The compensation landscape in banking is constantly evolving, and compensation committees must evolve with it. We want to highlight three priorities for bank compensation committees today: the rising cost of talent, the uncertain economic environment, and the link between environmental, social, and governance (ESG) issues and human capital and compensation.
The Rising Cost of Talent
The always-fierce competition for top banking talent has intensified in recent years, especially in certain pockets like digital, payments and commercial banking. Banks are using a variety of approaches to compete in this market and make their compensation and benefits programs more attractive, including special one-time cash bonuses or equity awards, larger annual or off-cycle salary increases, flexible work arrangements and other enhanced benefits.
In evaluating these alternative approaches, compensation committees must weigh the value each offers to employees compared to the cost to the bank and its shareholders. For example, increasing salaries provides near-term value to employees but results in additional fixed costs. Special equity awards that vest over multiple years provide less near-term value to employees but represent a one-time expense and are more retentive.
We expect the “hot” talent market, combined with inflation, to continue applying upward pressure on compensation. However, the recent rate of increase in compensation levels is untenable over the long-term, particularly in the current uncertain economic environment. Banks will need to optimize other benefits, such as work-life balance and professional development opportunities, to attract and retain top talent.
The Uncertain Economic Outlook
In 2021, many banks had strong earnings as the quicker-than-expected economic recovery allowed them to reverse their loan loss provisions from 2020. As a result, many banks could afford to pay significantly higher incentives for 2021’s performance than they did for 2020’s performance. The performance outlook for 2022 is unclear. Inflation, rising interest rates and macroeconomic uncertainty will impact bank performance results in 2022. Results will likely vary significantly from bank to bank, based on the institution’s business mix and balance sheet makeup.
Compensation committees will need to consider how the push and pull of these factors impact financial results and, as a result, incentive payouts. Some compensation committees may need to consider adjusting payouts to recognize the quantifiable financial impact of unanticipated conditions outside of management’s control, like the Federal Reserve’s aggressive interest rate increases. Banks may find it harder to quantify the financial impact of other economic conditions, like inflation. As a result, many compensation committees may find it more effective to use discretion to align incentive compensation with their overall view of performance.
Bank compensation committees considering using discretion to adjust incentive payouts for 2022 should follow three principles:
1. Be consistent: Apply discretion when macroeconomic factors negatively or positively impact financial results.
2. Align final payouts with performance and profitability.
3. Clearly communicate rationale to participants and shareholders.
Compensation committees at public banks should also be aware of potential criticism from shareholders or proxy advisory firms. The challenge for compensation committees will be balancing these principles with the business need to retain key employees in a tight labor market.
ESG and the Compensation Committee
Bank boards are spending more and more time thinking about their bank’s ESG strategies. The role of many compensation committees has expanded to include oversight of ESG issues related to human capital, such as diversity, equity and inclusion (DEI). Employees, regulators and shareholders are increasingly paying attention to DEI practices and policies of banks. In response, many large banks have announced public objectives for increasing diversity and establishing cultures of equity and inclusion.
In an attempt to motivate action and progress, compensation committees are also considering whether ESG metrics have a place in incentive plans. In recent years, the largest banks have disclosed that they are considering progress against DEI objectives in determining incentive compensation for executives. Most of these banks disclose evaluating DEI on a qualitative basis, as part of a holistic discretionary assessment or as part of an individual or strategic component of the annual incentive plan. Banks considering adopting a DEI metric or other ESG metrics should do so because the metric is a critical part of the business strategy, rather than to “check the box.” Human capital is a critical asset in banking; many banks may find that DEI is an important part of their business strategy. For these banks, including a DEI metric can be a powerful way to signal to employees and shareholders that DEI is a focus for the bank.