Equity compensation practices at community banks have shifted significantly during the past 10 years. This shift has focused primarily on the type of equity, the way in which equity is granted, and the prevalence of equity use for both executives and directors. While some of the changes have been triggered by regulatory bodies, I believe some of the changes have also been the result of common sense and experience.
Executive Equity Grant Trends
In the early 2000s, before the implementation of stock option accounting, stock options were the most prevalent form of equity compensation. But with the implementation of stock option accounting under FAS123R (now ASC 718), companies now had to recognize a stock option expense and there was the chance that the executive never recognized a reward if the stock price declined after grant. In the late 2000s, numerous stock options were “underwater,” or no longer accomplishing the goals of equity compensation for executives, including reward, retention and link to shareholders. As such, the last five years have seen a significant rise in grants of full-value shares (commonly, restricted stock units or RSUs). These full-value shares will:
- Always have value (so long as the underlying stock has value). They can’t go “underwater.”
- Create executive shareholders. They are stock grants and executives become shareholders upon vesting.
- Promote retention if vesting provisions are included, with vesting typically ranging from three to five years.
In a Blanchard Consulting Group study of approximately 200 publicly traded banks, 86 percent of those that granted equity to the top executive in 2013 used restricted stock, 39 percent used stock options, and 24 percent used a blend of both. Restricted stock has clearly become the preferred equity compensation vehicle.
Another trend with executive equity grants is the use of performance criteria in determining the amount and/or vesting of the equity grant. Historically, equity was often granted on a discretionary basis and not tied to any performance criteria. Today, I see banks using performance-based grants, where the bank determines specific levels of performance that will result in equity awards if achieved. After the performance cycle is complete, the resulting equity award is granted, typically with additional time vesting. Performance-based vesting is also being utilized in larger banks and Fortune 500 companies. Under this concept, a number of shares are granted, but shares will only vest if performance levels are achieved. I have not seen a high prevalence of performance-vesting in community banks (time-based vesting is more common), due to some complexities with the performance-vesting methodology and accounting. However, banks certainly tie equity grants more frequently to performance than they did in the past.
Director Equity Grant Trends
Ten years ago, the use of equity grants for directors was somewhat sporadic. I have seen this change significantly in recent years, as bank boards decide that director pay should be based on time spent, as well as value and expertise brought to the board. There also is an increased need to attract qualified directors with specific skill sets to help assess risk and handle increased regulatory scrutiny.
These changes to the typical community bank board have created a situation where banks are granting directors equity, commonly as restricted stock. Often, this stock is granted in the form of an annual retainer with either immediate or very short vesting periods, often just a year. Blanchard Consulting Group conducted a study of approximately 150 publicly traded banks and found the following:
- 75 percent of the banks have an equity plan in place for directors
- 49 percent of the banks granted equity to directors in 2013
- 90 percent of those banks which granted equity to directors utilized restricted stock
The goal is to provide directors with a specific amount of remuneration for their annual service on the board, and restricted stock retainers with quick vesting are the best way to tie a specific dollar value to director service. It also makes new directors shareholders and further links them to the people they represent. Our study also found 38 percent to be the median value of equity as a percent of total director compensation.
Another area that is gaining traction in larger organizations and among shareholder advisory firms is executive and director equity ownership guidelines and holding requirements. I have yet to see these items reach a significant prevalence level in community banks, but I expect a gradual increase in upcoming years.
In summation, community bank equity practices have shifted. The shift has been to full-value equity vehicles and restricted stock has become the clear choice. We will see what the future holds.