What Every Director Should Know About Executive Compensation
Todd A. Leone, managing director, Clark Consulting

First of all, every bank director should understand that we’re at the close of a four-year time frame that has arguably seen the most regulation aimed at compensation in corporate history. It began in 2002 with the Sarbanes-Oxley Act, and while it seems like much more time has passed, it was just four years ago this past June. From there it moved on to the American Jobs Creation Act, also referred to as Section 409A. Beginning this year,we have experienced the impact of stock option accounting, life insurance accounting addressed by the FASB, as well as the Pension Protection Act. Finally we have the Securities and Exchange Commission’s regulations on compensation disclosure through the proxy statement.

As directors sit back and think through these regulatory changes, four of the six have applied to all types of institutions. Two of those four, the SEC’s regulations on executive compensation and proxy disclosure and Sarbanes-Oxley, are more focused on public institutions. The biggest piece of regulation at this time is the former, the SEC regulations.While these changes are aimed at public corporations, the question in the marketplace is how they will impact institutions that aren’t publicly traded, but which may be affected due to regulators looking at the SEC regulations for best practices.The key points in this particular SEC regulation are disclosure, disclosure, disclosure. Even if an organization is not public, best practice dictates that all forms of executive compensation be highlighted and discussed, at minimum, at the compensation committee level. There should be no surprises. Everyone should understand what each executive can be paid in different situations, and there should be good discussion surrounding that.

What Are Current Compensation Committee Challenges?

Compensation committees are focused on two areas: managing the committee and dealing with the agenda. First, regarding the process, compensation committees are continuing to work through the kinks related to Sarbanes-Oxley. Even though this law was passed in 2002,many organizations are still trying to find the best way for them to work through the process of coordinating interaction between the compensation committee and management.This speaks to the role of the compensation committee chair, the role of the liaison between management and the compensation committee, and the role of the CEO, and how all three of these parties work together.

Each institution needs to take these rules and individualize them.There isn’t one single model that works best. In the end, the compensation committee needs to be able to look at compensation,understand it, ask questions,and review materials; at the same time,management has to feel comfortable that the compensation committee is reviewing the appropriate matters, that they’re performing their role regarding appropriate due diligence, and that management clearly has a voice as it relates to the compensation committee’s process. Second, as it relates to what compensation committees are addressing or struggling with, one of them quite honestly is their agendas.There is so much activity on their agendas that some committees are struggling to get everything done.Many institutions are now looking at the SEC rules on proxy disclosure and are on the front end of dealing with this issue for proxies that will be published next year. So they have regulatory issues they’re addressing, and at the same time, they’re dealing with a very hot and active commercial lending marketplace. Then there’s board pay, which is moving at a fairly strong clip, let alone dealing with anything they want to do for their own institution, be it redesign an annual incentive plan or look at a long-term incentive plan or executive benefits or agreements.

What Are Successful Bank Compensation Best Practices?

The compensation committees we work with that are in the best-practices category are those that, along with management, are focused on the goals that are driving the various performance plans, and these committees, by inference, aren’t spending all that much time as it relates to what base salary annual incentives or long-term incentives should be.They’re focused on goals.Now, a couple of things spring from this. It’s not that they haven’t focused on those compensation elements–they have done that; it’s actually all based on their compensation philosophy,which says where their institution is and where they want to have their compensation relative to the marketplace, depending on a good versus a great year.With that, their base salaries, their annual cash incentives, their long-term incentives, and all aspects of their compensation are tied to the marketplace, based on this compensation philosophy.With that foundation laid, the real focus is to ensure the goals driving these various performance plans are appropriate for their institution.

This really gets back to the core of a best-practice organization, the strategic plan-what the organization is trying to do,who the board and management are trying to motivate,what they are trying to do beyond the current fiscal quarter or fiscal year, and what they are trying to do in two or three years.Those expectations need to find their way into the compensation programs, so that they know when they achieve these goals, they will be paid appropriately.

The other issue is the compensation philosophy and how programs are aligned to it so that it is a bedrock foundation for the SEC rules on proxy disclosure.Those institutions that need to comply with the rules should find themselves in discussion fairly soon. Our best-practice companies have done this in the past; their programs are aligned, therefore the new SEC rules aren’t going to be as much of an issue as compared to other institutions because, again, they’re already focused on the right things.

Directors need to understand that they are at the end of a period that has seen the most regulation in corporate America’s history. That said, as the compensation committees are struggling to deal with all these external activities, they should know that we aren’t expecting any other major regulations.That’s a good thing.We see the light at the end of the tunnel. Second, as it relates to their compensation programs, go back to the foundation points-what do you want your compensation programs to pay? Go back to your compensation philosophy and make sure your plans are aligned with it.Take each item one step at a time, and a year from now, you’ll be in a much better place.

© Board Member Inc. All Rights Reserved