Sizing up the CEO

Scenario:

This is the second board meeting for Jane Lawrence as a director of the $550 million County Bank. The bank`s compensation committee chairman is soliciting input from the board that will help determine the salary increase and bonus awarded to the CEO. Being new, director Lawrence asks how the CEO has performed versus any set goals and how the bank has performed relative to its strategic plan. Her colleagues inform her that while the bank has an employee performance review program in place, no formal evaluation or individual goals exist for the CEO. She is also advised that the bank`s stock price has increased nicely over the year, even though earnings were modest.

Director Lawrence privately wonders if the lack of a CEO performance evaluation is standard for banks this size and how vocal she should be on the importance of tangible goals and formal senior executive reviews.

Although there is a need for standards, most banks tie incentives to the wrong things. While it makes sense to set goals and monitor the strategic direction of the bank, tying the CEO`s incentives to how well he or she did in meeting the objectives of the strategic plan would be archaic and dangerous.

Strategic planning is a bankrupt model based on the belief that the world isn`t changing quickly. The most sophisticated businesses in the knowledge economy have left that model for scenario planning, strategic think tanks, and other methods that keep an organization agile yet focused. In a tactical world, connecting incentives to a strategic plan is dangerous because it keeps people focused on what would have worked had things not changed. They will.

That said, a formal performance review is both necessary and recommended for the CEO. The criteria should be well thought out, based on the objectives identified as important to moving the bank forward. These objectives may be different for every bank. They should, however, be focused on long-term results versus quarterly performance, effectiveness versus efficiency, and some nontangibles like vision and leadership skills.

Roxanne Emmerich, CSP, CMC
President
The Emmerich Group
Minneapolis, Minnesota

The simple, straightforward answer for Ms. Lawrence is no-it is not acceptable in a bank of any size for there to be no formal evaluation or measurable individual goals for the bank`s CEO. And as a director of the bank and a representative of the shareholders, it is her responsibility to be very vocal about setting specific performance goals for the CEO. These goals should be mutually agreed upon by the CEO and the bank`s board. They also should be realistic.

I would suggest setting financial goals and corresponding performance incentives tied to measures such as ROA, ROE, earnings per share, and efficiency ratio. The board also may consider setting growth objectives in areas like assets, loans, deposits, and market share, along with quality targets, such as classified assets as a percentage of capital. Obviously, there needs to be an integrated balance among these goals and objectives. I also would not shy away from certain less-quantifiable goals, such as having the CEO create a comprehensive plan with a well-articulated vision, attainable strategic initiatives, and tactics to support those initiatives. Ultimately, this plan should be the catalyst for the financial objectives.

The important thing for Ms. Lawrenceu00c3’or any directoru00c3’to remember is that it is difficult, if not impossible, to manage what you cannot measure. And it is the responsibility of the board to manage the CEO`s performance. Without such a process, the board leaves the bank`s stock performance to chance and, ultimately, the whims of the marketu00c3’something any director knows is never in the best interest of shareholders.

Hal Oswalt
Managing Director of Consulting
Alex Sheshunoff Management Services
Austin, Texas

Director Lawrence has raised some valid issues. A board committee composed of outside directors should recommend the CEO`s compensation to the full board as opposed to a compensation committee of the bank making such a determination. Board members should be concerned about the CEO`s performance relative to the bank`s performance. The full board should approve the committee`s proposal.

An annual pay-for-performance plan should be established for the CEO, setting specific goals tied to the bank`s strategic short- and long-term objectives. Performance goals may be based on positive trends in ROA and ROI; the risk profile of the bank compared to board directives; response time and adequate resolution of audit findings; asset quality; comparisons with peers; and key marketing objectives, such as growth in a particular loan or deposit product. Other factors, like adverse comments in examination reports and staff morale, also may be considered. Because fluctuations in stock price may be influenced by factors independent of the bank`s performance, such as overall changes in the stock market or bank stocks in general, the CEO`s basic compensation should not be tied to the stock price.

The performance of senior management, and in particular the CEO, directly impacts the performance of the bank. At least annually, the board of directors and the CEO should discuss and agree upon specific written goals and objectives for the CEO. A formal, written performance evaluation may be optional, but in any case, an assessment of the CEO`s performance should be made based upon the results obtained. Director Lawrence, even as a new board member, should be vocal on the importance of tangible goals and formal senior executive reviews.

Elizabeth R. Costle
Commissioner of Banking
Insurance, Securities, and Health Care Administration
Montpelier, Vermont

Establishing goals for a chief executive officer, evaluating him or her, and considering the bank`s strategic plan are vital board responsibilities. Ms. Lawrence certainly should raise the need to address these issues in a manner consistent with good manners and with some modesty.

I would suggest that Ms. Lawrence initially discuss the matter with the chairperson of the compensation committee, or if there is none, the board chairperson. If that doesn`t work or if the chairperson is a full-time employee of the bank, such as the CEO, I would suggest that she discuss the matter with an influential director or with the board members most influential in her joining the board. I would expect that her suggestions, given the significance and validity of the issues, would be received appropriately and, within a reasonable period of time, implemented.

Given the importance of this issue, if Ms. Lawrence`s issues are not addressed and there is no satisfactory explanation, I would suggest raising them at a future board meeting, preferably advising the chairperson in advance of her intentions. If no satisfaction is obtained within a reasonable period of time, Ms. Lawrence should consider whether her membership on the board is appropriate. The fact that the bank`s stock price has increased despite modest earnings is not sufficient to form a basis for failing to conduct an evaluation. Board members are obligated to look toward a more-distant horizon.

Fredric J. Sirota
Director
First Morris Bank & Trust
Morristown, New Jersey

It is not uncommon for banks the size of County Bank to have informal standards and procedures for determining a CEO`s salary. However, with respect to bonuses, more often than not there is a written plan that establishes goals and sets parameters for awarding executive incentive pay. Assuming County Bank is a public company, director Lawrence should review the compensation committee reports that have been included in previous years` proxy statements. At a minimum, she should make sure that the disclosure, especially for the upcoming annual meeting, accurately reflects the process that is undertaken at the board level.

Since it appears that the compensation committee chairman is soliciting board input because the fiscal year is ending and a determination as to salary and bonus is imminent, it is obviously too late for the board to establish performance goals at this time. However, there may be additional information that could prove useful to the board and that could be obtained fairly quickly, such as surveys revealing the salary and bonus paid to CEOs at similarly situated community banks. As for stock performance, the proxy statements also will illustrate the relationship between stock price and CEO performance over a five-year period. As far as long-term shareholder value is concerned, earnings performance should be considered as important as stock performance over any one-year period.

John Gorman
Partner
Luse Lehman Gorman Pomerenk & Schick
Washington, D.C.

At the end of a season, would George Steinbrenner hold manager Joe Torre responsible and decline to renew his contract simply because the New York Yankees did not perform to expectations? Absolutely not! Would he work with Torre to correct any team deficiencies and offer incentives for a better record next season? Absolutely! Why should a bank CEO be treated any differently?

As a board member, one must help set aggressive company goals reflecting high expectations. Goals need to be established for traditional as well as nontraditional products. As a banker, I compete with brokerage and insurance agents who must meet quotas or face a new career. Furthermore, these agents are on incentive compensation! Who finishes on top in the financial arena? The winning advantage for bankers is our relationship with customers. The CEO compensation package should be slanted toward incentive compensation based on goals and performance. Mine is!

A formal evaluation of the CEO allows the board to reward, recognize, or offer constructive criticism. If the evaluation process indicates weaknesses, then the board should do whatever is necessary to strengthen performance. Without measurable goals, the board would have difficulty dealing with a CEO in either positive or negative situations.

Tangible goal setting and a formal performance evaluation should be a top priority for board members.

James L. Brown
President and CEO
Union Planters Bank
Grenada, Mississippi

Unfortunately, this scenario is probably more common than most would believe. From the mid-1980s on, many community banks have formalized their strategic plans along with mission and vision statements. While performance review programs have been around for quite some time, they continue to be an important management tool. However, they are often operational in focus.

The CEO should be evaluated on how well he or she executes the business plan. The business plan should be tied to the bank`s projected financial performance.

With support from the board, the CEO should be encouraged to develop an executive review program that measures the bank`s performance in relation to the strategic plan. This process is one way that the CEO can truly add to the bank`s overall performance, therefore enhancing shareholder value.

John K. Keach Jr.
Chief Executive Officer
Home Federal Savings Bank
Columbus, Indiana

Liability resulting in civil or criminal penalties is a latent threat to bank directors. Competent management is the primary safeguard against liability, not D&O insurance. To ensure that this safeguard is firmly in place, evaluation of management, particularly the CEO, is essential.

An increase in the bank`s stock price could be attributable to market conditions, including riding the wave of takeover speculation, and not reflective of modest earnings. How did the stock perform relative to its peersu00c3’better or worse? Stronger earnings could easily have translated into an even higher stock price.

CEO evaluation should be an ongoing process and monitoring benchmarks include performance against goals, budget, and peers; asset quality; regulatory examination reports; and interpersonal relationships with subordinates, customers, and the board.

J. Gilbert Soucie
President
Glastonbury Bank & Trust Co.