Committees : Compensation

The Evolution of Strategic Business Objectives in Annual Incentive Plans


incentive-8-19-19.pngBoards are increasingly looking for ways to appropriately align pay and performance for bankers in the face of the disruptive changes in the industry.

Post-financial crisis, many bank boards shifted to a scorecard approach as a way to improve their compensation governance and accountability. However, industry disruption has sparked an evolution of the scorecard itself.

Before the financial crisis, determining annual bonus payouts at banks was a singular, annual event. The compensation committee and the CEO compared the bank’s current financial results to the prior year, assessed the operating environment, considered last year’s bonus pool and adjusted bonus accruals accordingly. Higher performers got a little more than prior year; poor performers looked for new jobs.

Following the financial crisis, a search for improved compensation governance and accountability ushered in a movement to construct incentive plans with payouts specifically tied to financial outcomes. This resulted in the popular financial scorecard approach used by many banks today.

Most scorecards include “hardwired” financial goals (usually earnings per share, net income and return on equity), banking-specific metrics (deposits, credit quality metrics and expense management) and a component that reflects “individual” or “discretionary” evaluations of performance.

Scorecards have served the industry well and addressed concerns that the lack of transparency into banking incentive plans resulted in shareholders being unclear of exactly what performance they were rewarding. The industry is now in the midst of a new phase of disruption that has banks reexamining their business models and entering a period of significant transformation.

In response, boards are increasingly enhancing the qualitative component of their scorecards to add balance and encompass the progress executives have made against clearly articulated strategic business objectives (SBOs). These strategic components balance the “backward-looking” nature of financial metrics with a “forward-looking” assessment that focuses on improving future financial performance.

Trends in Strategic Business Objectives
An SBO is a goal or metric that generally supports a key business priority and can be measured and objectively evaluated. For many boards, delivering against SBOs is critical to ensuring sustainability of their franchise. While growing earnings per share is a proven measure of current business success, achieving other critical outcomes is essential to creating long-term value for shareholders.

Detailed SBOs are specific to each bank and reflect where the bank is in its life cycle or period of transformation. Recently, we have observed banks incorporating the following eight categories into their SBOs for bank bonus plans:

  1. Executing the Digital Strategy: Depending on the bank’s current digital state, this category evaluates the success of critical milestones, such as percentage of paperless customers, “app” rollout and usage rates and expansion of service offerings through the digital interface.
  2. Technology Enhancements: This can include initiatives such as cybersecurity upgrades, automated fraud detection and general infrastructure enhancements like enterprise resource planning rollout.
  3. Corporate Development: This objective centers on the bank’s execution of its M&A strategy. It reflects the board’s evaluation of acquisitions, divestitures and integrations throughout the year. Banks often set goals based on quality, rather than quantity, to avoid incentivizing “bad deals.”
  4. Branch Strategy: This rewards the expansion, contraction or footprint-specific goals tied to the bank’s strategy for brick-and-mortar branch presence.
  5. Fee-Income Initiatives: Boards want to compensate for successful growing non-interest income from existing products, new products and complimentary service offerings.
  6. Customer Metrics: This can be measured through various means, such as net promoter score, internal customer satisfaction ratings, call center resolution rates and client retention statistics.
  7. Compliance: This generally focuses on the performance against anti-money laundering (AML) objectives and other regulator-specific compliance priorities.
  8. Risk Management: Boards define this SBO by evaluating process-related rollouts, infrastructure enhancements and talent upgrades across the risk function.

Banks are looking to drive their key initiatives during this time of significant transition in the industry. To do so, they are increasingly using SBOs to underpin the strategic drivers of future value creation in their business. Linking these initiatives to annual incentive compensation can communicate the importance of the strategies to the organization, and align compensation to the successful execution of these strategies.