The problem with creating an incentive plan is that your employees just might do whatever you incentivize them to do. If you pay bonuses based solely on earnings growth, then you might not only get growth in earnings but also really bad loans that eventually sink the bank. If you don’t include the quality of the bank’s ratings with regulators in the performance metric for your CEO, then you might end up with a bad regulatory rating.
During Bank Director’s Bank Executive and Board Compensation Conference on Amelia Island, Florida, yesterday, it became clear that many banks in the wake of the financial crisis are beginning to incorporate a variety of mechanisms to incentivize the behavior they want from their employees and management.
- Fifty-nine (59) percent of banks in a Blanchard Consulting Group 2016 survey of more than 200 public and private banks have some kind of formal performance-based incentive plan for management. Only 22 percent have a bonus plan that is solely discretionary, according to the survey. This is of increasing importance for publicly traded banks as well. The shareholder advisory group Institutional Shareholder Services recommends that at least 50 percent of a CEO’s shares be tied to performance, said Gayle Appelbaum and Todd Leone of consulting firm McLagan.
- Sixty-eight (68) percent use net income as one of the metrics in their performance-based incentive plan for the CEO. Seventy percent use it as a metric when evaluating the senior management team. It is more difficult for management to manipulate net income in their favor compared to return on assets or return on equity, said Mike Blanchard, CEO of Blanchard Consulting Group.
- In a survey of the audience at the conference, which consisted of roughly 225 attendees, 35 percent used asset quality as the primary non-profitability metric in their incentive compensation plan. Regulators want to see other metrics besides profitability in bank incentive compensation schemes. “Be careful if you have profits only,” Blanchard said. Building in a little bit of discretion for the board in setting senior management pay is a wise idea, rather than basing incentives solely on metrics, Blanchard said. That could give the board more flexibility when something has gone wrong.
Banks are increasingly using clawback measures or deferral of pay to reduce the risk of their compensation plans. A clawback measure could be similar to one used by Wells Fargo & Co.’s board recently when departing CEO John Stumpf forfeited $41 million in unvested stock and Carrie Tolstedt, the former head of consumer banking, forfeited $19 million, following a fraudulent account opening scandal. Clawing back unvested stock is helpful because it’s difficult to clawback pay when the executive has already received it, and presumably, spent it. Some banks are adding clawback provisions to their incentive compensation plans that allow the board to clawback for unethical behavior or reputational damage to the firm.
With Wells Fargo in the headlines, questions about incentive pay and motivating the right behavior were a big focus of the conference, although not the only one. Most speakers thought Wells Fargo’s crisis was more related to its culture and how management responded to problems, rather than its incentive plan.
Chris Murphy, the chairman and CEO of 1st Source Bank in South Bend, Indiana, a $5.4 billon asset institution, talked during a panel discussion at the conference about building integrity and character among staff. If someone violates the basic values of the company, he wants other employees to know why that person was let go. A reputational crisis could hurt the bank financially but it’s an even bigger deal than that. “We now understand a little better the impact of little things building up over time,’’ he says. Lying is a nonstarter. “You can’t have anyone lying in any way, shape or form in your organization.”