Wall Street gets creative with bonuses

February 7, 2013, 9:03 PM UTC

UBS is the latest bank to dole out bonuses in bonds. Will it pay off? 

FORTUNE – As Wall Street bonus season comes into full swing, UBS AG is the latest bank doing things differently to reel in excessive pay. On Tuesday, the Zurich-based bank announced plans to pay some of its top employees’ bonuses in bonds.

The move is something regulators have called for. Unlike stocks, debt-based bonuses discourage traders and bankers from taking on the kind of risky bets that helped drive the U.S. economy into financial disarray. After all, bonds have fixed payoffs; they don’t go up.

The reality, however, is that Wall Street bonuses have gravitated toward deferred bonuses, like stock options, since the financial crisis. Because they tend to be tied to the firm’s long-term performance, it makes them far less excessive than cash bonuses. However, unlike bonds, the payoff from stocks has the potential to rise. Which makes traders and bankers very happy, but it also gives them every incentive to take on business risks to see their banks’ stock soar. And such risks could lead to financial disaster, as we saw during the financial crisis.

MORE: This year’s biggest economic losers

“Did you ever buy stock in hopes of just getting your $10 back? Probably not,” says former Wall Street executive Sallie Krawcheck, who has repeatedly advocated debt-based compensation. Earlier this week, on LinkedIn, she laid out “10 reasons paying bankers in more stock is a bad idea.”

UBS isn’t the first to offer up bonds. Its announcement follows Credit Suisse Group (CS), where during the depths of the financial crisis, senior bankers received $5.05 billion of junk-grade loans and commercial mortgage-backed bonds as part of their annual bonuses. This was the bank’s way of compensating employees, but it was also a means for the bank to shift risk off its books.

True, the bonds seemed unappealing at the time. As it turns out, however, the deal paid off handsomely: The assets have delivered gains of 75% since the end of that year through Nov. 30, according to Bloomberg. During that period, Credit Suisse’s shares dropped 23%.

This year, Credit Suisse is doing it again — it announced plans last month to pay a portion of senior employees’ bonuses in bonds backed by derivatives, which employees will receive on top of cash and restricted stock.

MORE: LionTree roars with Liberty-Virgin deal

Going back to UBS (UBS), it remains to be seen how bond-based bonuses will work out for employees, but a few things are at least more certain: The plan helps the bank meet stricter capital requirements, since the bonds can be written off if the bank’s common equity ratio falls below 7% or if it needs a bailout.

To Wall Street’s credit, executives have that signaled recklessly risky bets won’t be rewarded. Last month, JPMorgan Chase (JPM) slashed CEO Jamie Dimon’s bonus by 53%, citing the bank’s $6.2 billion loss from its massive bet on credit derivatives made by one of its London units. Dimon may no longer be the best paid bank CEO, but he still gets to take home $11.5 million, including a $10 million bonus.

If anything, Wall Street’s message has been inconsistent. At the other extreme, Jeffries Group in December announced it will pay employees year-end bonuses in immediately available cash.

As the U.S. economy heals, the wear and tear of the financial crisis will start wearing off. For those lucky enough to have kept their Wall Street gigs, it will be worth watching what bonuses will look like years from today. And if debt-based compensation at UBS and Credit Suisse will catch on.