Seeing Red Over Green

Board members everywhere are feeling heat from shareholders over big executive compensation packages. Sometimes the scrutiny can inspire director outrage, and even departures. At $800 million Tennessee Commerce Bancorp in Franklin, Tennessee, three directors abruptly resigned this summer after the board approved a big pay hike for the companyu00e2u20acu2122s top four executives, including Chairman and CEO Arthur Helf.

In their letters of resignation, filed in July with the Securities and Exchange Commission, the directorsu00e2u20ac”private investor Fowler Low, Winston Hickman, a principal of a Nashville construction firm, and Regg Swanson, president of a local operator of physical therapy clinicsu00e2u20ac”all cited the new comp policy, and its approval process, as the reason for their exits.

u00e2u20acu0153I feel the direction the executive management has taken regarding their compensation is unethical,u00e2u20ac Swanson, 53, wrote in his resignation letter. u00e2u20acu0153Their desire to attain compensation that I feel is excessive, u00e2u20acu00a6 and the subsequent vote process which granted the compensation, has violated my trust in management of the bank.u00e2u20acGeorge Fort, Tennessee Commerceu00e2u20acu2122s chief financial officer and spokesman, declined to be interviewed for this story.

While individual directors sometimes step down over policy differences, Charles Elson, director of the University of Delawareu00e2u20acu2122s corporate governance center, says heu00e2u20acu2122s never heard of three resigning at once. u00e2u20acu0153Itu00e2u20acu2122s rather extraordinary,u00e2u20ac he says. u00e2u20acu0153To have [the resignations] accompanied by a harsh public critique of company policy sends a pretty negative signal to the world about the directorsu00e2u20acu2122 view of the company.u00e2u20ac

At issue was both the size of the increase and the process. The base salaries of both Helf and President Michael Sapp each more than doubled, to $400,000, from $190,000 in 2006, while Fortu00e2u20acu2122s base pay jumped to $335,000, from $130,000. They and one other executive each were granted 50,000 in stock options, which vest over the next five years if the company meets performance goals.

Yet, in a world of eight-digit pay packages, the increase doesnu00e2u20acu2122t appear terribly egregious. A one-branch business bank, Tennessee Commerce was launched in 2000, and has grown rapidly. Net income for the second quarter jumped 72.9% over a year earlier, to 34 cents per-share, powered by a 50% growth in loans and a 48% jump in deposits. Return on equity was 11.71%, while return on assets was 0.91%.

Sapp, who is also a director, told investors that the raises were u00e2u20acu0153an attempt to restore some parity with our peers,u00e2u20ac according to one news report. To get there, the board followed some best practices. It employed a consultantu00e2u20acu2122s benchmarking study, and got an opinion from outside counsel on the legality of the process. The board then won shareholder approval for the new plan.

Even so, the dissidentsu00e2u20acu2122 criticisms were harsh. In his resignation letter, Low, a former chairman and CEO of shoe retailer Johnston & Murphy, charged inside directors with voting for each othersu00e2u20acu2122 pay hikes in an u00e2u20acu0153I cover you and you cover meu00e2u20ac manner. (The firm that established the benchmarking could not comment for the story, citing client confidentiality.)

At the time, the board didnu00e2u20acu2122t have an independent compensation committee, instead relying on the full 13-member board to fill that role. Three of the four executives who got pay hikes also serve as directors, and voted on the new compensation policy.

The lack of an independent compensation committeeu00e2u20ac”a Nasdaq listing requirementu00e2u20ac”got Tennessee Commerce in trouble with the exchange, which in late July issued a letter of reprimand. The company reportedly established independent comp and nominating committees as a result, and Nasdaq closed its review. But in October, the exchange issued a letter stating that Tennessee Commerce was not in compliance with listing requirements. The company is appealing the exchangeu00e2u20acu2122s findings.

The lesson for other boards is to keep practices and structures a step ahead of the companyu00e2u20acu2122s evolution. While having three management insiders isnu00e2u20acu2122t uncommon for the board of a private startup, it is for a public company with a $100 million-plus market cap. The appearance that top managers are involved in approving large pay increases can spark unease among outside directors.

u00e2u20acu0153A lot of boards go along following old practices and not adapting. Then something like this comes up, and theyu00e2u20acu2122re stuck because they havenu00e2u20acu2122t thought through the ramifications,u00e2u20ac says Eleanor Bloxham, CEO of The Value Alliance, a Columbus, Ohio-based governance firm. The dissidents u00e2u20acu0153clearly felt they had no alternative but to leave.u00e2u20ac As a result, Tennessee Commerce will go on, but without three of the directors that got it this far.