5 Ways Executive Pay Programs Need to Evolve as Banks Grow

As banks grow, their executive compensation programs must adapt to reflect greater complexity, heightened regulatory oversight and a more competitive talent market. The compensation committee plays a critical role in ensuring that pay programs remain aligned with business strategy and shareholder expectations. Below are five key areas where compensation programs should evolve with growth.

1. Compensation Benchmarking Approach

Compensation benchmarking is closely linked to asset size. As the bank grows, the compensation committee should ensure the market data used to inform executive compensation decisions evolves in line with the bank’s asset size.

Smaller banks often rely primarily on data from published surveys that include banks of a similar asset size and geographic footprint. These banks are the most relevant benchmarks for attracting and retaining talent while ensuring pay levels remain defensible to regulators and shareholders.

As banks approach the $5 billion asset mark or prepare to go public, CAP recommends developing a custom peer group of publicly traded banks. The peer group enables the compensation committee to review both executive pay levels and practices individually for each bank and in aggregate. The best practice is for peer groups to include 15-20 banks of a similar asset size and geographic footprint, positioning your bank near the median in terms of asset size to maintain credibility and defensibility.

Once a bank crosses the $10 billion asset threshold, the universe of comparably sized local banks shrinks and the market for executive talent becomes national. At this stage, the peer selection criteria should expand to include business characteristics (e.g., business mix, deposits per branch, margins) and performance results, in addition to asset size and geography. 

While it is critical to ensure your peer group grows with your bank, CAP cautions banks against “getting ahead” of their size when selecting peers. Doing so may draw criticism from shareholders and proxy advisory firms such as Institutional Shareholder Services and Glass Lewis & Co. That could in turn negatively impact say on pay voting results, the advisory shareholder votes on compensation that public companies face.

2. Executive Pay Levels and Mix

Executive pay tends to increase with asset size to recognize additional responsibilities that come with size, complexity, regulatory oversight and shareholder scrutiny.

CAP reviewed CEO pay levels for 53 publicly traded banks across four asset sizes:

Median total CEO compensation for banks with greater than $10 billion in assets is six times that of banks with less than $1 billion in assets. As compensation increases, banks deliver a greater portion through variable incentives rather than fixed base salary with larger banks emphasizing long-term incentives.

3. Incentive Design

Annual incentive plans for smaller banks tend to measure the component parts of performance (e.g., deposits, loans) in addition to overall results (e.g., net income). Larger banks tend to remove deposits and loans and focus exclusively on overall results (e.g., net income or earnings per share (EPS), return on assets (ROA), efficiency ratio).

As banks grow, long-term incentive plans become more complex and more directly tied to shareholder returns. Smaller banks tend to use one or two time-vested vehicles, including time-based restricted stock units (RSUs) and/or stock options. Larger banks typically use two or three vehicles, with performance share units (PSUs) comprising at least 50% of the mix, consistent with many shareholder and proxy advisor policies. PSU metrics also evolve with size: smaller banks emphasize profitability metrics such as EPS, while larger banks focus on shareholder return metrics such as relative total shareholder return (TSR) and return on equity (ROE).

4. Risk-Adjustment

Larger, more complex banks must integrate risk management into their executive compensation programs. Best practice is for compensation committees to annually review risk outcomes for each executive’s area of the business and have a mechanism to reduce incentives for negative risk outcomes. Banks also incorporate risk management into their incentive plans through regular risk reviews. 

5. Stock Ownership Guidelines and Holding Requirements

Stock ownership guidelines and holding requirements are viewed as strong governance practices that align executives with shareholders. CEOs are typically expected to hold five to six times base salary in stock, with five years to reach the guideline from the time of promotion or hire. Holding requirements often mandate retention of vested stock for one to two years post-vest, or until retirement.