2004 Bank Director Annual Compensation Review

Respondent Profile

Of the 638 surveys returned, 55% were from directors at banks in the $251 million to $1 billion asset range. Another 20% were from those banks in the $100 million to $250 million asset range, 14% were from those at banks greater than $1 billion in assets, and 11% were from banks under $100 million in assets. The typical survey respondent is an outside director (74%) at a midsize public community bank headquartered in the Midwest (33%) or Southeast (22%). On average, he or she has been a director for about 14 years, serves on both the holding company and/or lead bank boards with six fellow outside directors and three inside directors, and sits on at least one of the following committees: audit, loan, compensation, or executive. Furthermore, our typical director spends 13 hours a month on board duties, attending approximately 12 board meetings annually.

While much of corporate America has been reeling from the crush of Sarbanes-Oxley, new listing requirements, and intense shareholder scrutiny, the banking industry has been uniquely situated to weather this latest regulatory storm. Though the ramifications of governance reform have been felt across the board, the government’s latest round of intrusion might be categorized as “business as usual” for commercial banks and thrifts that dealt with more egregious burdens when FIRREA was passed more than a decade ago.

Perhaps it follows, then, that while compensation packages for many corporate boards have undergone dramatic increases in the last 12 months, 2003 remuneration for our surveyed group of mostly community bankers remained fairly even. Moderate increases occurred in committee fees and retainers for some asset sizes in 2003, reflecting the direction of the larger trend that has borne out during 2004, according to recent publicized reports on corporate directors’ increasing pay levels.

It is against this backdrop that Bank Director polled 5,000 board members to gather information on retainers, fees, benefit levels, and boardroom practices for our ninth annual report on director compensation. Again this year, we asked bank directors to share their thoughts on topics ranging from corporate governance to liability to performance-based pay. Their responses to these questions vary, but one issue runs as a common thread: Are we fairly compensated for the amount of work we do, time spent on board business, and personal risk incurred?

A changing playing field

The advent of additional responsibilities and accountability after Sarbanes-Oxley has had a huge impact on directors of all companies, leading us to ask whether it has affected bank directors’ views on the fairness of their pay levels. We found wide-ranging opinions on whether the current environment and expectations have permanently changed the nature of the position.

Some felt that the latest round of regulation is more of the same. “I do not believe the institution of corporate governance reform has affected our work levels and compensation at all,” says Hal Cowan, Blue Ridge Bank, a $450 million institution in Kansas City, Missouri. “These conditions were already in place from good management and [continue] as board members accept more responsibility. There is never a fee that can be equal to the potential liability. Only by exacting oversight are we able to reduce those possibilities for our depositors and our shareholders.”

Mike Steinhauser, vice chairman of Texas United Bancshares, a $910 million publicly traded bank in La Grange, Texas, agrees. “The work levels have gone up for all committees for various reasons, such as Sarbanes-Oxley, strong loan demand, the growth of our institution, governance issues, and the like,” he says. “Our current pay levels are fair, though, at times, they are on the low side for the amount of work involved and responsibility involved.”

“At the current time and circumstances, I feel that the compensation is adequate,” says James A. Boyers, First Exchange Bank, Mannington, West Virginia, a $125 million bank. “Those circumstances are: qualified management informing the board adequately; fellow qualified board members, some of whom have expertise in the accounting arena; and competent internal and external auditors.”

Others admitted to being hit hardu00e2u20ac”and noted their pay hasn’t followed suit. “Sarbanes-Oxley 404 is costing a fortune and almost halting work on business development by taking so much organizational time and effort,” commented one director from our survey. “Liability and Sarbanes-Oxley make me wonder if compensation is adequate,” said another.

Several directors sounded off about the rigors of the new governance rules. One complained, “Sarbanes-Oxley legislation has caused undue hardship on smaller banksu00e2u20ac”[it is] too restrictive and costly. As board members, [we] are now underpaid and have more risk and responsibility. Regulatory oversight of banks is ridiculous; [the] liability risk is growing exponentially and will eventually eliminate the pool of qualified director candidates.” Another agreed, saying simply, “Sarbanes-Oxley is killing small banks in time and dollars.”

Among those surveyed, 79% of respondents said their board compensation has not increased as a result of the renewed focus on corporate governance. And while 80% of respondents are satisfied with the remuneration they receive, 50% did point out that they are not fairly compensated for the liability risk they assume. Furthermore, a majority (53%) indicated they believe their liability risk has increased in the last year, while another 43% said their risk has remained the same. As one director noted soberly, “The risk and liability of directors is scaryu00e2u20ac”I don’t know that I would serve again knowing an error or omission could break me to poverty.” Other directors agreed, saying, “Most directors are vastly underpaid, in my opinion, as it relates to liability,” and “Pain now exceeds gain!” Yet another director saw both sides of the issue: “Board members should be fairly compensated and retired when they fail to ‘earn’ their compensation (for any reason).”

Another paradigm causing consternation is this: In the post-Enron world, more questions are being asked, more information is being requested, and the bar on accountability has been raised. Are directors expected to become more involved in daily management than they once were, and, if so, is this a good thing?

“The challenging part today is you have board members saying, ‘Are we managing or are we directing?’” says Todd Leone, senior vice president of the bank compensation group of Clark Consulting, a co-sponsor of the 2004 Bank Director survey. He says this scenario is causing a lot of confusion among board members. “The answer [to this dilemma] is the same as always: Directors are there to monitor policies and provide oversightu00e2u20ac”nothing has really changed in that regard.”

A recipe for fair compensation

While the components of directors pay usually don’t change drastically from year to year, they do tend to ebb and flow reflecting the sensibilities of the times. The primary ingredients that comprise director compensationu00e2u20ac”annual retainer, board meeting fee, and sometimes bonus (committee fees and chairman fees were broken out separately)u00e2u20ac”again this year show a mostly positive correlation between asset size and director pay.

According to our survey, board meeting fees for 2003 remained stable for directors at banks of all asset sizes, other than a 10% decrease in meeting fees for those at banks in the under $100 million asset category for the second consecutive year.

Annual retainers among respondents were also mostly unchanged across asset sizes, except for a 39% increase in the average annual retainer for directors at banks under $100 million in assets and an 11% decrease in retainer for directors at banks over $5 billion in assets. Geographically, as in the last two years, directors in the West and Mid-Atlantic states reported the highest average annual retainers.

Clark Consulting’s Leone says the breakdown between fees and retainer has a large cultural element to it. “There’s no magic formula between fees and retainers.” Even so, there are trends that tip the scale from one side to the other, depending on the times. “At one point everyone wanted to put everything in retainers,” he explains, “but today that’s changed 180 degrees. The focus is back on committees nowu00e2u20ac”especially on making sure you adequately compensate the audit committee, compensation committee, and their chairs.” (For a complete breakdown of pay components by asset size, see Figure 1.)

Following last year’s approach, we broke out committee fees according to type of committee. For the three committees on which respondents most often served in 2003, the fees are as follows: For the audit committee, fees ranged from an average of $167 to $874; for the loan committee, fees ranged from an average of $149 to $433; and for the compensation committee, fees ranged from an average of $157 to $702. Overall, the largest average increases were seen in committee fees for those directors at banks under $100 million in assets, except for executive committee fees. (For a complete breakdown of the various committee fees and committee chair fees by asset size, see Figure 2.)

Anecdotally, several directors reported they were involved in more committee meetings and were approving additional compensation for those meetings, particularly for committee chairmen. Comments such as “meeting frequency has increased, chairman got extra amount”; “retainer for chairman of audit committee has doubled”; “additional compensation committee fees are being considered”; and “in 2004, fees have doubled” were commonplace among this year’s respondents.

Thus, in general, the amount of additional work has affected directors’ views on compensation this year, whether they sit on an SEC-reporting public company directly affected by Sarbanes-Oxley or a privately owned bank. “Because our bank is privately owned, under $500 million, Sarbanes-Oxley does not apply, although we have implemented many of the corporate governance aspects of the legislation,” notes James A. Eagan, a director at $190 million Douglas County Bank in Lawrence, Kansas. “The board’s increased responsibilities have prompted us to review and update the board’s organizational effectiveness as well as the level of compensation. While we may increase compensation, it would be to address the overall time commitment and responsibilities rather than be directly related to Sarbanes-Oxley.”

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 our survey results. In fact, two out of three survey respondents currently receive no equity pay. When asked how they would prefer to be paid, the most common answer among community bank respondents (those $1 billion and under) was a 100/0 cash/stock split, while those at banks greater than $1 billion chose a 50/50 cash/stock split.

The compensation planning process

The way in which banks undergo the process of evaluating and structuring their pay programs varies according to asset size, our survey shows. Community bank boards are more apt to set their own compensation levels, whereas institutions greater than $1 billion in assets are more likely to use a compensation committee to set those fees. When asked who they believed should make the primary decisions, survey respondents backed these two methods, although those at banks in the $1.1 to $5 billion category slightly favored having the full board handle the duty. And while directors overall agreed peer review is the most popular method for setting board compensation, our data indicates directors at larger banks tend to rely more heavily on benchmark reports as a supplemental resource. Again this year, nearly two-thirds of those surveyed reported reviewing director compensation at their bank within the last 12 months.

Still, several respondents admitted that while a great deal of time is spent on staff and executive pay and bonus issues, they have a less-than-formal approach when it comes to compensation for the board. “Honestly, we probably don’t formally address director pay issues too often, and generally accept the recommendation of our CEO. But most of our directors are happy to serve at the current levelsu00e2u20ac”most likely due to their involvement with the bank,” says John W. Bowers III, a director and member of the compensation committee at Central National Bank and Trust Co., a $350 million institution in Enid, Oklahoma.

Of course, the picture isn’t rosy everywhere. The perspective is often quite different for directors on family-controlled boards, for instance, One such board member who wished to remain anonymous told us, “There is no compensation committee nor anything even close. There is no hint [of] democracy. Any decision as to directors’ pay and executive pay is made by the president and, as to directors’ pay, rubber stamped by the board. Executive pay doesn’t even see the rubber stamp.”

Other directors reported generally favorable views on the relationship with regard to compensation issues. Jay Their, a director of $300 million Mars National Bank in Mars, Pennsylvania, told us “Our shareholders are quite supportive of comp levels. Much of our voting ownership has been on the board at one time, and they understand the large amount of time it takes to do the job properly. We have not had a problem with directors’ views yet.” Robert Brown, a director at $800 million Centennial Bank of the West in Fort Collins, Colorado, feels similarly. “I believe that our owners/shareholders are certainly supportive of the board’s efforts and our views on compensation. Our board is enthusiastic and energetic about the future of the organization, and I believe that the shareholders recognize this. As long as we perform as an effective board and continue to lead our company in a profitable and successful direction, our shareholders will be more than satisfied.”

In general, how do compensation committees ensure an independent and objective evaluation of directors’ pay and executive pay? “Very carefully!” says director Hal Cowan of Blue Ridge Bank. We need to work more on this. However, we are quite aware of what all the executives’ performance is and that our compensation is internally equitable and externally competitive.

To that end, we asked survey respondents to rank issues on which they believe compensation committee members at their banks need more information. Annual incentives, salaries, and executive benefits were the top-three vote getters.

In reality, there are numerous factors that lead to the final determination of pay structure. One important thing to remember is simply to make communication itself a key component of the process. “With wide-open communication, our board is made aware of the status of compensation at all corporate levels. However, we could definitely take more time to discuss these extremely important issues,” notes Cowan.

But sometimes openness has its limits, as one director from our survey related. “The bank president refused to leave the room when his salary was discussed a couple of years ago, and the chairman backed him up. [We need] more information on the compensation committee’s rights.” In some cases, the overwhelming task may lead to the need for outside help. “Our committee has tried to compare [itself] to its peers and recently has retained a consulting firm to look at our option plan and related compensation issues,” Steinhauser of Texas United Bankshares says.

Equity/long-term compensation is another area our respondents identified as one for which directors are lacking information, and it’s also one that’s receiving more attention nowadays, especially as the issue of a mandatory retirement age for directors comes to the fore. Nearly half (49%) of this year’s respondents serve on a board that imposes a mandatory retirement age; among those boards, the average maximum age for board service is 71. Both figures are consistent with last year.

The question of how directors are paid can also lead to a discussion on the merits of performance-based pay. “[Our board is] gun-shy when it comes to performance/compensation ratios,” one director lamented, and another noted, “We were getting a bonus based on the bank’s performance, but because of Sarbanes-Oxley, we aren’t going to do that in the future.” Only 10% of survey respondents indicated their compensation is tied to bank performance, which is identical to last year. Of those 10%, 54% reported pay tied to ROE and 52% to ROA (respondents could choose more than one method). Other measures used include stock value, business development, net income, profits, etc. And in a continuing trend, our respondents were nearly evenly split on whether they favor director compensation tied to bank performance.

In exchange for compensation and other perks, survey respondents estimate spending as much as 100 hours per month on bank board activities. And there is a strong correlation to asset size: Generally speaking, the larger the bank, the more time spent on board business. (For a breakdown of time spent by asset size, see Figure 3.) As one director noted, “Time commitments continue to grow and prevent us from finding good men/women to serve on the board.” Another is worried that today’s climate may add to the problem. “The number-one factor in deciding to accept a board seat,” he said, “is the current condition and potential liabilities of the institution.”

Icing on the cake

In addition to their annual compensation, which may be a mixture of cash and stock, directors often receive other incentives. In fact, this year’s survey shows the vast majority of respondents do receive some form of benefits, including life insurance, medical insurance, travel expense reimbursement, charitable contributions made on a director’s behalf, retirement benefits, and education/training. (For a complete breakdown, see Figure 4.)

In particular, says Clark Consulting’s Leone, education has become significantly more important than it used to be. “We have seen a real uptick in banks paying for education and training as a benefit,” he says.

Indeed increased public and regulatory scrutiny and more stringent rules regarding corporate governance practices, director education and training has led to much more attention in this area. One director noted, “It would be nice to have a peer group of outside directors from banks that do not compete [to participate in] an informal exchange of ideas, a comparison of things that have worked or failed.” Another expressed real concern over the lack of training, saying, “Our board has a great need for continuing education, but it seems hard to find.” Past survey comments had also indicated a scarcity of education and training opportunities, so two years ago we began asking specifically how many directors receive this benefit. This year’s figure of 36% is up slightly from last year and up about 50% from 2002, a trend we expect will continue given the new era of director accountability.

Another benefit we track annually are retirement plans, an area in which many responding directors feel shorted. As one director put it: “Our employees get excellent benefits and retirement. The outside directors share in none of the above.”

Statistically only 7% of directors indicated they currently are offered one for their board service. Hal Cowan believes his institution should institute such a plan, saying it would help entice “new blood” on the board. Mike Steinhauser’s institution offers “a mandatory retirement plan for directors as they turn 72 years old. We also have a BOLI that allows directors to defer some compensation and realize retirement income after they no longer serve on the board.”

Whatever the plan, compensation expert Todd Leone warns about mixing up the notion of deferral pay programs with traditional retirement plans. “Deferral programs are fine. But things get sensitive for a retirement plan. They are, in fact, going away.” One reason for this, Leone explains, is that when directors have too big of an incentive to stay on the board long term, they may lose their objectivity. “You don’t want directors thinking they can’t speak their minds for fear they will get thrown off the board and lose their plan.”

Directorship: A labor of love?

Despite the give and take over parity and fairness, again this year survey respondents overwhelmingly told us monetary gain or prestige is not their primary motivation for board service. In fact, most directors said the satisfaction they receive for serving their community, the desire to protect their personal investment, and the opportunity to gain business experience far outweigh the direct compensation or star appeal. As one director admonished, “Anybody who wants to be on a bank board for prestige probably should not be on it in the first place.” Another added, “I find that 99% of the bank directors I serve with are extremely professional, dedicated, community-minded individuals. I am quite proud to be a bank director.”

Due to the time commitment and personal liability involved, survey comments over the last two years indicate a growing number of directors expect the board to benchmark compensation, which may also help attract new directors. When asked how the bank recruits new talent to the board, survey respondents chose director referrals as far and away the preferred method, thus how a director feels about issues such as compensation and liability may influence how he or she promotes the job to others.

Even with the rigors and increased responsibility of board service, many seem to truly enjoy the job and remain optimistic about their service long term. As one director proclaimed, “I have enjoyed every minute of being a director [and] getting new customers for the bank. The bank is sound, and I sleep very well at night.” What’s not to love?