Macquarie Group (ASX: MQG) has earned its nickname by richly rewarding its executives through a high compensation ratio that some believe favours employees over shareholders. Now it seems that could be changing, with the balance starting to tip back towards shareholders. But does that make Macquarie a buy?
As value investors, we must understand where the underlying value of a business flows. Does it go to shareholders, management, employees or third parties? Investment banking is one service industry where shareholders are likely to share excess returns with employees. But could this be changing at Australia’s ‘Millionaire Factory’?
Macquarie Group (ASX: MQG) has a policy of linking employee compensation to excess returns, but the actual compensation formula has never been disclosed. Jonathan Mott at UBS has done some excellent work regarding this compensation ratio, and argues that it may decline over time. Having done our own research on Macquarie, we tend to agree.
Macquarie Group has changed dramatically over the decades. Its Capital Markets division only comprises 30 per cent of group income, and it now has greater interests in asset management, mortgages, leasing and credit investments. As such, we actually see Macquarie Group as an asset manager with an investment banking arm, though the market may still see the inverse.
The Asset Management division comprises the largest share of income and profit, yet its compensation ratio is relatively low, which means that should the division continue growing strongly the Group’s compensation ratio should fall (but we appreciate that bonuses are still highly discretionary).
Macquarie has also had a magic run in the past two years, with a weakening Aussie dollar, a strong IPO pipeline, and impressive performance fees helped by a low interest rate environment. Macquarie’s income outlook appears weaker than in recent years, which means that management may be inclined to reduce compensation to support earnings (particularly given how much the wealth of their top executives is tied to the share price).
If the compensation ratio does continue to decline at Macquarie, the market may come to share our view that more of Macqaurie’s returns could accrue to shareholders than employees.
But while the stock has sold off materially since Brexit, we would still need the price to fall even further to warrant investment.