TARP-induced greater emphasis on base pay made sense: So, Youre going to overpay them regularly, instead of just sometimes? However, now that some time has passed, the economy has recovered (somewhat), and the stock market has bounced back, Merrill Lynch and other financial services companies are making money again. At Merrill Lynch, there is always a lot of action and discussion around compensation strategy. Merrill introduced a plan to expand its number of financial advisors by 8% (about 12,000 people). Where would they come from? Other firms? How would Merrill get them to move? By offering unusually high up-front signing bonuses and decentralizing authority to make such offers. Traditionally, top brokers from other firms can receive 1.5 times their pay at the firm they are leaving. Merrill was not the only firm looking to add top brokers. Indeed, what was described as a bidding war broke out, and signing bonuses were reported to have gone as high as three to four times previous pay in some cases. Why the bidding war? Wealth management firms make the bulk of their profits on the top 10 percent of their producers according to compensation attorney Ketten Muchin. And, very wealthy clients tend to be more loyal to their advisors than to the advisors firms. At Merrill, there are some concerns among financial advisors. First, in the non-Merrill part of the Bank of America, brokers are under a discretionary bonus system rather than (objective) incentive system where pay is based on a formula. Merrill financial advisors fear the Bank of America wants 4 | P a g e to extend that system to cover them. Second, and likely related, non-Merrill brokers at Bank of America are expected to cross-sell in other words, to push products sold by other parts of the bank. The opportunities for such synergies are typically seen as source of competitive advantage for a large, diversified financial institution such as Bank of America. However, cross-selling performance (and cooperation) is difficult to assess objectively. Thus, subjective evaluations are likely necessary. Merrill brokers appear to be opposed to cross-selling, both because they are concerned it could undermine their relationships with their clients and they prefer to have their pay determined by objective measures.

3. Describe the incentive and sorting effects at Merrill Lynch and how changes to the compensation strategy might affect them. (5 marks)