How Banks Can Adapt Incentives to Thrive in Volatile Times
An unstable operating environment can result in less-attractive incentives. Banks should rethink the structure of their incentive plans to account for this instability.
Brought to you by Compensation Advisory Partners
Uncertainty has become the new norm in the banking sector. Interest rates, inflation, stock price volatility, regulation, competition from fintech companies and the upcoming presidential election all have an impact on bank financial results and valuations. In compensation plans, this volatility can impact the value of incentives and create retention risks.
Banks can consider a variety of strategies to make their compensation programs more durable in this uncertain environment. These strategies generally fall into two categories: improving flexibility of core programs and awarding retention awards.
Improving Flexibility of Core Programs
In-flight annual and long-term performance plans may not adequately account for rapidly changing market conditions, as goals are often set at the beginning of the year and macroeconomic conditions beyond management’s control may impact actual company results. This may lead to incentive payouts that are well-below the target level. The chart below incudes several strategies banks can employ to improve the flexibility of their go-forward performance plans:
Applies to | |||
Strategy | Description | Annual Incentive Plan | Long-Term Performance Plans |
Semi-Annual Performance Periods or Annual Milestone Approach |
|
X | X |
Discretionary or Qualitative Components |
|
X | |
Wider Leverage Curves or Lower Thresholds |
|
X | X |
Set Target Goals as a Range |
|
X | |
Relative Performance Metrics |
|
X | X |
Time-based Restricted Stock Units (RSUs) |
|
X |
Retention Awards
To improve the retention hook of outstanding equity awards, companies may consider granting special retention awards outside of the core compensation program. While these types of awards may receive pushback from shareholders, they can be designed to support retention and drive performance. Important considerations when structuring these awards include:
Design Feature | Considerations |
Size of the Award |
|
Cash vs. Equity |
|
Performance vs. Time-Based Vesting |
|
Vesting Schedule / Performance Period |
|
Eligibility |
|
Ensuring Pay and Performance Alignment
Adopting flexible strategies in performance plans and implementing thoughtful one-time awards can support retention of key employees and help banks effectively navigate economic uncertainty. Banks should continue to ensure that their compensation programs support the pay and performance relationship, take a balanced approach to risk management and reflect principles of good governance. Additionally, public banks should provide robust disclosure describing to shareholders the rationale for any compensation actions and demonstrating the continued alignment between the compensation program and shareholder outcomes.