Ray Davis arrived at the helm of then-tiny Umpqua Holdings in rural Oregon in 1994 and over the next decade leveraged acquisitions and a unique retail culture to transform the company into a regional powerhouse with more than $8 billion in assets. Early this decade, the board of the now-Portland-based company put together a supplemental executive retirement plan, or SERP, for its CEO that seemed a just reward for a job well doneu00e2u20ac”and a way to ensure the keeper of the vision would stay put.
The planu00e2u20acu2122s structure looked solid at the time. But as Umpqua continued to grow and prosper over the next several years, a problem emerged. Since the value of Davisu00e2u20acu2122s SERP was tied to short-term pay (a typical arrangement), each year of bonuses and higher base pay ballooned his pension benefit to new heights.
By 2006, the plan had become a u00e2u20acu0153runaway freight train,u00e2u20ac says Bill Lansing, 61, an Umpqua director since 2001 and chairman of its comp committee. That was an especially unnerving development, given that new Securities and Exchange Commission disclosure rules would soon mandate laying out the numbers in all their glory. u00e2u20acu0153Every time we got into a discussion about annual increases, we had this elephant in the room,u00e2u20ac he explains. u00e2u20acu0153If you projected the growth rate of the company for another seven or eight years, you came up with a number that would gag Lee Iacocca. We had to do something.u00e2u20ac
It fell to Lansing to have a heart-to-heart with Davis. u00e2u20acu0153I asked Ray, u00e2u20acu02dcHow much money do you really need? You could walk out of here with $100 million,u00e2u20acu2122u00e2u20ac he recalls. u00e2u20acu0153It didnu00e2u20acu2122t make sense.u00e2u20ac The SERPu00e2u20acu2122s terms were written down in a contract, and, like most successful CEOs, Davis felt the payout was justified. To his credit, he also understood that few things can inflame the passions of investors and the general public more than a CEO pay package that appears like itu00e2u20acu2122s from another planet.
Eventually, the two sides struck a compromise, though it took more than six months to pull together. Compensation consultants and lawyers offered insights on what other companies were doing with SERPs. The comp committee met at least once a month, and held countless conference calls to get the details right, while Lansing, a retired CEO of Menasha Forest Products Corp. in North Bend, Oregon, logged up to 30 hours a week of his own time making sure the right balance was struck.
The result: an amended SERP that fixes Davisu00e2u20acu2122s annual retirement benefits at a maximum $850,000 per year. In return, the board granted him 38,284 deferred shares, and another 50,000-share stock option award that vests gradually over the next three years. The new agreement, Lansing says, ties Davisu00e2u20acu2122s long-term payout more closely to the fate of shareholders, while still giving him a reason to stay. u00e2u20acu0153It allows Ray to increase his wealth,u00e2u20ac he explains, u00e2u20acu0153But it also puts some performance standards around that SERP that are better for investors.u00e2u20ac
As shareholders turn up the heat, compensation fine-tunings like the one at Umpqua are becoming more commonplace. The new SEC disclosure rules provide more detail about individual comp components, and naturally the focus is on those areas that havenu00e2u20acu2122t been clearly delineated before. Because the numbers can be so large, SERPs are a common overhaul target. So, too, are components like severance and change-in-control benefits, long-term equity and option grants, and nickel-and-dime charges for perquisites.
u00e2u20acu0153Before, comp committees spent most of their time focused on salary and bonus, but were less aware of the interrelated effect of those decisions on other parts of the package,u00e2u20ac says George Paulin, CEO of Frederic W. Cook & Co., a Los Angeles-based compensation consultant. Today, u00e2u20acu0153directors are being forced to look at the value of whatu00e2u20acu2122s being provided on a much more holistic basis, and as a result weu00e2u20acu2122re seeing some changes.u00e2u20ac
This is part of an ongoing evolution of the comp committeeu00e2u20acu2122s role and function. Once a low-profile, almost clubby group made up of the CEOu00e2u20acu2122s friends, the compensation body is now commonly referred to as u00e2u20acu0153the new audit committeeu00e2u20acu00e2u20ac”a reference to the post-Enron scrutiny that Sarbanes-Oxley and other reforms foisted on directors who must sign off on the numbers.
But thatu00e2u20acu2122s far too generous. Audit committees at least have structure and guidanceu00e2u20ac”concrete, mostly objective rules that must be followed, line by line, all wrapped up in a tidy bow with the CEO and CFO swearing an oath in blood that the figures are right. In contrast, the comp committeeu00e2u20acu2122s job is often more art than scienceu00e2u20ac”composed of judgment calls, colored by personalities and egos, and wrapped in risk.
Over the past six years, comp committees have faced a steady onslaught of new rulesu00e2u20ac”some structural (committee members must be independent of management), others technical (new tax treatments for options grants, for instance). Even so, there are relatively few guideposts to follow, just some best practices and a vague mandate to come up with a pay formula that can keep both shareholders and executives happy.
u00e2u20acu0153Managing people is always more difficult than managing numbers,u00e2u20ac says Janice Halladay, 63, chairman of the comp committee at Cascade Financial Corp. in Everett, Washington, and a former senior vice president for operations at Pioneer Bank in nearby Lynnwood.
The SECu00e2u20acu2122s disclosure rules, which went into effect last December, mark the most significant change yet. The rules require that proxies lay out total compensation figures for each of a companyu00e2u20acu2122s five highest-paid executives and place snapshot values on each component, including not only base salary, bonus, and incentive payments, but also perquisites, severance agreements, retirement benefits, options grants, and the like, which heretofore have been difficult for shareholders (and apparently more than a few boards) to grasp.
They also demand that boards justify those numbers via a thorough compensation discussion and analysis (CD&A) section in proxy statements thatu00e2u20acu2122s expected to explain the committeeu00e2u20acu2122s actions on a wide variety of topics, including the objectives of the pay program, how the committee chose each element of an executiveu00e2u20acu2122s compensation, policies for allocating short- and long-term components, and how equity grant awards are determined. In a nod to recent options backdating scandals, it also must address the timing of options grants.
This first season has been widely panned for presenting too much information in a manner thatu00e2u20acu2122s too complicated for investors to understand and makes company-to-company comparisons difficult. If a company granted options worth $1 million in 2006, for instance, that wouldnu00e2u20acu2122t be counted; only options that vested in the year are tallied. Many companies didnu00e2u20acu2122t file all of the required tables, and itu00e2u20acu2122s not clear yet if that will lead to penalties.
The SEC is expected to review comments and tweak the system this fall. But the core notionu00e2u20ac”that forcing directors to justify the various components of executive pay will bring some badly needed accountability to one of the highest-profile decisions a board can make, and also link compensation more closely to performanceu00e2u20ac”is here to stay.
u00e2u20acu0153Thereu00e2u20acu2122s a much more detailed disclosure of performance targets and goals,u00e2u20ac says Thomas Desmond, co-chairman of the executive compensation group at Vedder, Price, Kaufman & Kammholz in Chicago. u00e2u20acu0153The idea is to hold boardsu00e2u20acu2122 feet to the fire and give investors a window into the compensation committeeu00e2u20acu2122s deliberations.u00e2u20ac
Investors say getting this kind of glimpse into a boardu00e2u20acu2122s internal workings can serve as sort of a litmus test for director diligence in general. Beyond compensation, itu00e2u20acu2122s a window into the boardroom at large, says Patrick McGurn, an executive vice president for Institutional Shareholder Services, a Rockville, Maryland, firm that advises pension funds and other big investors on proxy-related issues.
The added scrutiny is having both tangible and psychological effects. u00e2u20acu0153Itu00e2u20acu2122s made us anxious. We never thought weu00e2u20acu2122d have people examining the nitty-gritty details of our decisions,u00e2u20ac Halladay says. u00e2u20acu0153Having to write everything down and knowing that someone on the outside is going to be looking at it has made us much more thoughtful about the entire process.u00e2u20ac
In more than a few cases, pulling together all the numbers has surprised board members themselves. Michael Melbinger, chairman of the employee benefits and executive compensation practice at Winston & Strawn, a Chicago law firm, tells of one corporate client that paid not only for the bossu00e2u20acu2122s health care premiums, co-pays, and deductibles, but also provided a u00e2u20acu0153gross-upu00e2u20ac to cover the tax liability that was generated by those benefits.
During a preproxy mock-up of the numbers, one angry board member challenged the payout. u00e2u20acu0153He said, u00e2u20acu02dcLet me get this straight. We pay for all of your medical coverage, and we pay the taxes on those payments, too?u00e2u20acu2122u00e2u20ac Melbinger recalls. The red-faced CEO, aware the figures would soon be made public, willingly agreed to give up the gross-up.
Cook & Co.u00e2u20acu2122s Paulin says the spotlight is inspiring many of his clients to eliminate smallish perks altogether. He says one firm gave its CEO a company car and reimbursed him for getting it washed. Thatu00e2u20acu2122s been replaced by a bump in pay. u00e2u20acu0153Directors are saying, u00e2u20acu02dcWe donu00e2u20acu2122t want to disclose that kind of thing for someone making so much money.u00e2u20acu2122u00e2u20ac
u00e2u20acu0153The metaphor is that the best disinfectant is a bright light,u00e2u20ac adds Todd Leone, managing director of the compensation group at Clark Consulting, a Chicago firm that specializes in bank compensation. u00e2u20acu0153With some comp committees and CEOs, just the notion that theyu00e2u20acu2122d have to disclose this stuff has changed behaviors.u00e2u20ac
Many more boards have been left with little more than remorse, unable to wriggle out of already-made promises. u00e2u20acu0153Thereu00e2u20acu2122s been a lot of, u00e2u20acu02dcI wish we hadnu00e2u20acu2122t paid this,u00e2u20acu2122 or u00e2u20acu02dcI wish we could get that back,u00e2u20acu2122u00e2u20ac Melbinger says. u00e2u20acu0153But most of this stuff is written into contracts, so itu00e2u20acu2122s not that simple.u00e2u20ac
Even boards that are confident theyu00e2u20acu2122re doing a good job are feeling the heat. At First Northern Community Bancorp, a $700 million institution in Dixon, California, CEO Owen u00e2u20acu0153Johnu00e2u20ac Onsum, 62, made $261,120 in salary, $242,401 in bonus, and another $120,495 in options expense. He also had realized $847,290 of value from options exercises, with another $664,304 in accumulated supplemental pension benefits and $575,747 in deferred comp holdings.
When the figures came out, u00e2u20acu0153there was a lot of concern from the committee about how shareholders would react when they saw the numbers,u00e2u20ac says Lori Aldrete, a founding principal with ACS Quantum Strategies LLC, a marketing consulting firm in Sacramento, and chairman of First Northernu00e2u20acu2122s comp committee.
Sure enough, a couple of investors, homing in on the companyu00e2u20acu2122s profit margin, demanded to know how the package u00e2u20acu0153translated to shareholder value.u00e2u20ac Aldrete concedes such a measure made performance look less appealing than the committeeu00e2u20acu2122s approach: Onsumu00e2u20acu2122s base pay is targeted for the 50th percentile of bank CEOs in First Northernu00e2u20acu2122s peer group, while his incentive bonuses are tied to returns on equity and assetsu00e2u20ac”both of which are above peers, according to SNL Financial, a research firm based in Charlottesville, Virginia.
Even under pressure, the board stuck by its own calculations. u00e2u20acu0153Weu00e2u20acu2122re looking at how the bank has performed,u00e2u20ac Aldrete explains. She notes the companyu00e2u20acu2122s share price nearly doubled between early 2005 and the end of 2006. u00e2u20acu0153If the bank has an enormously successful yearu00e2u20ac”like weu00e2u20acu2122ve had for the last coupleu00e2u20ac”then people should be rewarded for that,u00e2u20ac Aldrete says.
Underlying shareholder scrutiny is the widely held notion that America has a CEO-pay problem. According to calculations by the Associated Press, half of the S&P 500u00e2u20acu2122s CEOs earned at least $8.3 million in total pay in 2006, while the whole lot of them brought home a combined $4.16 billion.
A recent study by the Congressional Research Service found that CEOs make, on average, 179 times as much as the typical American workeru00e2u20ac”nearly double the 90-to-1 ratio a similar survey found in 1994. And thatu00e2u20acu2122s before taking into account retirement and other long-term components that often are the most eye-popping parts of a package.
u00e2u20acu0153[Thereu00e2u20acu2122s] a real push-back from investors and the public against the amazing amounts of greed weu00e2u20acu2122re seeing out there,u00e2u20ac says Marilyn Seymann, author of The Governance Game, a post-Enron critique of board practices, and an associate dean at Arizona State Universityu00e2u20acu2122s Sandra Day Ou00e2u20acu2122Connor College of Law.
Banking leaders arenu00e2u20acu2122t exactly missing out on the party. The industryu00e2u20acu2122s top-paid CEO in 2006 was JPMorgan Chase & Co.u00e2u20acu2122s Jamie Dimon, who collected just over $39 million in total compensation, according to figures compiled by SNL. The figure included $1 million in base salary, $13 million in bonus, and another $24.5 million in stock and option awards. Capital One Financial Corp. CEO Richard Fairbank ($37.4 million in total comp) was next, followed by Wells Fargou00e2u20acu2122s Richard Kovacevich ($29.8 million) and Kenneth Lewis at Bank of America ($27.9 million). While these payouts might appear unjustly rich to many observers, to some investors, such comp levels may be well worth it. With the exception of Capital One, all three of the other institutions above were among the list of Bank Directoru00e2u20acu2122s Top 25 Large-Bank Performers published in its 4th quarter 2006 issue. For its part, Capital One has raised its ROA and ROE significantly over the past year.
To broaden this context, it should be noted that large comp levels arenu00e2u20acu2122t limited to national or money-center institutions. Among the smaller-bank chiefs who pulled in big 2006 pay packages was Gerald Lipkin, chairman of Valley National Bancorp, a $12 billion institution in Wayne, New Jersey, whose total take was valued at $5.4 million. But Valley National, too, has demonstrated its worthu00e2u20ac”ranking 31 among the total 150 of Bank Directoru00e2u20acu2122s 2006 Top 150 performers list.
Yet, for most people, the numbers are so out of step with Main Street that Congress is considering imposing limits on what executives can make. Shareholders, meanwhile, are demanding a seat at the table. So-called u00e2u20acu0153say on payu00e2u20ac resolutionsu00e2u20ac”nonbinding measures that call for giving shareholders annual advisory votes on executive comp packagesu00e2u20ac”were introduced at several dozen companies this spring, including the likes of Wells Fargo & Co. and U.S. Bancorp.
None of the bank proposals won shareholder backing. But similar measures garnered majority support at Verizon Communications and film rental company Blockbuster, where the CEOu00e2u20acu2122s package has won notoriety. A majority of shareholders at retailer J.C. Penneyu00e2u20acu2122s annual meeting voted to cap severance packages after a controversial $10 million payout to Catherine West, a former Capital One Financial Corp. executive who served as Penneyu00e2u20acu2122s chief operating officer for just 10 months.
Sometimes the fallout can hit board members directly. In June, three compensation committee members at Yahoo, the big Internet search engine firm, faced strong withhold votes in response to CEO Terry Semelu00e2u20acu2122s total pay package, reported at $71.7 million. The key issue: Yahoo has been losing market share to chief rival Google, even as Semelu00e2u20acu2122s pay has soared. [Editoru00e2u20acu2122s note: Semel resigned June 18 from Yahoo.]
As if all this isnu00e2u20acu2122t enough, comp committee members can be sued for the pay decisions they make. At industry comp conferences, u00e2u20acu0153What weu00e2u20acu2122re told is that there is increased liability for compensation committees as a result of some recent scandals,u00e2u20ac Aldrete says.
McGurn says the perception of liability risk is u00e2u20acu0153overblown.u00e2u20ac The courts have ruled that the business judgment rule, combined with good-faith efforts to exercise proper diligence, are a solid defense against shareholders who get angry enough about pay levels to file suit.
Even so, Melbinger notes that the Delaware courts have made discovery of documents easier in such cases. u00e2u20acu0153Once they get discovery, youu00e2u20acu2122d better hope your minutes and procedures were good,u00e2u20ac he warns. Such suits, he adds, can target the entire board. u00e2u20acu0153But the real focus is on the compensation committee members.u00e2u20ac
McGurn says banks have generally done better on the pay front than most industries, largely because they are regulated and because bank directors typically own more stock than board members in other industries. u00e2u20acu0153The fact that bank directors have some meaningful skin in the game seems to make a difference,u00e2u20ac he explains.
That doesnu00e2u20acu2122t mean theyu00e2u20acu2122re immune to some of the broader problems on the pay front. The big banks in particular have increased bonuses substantially in recent years. Each of the eight highest-paid CEOsu00e2u20ac”save Fairbank, who collected big on option awardsu00e2u20ac”received annual bonuses of at least $5 million in 2006, led by Citiu00e2u20acu2122s Charles Prince, who got $13.2 million.
As with Umpquau00e2u20acu2122s Davis, this can get sticky. A typical defined-benefit SERP for a top executive might provide 2.5% of the average of his final three years of pay, multiplied by every year of service up to 20 years. That means u00e2u20acu0153every time you give him $1 million of bonus, youu00e2u20acu2122re raising his pension by $500,000. Thatu00e2u20acu2122s worth $5 million on a lump-sum basis,u00e2u20ac Paulin, the consultant, explains. u00e2u20acu0153So giving the $1 million bonus is only part of what youu00e2u20acu2122ve done.u00e2u20ac
Some large-bank boards have made moves to limit these payouts. Over the past two years, for instance, Bank of America, Bank of New York Mellon Corp., PNC Financial Services Group, and SunTrust Banks have placed caps on SERP payouts. Those that havenu00e2u20acu2122tu00e2u20ac”including Wells Fargo and U.S. Bancorpu00e2u20ac”were forced to fend off resolutions demanding formal limits on SERP benefits. u00e2u20acu0153When the SERP begins to look like a wealth-accumulation plan, then youu00e2u20acu2122ve got trouble,u00e2u20ac Melbinger says.
Meanwhile, JPMorgan Chase shareholders considered separate proposals to eliminate the granting of stock options and to tie future stock grants to achieving performance goals.
All three boards opposed those proposals on the grounds they would limit directorsu00e2u20acu2122 pay flexibility and could make the companies less competitive in the battle for talent, and all were defeated.
The easy way to sidestep the pressure would be for boards to keep compensation for top executives low. u00e2u20acu0153The main elements of risk revolve around the amount,u00e2u20ac Melbinger says. u00e2u20acu0153If the total compensation package isnu00e2u20acu2122t big enough to attract attention, then you donu00e2u20acu2122t have much to worry about.u00e2u20ac
But thatu00e2u20acu2122s not realistic in any industry, and certainly not for banks in 2007. CEOs are typically the figureheads of their organizations and the chief holders of the strategic vision. Many are also known for their egosu00e2u20ac”itu00e2u20acu2122s part of what got them to the positionu00e2u20ac”and like pro athletes, some view their pay less as a way to eat (no worries there) than as a measuring stick.
Plenty of comp committee chairs can relate stories of head butting with their CEO over pay issuesu00e2u20ac”either the CEOu00e2u20acu2122s or those of subordinates. And itu00e2u20acu2122s not unheard of for top executives with big money at stake to enter contract negotiations with their own consultants and attorneys in tow. Umpquau00e2u20acu2122s Lansing says Davis is reasonable about his pay demands. Still, he admits to having had u00e2u20acu0153several nose-to-nose situationsu00e2u20ac with the CEO over compensation-related issues.
Thatu00e2u20acu2122s not all bad, by the way. Most agree that having a good, open dialogue with the CEOu00e2u20ac”keeping him or her in the loop on the boardu00e2u20acu2122s progressu00e2u20ac”is wise. u00e2u20acu0153The CEO canu00e2u20acu2122t control what the committee is doing, but he needs to know what youu00e2u20acu2122re thinking,u00e2u20ac Lansing says. u00e2u20acu0153You donu00e2u20acu2122t want him to be surprised by the comp committeeu00e2u20acu2122s actions.u00e2u20ac
The competitive landscape provides a backdrop for the numbers. Most financial institutions find themselves vying for top talent not only with established bank rivals but also with start-ups, hedge funds, investment banks, insurers, and, lately, private equity firms, most of which donu00e2u20acu2122t face the same sort of outside scrutiny.
With so many alternatives available to sharp managers, a board thatu00e2u20acu2122s happy with the job top management is doing has little choice but to pay up. As Paulin explains, u00e2u20acu0153banks are competing with a lot of private companies whose pay practices counter any downward pressure on compensation. Itu00e2u20acu2122s a very real phenomenon and is much more pronounced in this industry than in any other.u00e2u20ac
Itu00e2u20acu2122s a caution many bank directors must weigh if they want to keep their top talent. u00e2u20acu0153Thereu00e2u20acu2122s a pyramid effect at work: Only a few people are capable of doing the job at the top. So you canu00e2u20acu2122t overreact and start cutting back where you shouldnu00e2u20acu2122t, just because a few shareholders think it looks out of line,u00e2u20ac Aldrete explains. Most First Northern shareholders u00e2u20acu0153understand that we need to be competitive and that weu00e2u20acu2122re trying to align compensation with their interests.u00e2u20ac
Many experts say linking pay to performance is the logicalu00e2u20ac”and bestu00e2u20ac”solution. Interviews with comp consultants, attorneys, and board members suggest many boards are setting CEO base pay near the 50th percentile of what a group of peer institutions is paying, with performance-based incentives tied to big-picture numbers, such as earnings-per-share growth or returns on equity and assets.
Thatu00e2u20acu2122s pretty much the formula employed by $1.4 billion Cascade, where CEO Carol Nelson, received a base salary of $243,075 in 2006 and got a bonus of $297,450 that was calculated on net income, EPS, and ROE. In a tough operating environment, Cascade reported record profits of $13.4 million last year.
Oftentimes, part of the CEOu00e2u20acu2122s bonus is based on softer, more subjective factors, such as u00e2u20acu0153leadership,u00e2u20ac which are important to the organization but sometimes difficult to measure. At Umpqua, Davisu00e2u20acu2122s bonus is based 65% on EPS growth, 15% on regulatory issues (maintaining top-flight CAMEL ratings), and 20% on leadership, which Lansing says includes such matters as u00e2u20acu0153succession planning, introducing new employees to the board, the results of customer relations surveys, and maintaining a healthy culture.u00e2u20ac
u00e2u20acu0153Itu00e2u20acu2122s somewhat nebulous,u00e2u20ac he concedes. u00e2u20acu0153But these are things that cut to the core of the company.u00e2u20ac
Seymann, the author and educator who serves on several corporate boards, including the one at State Farm Bank, says smart boards use compensation as a tool to help achieve strategic objectives. u00e2u20acu0153The committeeu00e2u20acu2122s clout today pretty much allows you to insist that things get done,u00e2u20ac she explains. Effective pay packages u00e2u20acu0153can be a carrotu00e2u20ac to help ensure that broader board goals, such as succession planning or setting aside enough capital for acquisitions, are accomplished, she says.
For many bank comp committees, the fly in the ointment is the present operating environment. Competition for loans and deposits from de novos, Internet banks, and established players has run head-on into the flat yield curve, sparking margin compression. An increasing number of banks are struggling to grow profits, which makes it tougher to find performance targets that are acceptable to shareholders and can be achieved by management.
More than a few comp committees have toned down targets, paying bonuses for less growth than they might have a couple years ago. Some are using relative performance numbers to mute the effect. u00e2u20acu0153In the past, you might have paid target bonuses if per-share earnings rose. Today, some banks are paying bonuses if the bank breaks even,u00e2u20ac Vedder Priceu00e2u20acu2122s Desmond says. u00e2u20acu0153Itu00e2u20acu2122s a real struggle to strike a balance between pay for performance and pay for retention.u00e2u20ac
Still others reckon that the best course is to let executives share the fate of shareholders, and thus are holding firm to absolute targets. Halladay says Cascadeu00e2u20acu2122s comp committee weighed tweaking its targets when performance fell just short of some option-grant thresholds. u00e2u20acu0153There was a lot of conversation: u00e2u20acu02dcShould we make an adjustment?u00e2u20acu2122u00e2u20ac she says. u00e2u20acu0153But we came to the conclusion that it would be difficult to explain in our proxy statement why we did something different from what we said weu00e2u20acu2122d do.u00e2u20ac
To ensure theyu00e2u20acu2122re doing the best job possibleu00e2u20ac”not to mention shelter themselves from liabilityu00e2u20ac”comp committee members are devoting a lot of attention to process and employing best practices. Many of these, such as state-of-the-art charters, amount to boilerplate statements that look pretty much the same from institution to institution. Others, including compiling tally sheets, are dynamic by definition, dependent on the numbers and components of various plans.
Earlier this year, First Northernu00e2u20acu2122s directors wrote up a new, five-page charter. The document lays out rules for committee composition (at least three independent board members), its purpose (to u00e2u20acu0153review and recommendu00e2u20ac comp policies and specific pay packages for senior executives to the full board and produce a compensation report for the proxy), and mission (overseeing overall compensation strategy).
It also includes a handful of guiding principles for paying top executives and a philosophy, which states that compensationu00e2u20acu2122s main purpose is to u00e2u20acu0153attract, motivate, and retainu00e2u20ac good employees in a way that u00e2u20acu0153aligns employee interests with those of the companyu00e2u20acu2122s stockholders.u00e2u20ac
In practice, the board had long approached matters of executive compensation in just this way, Aldrete says. Even so, putting something formally down in writing u00e2u20acu0153helps clarify what we were already doing,u00e2u20ac and provides a touch point when potential glitches emerge.
At Cascade, the story is much the same. The charter u00e2u20acu0153gives us some guidelines and a checkpoint to go back and say, u00e2u20acu02dcShould we be paying more?u00e2u20acu2122u00e2u20ac Halladay says. She envisions a theoretical point in the future when management might want a bump in pay that isnu00e2u20acu2122t merited. u00e2u20acu0153It gives us a structure for telling management, u00e2u20acu02dcWe canu00e2u20acu2122t do that, because we have these rules and criteria to follow.u00e2u20acu2122u00e2u20ac
A special emphasis is now being placed on hiring independent advisers. Comp consultantsu00e2u20ac”hired by the committee, not managementu00e2u20ac”are considered a necessary by many boards. u00e2u20acu0153From our perspective, the big macro change is that weu00e2u20acu2122re now interviewed, hired byu00e2u20ac”and report tou00e2u20ac”the comp committees, not management,u00e2u20ac says Jim Kauss, a compensation consultant with RSM McGladrey. u00e2u20acu0153You donu00e2u20acu2122t want the appearance of a conflict of interest.u00e2u20ac
Good consultants provide a valuable service but there is a pricetag involved. A small bank can expect to pay up to $50,000 for outside help; larger institutions run tabs into the millions. But consultants can provide some valuable handholding and guide committee members through the process.
Kauss says the relationship often begins with a cold call from the comp committee chairman. Some find consultants at industry conferences. Others get a little help from management. At Cascade, Halladay asked CEO Nelson, whou00e2u20acu2122s familiar with the marketplace, for a list of firms. The committee took it from there, making the contacts and conducting its own interviews.
Once chosen, consultants will typically hold a strategy session with the full committee. u00e2u20acu0153We want to find out how the bank wants to pay its executives. Whatu00e2u20acu2122s the competitive market like, and where [does the bank] fit into that market? What sort of balance do [directors] want between salary and incentives?u00e2u20ac Kauss explains. u00e2u20acu0153Weu00e2u20acu2122re trying to get a handle on what they want. From there, we can develop some guidelines on the philosophy they want to pursue.u00e2u20ac
Itu00e2u20acu2122s crucial to develop a compensation strategy that factors in performance goals and the hiring market. A chief tool in that task requires coming up with a viable group of peer institutions against which the bank will ultimately compete for talent. For some banks, this group is drawn from the town in which they operate; for others, itu00e2u20acu2122s national.
Kauss says he recently helped pick a peer group for one $500 million bank in Las Vegas. During the process, he asked, u00e2u20acu0153Where do you hire people from, and where do they go? Are you competing with Las Vegas banks? Nevada banks? Or is it the entire Southwest?u00e2u20ac In the end, that bank chose to focus on local banks. u00e2u20acu0153Las Vegas is a very competitive market, and [players there] donu00e2u20acu2122t really care what banks in other parts of the country are paying.u00e2u20ac
In contrast, a client bank in rural Missouri chose to benchmark against national competitors of the same size. u00e2u20acu0153When they hire,u00e2u20ac Kauss explains, u00e2u20acu0153they need to do a national search.u00e2u20ac
The use of peer groups isnu00e2u20acu2122t without controversy. The group that is selected can have a big impact on the ultimate pay package executives receive. Critics say their selection is too subjective and vulnerable to subtle manipulation.
Peer groups u00e2u20acu0153arenu00e2u20acu2122t a very good way to set a CEOu00e2u20acu2122s pay,u00e2u20ac says Marilyn Seymann. u00e2u20acu0153I mean, how you define a peer? Is it by revenue size? By asset size? By geography? If you do it by asset size, do you look at different parts of the country or stay close to home?u00e2u20ac
Some board members concede discomfort with the process. On the advice of its consultants, $1.4 billion Cascadeu00e2u20acu2122s comp committee recently changed its peer group from a group of community banks in the Puget Sound area to one that includes mid-sized banks along the West Coast. Since pay is typically linked to institution size, executive pay is up. u00e2u20acu0153They convinced us weu00e2u20acu2122re now competing for talent regionally,u00e2u20ac Halladay says. Even so, u00e2u20acu0153weu00e2u20acu2122re not all convinced weu00e2u20acu2122ve got the right peer group.u00e2u20ac
Perhaps more controversial is where among that group of peers directors set their targets. Kauss says most of his comp committee clients want to pay u00e2u20acu0153above marketu00e2u20ac rates for their executives. u00e2u20acu0153Theyu00e2u20acu2122ll say, u00e2u20acu02dcWe want to pay at the 75th percentile, so weu00e2u20acu2122re sure we get the right people.u00e2u20acu2122u00e2u20ac By definition, this so-called u00e2u20acu0153Lake Wobegon effectu00e2u20acu00e2u20ac”where everyone pays their CEO above averageu00e2u20ac”fuels steadily rising salaries and benefits.
The emerging best practice looks more like this: base salaries at around the median level of competitors, and bonus and incentive payments that fall around 75% of base salary if a combination of individual, business-unit and overall bank performance targets are met.
Peer groups might not be perfect, consultants say, but given the competitive dynamics, thereu00e2u20acu2122s no better alternative on the horizon. Some expect theyu00e2u20acu2122ll actually become more useful because of the disclosures made by other companies. Many boards are now going through post-mortems of this springu00e2u20acu2122s proxy season, examining not only what they can do better, but also the details of competitorsu00e2u20acu2122 plans.
u00e2u20acu0153Before, there was a lot of educated guesswork about what other banks had in their plans,u00e2u20ac Clarku00e2u20acu2122s Leone says. u00e2u20acu0153Now thereu00e2u20acu2122s much more information available, so you can benchmark your programs more completely against peers.u00e2u20ac
Comp consultants also can help committees avoid surprises with tally sheets, which lay out the numbers in a form that somewhat mimics the SECu00e2u20acu2122s required disclosures. Larger companies began using these tools earlier this decade, and now theyu00e2u20acu2122ve become standard. The latest innovation involves interactive models that can show how a proposed change in one part of a comp package can impact other parts. u00e2u20acu0153We can say, u00e2u20acu02dcIf you increase the bonus by $1 million, hereu00e2u20acu2122s what it will do over the long run to pension and severance,u00e2u20acu2122u00e2u20ac Cook & Co.u00e2u20acu2122s Paulin explains.
Lawyers are part of the mix, too. Theyu00e2u20acu2122re needed to craft complicated employment contracts and to ensure that the comp committee is following proper procedures. They also help the committee review the CD&A and other required disclosures. Cascadeu00e2u20acu2122s board, for instance, asked a law firm to double-check the work of the comp consultant. u00e2u20acu0153Thereu00e2u20acu2122s a feeling among the [comp] committee members that consultants are biased toward offering more programs than neededu00e2u20ac to generate additional business, Halladay explains.
In some cases, attorneys have been known to get more hands-on. More banks, for instance, are inserting clawback provisions into employment contracts that allow them to recoup bonus and incentive payments if restatements or malfeasance occurs.
Largely because of the personalities involved, Melbinger of Winston & Strawn says heu00e2u20acu2122s been asked more than once to lay down the law with assertive CEOs on the comp committeeu00e2u20acu2122s verdicts. u00e2u20acu0153Itu00e2u20acu2122s sometimes easier to have an outside party deliver bad news.u00e2u20ac
To help make sense of it all, many comp committees are keeping more detailed minutes and other records to reflect their deliberations on such touchy matters. At Umpqua, the committee has gone against the advice of some lawyers, who argue that u00e2u20acu0153every page of minutes is an hour in a depositionu00e2u20ac and is retaining most of the documentation from its discussions (under lock and key in its lawyeru00e2u20acu2122s office and shielded by the attorney-client privilege) to create a paper trail for its own reference and those who might follow.
In the end, compensation trends are affected by dynamics that alter board governance. Almost by definition, director workloads have increasedu00e2u20ac”sometimes dramatically. The comp committee at Cascade met nine times in 2006u00e2u20ac”more than any other governance committee, including audit. u00e2u20acu0153We normally meet every other month,u00e2u20ac says Halladay, u00e2u20acu0153But thereu00e2u20acu2122s been so much involved in getting things right, weu00e2u20acu2122ve had to throw in a few additional meetings.u00e2u20ac
In some cases, greater expertise is being added to the comp committee. In 2004 Umpqua added Diane Miller, 53, longtime president of Wilcox, Miller & Nelson, an executive search firm, to its board. As a comp committee member, sheu00e2u20acu2122s provided plenty of insights on what other companies are doing, and she was the driving force behind a recent rewrite of the committeeu00e2u20acu2122s charter.
u00e2u20acu0153Diane said, u00e2u20acu02dcWe need something to better articulate our philosophy on how people are going to be paid,u00e2u20acu2122u00e2u20ac Lansing recalls. CEO Davis u00e2u20acu0153wasnu00e2u20acu2122t too excited about the idea,u00e2u20ac but as the committee began working on it, u00e2u20acu0153the whole idea caught fire u00e2u20acu00a6 and weu00e2u20acu2122re better for it today,u00e2u20ac he says.
To keep pace, individual directors are attending conferences and seminars more often to boost their knowledge levels and are spending more of their free time reading up on compensation issues. And itu00e2u20acu2122s not unheard of for some comp committee chairs to informally bounce ideas off of counterparts at other companies to gain some reassurance that theyu00e2u20acu2122re on the right track.
Is all this time and effort worth it? Lansing says pay really shouldnu00e2u20acu2122t be the complex endeavor itu00e2u20acu2122s become. u00e2u20acu0153If you can come up with a formula where the pay translates into increased value to the shareholder, you should be OK,u00e2u20ac he says.
Even so, u00e2u20acu0153in the present environment, the comp committee has a bullu00e2u20acu2122s-eye on its chest,u00e2u20ac Lansing continues. u00e2u20acu0153In the end, we need to be able to stand up in front of shareholders and justify the work weu00e2u20acu2122ve done.u00e2u20ac
In other words, while executives might get the big bucks, for directors the payoff from all the work theyu00e2u20acu2122re putting in comes down to a simple notion: peace of mind. It seems a fair trade-off.