2003 Bank Director Annual Compensation Review

The past year has thrown more than a few curve balls at directors who are grappling with the consequences of new laws and regulations designed to ferret out corporate fraud and ensure more accountability for executives and board members. Thus, directors are faced with increasing demands on their timeu00e2u20ac”along with additional liability. Although board membership still carries many benefits, most directors are weighing the decision whether to serve more carefully today.

While the passage of the Sarbanes-Oxley Act has caused all corporate board members some consternation, bank directors appear to be well equipped to handle the pressure. For decades they have lived with intense regulation, and many of today’s directors survived the horrendous financial crises of the 1980su00e2u20ac”marked by bank failures, lawsuits, and civil money penaltiesu00e2u20ac”and are arguably stronger for it. Nonetheless, bank directors say that fair remuneration is increasingly necessary to balance the challenges of board service in a more rigorous environment.

In this article, Bank Director is pleased to publish the results of its 2003 compensation survey, which reports pay levels and provides guidelines for financial institution directors’ compensation practices. For our eighth annual report, we polled 5,000 board members to gather information on retainers, fees, and benefit levels and to allow directors an opportunity to express their opinions on a variety of boardroom concerns, from corporate governance issues to those involving liability and performance-based pay.

Of the 644 surveys returned (a 13% response rate), nearly 50% were from directors at banks in the $251 million to $1 billion asset range. Another 22% were from those at banks with assets greater than $1 billion but less than $5 billion and 18% were from banks in the $100 million to $250 million asset range. And while directors at large money-center banks may face different challenges than those at small, privately held community institutions, the key compensation question they must ask themselves is the same: Are we fairly compensated for the work we do, time spent, and personal risk incurred? We hope the following will help your board decide.

Director profile

The typical survey respondent is an outside director (83%) at a midsize public community bank headquartered in the Midwest (32%) or Southeast (21%). On average, he or she has been a director for about 14 years, serves on both the holding company and lead bank boards along with seven fellow outside directors and two or three inside directors, and sits on at least one of the following committees: audit, loan, or compensation. Our survey shows that the typical director spends more than 14 hours a month on board duties, and attends approximately 13 board meetings annually.

How it all stacks up

The primary elements comprising director compensationu00e2u20ac”annual retainer, board meeting fee, and board chairman fee, if applicable (committee fees were broken out separately)u00e2u20ac”again this year show a positive correlation between asset size and director pay. Board meeting fees were up for directors at banks of all asset sizes, except for a 10% decrease in meeting fees for those at banks in the under $100 million in assets category. Annual retainers from our survey sample were mostly lower this year across asset sizes, with the exception of a 41% increase in the average annual retainer for directors at banks over $5 billion in assets (a number that dipped last year) and a slight gain for directors at banks in the $1.1 billion to $5 billion asset range. Interestingly, 21% of the 326 respondents (approximately half of the survey pool) who answered this question reported receiving an annual retainer of $0. (All other figures are based on data from respondents who reported receiving fees greater than $0. For a breakdown of these components by asset size, see Figure 1.)

To provide more in-depth reporting, we broke out committee fees according to type of committee this year. For the three committees on which respondents most often served, the results are as follows: For the audit committee, fees ranged from an average of $163 at banks under $100 million in assets to $770 at banks over $5 billion in assets; for the loan committee, fees ranged from an average of $144 at banks less than $100 million in assets to $846 at banks greater than $5 billion in assets; and for the compensation committee, fees ranged from an average of $133 at banks below $100 million in assets to $773 at banks above $5 billion in assets. (Figures are based on data from those respondents who report receiving such fees greater than $0. For a complete breakdown of the various committee and committee chair fees by asset size, see Figure 2.)

Beyond cash compensation, equity benefitsu00e2u20ac”stock options, restricted stock, SARs, phantom stocku00e2u20ac”are still more likely to be found at larger-asset-size institutions, according to the survey results. In fact, two out of three respondents currently receive no equity pay. When asked how they would prefer to be paid, most of our respondents at banks in the under $5 billion in assets category chose a 100/0 cash/stock split, while those at banks with greater than $5 billion in assets chose a 50/50 split.

In return for the compensation and other benefits, survey respondents estimated spending as much as 300 hours per month on bank board activities. There was a strong correlation to asset size: Generally, the larger the bank, the more time spent on board business, a reversal of last year’s findings. (For a breakdown of time spent by asset size, see Figure 3.) But as one director noted, “Given the time, expertise, and responsibility involved, to assert board members receive ‘compensation’ is inaccurate. At best, it is a stipend.”

The responsibility for making compensation decisions also varies across asset size. Community bank boards are more likely to set their own compensation levels, whereas those at institutions greater than $1 billion in assets are more apt to use a compensation committee to set those fees. When asked who they believe should make the primary decisions, respondents backed these two methods, although lead directors and advisory board members were evenly split on whether the board or a compensation committee should handle the duty. And while those at banks across all asset sizes indicated that peer review is the most popular method of setting board compensation, our data indicated that directors at the larger banks tend to rely more heavily on benchmark reports as a supplemental tool. Again this year, two-thirds of those surveyed reported reviewing director compensation at their bank within the last 12 months.

The question of how directors are paid may also prompt a discussion on the merits of performance-based pay. Only 10% of those surveyed indicated that their compensation is tied to bank performance, down three percentage points from last year. Of those 10%, 48% reported that their pay is tied to ROE and 41% to ROA. In 2002, ROA was the more popular of the two. Other measures used include stock value, business development, asset size, EPS, growth, etc. [Note: Respondents could choose more than one measure.] For the first time in three years, however, more than 50% of our respondents said they favor director compensation that is tied to bank performance.

On the fringe

In addition to their annual compensation, which may be a mixture of cash and stock, many directors receive other incentives. In fact, this year’s survey shows that the vast majority of respondents do receive some form of benefits and the overall percentage appears to be rising annually, based on increases in specific benefit categories. Such perks include deferred compensation, life insurance, medical insurance, travel expense reimbursement, charitable contributions made on a director’s behalf, retirement benefits, and education/training. (For a breakdown of benefits, see Figure 4.)

As a result of increased public and regulatory scrutiny and more stringent rules regarding corporate governance practices, the latter is an area that is high on the directors’ hot list. One board member vehemently expressed his concern, saying, “I wish my fellow directors would educate themselves more on the banking industry. [If not], they should retire. It’s a crime.” Another suggested “education requirements for board members [should be] part of compensation.” Past survey comments had indicated a dearth of education and training opportunities, so last year we began asking how many directors receive that benefit. This year’s figure of 36% is up nearly 50% from 2002u00e2u20ac”a trend that seems likely to continue given a heightened stress on director accountability. One director this year lamented, “As much as there has been emphasis placed on director education, little has been done to require it. Directors have tremendous liability and not much in the way of knowing how to decrease that liability, unless the bank encourages directors to increase their knowledge.” Another agreed, saying, “With Sarbanes-Oxley in place, it would seem necessary for audit committee members to be given access to educational forums directly related to their responsibilities.”

We also asked survey respondents to rank issues on which they believe compensation committee members at their banks need more information. Annual incentives, board compensation, and executive benefits were the top three vote getters, followed closely by salaries and equity/long-term compensation, another area that’s garnering more attention these daysu00e2u20ac”especially as the issue of a mandatory retirement age for directors heats up. This year’s surveys indicates that 51% of our respondents serve on boards with a mandatory retirement age, an increase of almost 40% over last year. The average maximum age for board service was 71, up one year from the 2002 survey.

For love or money?

Despite ongoing industry discussions regarding parity and fairness, respondents overwhelmingly again this year told us that compensation is not their primary motivation for board service. In fact, most directors said that the satisfaction they receive in providing a service to their community and the chance to gain valuable business experience far outweigh the monetary gain. As one director put it, “I really enjoy serving on the board. It helps me to know what is going on in my community.” Another agreed, saying, “No one should accept a director position if they ‘need’ the money or for prestige reasons.” One director, however, wryly noted, “Too many directors think prestige is so important, they ignore respect and serve at slave wages.”

Given the time commitment and personal liability involvedu00e2u20ac”especially as a result of Sarbanes-Oxley and the new stock exchange requirementsu00e2u20ac”survey comments indicated that more and more, directors are calling for the board to benchmark compensation, which may also be a selling point in recruiting new board members. [When asked how the bank recruits new talent to the board, the vast majority of our survey respondents indicated that director referrals and CEO recommendation are the primary methods, thus how a director feels about issues such as compensation and liability may play a role in how he or she represents the job to others.] One director illustrated this point perfectly by saying that once his bank collected adequate comparison data, it “became a catalyst for the holding company to revamp director compensation for all subsidiary banks.” Another pointed out that “the fiduciary responsibility of board directors needs emphasis in regard to acceptable compensation for CEOs and directors,” and a third echoed that sentiment, saying, “Given the increased responsibility and accountability, our compensation should be increased.”

Within our survey pool, 83% of directors at public institutions and 92% at private institutions said their board compensation has not increased as a result of the renewed focus on corporate governance. And while nearly 80% of those surveyed are satisfied with the remuneration they receive, 51% did point out that they are not fairly compensated for the liability risk they assume, a percentage that continues to increase each year. A majority (56%) indicated that they believe their liability risk has increased in the last year, while another 40% said it has remained the same. As one director noted, “Sarbanes-Oxley dramatically increases the risk and liability, particularly for outside directors. Thus, outside director remuneration must be increased dramatically.” However, another director believes it may never be possible to be fully compensated: “It’s got to be a labor of love and integrity, because the compensation could never be enough to offset liability and keep the bank making money.”

*Bank Director wishes to acknowledge the assistance of Clark Consulting in the preparation of this year’s survey questionnaire.

In Their Own Words

We posed several additional questions via e-mail to a group of directors who agreed to give us their views on compensation. The following comments have been selected from those interviews.

How independent is your compensation committee from management?

“Completely. It is composed entirely of outside directors. Every three years, we bring in an outside consultant to substantiate and evaluate our goals and objectives. The consultant interviews senior management and reviews the goals of our organization and then compiles extensive information on institutions of like size. This information is utilized by our committee to establish a fair and equitable pay plan.”

u00e2u20ac”Robert B. Rogers, chairman, Southwest Bancorp, Stillwater, Oklahoma, $1.5 billion in assets

“Our compensation committee is made up of four directors. Three are outside directors, and one is our CEO, who is also a director. Except for staff support and research by the CEO member, we think it is very independent from management. It has been in place for 17 or more years.”u00e2u20ac”William D. Chiodo, chairman, Windsor Federal Savings and Loan, Windsor, Connecticut, $213 million in assets

“Ours is moderately independent. We hire an outside provider to develop compensation comparisons for both senior management and the board of directors, so we have some objectivity. Of course, we listen to management on the subject.”
u00e2u20ac”Name withheld

“Our CEO provides data for our committee, but does not serve on our committee, nor do any of the other managers.”
u00e2u20ac”Cathy Layton, founding director, The Bank of Commerce, Sarasota, Florida, $135 million in assets

“Our compensation committee is not independent at all.”
u00e2u20ac”Name withheld

Has corporate governance reform had any influence on your director compensation level?

“Our [approach to] directors compensation has always had shareholders’ perception in mind. We did not accept compensation until after we were profitable, and then did so only modestly. Over a year later, we have not, and probably will not, increase such compensation. It is simply not an issue with us.”u00e2u20ac”Cathy Layton, founding director, The Bank of Commerce, Sarasota, Florida, $135 million in assets

“I think we are all aware of the microscope-like scrutiny of corporate management by the public. We have been a mutual S&L during this period and before and have not really been greatly influenced by the turmoil. We have felt the need to document discussions and decisions we make a little more than we used to, just to be able to respond to any outside inquiry.”

u00e2u20ac”William D. Chiodo, chairman, Windsor Federal Savings and Loan, Windsor, Connecticut, $213 million in assets
“It’s pushed it up in order to fill needs that are being asked for. The spotlight on boards makes us take more time and demand more expertise. This must be through education or new board members with the experience. This isn’t necessarily bad, but it does tend to breed expectations of higher compensation for the time, education, and skills.” u00e2u20ac”Janet Westling, outside director, HomeStreet Bank, Seattle, Washington, $1.5 billion in assets

“Our board has increased compensation to members and to the chairman of the audit committee.”
u00e2u20ac”Name withheld

Would you accept a board seat without compensation?

“I took the seat at a lower compensation level than present. I don’t know if I would have accepted as a volunteer. At present, I’m enjoying getting paid for the work I do, but there may be circumstances (I can’t imagine) which would sway me to do my duties voluntarily without compensation.”u00e2u20ac”Janet Westling, outside director, HomeStreet Bank, Seattle, Washington, $1.5 billion in assets

“Personally, I would not. The time I spend on my bank duties cuts into my self-employed professional life, and hence I sacrifice fee income. I consider fees received from the bank a quid pro quo for my time.”u00e2u20ac”William D. Chiodo, chairman, Windsor Federal Savings and Loan, Windsor, Connecticut, $213 million in assets

“No. There is too much liabilityu00e2u20ac”even though we have D&O [insurance].”u00e2u20ac”Kenneth Ramsey, chairman, Monticello Bancshares

“It depends entirely on the situation. If an ongoing concern, certainly not. If a start-up, then it would be appropriate.”
u00e2u20ac”Robert B. Rogers, chairman, Southwest Bancorp, Stillwater, Oklahoma, $1.5 billion in assets

“No way!”
u00e2u20ac”Name withheld

Are your bank’s current procedures for monitoring and setting director compensation working to your satisfaction?

“We use a lot of comparisons, outside input, etc., to come to a level that seems appropriate. We seem to stay a bit below average in compensation levels. There always seems to be something that doesn’t feel quite right that gets tweaked or reevaluated each year. In general, it seems to be working well.”
u00e2u20ac”Janet Westling, outside director, HomeStreet Bank, Seattle, Washington, $1.5 billion in assets

“Yes. It has been the duty of the compensation committee to research the competitive financial institution market from time to time to keep us in line with other financial institutions of our size.”
u00e2u20ac”William D. Chiodo, chairman, Windsor Federal Savings and Loan, Windsor, Connecticut, $213 million in assets