The Movement to Redefine Compensation, Cost and Control in the Era of Consolidation

February 29th, 2012

merger-chess.jpgMergers have become a big part of the banking landscape. The number of banks and savings institutions in the US dropped by 10 percent between 2004 and 2009, due to a record number of struggling banks either closing or merging with financially healthy ones. Increasing regulation could lead to more consolidation among community banks as well. The uptick in activity continued in to 2011 and is expected to increase throughout 2012.  

With this increase, bank directors, C-suite executives and others in the banking industry are challenged to better understand the compensation plans of all parties involved in a merger or acquisition. Interestingly, the March 2011 Harvard Business Review points out that 70 to 90 percent of mergers and acquisitions fail.  The primary reason for many of these failures stems from an inability to address personnel issues. 

Flynt Gallagher, president of Meyer-Chatfield Compensation Advisors, recently spoke at Bank Director’s Acquire or Be Acquired conference, where he provided insights into the trends impacting compensation in the banking industry. The primary trends include:

Shareholder Activism:  the need for shareholders to have a say on pay for executives, as well as to have better control on executive golden parachutes.

Sensitivity to Wealth Accumulation:  a new mentality on excessive annual bonuses and abusive stock options.

Compensation Arrangements under Scrutiny:  In today’s cost-cutting economy, compensation is viewed as costly to a corporation and its shareholders and a place where concessions can be made.

Understand Your Agreements

It’s important to fully understand the compensation plans for all of the parties involved in a merger or acquisition.  Without comprehending the terms of your compensation plans, you could find yourself in an ugly situation.  In one case, a bank was able to terminate an executive, but could not terminate his compensation.  The executive was paid for nearly 20 years after he was fired.  On the opposite end of the spectrum, an executive who could not quit or be terminated for any reason because he would have to pay his bank for one year of his salary.  Frustrations such as these showcase the need to review and understand the terms of all your compensation plans.

Use Non-Compete Agreements to Avoid Higher Tax Burden

To avoid issues, Gallagher recommends addressing employment agreements during compensation negotiations.  Limit the scope, revise or remove change-in-control provisions that expose the executive and the bank to IRC 280G, the tax on excessive golden parachute payments.  This results in a 20 percent excise tax to the executive, loss of income tax deduction to the bank, as well as the need to pay income taxes on the benefit payment.  Instead, Gallagher recommends using non-compete agreements that eliminate the bank’s exposure for IRC 280G and the excise tax.   This instantly provides shareholders with a value equal to the payment for service and allows the bank (and the executive) to retain a greater portion of the payment —unlike change-in-control agreements.

Use Performance-Adjusted Restricted Stock

Gallagher also recommends taking a closer look at using Performance-Adjusted Restricted Stock (PARS) to control the expenses on compensation.  This approach mitigates any shortfalls compared to other options in the marketplace. 

Consider Nonqualified Plans

More executives are realizing more of their benefits from nonqualified plans than ever before.  This approach is also viewed favorably by regulators, plus it reduces the bank’s obligations and establishes a fixed cost for a defined benefit.  It also maintains the current level of executive benefits without any additional cost to the bank.  Gallagher’s company, Meyer-Chatfield Compensation Advisors, also has a program called LINQS+ that reduces the expense associated with nonqualified deferred compensation plans such as supplemental executive retirement plans (SERP) or salary continuation plans without reducing retirement benefits due to executives.

Through the accounting methodology of LINQS+, traditional defined benefit SERP plans are extended from a 15 years into a lifetime benefit to the executive.  This reduces the expense to bank, saving them a significant amount of money without reducing the benefits paid to the executive.  

Improve your Chances for Success

In order to orchestrate a successful merger or acquisition, it’s crucial to develop a plan that enables you to review compensation plans, evaluate non-compete agreements and look for new ways to retain and motivate your key employees.  Put yourself in a better position and avoid costly mistakes by implementing programs based on these principles.

Meyer-Chatfield Compensation Advisors is a leading compensation consulting firm offering over 20 years of unmatched experience designing compensation strategies for financial institutions nationwide.