How Directors Get Paid: What to Know if You are on the Compensation Committee

Bank directors have experienced an increased workload in recent years with many new regulations and compliance guidelines. It is now more important than ever to ensure the total compensation program for your directors is competitive and linked to the bank’s overall compensation philosophy. In addition, it is important that your bank has an independent compensation committee that ensures that the compensation programs for both executive officers and directors are designed appropriately.

How Directors Get Paid
Once banks become profitable, they typically begin to pay cash fees to the board of directors to compensate them for the time they spend on board activities. Many banks have adopted a “pay-for-time” director compensation philosophy that is based on participation in board and committee meetings. These meeting fees can range from a couple hundred dollars to thousands of dollars per meeting with larger banks typically paying higher per meeting fees. Since the chairman of the board and the chairmen of committees typically spend more time preparing and presenting, these positions will often receive 20 percent to 30 percent more compensation per meeting than regular board or committee members.

In addition to per meeting fees, many banks use retainers in the form of cash to compensate directors. Retainers can be useful to attract directors in competitive markets when meeting fees may not provide enough to retain high quality professionals.

Paying Long-Term Incentives
Cash bonuses for directors are not considered a best practice in the banking industry. Best practices from the National Association of Corporate Directors state that the board should not receive compensation based on the achievement of annual performance metrics, as the board should be focused on making decisions for the long-term success of the bank. In place of annual cash-based incentives, the suggested incentive for the board is in the form of stock grants or cash-based deferred compensation programs such as phantom stock for private corporations, where compensation is given based on the bank’s long-term increase in book value. These types of long-term incentive plans have replaced or supplemented many of the cash retainer programs.

Paying Benefits to Directors
Director health and welfare programs are not common in the industry, as most insurance and retirement programs for directors are cost-prohibitive. A cost-effective benefit for directors is a voluntary deferred compensation plan where directors can defer their cash fees or retainers to retirement or an agreed upon date. The cost of these plans to the bank is any above-market interest rates applied to these types of deferred compensation programs, which typically makes this the most affordable benefit for bank directors.

The Importance of Compensation Committee Independence
Typically, the compensation committee is made up entirely of independent outside directors, which is now a requirement for publicly traded banks under the new Securities and Exchange Commission (SEC) compensation committee governance rules. These rules dictate that an independent director must not be an officer or employee of the company or its subsidiaries or any other individual having a relationship that, in the opinion of the company’s board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.

Hiring Independent Advisors
The SEC also is now requiring public banks to conduct an independence assessment of individuals who are advisers to the compensation committee. Prior to retaining or receiving the advice of any advisor, we believe all compensation committees should ask the following questions to assess independence:

1. Does the advisor offer any other services to the bank that are paid by management?
2. Are the amounts paid to the advisor a significant portion of the advisor group’s total revenue?
3. Does the advisor have any business or personal relationship with a member of the compensation committee or an executive officer?
4. Does the advisor own any stock of the company?

Director compensation programs are becoming more of a strategic focus in the banking industry as the workload and risk associated with being a bank director has increased. Also, there are more requirements now for the compensation committee to be aware of. It is more important than ever to ensure that the total compensation program for your directors is competitive and is in line with the compensation philosophy of the bank, and that the bank is following compensation rules. This will help ensure that the bank attracts and retains high quality directors to help direct the bank to future success.