As banks look ahead to 2015, compensation committees are entrusted with the task of determining executive pay for the upcoming year. The goal is to ensure an optimal balance between providing fair compensation for the job and motivation to meet and exceed business objectives.
Based on Pearl Meyer & Partners’ recent survey, Looking Ahead to Executive Pay Practices in 2015 – Banking Edition, there are five trends that compensation committees should consider as they make decisions for the upcoming year.
Banks of all sizes are facing the same pay challenges.
Regardless of size, the study indicates that banks are facing the same top three pressing issues:
- Alignment of incentives with business strategy and objectives;
- Assuring compensation plans ultimately result in pay/performance alignment; and
- Attraction and retention of key executives.
Implications: The ongoing quest to align pay programs with business strategies requires specificity. Boards should define “what is success?” in enough detail that incentive plan metrics can be chosen that have a direct linkage to realizing that success.
Compensation committees should also consider the definition of pay being used as they analyze pay-for-performance. Pay realized or realizable by the executive may offer the best insight into the relationship between compensation and financial results.
More banks are increasing CEO and direct report base salaries.
The overall number of institutions in 2015 that expect to increase CEO base pay between 2 percent and 4 percent is 41 percent, up from 26 percent in 2014. Increases in the 4 percent to 6 percent range are also on the rise versus the previous year.
CEO direct report base salaries are also rising modestly with 59 percent of banks anticipating increases between 2 percent and 4 percent, an improvement of 9 percentage points over the previous year.
Implications: As banks return to profitability, more are reinstituting modest base salary increases. Significant gains in executive compensation are more likely to come through incentive compensation and in particular, long-term awards as compensation committees seek to strengthen the pay-for-performance relationship.
Annual incentive program payout levels are expected to be strong.
Thirty-three percent of banks anticipate that bonuses will be somewhat higher for 2014 performance, with 32 percent expecting bonuses to exceed 100 percent of target. In particular, larger banks with more than $3 billion in assets expect strong payouts, with 47 percent indicating bonuses above 100 percent of target. Another 33 percent expect bonus payouts similar to the prior year.
Implications: Annual incentive plan payouts are an indication that many banks have recovered from the worst of the financial crisis. Compensation committees should align payout levels with strengthening bank financials and the economy as our next trend suggests.
Incentive program performance goals are expected to get tougher.
Perhaps as a sign of continued economic recovery and greater scrutiny on pay-for-performance, 48 percent of banks are planning to increase the difficulty of their performance goals in 2015. This again is most pronounced among institutions with more than $3 billion in assets, where 67 percent expect to increase goal difficulty.
Implications: Goal difficulty should be tested using both internal and external benchmarks to ensure performance levels employ an appropriate level of stretch goals while being realistic and achievable. Comparisons to historical performance, budget, analyst forecasts and peer group performance may prove useful.
Long-term incentive values are steady and growing. Performance shares are gaining in prevalence.
As banks consider shareholder alignment and regulator encouragement to link rewards to the time horizon for risk, 44 percent of banks predict equity award values will remain at current levels, while 38 percent of all respondents are expecting either somewhat or considerably higher value in 2015.
Banks continue to adopt performance shares, which are prevalent in other industries. Currently, only 18 percent of banks use performance-based vesting versus 33 percent in other industries; however, more than 15 percent of bank participants are planning to use performance-based awards for the first time in 2015.
Implications: The data indicates that banks may be shifting the executive compensation mix to be more long-term through the use of equity awards. As stock option usage declines and there is greater pressure to link pay and financial performance, banks often are adding performance vesting to restricted stock (or restricted stock units) in order to achieve the objectives of shareholder alignment, stock ownership and executive retention.
As banks address the same pay challenges across asset sizes, compensation committees are seeking ways in which to improve the pay-for-performance relationship. Based on the results of the study, boards are doing this by increasing the difficulty of annual incentive plan goals, placing emphasis on long-term incentive compensation and granting performance-based equity. Combining these actions with a review of performance to realized/realizable pay and testing incentive plan goal difficulty can assist the committee in making appropriate compensations decisions for 2015.