2008 Bank Director Compensation Review

If an artist were to paint the compensation landscape, this year’s canvas would feature some familiar broad strokes with a strong hint of new elements on the horizon. There are some recurring themes: cash compensation is up slightly; liability has increased; the time commitment is growing. But intertwined with these constants are two other movements that have come into more intense focus: performance-based pay and equity-based pay.

Although 83% of those responding to Bank Director‘s survey said their company does not employ performance metrics, performance-based pay was the board issue deemed most challenging by our respondents. Furthermore, 60% anticipate the governance spotlight on pay practices will better align pay and performance, and 66% expect an increase in “say on pay” proposals by shareholders who support performance-based pay. While these proposals primarily apply to executive remuneration at this time, director compensation practices often follow suit. Furthermore, while executive pay has always been considered the board’s domain, many in the industry are concerned there is potential for a power struggle with shareholders over what’s becoming an increasingly public subject.

Nearly all the directors interviewed for this article, however, appear ready to step up to the plate when it comes to aligning their interests with that of shareholders, and those we spoke to uniformly agree with the concept of mandated stock ownership. “Ownership changes your view of any situation,” says Charles J. Thal, audit committee chair for The Business Bank of St. Louis. “When you have a vested interest, I believe your interests better parallel those of the shareholders and depositors; [that is] safety and soundness.”

So while the topic of equity-based pay and alignment of ownership interests with that of board members continues to grow in acceptance, there is still a fair amount of discussion and debate on the best means for achieving that end. As one director remarked, “Bank comp is out of sync with what’s going on in the world. The conundrum is to hire and retain the best and brightest without giving away the (shareholders’) farm. Fair alignment only comes through equity.” The challenge for each institution is to find the scenario that works for them-there is no one-fits-all solution.

To assist your board in tackling these and other issues, we’ve collected survey data on compensation rates, types of equity pay, benefits and training, and related areas, breaking that information down as necessary by bank type, asset size, and region.

Survey overview

After compiling and analyzing this year’s data, it appears that cash compensation figures remained fairly steady overall, with increases most evident for directors serving on lead bank boards.

Specific increases were noted in annual retainers for directors at banks greater than $1 billion. Annual retainers for chairmen increased across asset sizes, with the exception of those at banks greater than $5 billion. Board meeting fees showed mostly moderate increases for directors and chairmen, regardless of asset size.

De novo banks registered increases in all categories, even though more than 10% of de novo respondents indicated they receive no compensation: “As a de novo bank,” one director wrote in, “the directors’ compensation is principally personal satisfaction in this start-up endeavor. We expect to revisit compensation when we reach profitability.” Even though many de novos delay the awarding of directors compensation, 88% of de novo directors who responded to our survey do receive some form of pay.

To get a more in-depth look at director pay, we’ve broken our survey data down into five basic compensation components: annual retainer, board meeting fees, committee meeting fees, equity income, and benefits. We found that 56% receive cash compensation only, while 39% receive both cash and equity compensation. Just over 2% reported receiving equity compensation only, and 3% receive no compensation whatsoever. Seventy-three percent of those at banks $251 to $500 million receive cash compensation only, while 81% of directors at banks greater than $5 billion receive both cash and equity. Those who receive no compensation are primarily from the smallest banks and are most often directors at de novos, as noted above.

In designing their plans, our survey found that 45% of boards rely on a compensation committee, while 29% keep that duty with the full board. Nearly 13% of respondents said the CEO at their bank sets director pay and 9% said the chairman has that responsibility.

When viewed from an asset-size perspective, we found that the full board is much more likely to set fee levels at banks $250 million and under, whereas mid-size community banks ($251 million to $500 million in assets) are more evenly split on using a compensation committee versus the full board. The use of a compensation committee is more prevalent at banks greater than $500 million in assets and CEO involvement is most often found at banks in the $1.1 billion to $5 billion asset range.

As to how often banks undertake this process, nearly two-thirds (61%) of our respondents reported having their compensation reviewed in the last 12 months-about half of those said it had been done in the last six months, with the greatest percentage of those responses coming from directors at banks in the $1.1 to $5 billion asset range. Somewhat surprisingly, 16% of those surveyed indicated it had been more than two years since their compensation was last reviewed.

Board fees: cash components

Retainers and meeting fees-At most banks, the annual retainer and/or board meeting fees-along with committee fees, which are detailed below-comprise the lion’s share of a director’s pay package. Many directors consider meeting fees their bread and butter for the hours they put into the job.

“Our board’s policy is to pay for both board meetings as well as committee meetings. Also, committee chairs are paid an extra amount. The time spent attending meetings is only a small part of the job, so paying a per-meeting fee is fair. Management is sensitive to these fees and makes sure that meetings are important and useful. The dynamics would be disturbed if these fees were removed,” notes director Eric Silverman, Leader Bank, N.A, Arlington, Massachusetts. Other directors were proponents of some type of performance measure, along with a more traditional fee structure. “I believe a combination of fixed fees/retainer blended with a performance incentive based on ROE/ROA and growth is the best overall structure. This keeps the board aligned with the needed benchmarks to drive the bank toward being a success,” says Jim Boyers, director, First Exchange Bank, Mannington, West Virginia.

Our research indicates 41% of directors receive both board meeting fees and an annual retainer-the majority of these are at public institutions greater than $500 million. To further assist in making peer comparisons, we’ve broken out compensation levels at both holding companies and lead banks, as well as figures specifically for de novos.

The overall median annual cash retainer for directors we surveyed is $9,600, matching last year’s figure. That figure rises slightly to $10,000 when viewed for holding company boards (a 9% decrease from last year) and sits at $8,000 for lead banks (a 14% increase over last year). The overall median board meeting fee is $700, with a $700 median board meeting fee at holding companies and a $600 median board meeting fee at lead banks (a $100 increase over last year).

When analyzed by asset size, annual retainers and board fees show a parallel relationship to asset size, with most fees increasing as the size of the bank increases. In terms of range, the median annual retainer for directors at banks greater than $5 billion in assets is four times that of the annual retainer for directors at banks $250 million and less. Similarly, the median board meeting fee for directors at the largest banks is more than twice the amount received by directors at the smallest banks.

By comparison, the median time spent on director duties-up from 10 to 12 hours per month overall-varies less dramatically when broken out by asset size. That moderate year-to-year increase may be the result of more time spent on governance/liability issues, which is a common theme throughout the industry and one that has surfaced in past surveys. As one respondent noted, “The significant increases in director liability (potential) and regulatory/law enhancements have resulted in significantly more time spent studying prior to board and committee meetings.” Another picked up on the “study” analogy, saying, “Being a director is becoming like going to college-two hours of preparation (study) for every one hour of meeting (class).”

For many directors, however, the bottom line is that they want to be compensated fairly and in line with the responsibility they are shouldering. “I am not nearly as concerned about the structure of director fees as I am that the total amount of these fees reflect director responsibility and liability,” says Gary J. Young, a director at Desert Hills Bank, Phoenix.

Remote meeting pay-A somewhat new issue has arisen with regard to directors who attend meetings through some electronic means-usually by telephone. There’s little doubt that directors who sit in a room together and hash out issues eye to eye are better able to work through challenging problems and reach consensus on solutions. But a director who cannot attend a meeting in person can still contribute his or her views by telephone, and he or she certainly offers more to the group than by being absent. Yet, for many, the situation begs the question: Is it equitable to pay directors who electronically attend meetings the same rate of pay as those who attend in person? Directors we interviewed are generally favorable toward the idea.

“We are compensated for phone-in participation, but the rate is set at $100 lower than in-person participation. There is additional value to in-person attendance, so this difference is fair. That said, if there was no compensation, there would be a disincentive to participate in those instances where in-person attendance was not possible,” says Eric Silverman.

John Kilcoyne, a director at Clinton Savings Bank, Clinton, Massachusetts, agrees paying a fee is appropriate. “As long as a director doesn’t abuse the option of attending an occasional meeting by phone, I think the fees should be at the same rate of pay received by directors attending meetings in person. In today’s busy society, combined with ever improving technology in the communications field, providing this kind of flexibility in attending meetings will probably become the norm for many businesses, including banks.”

Several directors we interviewed shared similar views, but others had reservations about allowing such situations to get out of hand. For example, says Michael Rabbett, a director at Windsor Federal Savings & Loan Association in Windsor, Connecticut, “If an emergency requires a director to be unable to attend a meeting, full compensation should be paid. If, however, that person frequently is unable to attend in person, serious consideration should be taken to [he or she] retiring from the board.”

Equity pay: aligning with shareholder interests

Across the board, directors told us they were solidly in favor of a compensation plan that enhances their ability to share the perspective of the shareholders they represent.

“It is essential that directors demonstrate their commitment to the bank by maintaining a significant investment position in the bank’s shares,” says director Hayden D. Watson, of Austin, Texas-based Treaty Oak Bank. Clyde White, a director of Ouachita Independent Bank, Shreveport, Louisiana, agrees: “I most certainly believe that directors should own a reasonable amount of stock in the institution. If they don’t have some skin in the game, how can they empathize with stockholders?”

“No question in my mind that equity is the best and fairest way to couple these sometimes disparate interests and is probably the single most effective way to build strong bonds between the company and her shareholders. The ‘thrill of victory or the agony of defeat’ is shared by all,” says A.J. Thompson Jr., director, The Peoples National Bank, Easley, South Carolina.

In the end, the best option is often a combination of the cash/equity ratio. One provides stability; the other offers upside potential and some level of risk/reward. “A combination of cash (per-meeting fees) and equity compensation is the most appropriate method of ensuring that overall director compensation is aligned with shareholder interests. The equity component should be awarded annually based on the bank’s performance on key metrics relative to a designated peer group,” Treaty Oak’s Watson says.

Performance metrics: yea or nay?

One of the great debates within the scope of director compensation issues is whether to base all or part of board pay on one or more aspects of the bank’s performance. There are many different approaches taken by companies that target pay based upon performance metrics such as return on assets, return on equity, earnings growth, or even CAMELS ratings, to name a few. Finding the right mix of performance goals is not a one-size-fits-all situation-each institution will have certain areas that it wishes to promote, and those goals may change from year to year. There are also diverse views on whether such a system is a sound method for quantifying director remuneration. Proponents take the view that such a structure provides a better alliance between owners and directors; others feel it skews directors’ thinking too much toward a single performance measure for the bank.

“I think that rewarding above-average performance with some form of reasonable bonus or fringe benefit increases directors’ incentive to perform at a higher level,” says director John Kilcoyne. Gary Young agrees. “It is critical that board compensation, like management compensation, should reflect bank performance. I would recommend a bonus for directors based on performance.” However, Young points out that the downside, whether it be from regulatory action or severe capital problems, should never result in punitive compensation.

Marvin Schrager, a director at Treaty Oak Bancorp, Austin, Texas, says the caveat with this type of structure is that the directors may tend to hyperfocus on a singular facet of the bank’s performance. “If you start setting pay based on performance (of some sort) you run the risk of the directors wanting to micromanage the bank’s operation in an attempt to maximize their compensation,” he asserts.

Both sides of the argument make good points, say compensation experts, but the key is finding a formula that works for each individual board. Having some means of flexibility is important, also, consultants say, in order to meaningfully respond to different aspects of performance that may change depending on the circumstances at hand.

Committee work

By and large, a good deal of the board’s business is conducted via committee. The top two committees on which our respondents serve are loan (48%, 11% are chairmen) and audit (43%, 17% are chairmen). For a better understanding of how much directors are paid for these duties, we’ve isolated fees for the major committees at both holding companies and lead banks (Figure 6) by director fees per meeting and by annual retainer (our research indicates only 7% receive both) as well as chairman fees.

According to our survey, governance/nominating members are the highest paid on a per-meeting basis, while audit committee members are the most likely to receive annual retainers. Furthermore, audit committee chairs at holding companies receive the highest annual fees-at least double the fees for chairmen of other committees. This year’s data also shows significant increases for loan committee members at both holding companies and lead banks.

With regard to time spent on committee duties, our survey found that loan committee members meet most often, an average of 17 times a year at holding companies and 23 times annually at lead banks, followed by executive committee members, who meet an average of seven times a year at holding companies and nine times annually at lead banks.

Benefits and training

In addition to cash and equity income, the majority of directors (68% of those surveyed) are offered benefits to supplement their compensation package. According to our respondents, the three benefits most likely to be received are education and training (34%), travel expenses (31%), and deferred compensation (26%), mirroring last year’s results. Rounding out the list: life and medical insurance, retirement plans, and charitable contributions, among others mentioned.

Managing risk

Beyond the workload and time commitment, directors also must deal with the risks involved in board service. Given the spate of new requirements and increased scrutiny by regulators, along with escalating involvement by shareholders, boards are paying more attention than ever to accountability and the potential for liability, both professionally and personally. In fact, 75% of those surveyed believe the risk level for directors increased during the previous year, a 56% jump over last year’s number. Less than 1% of directors indicated director risk had decreased, with the remainder asserting the risk level for directors remained unchanged. As one director succinctly noted, “The current banking environment is creating more liability for directors. Regulators appear to be overreacting to the situation.

The big picture: looking ahead

All in all, the directors we surveyed seem pleased with how their board handles director compensation. Rated on a scale of 1 to 5, with 1 being “very well,” the average rating was 2.25. However, not everyone is satisfied. “Outside directors’ compensation has not kept pace with potential liabilities” and “compensation is pretty much controlled by chair/CEO as he and his family are majority stockholders” are familiar refrains from past surveys.

Others are very worried about the business economy. As one director noted: “These are challenging times in a difficult economic climate. Many banks will spend the next year or so just surviving.”

Despite their concerns and the challenges that lie ahead, most of our respondents agree that it continues to be an honor to serve as a bank director. When asked to rate the benefits of board service in terms of thinking about accepting a new board seat, our respondents gave “providing community service” their highest marks. Rounding out the top five were paid expenses for board service, levels of cash fees/retainers, equity compensation, and networking opportunities.

So while compensation is important, it isn’t the primary reason most directors serve. And over the years, many have told us it would be difficult to compensate fully for the liability incurred, regardless. Each board simply must do its best to consider its own dynamics, draw on peer comparisons, and arrive at a fair remuneration that will allow the bank to build its board with the strongest talent available.

Bank Director wishes to thank those board members who responded and helped make the survey a success. We are also grateful for the assistance of Amalfi Consulting in serving as a cosponsor of this project.

Respondent Profile

Of the 511 surveys returned, approximately three-fourths were from directors at banks $1 billion and under in assets: 27% were from those in the $251 million to $500 million range; 24% were from those in the $501 million to $1 billion range; and 22% were from those $250 million and below. Of the remaining 26%, 8% were from directors at banks greater than $5 billion in assets. The typical survey respondent is an outside director (71%) at a public community bank in the Midwest.

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