The $1.5 trillion tax law that was signed in December reduces the corporate tax rate from 35 percent to 21 percent, and should provide an economic windfall for U.S. companies as well as the banking industry. The legislation does include some negative impacts to executive compensation by ending the performance-based exemption through Internal Revenue Code Section 162(m) for compensation over $1 million, but overall, the change in tax rate should bring additional revenue to all companies. Employees are expecting a slice of the pie.
Several Fortune 500 companies, including Wells Fargo & Co., AT&T, JP Morgan Chase & Co., U.S. Bancorp, Wal-Mart, Apple and The Walt Disney Co. have given employees special bonuses, and in certain instances have raised the minimum wage to $15 per hour. These bonuses and raises were given without consideration to employee or company performance, and may set expectations or encourage a feeling of entitlement to future compensation increases regardless of performance.
Community banks should exercise caution when making special salary adjustments and bonus payouts. Salary increases and bonuses without performance or market-driven reasons will drive up fixed costs for the bank, which could impact the achievement of future budget or profitability goals. Raising the minimum wage may also cause salary compression at lower levels of the organization, and make differentiating pay between managers and employees, or high performers and low performers, difficult.
Be Strategic with Salary Increases
Because employee expectations for pay increases are high in relation to the potential for the organization to reap additional profits, we recommend that banks make strategic changes to their salary increase methodology.
One such change is to increase the overall budget for salary increases. A study conducted by Blanchard Consulting Group at the end of 2017, which included over 100 banks, found that the average projected salary increase in the banking industry is 3 percent for 2018. Instead of raising the minimum wage, an alternative would be to increase the salary increase budget from 3 percent to 3.25 or 3.5 percent. This would allow all employees to enjoy the windfall from the additional income projected from tax reform, and maintain the bank’s ability to tie performance and market position into the salary increase process. For example, if an employee is meeting performance expectations, that person would be eligible for the higher base salary increase of 3.25 percent. If the employee is exceeding performance expectations or the salary is below market, that employee may get a higher increase. If the employee is meeting some expectations or no expectations, that individual may get half of the budgeted increase or no increase at all.
Use the Windfall to Increase the Bonus Pool
In regard to employee bonus plans, your bank may consider increasing its annual incentive plan payout levels to coincide with the anticipated increase in bank profitability. For example, if the target bonus payout was 4 percent of salary (or about two weeks’ pay) for staff-level employees, the bank may want to increase the target payout to 6 percent of salary because of the additional profits from the tax reform law. In order to pay out this 6 percent bonus, end-of-year bank profitability goals still need to be met, which keeps the employee’s focus on performance and does not encourage a feeling of entitlement to the bonus payout.
We also recommend that a threshold payout—the minimum performance level at which a bonus may be paid—be incorporated into the incentive plan design. The payout may be linked to a performance goal that is similar to the previous year’s profitability level, with a bonus amount equal to the previous year’s payout. This methodology could also be used for officer and executive plans that typically incorporate higher payout opportunity levels.
If your bank considers this approach, we recommend testing the reasonableness of the program by examining the total payouts of your bonus plan for all employees (staff and executives) as compared to total profits. Typically, if a bank is meeting budget, the bonus plan will share approximately 10 percent of the profits with all employees through cash incentive payouts. If the bank is exceeding budget—for example, profits are 20 percent above the target—the bank may share 15 to 20 percent of the profits with employees.
The passage of tax reform has created an expectation with employees across the nation that their compensation packages will be positively impacted. Despite the expected positive effect on bank income, it is still a difficult environment for banks due to regulations and increased competition. We recommend that banks be strategic in allocating increased profits into a compensation plan that rewards employees for performance and ensures that the bank is meeting or exceeding its annual goals.