* FICC revenue falls 44 percent to $1.25 billion * Bank slashes costs to make up for overall revenue drop * Quarterly dividend raised to 55 cents/shr from 50 cents * Third-quarter profit $2.88/share vs Street view $2.43 * Shares drop 2.4 pct to close at $158.32 By Lauren Tara LaCapra Oct 17 (Reuters) - Goldman Sachs Group Inc's bond-trading revenue plunged in the third quarter, and the bank slashed employee compensation costs by 35 percent - an unusual step that signals its concern about performance for the rest of the year. Revenue from trading fixed-income, currency and commodity products for clients, one of the bank's biggest businesses, tumbled 47 percent in the quarter, excluding an accounting adjustment, Goldman said on Thursday. That was a much sharper decline than rivals have posted, which sources said was dispiriting to some employees. Goldman's shares fell 2.4 percent to close at $158.32. "Goldman showed that they are also mortal," said Michael Holland, founder of Holland & Co, which owns financial stocks but does not own Goldman shares. Client trading volume dropped across Wall Street as the Federal Reserve said it would refrain from changing its bond-buying stimulus policy, giving investors less reason to trade. But Goldman Sachs was hit harder than peers because it has a big mortgage-bond trading business, which was strong a year ago but particularly weak last quarter. Goldman also has a good deal of institutional clients such as hedge funds that trade frequently - often on economic data that were not being released during the government shutdown. That factor hurt the bank late in the third quarter and into the fourth quarter as well, while rivals including Bank of America Corp can rely on a broader array of clients. "We just had a tough quarter," Chief Financial Officer Harvey Schwartz said on a conference call with analysts. Management is "not happy with" the bank's performance, he added. While rival Morgan Stanley has been building up its brokerage unit - sometimes painfully - to reduce its reliance on areas such as trading, Goldman has been resolutely sticking to its traditional businesses, focusing on advising companies, underwriting and trading securities, and managing assets. Investors seemed less worried on Thursday about Morgan Stanley, which reports earnings on Friday. Its shares rose 1 percent amid a broader market rally to close at $28.93. The third quarter may have been lackluster for Goldman, but its executives said it has no plans to change its strategy to be more diversified like its rivals JPMorgan Chase & Co or Morgan Stanley. Regulators are reluctant to allow big banks to get bigger through acquisitions now, and until regulators write more rules, it is not clear how different businesses will perform in the post-crisis world. Goldman responded to the weaker revenue by setting aside less money to pay employees during the quarter - $2.38 billion, compared with $3.68 billion in the same quarter last year. The 35 percent decline is high compared with competitors. JPMorgan Chase & Co's investment bank cut its third-quarter compensation expense by 15 percent. Goldman's compensation costs amounted to 35 percent of its revenue in the quarter. The bank's target is usually closer to 43 percent. The bank sometimes cuts the money it sets aside for pay in a quarter, but it usually does so in the fourth quarter, when there is no hope of earning extra revenue for the year. Doing so in the third quarter signals that it does not expect a big rebound in the fourth quarter, a point Schwartz conceded on the conference call. One bright spot - Goldman set aside a fair amount for pay in the first half of the year, when net income was up about 35 percent over the year-earlier period. Even with the third quarter drop, total compensation costs for the first three quarters are only down 5 percent from the same period last year. While the bank may always change the amount of money it sets aside later in the year, the third-quarter reduction will likely translate to lower bonuses for employees. TOWN HALL Ahead of the bank's analyst conference call on Thursday morning, Schwartz held a town hall meeting in which he, CEO Lloyd Blankfein and Dane Holmes, head of investor relations, spoke with managing directors about the firm's results. Two managing directors told Reuters that employees in underperforming divisions were dispirited on Thursday - as the earnings report underscored that market conditions have been so difficult for so long. Layoffs are all too familiar to many at the bank. Goldman had been cutting jobs almost consistently since the end of 2010. The bank added 900 workers to its payroll in the third quarter, even as it cut the amount of money it set aside for compensation. But the drop in revenue and bleak outlook for the fourth quarter suggested job cuts might be on the table again, one Goldman trader said. Even if banks are not forced to cut staff, fixed-income, currency, and commodities trading bonuses could fall 10 to 15 percent this year across Wall Street, with many employees getting no bonus checks, pay consultant Alan Johnson estimates. Overall, Goldman reported net income for common shareholders of $1.43 billion, or $2.88 per share, down 2 percent from $1.46 billion, or $2.85 per share, a year earlier. Per-share earnings rose because of stock repurchases. Analysts had been expecting earnings of $2.43 per share, on average, according to Thomson Reuters I/B/E/S. Analysts had forecast higher revenue, and most of the better-than-expected performance came from cost-cutting and a lower tax rate, which are difficult trends to sustain. Overall revenue fell 20 percent to $6.72 billion. Excluding an accounting adjustment that investors often ignore, revenue from the bank's fixed income, currency and commodities business for clients fell to $1.29 billion, from $2.49 billion. Its revenue from investments in debt securities and loans fell 46 percent to $300 million from last year's third quarter. BLAME IT ON WASHINGTON The bank boosted its dividend for the third time in less than two years, to 55 cents per share quarterly from 50 cents. The dividend is a relatively small expenditure for the bank, but Goldman is usually loath to boost its payout if there are better opportunities for it to invest the money elsewhere. "The third quarter's results reflected a period of slow client activity," Chief Executive Blankfein said in a statement. Blankfein laid some of the blame on the budget impasse in Washington, which made companies and investors hesitant to take risk. Wall Street banks that reported earnings earlier in the month, including JPMorgan Chase & Co, Citigroup Inc and Bank of America, also reported lower fixed-income trading revenue, and said that uncertainty about the Federal Reserve's plans for monetary easing had also hurt trading volumes. But declines at Citigroup and Bank of America were more in the 20 percent range. Goldman said its mix of products and clients, including its mortgage bond trading business and its focus on institutional clients, was responsible for the bigger drop.