Bank Director Annual Compensation Review

Establishing the right director compensation structure can be a challenging task for any bank. In doing so, board members must consider the interests of shareholders alongside their own; establish fair, objective policies within their ranks; and eliminate any hint of self-interest.

Moreover, in the wake of governance reform, more accountability has been placed on the board to be the gatekeeper for sound compensation policies and decisions. To fulfill their obligations, board and compensation committee members require a great deal of information and training to make prudent decisions.

Though compensation is rarely the sole reason for accepting a director’s seat, it is an important means of rewarding individuals for the time and inherent risk of the position. Therefore, as industry and regulatory challenges have become more complex, it’s reasonable to periodically evaluate director pay to ensure it keeps pace with responsibilities, hours, and the risk of liability. To aid in this process, Bank Director annually surveys bank board members to obtain the latest information on retainers, fees, benefit levels, and compensation review practices. In addition, we ask directors to share their opinions on their perceptions of liability, director education, and the challenging environment in which they work. The results of the 10th annual Director Compensation Survey are presented here to help boards become better equipped to structure a competitive and equitable director compensation package.

Drawing up a blueprint

The approach taken by boards in designing pay and benefit plans is unique to each institution’s culture, but in general, boards use a common array of tools. The survey found 64% of institutions use peer review to assess compensation; larger institutions also rely on consultants’ benchmarking reports.

The parties involved in evaluating and structuring pay programs often differ according to institution size. Community bank boards are more apt to review their own compensation levels, whereas institutions greater than $1 billion in assets more often have a compensation committee oversee the process. Across the board, 50% of respondents believe the full board should be the primary decision maker in this regard, 35% believe it should be the compensation committee, and 7% believe it should be the CEO. In reality, 38% reported that the full board currently has this primary responsibility, 36% reported that the compensation committe does so, and 15% reported that their CEOs are primarily responsible for setting director compensation.

In large part, directors’ comments reflect a system that is working satisfactorily. “For a community banking organization, I believe peer studies of director compensation, as well as a common sense approach, works well,” says Charles Funk, president and CEO of $535 million Iowa State Bank & Trust Co. in Iowa City, Iowa. He adds, “I have had the sense that our directors are not on our board for the compensation they receive.” He admits that demands placed on his outside directors have increased during the last three years, but explains that Iowa State Bank has proactively raised director compensation during that period to balance those extra demands. Director Dennis C. Hovis, from $525 million Eagle Bank & Trust of Missouri in Festus, Missouri, estimates his director workload has increased about 25% over the last three years and believes director pay “should be evaluated every couple of years.”

Given the wide variety of methods and tools available, how does a compensation committee or community bank board-or in some cases, the CEO-ensure an independent and objective evaluation of director compensation? What means of measurement should a board consider?

One thing to remember is that regular board compensation review shouldn’t necessarily translate into regular increases. Todd Leone, managing director for the compensation group of Clark Consulting, a cosponsor of the Bank Director survey, says board pay has been in a state of flux since the passage of Sarbanes-Oxley and may take more time to settle. “We do not recommend changing or increasing board pay every year,” Leone says. Rather, Clark Consulting encourages most boards to review pay levels and practices every two to three years. According to the Bank Director survey, about two-thirds of responding board members reported their director compensation had been reviewed within the last 12 months.

When the time is right to undergo a review, however, banks may need guidance on how to go about it objectively. While there are many methodologies available, in the end, processes used to review compensation are unique to each institution. Leone suggests banks look at proxies as a means of peer review or create their own local peer group survey through original research. Whenever possible, he advises banks to ensure that a number of factors be taken into consideration when developing the peer group-asset size, type of bank, performance, geographic influences, etc.

Nuts and bolts

After conducting research and reviewing its process, an institution should focus on both the pay package components as well as the overall pay on a per-director basis. To assist with this, the Director Compensation Survey breaks out the primary elements that comprise director compensation-cash retainer, board meeting fees, committee meeting and chair fees, and other compensation such as equity. The data from survey respondents is then tabulated and these results are presented in the charts and analysis that follow.

This year, we offer results both at the holding company and lead bank levels (Figure 1). For holding company boards, 2004 cash retainers averaged $10,489 (median $9,000); for lead bank boards, cash retainers averaged $8,704 (median $6,500). Board meeting fees averaged $769 (median $600) at holding companies; at lead banks, board meeting fees averaged $662 (median $500). Total 2004 cash compensation for directors on holding company boards averaged $13,724 (median 9,000); total cash compensation for those at lead banks averaged $13,347 (median $10,900).

As in the past, we note a positive correlation between asset size and total cash compensation as well as by the individual cash components (Figures 2 and 3). Total cash compensation for banks $1.1 billion to $5 billion in assets, for instance, is more than three times as high as for banks with less than $100 million in assets.

Interestingly, while the average number of hours spent on board activities increases slightly with asset size, the annual retainer at banks $1.1 billion to $5 billion is nearly triple that of directors at smaller institutions. One reason for this may be that at least 80% of reporting institutions in the larger-bank category are publicly traded, which brings more complex business models and layers of regulatory concerns. (Only 33% of those in the under $100 million group were publicly traded.)

Leone explains this phenomenon as it relates to pay level comparisons for larger and smaller institutions. “When a bank becomes a certain size, or of a certain complexity, which often happens when a bank moves into the $1 billion to $5 billion range, the board must attract members who are directors and professionals serving at other large, often publicly traded organizations. These individuals have more sophisticated backgrounds and experiences that they bring to the bank. Therefore, it’s not the hours you serve, per se, it’s the type of people you must have on your board that dictates higher compensation for those at larger banks.”

Committee work

Beyond full-board meetings, a great deal of directors’ work occurs in committees that oversee and monitor specific governance functions. To take a closer look at committee compensation, we isolated meeting fees by major committee types for both holding companies and lead banks (see Figure 4).

The table affirms a growing trend of differentiating pay levels among committee types. Publicly traded audit committees, for instance, must supervise external auditors, ensure compliance with internal control guidelines, and oversee certification of quarterly financial reports, which has led many directors and managers to the conclusion that audit committee members deserve additional remuneration. Pay for other committees and roles is following suit, according to Leone.

“By 2003, every board member realized he or she was spending more time on the job-but now the pay differentiation is directed mainly toward specific positions, for example, the audit committee chair.” Among those also being singled out, he says, are lead directors or nonexecutive chairs, and, to a lesser extent, compensation and governance committee chairs, and in some instances, members of the audit committee.

Directors commenting on the fairness of this sliding scale provide fodder for both sides of the issue. In general, says Charles J. Volpe, director at the $553 million Greater Community Bancorp in Totowa, New Jersey, all members of the board should be paid equally, with a few exceptions. “I do believe certain committees (i.e., Audit) should receive higher compensation than other committees,” he says. But Harry Truitt, chairman of $75 million Prime Pacific Bank in Lynnwood, Washington, points out that simply carrying the mantle of the audit committee shouldn’t be a slam dunk for higher pay. “Board members contribute different amounts of time and should be compensated for the time they spend, not the committee they serve on,” he says.

Whether or not it translates to additional pay, across the board, directors acknowledge that the workload for certain committees-and the training and expertise necessary to fulfill those responsibilities-has increased. “It is incumbent upon companies to encourage members of the audit committee to invest time outside the framework of the board and committee meetings to perform research and to educate themselves,” says Eli Kramer, director of $3.2 billion Sun National Bancorp in Vineland, New Jersey. “This is also true for board members involved in other areas such as technology, compensation, and the like.”

Equity

Outside of cash compensation, equity benefits-such as stock options and restricted stock-are still far more prevalent at larger asset-size institutions, according to survey results. Clark Consulting’s proxy study from 2004 provides a snapshot of equity values reported among various asset sizes (see Figure 5). When asked how they would prefer to be paid, the most common answer among community bank respondents was a 100/0 cash/stock split; only those at banks greater than $5 billion chose a 50/50 cash/stock split.

The merits of equity compensation are debated by some, extolled by others. “I believe [equity compensation] drives bank performance, but I am not convinced it will motivate a nonperforming director-nor do I believe it will drive a motivated director to do anything he is not already doing,” says Greater Community Bancorp’s Volpe.

But Prime Pacific chairman Harry Truitt disagrees. “If directors are serious about growing their shareholders’ investment in the bank, then increasing a director’s equity would be most beneficial. Tying equity compensation for directors to bank performance would be a good way to increase bank performance.” Sun National’s Kramer also believes it’s a positive influence, saying, “Equity compensation reminds the directors we are not just being paid to be the government’s policeman-but the shareholders’ champion.”

Leone says equity will continue to play a key role in motivating and rewarding directors and management. “Equity today is alive and well for directors. It is something that, arguably, perfectly aligns directors’ interests with that of shareholders-which is a good thing.” He adds there is an increasing use of full-value shares today, that is, restricted stock. These are being given in lieu of options, which, Leone explains, are sometimes viewed as clouding directors’ independent judgment by inviting them to focus on short-term stock price goals.

The true value of a director

Respondents estimated spending an average of 14.5 hours per month on board activities (see Figure 6), a 36% increase since our 2001 survey. Even so, pay increases appear to have kept pace, as 80% of responding directors reported they are “fairly compensated” for the time required to perform their director duties (see Figure 7).

When measuring pay levels against risk factors, 54% of respondents believe they are not fairly compensated for the risk they assume, with slightly higher percentages of private company directors and those from smaller-sized institutions feeling less satisfied than other groups on this issue. Along those lines, 57% indicated they believe their liability risk has increased in the last year, while 41% said their risk has remained the same. “Our fee is small versus the liability” and “For the liability risk, the compensation is low compared to peers” were common refrains on our survey comment section. One director, however, had a different spin: “The issue is not to increase director comp to relate to liability, but to limit liability for those who act properly in order to attract better and more-qualified people.”

In the end, finding the golden mean can be challenging, but banks that properly motivate their directors will be rewarded with a win-win. “Considering the risk a director accepts while serving and the time away from his or her business and family, a director should definitely consider the total compensation package (fees, benefits, stock options, equity, etc.) over time that will be earned,” says Harry Truitt. “As chairman, I can expect more from a director who takes his or her job more seriously [because the director feels he or she] is compensated appropriately.”

Director Eli Kramer adds that compensation levels also reflect an institution’s respect for its directors. “If a company does not demonstrate (through appropriate compensation) that it respects and appreciates the efforts of its directors, then similarly, the company might not pay the right attention to the guidance offered by the board members.”

In evaluating a bank’s overall compensation program, Leone advises board pay be kept consistent with officer and employee pay. “Banks should work toward a compensation philosophy that is generally consistent throughout the organization,” he says. And while officer and employee pay is based more directly on bank performance, the board plays a key role in helping evaluate and direct the bank’s performance. “You don’t want the board’s role to create friction with the employee base, you want to be creating areas of alignment and the motivation to work together.”

Benefits

In addition to cash and equity compensation, this year’s survey shows that nearly three-fourths of all respondents receive some form of benefits, such as life insurance, medical insurance, travel expense reimbursement, charitable contributions made on a director’s behalf, retirement benefits, and education/training (see Figure 8). But as one director noted, this is still an area that could use improvement: “Board members are increasingly responsible for bank management, yet board benefits such as medical benefits are nonexistent in our area (Pennsylvania). It’s unfair.”

It’s hard to make sweeping generalizations about board benefits because they will often look completely different among banks of differing asset sizes, and sometimes Leone says it’s a bit of a balancing act. If you are a closely held organization, he says, you may not get an equity or retirement plan, but there may be other areas that fill out the compensation and benefits picture.

With increased public and regulatory scrutiny and more stringent rules regarding corporate governance practices, director education and training is another area that’s gaining interest. Past survey comments had indicated a paucity of education and training opportunities, so three years ago we began asking specifically how many directors receive this benefit. This year’s figure of 44% is up more than 20% from last year and nearly 80% in two years. Survey comments indicate most directors believe such training is valuable. “Banking is becoming more of a business and … many directors are falling behind in their knowledge of the industry and decisions required,” offered one respondent. Another director suggested that a “certification program for training purposes should be introduced for new board members to assure [their] qualifications.”

The changing governance landscape

This year’s survey asked whether heightened scrutiny and accountability has affected bank directors’ views on the fairness of their compensation and their satisfaction with the job overall. Directors who provided comments agree the responsibilities and experience necessary to run a public banking institution are much greater today. “With the emergence of Sarbanes-Oxley and new regulations from the various exchanges, the role of the director has changed from business mentor to regulator,” says Eli Kramer. Another respondent, who identified himself as chairman of the holding company’s audit committee and the designated financial expert, said, “There is too much liability associated with [Sarbanes-Oxley] and no additional compensation.” One director spoke for those who are completely fed up with the latest round of bureaucracy: “Sarbanes-Oxley has created an unrealistic and unnecessary deck of unknown wild cards for bank directors. I am at the end of a career and would never consider a bank directorship today if I were young. It’s too much risk and not enough reward.”

While governmental regulations on publicly traded companies garner much attention, closely held institutions report their own challenges. “The only reason [we have] a board is because it is mandated,” one director reported. “Our bank is closely held and … there has not been a board compensation review for at least 10 years. I feel board members are frightened to bring the topic up for discussion.”

Despite such comments, most directors said the upsides-the satisfaction they receive in serving their community, the desire to protect their personal investment, and the opportunity to gain business experience-generally outweigh the compensation and prestige a directorship may bring.

When asked whether he would advise a friend or associate to consider becoming a bank director, Eagle Bank & Trust director Dennis Hovis said he would, “as long as that person understands the responsibility, because [a directorship] does expand a person’s knowledge and understanding of the banking industry.” Charles Funk noted three reasons to become a bank director: “The ability to make a positive difference in an important local institution; the ability to grow as a businessperson as a result of board involvement; and the prestige that comes from being a director of one of the community’s leading corporate citizens.”

So although longer hours and increased responsibility of board service are the new reality, most directors still find purpose in what they do and remain optimistic. As one director put it, “Director responsibility is way up and compensation is far behind, but being a director has been a great experience. I love getting customers for the bank. Our bank is well run, and I sleep well at night as a result.”

For the vast majority of bank directors, board membership will always be more about serving one’s community than amassing wealth. But the tangible rewards-cash, equity, and other tangible benefits-certainly help make it worth the effort.

Respondent Profile

Of the 497 surveys returned (a 10% response rate), 49% were from directors at banks in the $251 million to $1 billion asset range. Another 21% were from those at banks greater than $1 billion in assets, 20% were from banks in the $100 million to $250 million asset range, and 10% were from banks under $100 million in assets. The typical survey respondent is an outside director (76%) at a midsize public community bank headquartered in the Midwest (40%). On average, he or she has been a director for nearly 18 years; serves on the holding company and/or lead bank board with six fellow outside directors and two or three inside directors, one of whom is board chairman; and sits on at least one of the following committees: loan, audit, compensation, or executive. Furthermore, the typical director spends about 15 hours a month on board duties, attending approximately 12 lead bank board meetings and/or nine holding company board meetings annually.