Compensation Considerations in a Merger of Equals

2021 has been a very active M&A year for regional banks, with some organizations combining through a merger of equals.

As the term suggests, a merger of equals is when two banks of comparable size merge to form a larger new company. There is a lot to consider in these situations to ensure the combination effectively unlocks value for stakeholders. Developing the human capital strategy and compensation program at the pro forma bank is a key factor for the management teams and boards of directors to consider. It is critical they get this right in order to retain and engage critical talent through the key milestones in the merger and beyond. In this guide, we identify some of the key compensation-related items that must be addressed in a merger of equals.

Leadership Structure and Executive Team
In a typical acquisition, the executive team of the acquirer often stays in place and the executive team of the target may take on newly created executive roles or leadership roles in a subsidiary business. In a merger of equals, the combined executive team is typically comprised of executives from both legacy organizations. Companies should identify the best talent to lead the bank well before the close of the merger so they can seamlessly execute on the integration and develop a retention plan.

Companies must also determine if they will combine the roles of CEO and chairman of the board, or if the roles will be split between the two legacy CEOs. It is common in a merger of equals to split the roles for a defined time period. This approach gives the pro forma bank the benefit of the leadership of both legacy CEOs as it navigates how to effectively operate as a new organization and create a harmonized organizational culture.

Compensation Philosophy and Competitive Market
It is important for the newly formed entity to have a cohesive compensation philosophy promoting a “one company” mindset among employees who are from different legacy organizations. The compensation philosophy should guide how the bank now pays its employees, including mix between fixed and variable compensation, mix between cash and equity compensation and where compensation is positioned relative to the market. If the two legacy banks have different compensation philosophies, the pro forma bank should develop a strategy to harmonize these philosophies in the near-term. For example, it set a goal to pay all corporate employees using the same mix by the anniversary of the close of the merger.

The combined entity will also need to define its new competitive market. Clearly, it will need to compare itself to larger institutions than the legacy banks, but it should also consider if there are other differences that should define the competitive market, like if the two legacy banks operated in different geographies or had different operating characteristics. It is paramount that the board compensation committee and management teams identify relevant criteria to define a competitive market that best reflects the combined bank’s business.

Retention and Success Awards
Once the banks establish the compensation philosophy and define the new leadership team, it is important to consider how ongoing compensation programs can incent and retain the new team. A common approach to tie the new team together is by providing a long-term incentive award, often referred to as “success awards.” A portion of the award typically vests based on performance linked to achieving deal-based objectives such as synergies or systems conversions. A portion of the award may also vest over a period of time to provide an additional retentive hook. Success awards with performance conditions are better received by external investors and proxy advisory firms. The combined entity should also consider retention risks among the executive team, including the ability to trigger change in control severance and current equity holdings. This may influence which executives receive additional awards or larger success awards.

A merger of equals can be an exciting but also uncertain time for an organization. Early planning on the new bank’s compensation philosophy, leadership team compensation program and success and retention award approaches can help alleviate some of the uncertainty and allow the executive management team to focus on successfully completing the integration. A well thought-out program can combine the best of both legacy organizations into a harmonized compensation program that supports a “one bank” strategy and culture.