Skin in the Game

Stock Ownership.pngInvestors like directors to have some skin in the game-a significant enough ownership stake to make them think like shareholders, not hands-off managers. Regulators also want board members feeling like owners, viewing it as an effective deterrent on excessive risk-taking.

The question is, how many shares should that be?

There are no definitive answers. Non-employee directors of nationally chartered banks and holding companies are required by law to own $1,000 in their institution’s shares-a throwback requirement that is easily surpassed by most board members.

Institutional Shareholder Services, the influential proxy advisor, gives the most points in its QualityScore rating system to companies where directors own shares worth at least five times their annual cash retainers-a level it terms “robust.”

“If you have three times [the retainer] you get some points, but not the full amount,” says Natalia Weaver, a vice president for ISS Corporate Solutions, a subsidiary that provides advisory services. “Five times the retainer is the best practice.”

Yet according to ISS figures, only 35 percent of publicly traded banks actually hit that lofty level. Many compensation consultants peg three times a director’s retainer as a comfortable target, but required ownership levels at a significant number of banks (and other companies) don’t even come close to approaching those figures.

“We work with a lot of privately held banks and standalone institutions where the directors don’t own any shares,” says Robert Fleetwood, a partner in the financial institutions group at Barack Ferrazzano Kirschbaum & Nagelberg, a Chicago law firm.

“If someone is happy getting cash compensation and likes the prestige and experience of serving on the board, that’s usually good enough,” he adds.

At the same time, many privately owned banks won’t put anyone on the board who isn’t a significant shareholder: Indeed, ownership is the ticket to a board seat.

For publicly owned banks, disclosure is often considered more important than the actual levels. ISS gives a black mark to companies that don’t include ownership guidelines in their proxy statements; many large investors won’t specify targets, but want guidelines in place.

Despite that, in 2016 a whopping 34 percent of banks in the Russell 3000 disclosed no guidelines at all.

Good guidelines state the levels of ownership required, how much time directors have to build their positions, what types of equity can be used to meet the requirement and how long shares must be held.

Depending on the guidelines, directors who don’t live up to expectations could risk not being nominated in future elections, though no one interviewed can remember it happening.

More common is for the rare scofflaw to receive retainer and fees in stock until they catch up, says Michael Melbinger, an executive compensation expert and partner at Winston & Strawn, a law firm.

Setting ownership targets is part art, part science. Consultants and lawyers say they see a lot of variation, in both how much equity ownership is required and how the quantity is measured. While ISS looms large in many boards’ thinking, factors such as culture, the institution’s age and what peers are doing weigh just as heavily.

“The standard practice is to shoot down the middle of your peer group,” says Matthew Goforth, a research specialist with Equilar, a board consultant. “No one wants to get creative with ownership guidelines. It’s about getting in a window that works for the board and keeps shareholders and governance advisors happy.”

The shares are sometimes purchased-a handful of institutions require directors buy some of their shares on the open market-but more often are accumulated through grants that are designed to help a new board member to achieve the targeted threshold within the desired timeframe.

Most financial institutions don’t count directors’ unexercised options as equity, though they usually count restricted shares and deferred equity. Many have holding periods that require shares to be held until a year or more after the director leaves the board.

“Banks almost always take the more conservative approach in these matters,” Melbinger says.

While many banks measure ownership in multiples-of-retainer terms, it’s also common to see a bank set a specific number of shares or simply a dollar amount. More than a few expect directors to own more shares than their formal guidelines state.

“You’ll see boards saying…. ‘We want them to be very invested in this, giving their best and greatest thoughts,’” says Todd Leone, a Minneapolis-based partner with McLagan Aon Hewitt, a compensation consultant.

“Having an equity ownership requirement that’s significantly above the three-to-five times requirement makes it real for them,” Leone adds.

Statistics show that larger banks are much more likely to boast high board ownership levels, due to greater shareholder scrutiny and regulator desires to see directors invested in their risk-management duties.

At Wells Fargo & Co., for example, outside directors are given five years to build a position with value equal to five times their annual cash retainer, which in 2016 was $75,000.

Pittsburgh-based PNC Financial Services Group requires directors to own a straight 5,000 shares of company stock-which, at a recent price of $125 per-share, is equal to about $600,000, a hefty nine times the last year’s $67,000 base retainer.

Regulators of large-cap banks want directors to have some real skin in the game, to ensure they’re managing for long-term value and aren’t taking any excessive risk,” says George Paulin, chairman of Frederic W. Cook & Co., a compensation consultant.

There is more variety at the regional bank level. Iberiabank Corp., a $20 billion asset institution based in Lafayette, Louisiana, sets the level at three times the annual retainer, which was about $50,000 in 2016.

The board of F.N.B. Corp., a $31 billion asset company based in Pittsburgh, reviewed its guidelines in 2016 and boosted its required ownership levels to the lesser of 40,000 shares or $400,000-up from previous levels of 35,000 shares or $350,000. At a recent share price of $13, directors must own 31,000 shares.

David Malone, F.N.B.’s compensation committee chairman, notes that the company has grown substantially in recent years, but had not examined director equity ownership in more than a decade.

The committee reviewed peer data and the financial situations of its board members before suggesting the increase to the full board. ISS’ views were a consideration, but only after the fact.

“We try to think about where we’re trying to go as an organization and what is fair for board members and shareholders,” says Malone.

“Being a director is a hard job,” he adds. “At the end of the day, we want to make sure that we’ve got everyone’s attention on a regular basis.”

There is little pushback among directors to such mandates. For many, owning a piece of the bank is one of the chief appeals of board service. Banking is a profitable business, and being able to help drive personal financial success while also doing good for the community is a compelling proposition.

To make sure there weren’t any problems, Malone’s committee met with individual directors before bumping up F.N.B.’s ownership requirements and got their buy-in. “It’s been a pretty good investment, so it didn’t take a huge sales job,” he says.

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