Bank Director Annual Compensation Review

Determining fair pay for board service can be a challenging proposition. Sure, you must consider a director’s expertise, the number of committees on which he or she serves, including chairman duties, if applicable, as well as overall time spent on board service, but what about the intangibles? Do you factor in the potential personal and professional liability directors now face? Or can you really compensate for that?

And then there’s the new buzzword: compliance. Directors these days face a seemingly endless list of regulations and governance issues they must be versed in. Should they receive additional pay for the learning curve and hours they must spend absorbing new policies?

It’s what some refer to as the compensation conundrum. As one comp committee chairman noted recently, “I do think director compensation is important, though I am not a bank director for the money. But it is a huge [commitment], and I am concerned about if you can ever be compensated for the responsibility of being a board member.”

Once a reasonable rate is determined, the compensation committee must decide on the best mix of remunerationu00e2u20ac”cash, options, annual retainers, meeting fees, and performance bonuses. Furthermore, directors must also balance their rights alongside the interests of shareholders. It’s a situation that’s bound to be sticky at times, requiring an objective process and tools to help make sound and equitable decisions.

To aid boards in this complicated assessment, Bank Director offers the results of its yearly Director Compensation Survey. Every summer, in conjunction with Clark Consulting, the magazine undertakes a survey of directors nationwide to determine the latest data on compensation trends and director pay. The results of the 11th annual survey are presented here to help directors fine tune their own compensation programs and individual pay packages by benchmarking their numbers with those of their peers.

Compensation overview

Although compensation programs are unique to each institution based on its size, culture, and philosophy, most boards break down director pay into basic components: annual retainer, board and committee fees, equity income, and benefits. Overall, 39% of those surveyed indicated their compensation had increased in the last 12 months, with most receiving a 10% increase. Less than 1% indicated their compensation had decreased in the last year.

To structure their plans, our survey found that 43% utilize a compensation committee to set director pay, while 34% call on the full board to make these decisions. About 13% said the CEO sets director compensation and 8% said the chairman determines these levels. Nearly 60% of these decision makers rely on peer review to assess compensation, although those at larger institutions also depend on consultant reports.

From an asset-size perspective, the full board is more likely to set fee levels at community banks, while compensation committees are more frequently used at larger institutions. Regionally, compensation committees are heavily favored in the Mid-Atlantic (66%), while those in the Midwest (41%) more often assign this job to the full board.

As to how often this process is undertaken, 63% of respondents reported that their bank had reviewed director compensation in the last 12 monthsu00e2u20ac”and nearly 36% of those said it had been done in the last six months, with the greatest percentage of those responses coming from directors at the largest banks. However 16% noted it had been more than two years since director pay was last reviewed at their institution. When asked how often they think their compensation should be evaluated, 58% said annually, while 28% said every two years is adequate, and 13% believe every three years is enough.

Our survey group was equally split on what should be the primary gauge for setting and reviewing director compensation: 33% selected bank performance metrics (i.e., ROA, ROE, stock price); another 33% chose time spent on director duties; 30% picked peer bank comparisons.

Retainers and board fees

In many cases, these two areasu00e2u20ac”along with committee fees, which are broken out belowu00e2u20ac”form the backbone of a director’s compensation package. To assist with fair comparisons, this year we are providing breakouts of compensation levels at both holding companies and lead banks, as well as figures specifically for de novo banks (Figure 1). Overall, the median annual cash retainer for 2005 was $8,400 for all responding boards. That figure rose to $10,000 for holding company boards and came to $7,320 for lead bank boards. The overall median board meeting fee was $550, with a $600 median board fee for holding company directors and a $500 median fee for lead bank board members.

When analyzed by asset size (Figure 2), annual retainers and board fees generally increase proportionately, with the median board fee for directors at banks greater than $5 billion in assets nearly four times that of the board fee for directors at banks under $100 million in assets. Similarly, the median annual retainer for the largest banks is significantly larger than that of the smallest banks in our survey.

In comparison, the median time spent on director duties varies less dramatically, holding steady at about 10 hours per month for banks under $500 million in assets, moving to a median of 12 hours for those in the $501 million to $5 billion range, and ratcheting up to about 15 hours for those at banks greater than $5 billion in assets (Figure 3). This disparity, both in time and money, is likely due in part to the duties necessary to attend to more complex compliance requirements (such as Sarbanes-Oxley and Section 404) as well as to more complex corporate structures and the related financial oversight that larger bank boards are called upon to handle.

Committee work

Much of the board’s work is done by its various committees. To get a better handle on how much directors are paid for these duties, we’ve segregated fees for the major committees at both holding companies and lead banks (Figure 4).

According to our data, audit committee members receive as much as, and in some cases more than, other committee members, as a result of having to deal with stricter internal control and financial reporting guidelines that add significant responsibilities. Thus, the audit committee chairman has become a very demanding role on most boards. When we asked our respondents who most deserved additional compensation (Figure 5), it came as no surprise that the audit committee chairman was the most popular choice, named by 44%. Other positions named include lead director (26%), compensation committee chair (18%), and loan committee chair (17%). Regarding the latter, according to our survey, loan committee members meet an average of 21 times a year at lead banks and 16 times a year at holding companies. Executive committees are second, meeting an average of 12 times a year at lead banks and eight times a year at holding companies.

Equity

A review of equity compensation provided by a proxy study performed by Clark Consulting (Figure 6) shows that on the whole, equity levels are in line with those reported in 2005 and are also proportionate with asset size. While some banks rely heavily on equity as a percentage of total compensation, most institutions surveyed prefer a balance of equity and cash. In many instances, it depends on the stage of development for the bank (often de novos offer equity-only arrangements until the bank matures) or the psychology of the board toward how best to align the interests of directors with that of the institution.

As one director observed, “We are a young, healthy bank. The industry is very competitive at this time, but due to a very strong executive team and a strong, active board, we’re growing rapidly. We don’t believe in large cash fees for our directors; our comp is stock options, [which offer] better alignment.”

Benefits and training

Beyond cash and equity income, many directors are offered a variety of benefits that help round out their total compensation package. This year, more than 70% of our respondents reported receiving some form of benefits, with the top three as follows: education/training (40%), travel expenses (33%), and deferred compensation (24%). Others include life and medical insurance, retirement plans, and matching gift/charitable contributions. When asked to rate the top three benefits they would most like to receive, our respondents most frequently chose deferred compensation, director education/training, and retirement plans, though paid medical insurance received the most number-one votes.

The desire to receive additional training is really not surprising given that the role of the director has become much more complex. Nearly 70% of those surveyed reported participating in a director training event in the last 12 months. Some areas in particular require additional education today. While 79% of those surveyed believe their compensation committee has the skills and training necessary to perform its job (Figure 7), the survey shows that more than one-fifth are concerned about this issue, which may illustrate a need for further training on compensation programs and practices, for example.

Board and director evaluations are one fairly new tool being used by compensation committees and others in helping to determine how well the board is functioning and which areas require more attention and training (Figure 8). One-quarter of our respondents reported participating in full board, in-house evaluations, and 20% said their bank conducts individual, in-house director evaluations. However, this tool is far from being widely accepted as more than 60% stated that their board participates in neither full board nor individual evaluations. Of those that do participate, nearly 60% believe the evaluations are fair and promote a stronger, better-functioning board.

Balancing risk with reward

As the board or its compensation committee tries to balance the rate of compensation in proportion to the work required and what the bank can afford to pay, another factor it is likely to consider is the risk involved in serving as a director. The corporate arena has become much more litigious, and new governance standards and recent court decisions have raised the bar for personal accountability. Although financial institutions have long dealt with regulatory oversight, here, too, the rules have tightened considerably. This year, while 77% of our respondents indicated they are fairly compensated for the time required to perform their duties, 51% said they are not fairly compensated for the amount of risk they assume. Furthermore, 48% believe their risk of liability had increased in the last 12 months, and only 3% believe it had decreased, with the remainder indicating no change in the amount of risk they faced.

However, when asked about their level of concern with new SEC proxy rules requiring additional disclosure of executive and director compensation, only 35% pronounced themselves “very” or “somewhat” concerned, although this number is slightly higher for those at public institutions.

In reality, most of our survey respondents appear to be more concerned about executive compensation than their own. When asked which issues have been of greatest concern for their compensation committee in the last year, 60% chose executive compensation, 47% executive bonuses, and 27% executive benefits. Equity compensation (21%) and board compensation (20%) rounded out the top five concerns. Employment agreements, severance issues, and disclosure rules were also mentioned. The concern with executive compensation issues may well stem from the risk of litigation directors have observed when dealing with executive pay, particularly given recent high-profile cases in the last year or two.

The other major concern echoed by directors throughout the comments section of our survey was with compliance, and some directors report they are feeling the squeeze from the regulators. “Examiners seem to expect that outside directors should be more familiar with banking practices, rules, and regulations than most of us are,” one director commented.

Others took issue with the time they are now required to spend on disclosures. “The proxy is getting so demanding in what it requires … and is time consuming in preparation.” Another director picked up on this thread, adding, “Compliance issues inhibit bank earnings and take executive time [away] from profit-taking opportunities.”

The 21st century director

Board members these days have a lot to balance: more committee work, seemingly endless paperwork to read and prepare to help the bank stay in compliance, increased shareholder activism, and the ever-present risk of liabilityu00e2u20ac”all of which means more time spent on the job. But most directors seem up to the task and look on their role as a matter of honor and personal integrity. As one director noted, “I take my position very seriously and spend many hours per week studying banking regs and issues. I owe it to the stockholders, employees, and my fellow directors.”

At the same time, those who are responsible for running a clean, compliant, profitable bank deserve to reap the rewards of their hard work. One director put it all in perspective: “We have an active board, our bank continues to grow, and I believe we are well compensated for the work we do. Of course, who doesn’t want more money, but I feel like I could look a shareholder square in the eye about that.”