All eyes are focused on executive pay-the media, shareholders and regulators want to scrutinize the decisions of bank boards and compensation committees. That makes the job of the compensation committee difficult. It doesn’t help that the field of human resources is filled with so much industry jargon, and that deciphering terms and concepts muddles the heavy work of putting together a compensation package. The following questions seek to explore some of the terms and trends compensation committees should know.
What forms of pay are growing in popularity?
Banks are moving to pay more of overall compensation with performance-based incentives rather than strict salaries, either in the form of restricted stock that vests when performance triggers are met, or cash bonuses tied to performance. Banks can be remarkably different in their approach.
Usually, both short- and long-term goals are emphasized, perhaps tied to strategic goals, internal performance metrics and/or performance relative to a peer group. The most popular internal metrics are return on assets, return on equity and asset quality ratios. Restricted stock that vests over time may create an incentive for the executive to stay, but if it’s not tied to performance goals, it’s not performance-based pay. Increasingly influential shareholder advisory groups such as Institutional Shareholder Services (ISS) are pushing for performance-based pay tied to shareholder returns, and they influence the outcome of the say-on-pay advisory shareholder votes now required of public companies.
Deferring compensation is another increasingly popular option. It delays short-term cash bonuses over a one- to three-year period typically, based on the performance of the business the employee had direct control over.
What has fallen out of the favor?
Stock options have fallen out of favor for multiple reasons, says Susan O’Donnell, lead consultant for financial services for Meridian Compensation Partners, LLC. Also, tax gross-ups, where companies pay an employee extra to cover the employee’s taxes, have severe tax consequences now to discourage them, so they have pretty much gone the way of unfiltered cigarettes.
SERPs, which stands for Supplemental Executive Retirement Plans, were very popular with banks 10 or 20 years ago, but are less popular now, says Rose Marie Orens, partner at Compensation Advisory Partners. They are considered fairly expensive for the bank. Shareholder advisory groups also dislike them, because executives can get paid huge bundles at retirement that aren’t linked to the performance of the company. On the other hand, private banks still may find SERPs to be an attractive option because private banks don’t have equity to offer an executive. They also can be structured to allow performance-based vesting and measured contributions over a long period of time, says O’Donnell.
What considerations should go into the creation of a pay package?
Aligning pay with performance is perhaps the most important job of the compensation committee, says Orens. During a period of three to five years, there should be less pay for poor performing years and more pay during good years, she says. What are the company’s strategic objectives? More than 60 percent of banks in a recent Bank Director survey tied compensation to achievement of strategic goals. Orens says to ask: How are you translating business goals to the compensation program? How tough is your goal setting? How are you doing compared to your peers? What will the total compensation package cost the bank in terms of the largest payout possible? Is there a disconnect between internal performance metrics and shareholders’ returns? If so, why? How much discretion do you want in handing out incentive awards versus relying on specific metrics?
How should the compensation committee handle risk in executive pay?
It’s the board’s responsibility to review incentive plans for all employees that could put the bank at risk, including loan officers, according to Interagency Guidance on Sound Incentive Compensation Policies that went into effect in 2010. This applies to all banks and thrifts. Adjusting pay based on the risk inherent in that business is one way to reduce risk. So is deferring pay and bonuses to give the bank time to determine whether good credits and good business decisions were made. Regulators often focus on reducing risk in incentive pay packages, while shareholder advisory groups may emphasize pay that rewards high shareholder returns instead. Striking a balance is a difficult challenge. “Making money involves risk,” says O’Donnell.
Are there new regulations the board should know about?
There are several new rules for publicly traded companies. Say-on-pay advisory votes for shareholders are now required for all publicly traded banks and thrifts. Exchange-listed companies have new independence requirements for compensation committee members and the compensation firms that advise them. Many new rule changes have been proposed but not finalized, including rules requiring clawbacks of executive pay based on inaccurate financial statements, as well incentive pay disclosures in public company filings. There is a new Securities and Exchange Commission proposal for the calculation of a pay ratio that would enable shareholders to see how much the CEO makes versus the median company employee, but it will likely take more than a year for that to be finalized.