March 11 (Bloomberg) -- Goldman Sachs Group Inc.’s announcement that it will now bestow coveted managing director titles upon its rising vice presidents every two years, instead of annually, may have shaken the foundation at its New York headquarters. For the rest of the world, even the rest of Wall Street, nothing much will be different.

If Chief Executive Officer Lloyd Blankfein really wants to shake up the industry, Goldman Sachs should break further from what remains of the Wall Street pack, and act like the leader it is. It needs a revamped compensation system that rewards people for taking prudent risks and penalizes those who take foolish ones.

I first suggested such a system more than two years ago. Ideally, it would apply the best of the incentives and risk-management practices of the old Wall Street partnerships -- where partners had their own capital on the line and were rewarded only if there was pretax income in a given year -- to the current incentive system that, incredibly, continues to reward bankers, traders and executives for taking huge risks with other people’s money in expectation of a big bonus.

Financial Accountability

The current system has made the people who work on Wall Street fabulously rich, and given the rest of us one financial crisis after another. It makes no effort to hold financial professionals responsible for their bad behavior. Instead, they continue to reap all the financial rewards for taking risks with the money of their depositors, counterparties, creditors and shareholders, with little or no accountability when things go awry. After what Wall Street put us through in 2008 and 2009, you would think that the compensation system would have been changed to prevent a repeat. You would be wrong.

Efforts to restore sanity, such as the plan from the European Union to cap bankers’ bonuses at twice their salary, are destined to fail: Bankers have already come up with an oh-so-clever plan to raise base salaries enough that compensation goes right back where it was before the cap.

Virtually nothing has changed about the Wall Street compensation system since the crisis, and no one is calling for the kind of reform that would actually change behavior. Bankers, traders and executives still get paid to take risks with other people’s money. These days, compensation and bonuses account for 40 percent to 50 percent of every dollar of revenue. That’s great for Wall Streeters but lousy for the rest of us.

This is where Goldman Sachs can show real leadership. It was the last major Wall Street partnership to go public, in May 1999, and it retains more vestiges of its former culture than almost any other Wall Street firm; the others have given themselves over fully to the corporate structure, with its neat legal separation of liabilities from assets. Goldman Sachs has found a little middle ground: Its top-echelon executives get paid only if there is pretax income at the end of the year. Needless to say, this pay structure makes this group of more than 450 people -- out of the company’s 32,600 employees -- very focused on prudent risk-taking and profit.

Goldman Sachs should build on this remnant of its old partnership ethos by allowing the bank’s creditors and shareholders to go after the assets of those top executives if the bank gets into serious trouble. In bankruptcy court -- or even in an out-of-court restructuring -- creditors could seek recovery from these Masters of the Universe.

Reduced Risk

Had such a plan been in place when Lehman Brothers Holdings Inc. failed in September 2008, creditors could have made a claim on the billions of dollars’ worth of Manhattan co-ops, Hamptons’ beach houses, Treasury securities and artworks that Lehman’s top bankers, traders and executives accumulated. Indeed, had such a plan been in place in the years leading up the collapse of Lehman, I bet the bank would still be around, because former Chairman Richard Fuld and his acolytes would have been far more prudent. They would have taken the time to analyze the risk the company was taking on, which is exactly what Goldman Sachs did in late 2006 when it decided to short the mortgage market to take advantage of its competitors’ foolishness.

The past five years have been rough on Wall Street. Profit is down, and regulation is increasing. Job cuts are coming fast and furious, and those lucky enough to remain employed are getting paid less. UBS AG provided the latest evidence of this inexorable trend last month when it decided to spread the cost of its $1.5 billion Libor-related fine to investment bankers and others at the company, not just those in the trading area responsible for the manipulation.

There is a serious leadership vacuum on Wall Street. Goldman Sachs, if it’s as smart as it thinks it is, will move to fill it. By showing creditors, shareholders, clients and counterparties that top people will get paid only if the company is profitable and that they will be held financially accountable when things go bad, Goldman Sachs would take a huge step toward restoring Americans’ confidence in Wall Street. Even better, it would erode the crazy incentive system that has produced little more in the past 25 years than one self-inflicted financial crisis after another and a bunch of overpaid bankers, traders and executives.

I guarantee you that if Goldman Sachs implements such a plan, the rest of the serious players on Wall Street will follow, and our fragile financial system will be much safer.

(William D. Cohan, the author of “Money and Power: How Goldman Sachs Came to Rule the World,” is a Bloomberg View columnist. He was formerly an investment banker at Lazard Freres, Merrill Lynch and JPMorgan Chase. The opinions expressed are his own.)

To contact the writer of this article: William D. Cohan at wdcohan@yahoo.com.

To contact the editor responsible for this article: Max Berley at mberley@bloomberg.net.