For Love Or Money

Being a bank director is a little like being a climber of the world’s highest mountains: it takes patience, determination, skillu00e2u20ac”and there’s always the chance that you’ll careen down a 20,000-foot precipice. Whatever your motivation for taking the job, it is most certainly not for the money.

Determining a fair level of directors compensation presents management and the board with a dilemma. Banks wrestle with the challenge of compensating board members for their time and expertise, fully realizing that when potential liability is considered, annual retainers or meeting fees are meager when a director’s net worth is on the line. Though directors and officers liability insurance is generally offered, directors themselves still have a sense of unease about the liability issue, often believing that their compensation should be adjusted accordingly.

To delve into this subject more deeply, Bank Director surveyed a portion of its outside director readership earlier this year, asking them to share anonymously their candid opinions on the fairness and structure of directors pay. Additionally, we analyzed statistical data from these 550 respondents to calculate average pay levels and report on the scope of compensation and benefits as represented by the survey group.

A similar chord ran throughout many of the comments we received: While three-quarters believe their compensation to be fair when considering the time required and the duties performed, over half feel they are not fairly compensated given the liability risk they assume. Though not a significant indicator, the role that management plays also provides subtle clues about boards’ satisfaction levels: directors from private or closely held institutions, as well as those who sit on boards with outside chairmen, reported being slightly less satisfied with their pay packages than those from public companies and those with inside chairmen.

Hence, compensation committees are faced with an age-old quandary: How much is enough? Top-quality executives who are willing to sign up for board service are a scarce commodity today. Recruitment of board members has never been harder, according to compensation experts. So what do you offer to the guy who has everything?

Long-term benefits may be the key, say compensation consultants. An executive who is in the prime of his or her life is probably already bringing in a relatively high salary and is likely covered by insurance and other benefit plans. But what about after retirement? Salary levels generally take a precipitous drop; thus, having a retirement plan that affords pension payments well after the prime of life can be a valuable drawing card. Stock option plans also can provide a form of deferred benefit, provided the institution is on solid footing in the market.

Of course, once good directors are recruited, the main objective is to keep them on the board. Here the structure of the compensation plan makes a tremendous difference. As demonstrated by the comments we received, it is important to build a consensus that the current plan is satisfactoryu00e2u20ac”or else address the dissatisfiers immediately. This will ensure that all board members concentrate on their primary responsibility: overseeing the policies and strategies of the bank to realize profitability and value for all stakeholders.

To provide some insight on the issues and opinions that currently surround directors compensation, the following sections illustrate, through the voices of today’s bank directors, their thoughts and opinions. These comments run the gamutu00e2u20ac”from those who are satisfied and love the job, to those who are frustrated and are ready to walk away.

“I love my director’s job! Would do it for free!”

Here’s a sentiment one doesn’t normally associate with the subject of directors pay, and yet a few directors freely told us they found the director experience rewarding, educational, evenu00e2u20ac”wonderful. “I am privileged to be a director of a relatively new community bank. … I’ve never even thought about compensation for my services,” wrote one board member. “I’m not serving for the money,” another stated.

Arguably, there are intangible benefits of directorship that go beyond the almighty dollaru00e2u20ac”or at least hand in hand with it. Directors have the chance to take part in the development of the communities in which they live by providing loans or forging business alliances; they also have the opportunity to learn and participate in a challenging new business. Over the long term, they build lasting relationships with fellow board members and enjoy the prestige of being seen as leaders in their communities. Such factors become even more valuable when one considers the impact these relationships will have on a director’s own business. Viewed in these ways, it’s easy to see why some directors don’t see remuneration as the primary reason they sit on the board.

Even among the majority of directors who do expect and value the pay they receive for their services, the intangible benefits clearly are motivating factors for maintaining a board seat. As our average compensation figures demonstrate (see Figure 1), we’d be hard-pressed to imagine a director who is doing the job solely for the money. By definition, directors are successful businessmen and women who already have, to some degree, “made it.” Even so, an undeniable thread of discontent runs through the sentiments of many board members who commented, making it clear that banks need to strive for a happy medium when setting director pay levels.

“The bank is making a lot of money and now it is time for the directors to get more.”

Now here’s an idea whose time has come, according to directors we surveyed. Though 87% of directors who responded said their compensation is not tied to a bank-performance-related incentive plan, the majority (58%) said they favor such plans. Obviously, the good times have been rolling in for banks, and directors now see the wisdom of sharing the wealth. “Directors’ fees have not been adjusted in 10 years,” wrote one director. “The bank has experienced tremendous growth and growth in earnings. There is no relationship to directors’ fees and what has really occurred in the bank.”

The idea of directors pay that is based on bank performance appears to be a win-win scenario, according to many bankers and bank compensation consultants. “We are and should be paid through stock options. Investors rely on us to oversee the appreciation of their investment. We should be rewarded accordingly,” said one director. “I believe in performance-based compensation that is tied to ROE and stock price (value),” remarked another.

In the real world, though, most directors’ compensation is still meted out through annual retainer and meeting fees, although there is a movement to align directors pay with the shareholders’ interest. “I’d love for you to come out strongly encouraging stock/incentive plans for directors,” one director wrote us. “I see this with my peers and across all industries, yet a few controlling directors think our shareholders wouldn’t go for it.” Another stated, “All of our compensation is paid in stock in the holding company. It has worked very well and has the full support of the board and the stockholders.”

Interestingly, several board members took off the gloves and spoke candidly about the inherent flaw in incentive plans. “A personal dilemma exists between my desire for investment growth and stock option benefits (I own 5.5% of the bank) and proper fiduciary representation of all stockholders (the timeless greed-versus-conscience moral dilemma).” Other directors noted that earnings performance can be manipulated to bring desired results, which could lead to abuse. “It’s an easy way to overpay … and lead to abuse. A performance criteria is a good solution but … one has to avoid rewarding mediocrity.”

Overall, it appears most directors agree that linking compensation with the performance of the bank is reasonable. “Our board of directors meets every week along with branch presidents, to approve loans. We are in a growth period, adding a number of new branches. If we continue to be as profitable as we are now, once our new branches become profitable also, I feel that our compensation will be increased.”

“The question that always concerns me is my liability as a director… that is always in the back of my mind.”

Even among the vast majority of directors who have taken the job happily and willingly, many express anxiousness about the subject of liability. Justifiably sou00e2u20ac”in an era when shareholder suits have escalated, employment practices liability and fears about Y2K are at near-fever pitch, and the scope of the banking business is expanding rapidly, bank directors have never had more on the line. And though they are likely covered under a D&O policy for some types of exposure, many directors believe that their compensation should more closely reflect the enormous liability they assume under the mantle of the job. “Compensation does not justify the risks associated with being a bank director,” one director stated.

Though the ability to fully offset a director’s potential liability through increased compensation is not a real possibility, many directors cited dissatisfaction because of this factor nonetheless. “When considering the liability issue, we are very much underpaid. I wonder at times why anyone would agree to be an outside director with little or no control over the daily activities and ultimately being accountable for all acts and omissions. If it weren’t for the glory and honor, it would not be a good bet.” Those who’ve challenged the forces of Mount Everest might agree.

“Board members today are underutilized, underpaid, and arenot fully appreciated. I should resign.”

While our survey didn’t specifically ask whether any respondents were considering resignation, the common thread of worry over liability and the relatively low number of plans that align pay with the success of the bank should serve as a cautionary sign. Retaining good-quality board members is no small achievement in the current environment. There’s no one compensation plan that’s rightu00e2u20ac”but there is one that is right for each board.

Communication on matters of pay and benefits, while sometimes uncomfortable, should be proactive, to ensure resentment isn’t bubbling beneath the surface between boardmembers and bank management. Nearly half (48%) of outside directors polled agreed that, indeed, their own compensation is a sensitive issue to discuss during board meetings. This indicates a need for improvement in the area of internal board communications.

“…This is an extremely awkward subject,” one director wrote candidly. “In 1998 we instituted stock options for management, but a few directors felt that it wasn’t appropriate for us to do that. I am spending more and more time as a bank director, with upward liability, and our fees haven’t risen in years….” A second agreed, adding, “Because our bank is controlled by one family, they have been extremely tight when it comes to directors’ compensation. It is difficult to bring up at the annual meeting because of their historical resistance. It is getting to the point where I am contemplating resignation.” Finally, the frustration was obvious in this director’s response: “Directors are responsible in the end. They are expected to hand out large compensation packages for senior staffs to keep pace with accelerating demands in the marketplace. But not enough attention is given to directors’ compensation. It gets particularly discouraging when you have less-than-stellar performance by your senior staff. What comes first: the chicken or the egg?”

“The compensation issue is difficult due to the varying effort and success of individual directors.”

Herein lies the rub. Once communications are on the table, how do you structure the package to the satisfactionu00e2u20ac”and fairnessu00e2u20ac”of all board members? A consultant may be necessary to provide a broader, more objective view of this sometimes-prickly subject, as well as to offer alternatives for retirement and investment plans or performance-based formulas. (For a closer view of equity plan alternatives, see “On Board with Shareholders,” page 22.)

Whether you feel you are undercompensated, overcompensated, or somewhere in between; everyone craves recognition for his or her efforts. One of our survey respondents summed it up nicely: “Bankers use the good name and character of their directors to build respect in the community they serve even when management is absent. This reputation, which directors put on the line for someone else’s business, is invaluable, and I don’t feel most bankers feel it is worth much…. Directors should feel respected for what they do and [should be] overly compensated so they know they are appreciated … and won’t mind being called on to do more.”

And now, the numbers

In the following sections, Bank Director presents the results of this year’s survey as a resource for boards to help them gauge their compensation plans against their peers, both regionally and according to asset size. Of course, peer group comparisons are only benchmarks. The real test will be how well individual board members are satisfied, and how well the entire board performs under its compensation plan.

After tabulating this year’s results, we broke down each question into five asset categories: less than $100 million; $100 million-$250 million; $251 million-$1 billion; $1.1 billion-$5 billion; and greater than $5 billion. In doing so, we were able to make some interesting comparisons among the various asset sizes in addition to offering broad observations about the entire survey sample.

In looking at total compensation, not surprisingly, director pay increases in proportion to asset size; thus the larger the bank, on average, the higher the director’s board income (see Figure 1). Of note, the average for each asset size increased over last year, from a minimum of 7% for directors surveyed at the largest banks and the smallest banks to a whopping 35% increase for those directors at banks in the $251 million-$1 billion category. The significant increase in the midrange asset category may suggest that some community banks are willing to pay more to keep their directors on board and to aid in recruitment against larger banks. The total average compensation for all asset sizes is $13,047, up from last year’s $9,898.

Geographically, directors in the Midwest and South reported receiving significantly lower compensation than those in the Northeast and West, a tendency that holds true across like-size banks (see Figure 2). These levels are similar to those reported in our 1998 survey.

In examining the components of director pay, board meeting fees averaging $5,847 represent about 45% of total compensation for our respondents, while an average annual retainer of $2,917 accounts for another 22% of total income. (It should be noted that, like last year, 63% of those polled claimed they received $0 in annual retainer; among those who acknowledged receiving an annual retainer, the average is $7,794.) According to the survey statistics, directors of larger banks are significantly more likely to receive an annual retainer for their services (more than 60% for banks with more than $1 billion in assets, but less than 20% for banks with less than $100 million in assets.) And since a larger proportion are public companies larger banks also are significantly more likely to receive stock options. While directors of small banks are less likely to earn committee meeting fees, they are more likely to be awarded bonuses as compared to their larger-bank counterparts. (See Figure 3 for a breakdown of annual retainers, board meeting fees, and committee meeting fees by asset size.)

Although 6 in 10 respondents favor performance-based compensation, only 8%u00e2u20ac”a similar number to those polled in 1998u00e2u20ac”reported that their compensation is tied to an incentive plan. Another 11% claimed that such a plan is under future consideration. These responses held true across asset sizes; however, directors of larger banks are significantly more likely to have stock awards tied to incentive plans.

In an effort to better understand the desires of directors regarding how their plans are structured, we posed an interesting question this year: If directors could structure their compensation according to five given componentsu00e2u20ac”annual retainer, stock price, peer group performance, earnings performance, and otheru00e2u20ac”how would they parcel out the amounts? Figure 4 shows the results of the compensation “wish list” for all asset sizes. Annual retainer claimed the lion’s share, 47% on average, followed by pay based on earnings performance at 24%. The other three components received only tepid interest, at about 10% each. Apparently directors (probably like the rest of us) still feel most comfortable receiving around half their compensation as a guaranteed, fixed amount.

A question of fairness

As mentioned earlier, we asked directors whether they felt they are paid fairly for their time and the work they do. Interestingly, three-fourths of the directors we surveyed answered “yes” to that very question. “I believe that my compensation is commensurate with the work I do and the time I spend doing that work,” offered one director. Another agreed, explaining, “I feel our bank compensates its directors fairly and adequately. My only complaint is that some directors do not fully participate or prepare adequately for meetings.” And as one director stated succinctly, “I am reasonably satisfied with the compensation. … If I wasn’t, I’d raise the issue and get improvement, or resign from the board.”

However, about 20% of those respondents with compensation above $10,000 indicated that they are not fairly compensated for their time, and a third of those with compensation of $5,000 or less felt the same. “My original motivation for serving on the bank board was nonpecuniary. The longer I serve and the more I learn, the more I contribute to the bank. Now the low compensation and failure to offer other perks has become a disincentive and has formed the basis for an organized effort to change director compensation.” Another wrote, “At times I feel the amount of time required to fill the expectations of the role exceeds the compensation package amount.”

And what about the ever-present risk of liability? When asked whether they are fairly compensated for the liability risk they assume as directors, the percentage of those responding favorably dropped below half, to 45%. Thus, more than half of the survey respondents agreed that the pay didn’t measure up against the risks inherent in the job.

Benefits: on the fringe

While cash and stock are the key components of a progressive directors compensation package, some banks also offer supplemental benefits, including life and health insurance, travel expenses, retirement plans, and the like. (Figure 5 outlines the frequency of these various benefits.) In accordance with the recent corporate trend of reducing or even eliminating such things as pension plans for directors, the vast majority of directors we surveyed do not receive benefits; however, as was the case last year, some of their comments indicate that such benefits would be a welcome addition.

Although travel expenses is the benefit received most often among those surveyed (21%), health insurance and retirement plans are the most-desired extras. “Directors need to be given incentives, i.e., stock options, retirement, insurance,” according to one director. Another wrote, “We improved our [compensation package] last year by increasing director fees and adding an innovative board stock option plan. Also, directors [should be allowed] to participate in the bank insurance plan for compensation to be really adequate.”

Among those who indicated that they receive retirement benefits, nonqualified, fee-deferral plans were cited as the most-often held (15%), followed by pension plans.

Sizing up pay

Perhaps the best way to study the spectrum of bank culture is to compare a large, money-center institution to a rural, small-town bank. Beyond some basic similarities in structure and fiduciary duties, there is little common ground. The survey showed that overall, personal income, like board compensation, increases, on average, with asset size. Also the chairman is significantly more likely to be an outside director at banks with assets of $250 million or lessu00e2u20ac”a point about which some directors feel very strongly. One respondent stated emphatically: “The chairman of the board should never be an insider.”

Some respondents revealed underlying resentment about the contrast between the pay and responsibilities of larger institution directors and those from community banks. “Big bank directors are paid too much,” one respondent wrote. “They do not contribute to the bottom line, they never meet with customers who may have a question about bank operations, they slough off everything to officers of the bank.” This comment may reveal more about the innate differences in serving for a community bank board versus a larger bank board than any statistic ever could.

To round out the survey data, Figure 6 offers a snapshot of the compensation practices and benefits at the nation’s biggest banks taken from a recent large-bank compensation poll by William M. Mercer, Inc.

So, why serve?

Whether it’s for the sense of personal accomplishment, as a service to the community, or for the challenge and perhaps even the thrill of it, thousands continue to serve on bank boards each year. The majority of directors agree they are underpaid considering the amount of responsibility and risk they assume. But many are reluctant to suggest an upgrade in pay for fear of sounding too self-serving. Perhaps, too, more information is needed. As one director noted, “Bank directors don’t vote themselves decent compensation because they don’t work hard enough as directors to really understand the banking business and their own bank’s performance.”

Some directors say they are unconcerned about the amount of compensation they receive. Those who sit on the boards of new banks, for instance, often told us they shun any form of remuneration until the institution demonstrates profitability.

These and other comments indicate that there’s something, or perhaps many things, beyond money that motivates men and women to sacrifice their time and accept a board seat. As with other things in life, it’s hard to put a price on a job well doneu00e2u20ac”although for many directors, an annual retainer isn’t a bad place to start.

Note: Bank Director would like to thank Rich Chapman and Tim Klein at the Bank Compensation Strategies Group and all the directors who participated in this year’s survey and made the research for this article possible.