Five Factors Directors Should Consider Before Granting Equity Awards

8-7-13-Pearl-Meyer.jpgThe three-year average total shareholder return of the KBW Regional Banking Index was greater than 13 percent as of June 30, 2013. Banking stocks are recovering, creating renewed interest in programs that reward executives appropriately for continued growth in share price and dividend yield.

Options provide the most direct reward for creating shareholder value. If the stock price goes up, executives and shareholders alike share in the upside. The counter argument is that options are far too subject to market whims and since an executive receives more “return” with options as the stock price increases, this could motivate the very behaviors that started the financial crisis. 

Restricted stock may seem like a safer alternative, but without some type of performance element, the awards may just serve as an incentive for executives to stay put, at least until their awards vest. 

In this environment, how do directors design equity awards that will provide a meaningful link back to shareholder value? 

There are five questions that directors can ask to gain clarity and create an effective equity grant strategy:

1. Who should receive an award?

There is often a consensus that senior management should receive equity as a normal part of the pay program. The subject of debate is typically who should receive awards below that level. Competitive practice, dilution and financial impact all play a role in determining how deep equity awards are granted within a bank. In our experience, the answer truly depends on the culture of the organization and what messages the bank wants to send regarding the behaviors that are most valued. If individual performance is important, defining and rewarding a pool of top performers can be highly effective. If revenue production is king, granting equity to top producers in areas such as commercial lending may aid in the retention of key rainmakers.

2. Is the goal of granting equity awards to reward performance or to retain executive talent?

In a recent survey conducted by Pearl Meyer & Partners, reward and retention tied at 89 percent as the top long-term incentive objectives for banks. Such multiple strategic objectives may call for granting both time- and performance-based awards. For example, a bank may decide to grant part of the award in time-vested restricted stock that is subject to holding requirements and provide the remainder as performance-based restricted stock.

3. Should performance-based awards strictly reward total shareholder return or operational performance that may result in a higher stock price?

In the same survey, nearly 70 percent of banks said they evaluate their long-term incentive programs on the basis of positive operational performance, versus 42.7 percent who focus on gains in total shareholder return. Members of management who believe that vagaries in the stock market are not under their control generally would prefer measures that correlate to increased shareholder value such as earnings per share, tangible book value, return on assets and return on equity as the key metrics for granting stock or vesting stock. 

4. Once an award is exercised or vested, what is the executive’s obligation?

One of the primary reasons for granting equity awards is to promote executive stock ownership, since tying a significant portion of an executive’s wealth to share price puts that executive on the same side as shareholders. The counterargument, however, is that long-term incentives are just that—incentives—and if performance is achieved, the executive should be able to reap the reward. Defining retention requirements and/or ownership requirements upfront can address these issues by establishing reasonable expectations around the executive’s obligation and what may be received as a reward.

5. How do we handle competing goals in our equity grant strategy?

Often, bank boards and management teams want to achieve multiple goals in their equity strategy. Being deliberate in the mix of equity types, the selection of eligible employees and the achievable retention/ownership guidelines will provide a balanced approach. 

What Keeps Bankers Up at Night

exhausted.jpgEvery industry has plaguing problems that just don’t go away. The fact that most of the issues with banking tend to turn into headlines only intensifies the anxiety we feel each day. Recently, Bank Director and Meyer-Chatfield Compensation Advisors conducted the 2012 bank director compensation survey to get first-hand information on the issues and trends regarding pay at the board level.

What Are the Stress Points on Bank Boards? Looking past the headlines, the survey enables us to get inside the heads of directors across the country to see what’s really concerning them.  Here’s what we saw as recurring issues in the banking industry:

  • Employee Retention
  • Succession Planning
  • Tying Compensation to Performance

Investing in Key Employees

Bankers are worried about losing key employees. At Meyer-Chatfield Compensation Advisors, we’ve seen a big increase in employee departures at companies around the country. There are triple digit increases in turnover on both the chief executive officer and chief financial officer level, with average turnover of about 37 percent in the CEO role and 75 percent for the chief financial officer. We’re seeing a 94 percent increase in turnover from the C-Suite down through corporate vice president levels.  Those are some pretty staggering numbers.  As the numbers continue to soar, bankers are concerned that their employee retention programs may not be strong enough to keep the employees they need. They are worried they’ll lose their best employees to the competition. Plus, with increased government regulations, many key executives are frustrated by the restrictions on the banking industry and are taking their talents to industries that are less scrutinized by government regulators. A trend we’re seeing is younger executives jumping ship in order to work for industries with less bureaucracy for higher pay.

Who’s Next?  Are Succession Plans in Place?

Another concern that is closely related to retention is succession planning. Many banks recognize that they have an aging executive team. Are younger executives being groomed for the next step?  And have banks done enough to retain new talent to keep them on board? Few things are as disruptive to a bank as a shake-up in the senior ranks. Without a succession plan, a bank cannot act quickly to attract talent and it runs the risk of losing other key members of the team. 

Banks in rural areas are also challenged by the higher amounts required to provide the salary and compensation packages that can attract the level of employees they need to thrive.  Compensation packages that were acceptable by a previous executive may not be suitable for the replacement. The local talent pool may not provide the right candidates and going outside the market costs money that some banks can’t afford. But not having the right talent in place can be much more costly.

Knowing How Compensation Can Help

The final issue that is at the core of most bankers’ angst is in understanding how compensation can work for them. This is a two-fold issue. First to consider is whether the board understands the impact compensation has on retention and succession planning. While compensation and benefits are the largest component of operating expenses, compensation isn’t an issue until something happens to turn it into an issue. Someone retires. Someone resigns. Someone dies. Suddenly compensation and benefits are at the forefront and the board is reacting to the situation. Compensation is most effective when it’s proactive.

The second part of the issue is that directors may not understand how to connect compensation back to the strategic plan. Nearly 44 percent of respondents of the survey revealed that CEO compensation is not linked to a strategic plan. Our conversations with bankers indicate that there may be a misunderstanding from the board on how their compensation is tied into the goals in the strategic plan. Effective compensation plans are based on achieving goals and meeting key performance indicators. From the bankers’ standpoint, they understand the link, but may feel that directors and board members are removed from the connection. 

Putting Compensation Anxiety to Rest

Surveys always spark conversation. And the compensation survey reveals the need for more conversation between bank officers and their boards. Frank discussions on retention strategies and succession planning are needed to alleviate stress. While compensation planning isn’t as complicated as quantum physics, it does require a strong level of focus to resolve the concerns that keep us up at night. Discuss the issues with your board. Talk about solutions. Resolve them before they become real problems.

Overworked, Underpaid and Unappreciated

Bank directors face familiar compensation challenges this year, but frustration with the board’s ability to handle these challenges appears to be increasing. That is according to the results of Bank Director’s 2012 board compensation survey co-sponsored by Meyer-Chatfield Compensation Advisors, which included nearly 550 CEO and director responses.

This year, only 58 percent of respondents feel their board is managing executive compensation well or very well, compared to 63 percent last year and 74 percent in 2010. Similarly, only 53 percent feel director compensation is being managed well or very well, compared to 56 percent last year and 68 percent in 2010.   

Meyer-Chatfield Compensation Advisors President Flynt Gallagher says that some of this dissatisfaction is the result of increased scrutiny from shareholders, regulators and the market.

In some cases, this increased scrutiny may be translating to increasing workloads for directors. The median hours spent on the job for institutions of all asset sizes remained the same this year as last year at 15 per month, but there were large changes in the hours reported by banks in the highest and lowest asset categories. While directors from the largest banks reported working fewer hours this year, the opposite was true for their small counterparts. Directors at banks with under $100 million in assets report working 20 hours per month this year; that is 5 hours more than they reported working last year and double the year before.

Justin Heideman, a director at Town & Country Bank in Saint George, Utah, a de novo institution with less than $70 million in assets, says he has no doubt directors at these smaller institutions are putting in more hours. He says the main reason is compliance.  “We have the same requirements on the [information technology] side in terms of safeguards that a major bank has,” says Heideman.  “It’s nonsensical the amount of time that is required to make sure that compliance is appropriate and to make sure we do all of our training. We have to do pop quizzes like I was in second grade during board meetings to make sure our training is done and to prove we are being trained.  It’s ridiculous.”

On a positive note for directors, more respondents (32 percent) expect director compensation at their banks to increase in 2013 than in 2012 (28 percent). Only 1 percent of respondents expect a decrease in compensation in 2013, and 67 percent expect director pay to stay the same.

Gallagher says the financial performance of many banks is showing an improvement after struggling with asset quality issues, lower margins and lower profits in recent years. With this improvement some banks are feeling relief and even optimism. 

The median board meeting fee for outside directors stayed the same this year as last year at $600 per meeting, while the median meeting fee for a chairman rose slightly from $600 last year to $675 this year. 

And yet, even as compensation holds steady or even increases, benefits for directors continue to erode. The number of banks offering zero benefits to outside directors has significantly increased—46 percent this year compared to 39 percent last year and only 28 percent the year before. 

Making cuts to benefits while keeping compensation steady might make sense for many banks, as it seems to align with what directors find most important when considering a new board seat. When asked to rank the importance of types of benefits and compensation when considering a new board seat, 51 percent of directors assign little or no importance to retirement plans while only 27 percent find them important or very important. Similarly, 44 percent of directors assign little or no importance to insurance benefits, while 28 percent find them important or very important.

It is important to note that many respondents report liability and potential growth of the institution are even more important factors when considering a board seat than the compensation or benefits package. Clyde White, chairman and CEO of Ouachita Independent Bank, a commercial bank in Monroe, Louisiana, with $570 million in assets, had this to say: “If I were considering joining a bank board, I would want to know what investment opportunity I would have and what the potential for growth is of that investment. I would also want to know what value I would be expected to bring to the table [i.e., business development activities, business acumen].”

The compensation survey was emailed throughout April and May to CEOs and directors at banks ranging in asset size from under $100 million to more than $5 billion. The response rate was 5.7 percent, with 549 responses. Of the banks represented, 9 percent have less than $100 million in assets, 25 percent are between $100 million and $250 million, 24 percent are between $251 million and $500 million, 17 percent are between $501 million and $1 billion, 18 percent are between $1.1 billion and $5 billion and 6 percent have more than $5 billion in assets. Of the respondents, 40 percent are publicly traded, 56 percent are private and 4 percent are mutual. Only 14 percent are de novo banks. 

For the survey report including committee fee pay breakdowns, click here.

The Movement to Redefine Compensation, Cost and Control in the Era of Consolidation

merger-chess.jpgMergers have become a big part of the banking landscape. The number of banks and savings institutions in the US dropped by 10 percent between 2004 and 2009, due to a record number of struggling banks either closing or merging with financially healthy ones. Increasing regulation could lead to more consolidation among community banks as well. The uptick in activity continued in to 2011 and is expected to increase throughout 2012.  

With this increase, bank directors, C-suite executives and others in the banking industry are challenged to better understand the compensation plans of all parties involved in a merger or acquisition. Interestingly, the March 2011 Harvard Business Review points out that 70 to 90 percent of mergers and acquisitions fail.  The primary reason for many of these failures stems from an inability to address personnel issues. 

Flynt Gallagher, president of Meyer-Chatfield Compensation Advisors, recently spoke at Bank Director’s Acquire or Be Acquired conference, where he provided insights into the trends impacting compensation in the banking industry. The primary trends include:

Shareholder Activism:  the need for shareholders to have a say on pay for executives, as well as to have better control on executive golden parachutes.

Sensitivity to Wealth Accumulation:  a new mentality on excessive annual bonuses and abusive stock options.

Compensation Arrangements under Scrutiny:  In today’s cost-cutting economy, compensation is viewed as costly to a corporation and its shareholders and a place where concessions can be made.

Understand Your Agreements

It’s important to fully understand the compensation plans for all of the parties involved in a merger or acquisition.  Without comprehending the terms of your compensation plans, you could find yourself in an ugly situation.  In one case, a bank was able to terminate an executive, but could not terminate his compensation.  The executive was paid for nearly 20 years after he was fired.  On the opposite end of the spectrum, an executive who could not quit or be terminated for any reason because he would have to pay his bank for one year of his salary.  Frustrations such as these showcase the need to review and understand the terms of all your compensation plans.

Use Non-Compete Agreements to Avoid Higher Tax Burden

To avoid issues, Gallagher recommends addressing employment agreements during compensation negotiations.  Limit the scope, revise or remove change-in-control provisions that expose the executive and the bank to IRC 280G, the tax on excessive golden parachute payments.  This results in a 20 percent excise tax to the executive, loss of income tax deduction to the bank, as well as the need to pay income taxes on the benefit payment.  Instead, Gallagher recommends using non-compete agreements that eliminate the bank’s exposure for IRC 280G and the excise tax.   This instantly provides shareholders with a value equal to the payment for service and allows the bank (and the executive) to retain a greater portion of the payment —unlike change-in-control agreements.

Use Performance-Adjusted Restricted Stock

Gallagher also recommends taking a closer look at using Performance-Adjusted Restricted Stock (PARS) to control the expenses on compensation.  This approach mitigates any shortfalls compared to other options in the marketplace. 

Consider Nonqualified Plans

More executives are realizing more of their benefits from nonqualified plans than ever before.  This approach is also viewed favorably by regulators, plus it reduces the bank’s obligations and establishes a fixed cost for a defined benefit.  It also maintains the current level of executive benefits without any additional cost to the bank.  Gallagher’s company, Meyer-Chatfield Compensation Advisors, also has a program called LINQS+ that reduces the expense associated with nonqualified deferred compensation plans such as supplemental executive retirement plans (SERP) or salary continuation plans without reducing retirement benefits due to executives.

Through the accounting methodology of LINQS+, traditional defined benefit SERP plans are extended from a 15 years into a lifetime benefit to the executive.  This reduces the expense to bank, saving them a significant amount of money without reducing the benefits paid to the executive.  

Improve your Chances for Success

In order to orchestrate a successful merger or acquisition, it’s crucial to develop a plan that enables you to review compensation plans, evaluate non-compete agreements and look for new ways to retain and motivate your key employees.  Put yourself in a better position and avoid costly mistakes by implementing programs based on these principles.

New Thinking on How to Handle Key Employees

Companies are trying to rethink executive pay packages in an environment of increased media, shareholder and regulatory scrutiny. New rules on pay are encouraging pay structures to reduce risk. But the problem of getting and keeping great employees is as pressing as it’s ever been. Meyer-Chatfield Compensation Advisors President Flynt Gallagher talks about ways to reward performance while reducing risk.

Is pay-for-performance the best approach to attracting and retaining key executives?

Pay-for-performance is not new, but it seems to get reinvented when the economy doesn’t cooperate.  The idea seems perfect.  In reality, however, the process of connecting pay to performance is far more difficult than it appears.

For the most part, a large percentage of an executive pay package is tied to the company’s stock.  As a result, the market may not be rewarding the executives for doing a good job. The stock market is not a rational indicator of a management team’s success year to year. If a company’s stock price is the gauge by which an executive’s success is measured, does that mean that when the dotcoms had a high price they were well managed? Certain industries, even in bad times, are on the rise. Does that have anything to do with the quality of their management teams?   There’s a mixed signal to executives asking them to take a long term view, yet they are measured quarter to quarter by stock market performance. 

Is there a better way to handle executive compensation?

The key to our economic recovery is to remove the handcuffs and the government’s position on pay. We need to get back to the free enterprise system, the fabric America was built on, and provide the incentives for the talent needed. No company wants to over-compensate or under-compensate, but the decision regarding the amounts paid to executives certainly can’t be left to Washington.

Maybe it’s time for a little creative thinking. Companies need to be able to attract and retain the talent that will make a difference during this recovery and consider approaches outside the box.

Nonqualified deferred compensation is a device that can work in concert with a company’s strategy and unquestionably aligns the interest of the executive with shareholders. These plans are friendly to shareholders, as there is no dilution in ownership, nor does the company have any significant cost of providing a plan.  The monies deferred are held as general assets by the company, subject to the claims of the company’s creditors. Executives are not taxed on those dollars until they are withdrawn, because they are at risk if the company fails.

What are the benefits of a performance-based Supplemental Executive Retirement Plan?

Traditional SERPs have been criticized by the media, shareholders, shareholder advocacy groups, boards and even the academic community. Their main criticism is that these plans have no performance element to them. Despite the negative sentiment regarding SERPs, there likely will be increased use of these plans, however, with a new design twist focusing the contributions on company performance. This concept is worth consideration for those companies looking for cost effective ways to attract, retain and reward key employees who can make a difference. A properly designed performance-based SERP can help companies reward executives for achievements that drive the company in the right direction, without the volatility of the stock price.

What words of encouragement can we provide to the industry?

The only way many companies can recover is to have the right people in key management roles; therefore, attracting and retaining people is critical.  It’s time to think a little more creatively.

The media and Washington would have us all believe that the senior executives in major companies and their rush to line their own pockets are at the core of the nation’s economic woes.  Executive compensation packages have been vilified and considered to be nothing more than corporate greed that is limiting our economic growth.  But if we are going to get this economy turned around, aren’t these executives the same people with the potential to restore investor confidence and market growth?

Trends in CEO Pay: Work Now, Get Paid Later

The financial crisis has had a huge impact on the way banks pay their executives and even their loan officers, but CEO pay is definitely creeping back upward. The smallest community banks to the international mega-banks have all made changes in the last few years to reduce the likelihood that employees will take big risks that threaten the long-term health of their financial institutions.

Many banks are moving away from short-term incentives, paying smaller amounts in cash bonuses for meeting short-term performance goals, and paying equity gradually over a longer period of time in the form of restricted stock based on performance goals.

One of those banks is First Commonwealth Financial Corp. in Indiana, Pennsylvania, a $6 billion-asset institution with 112 offices.

Bob Ventura, chairman of the board’s compensation and human resources committee, said at Bank Director’s Bank Executive & Board Compensation conference in Chicago recently that the bank has moved from paying a roughly 75 percent/25 percent ratio of compensation in short/long term pay to now using a 65/35 ratio.

Even more changes have been made from a risk standpoint among loan officers.

“We have gotten away from volume goals and put some profitability goals in there,’’ he said, adding that there’s an 18-month time period to get paid the full incentive package.

Even though the bank is not a recipient of Troubled Asset Relief Program money from the federal government, it still follows TARP compensation guidelines. The bank conducts third-party annual reviews of its compensation plans, and has created a position for a chief risk officer who reviews compensation plans and makes recommendations to the risk committee of the board.

 “We have evolved from plans that were primarily paid in cash,’’ he said.

Todd Leone, a principal at McLagan compensation consultants in Minneapolis and a speaker at the conference, laid out some general trends, including:

  • The use of full value equity plans (such as restricted stock) continues to increase.
  • Most banks don’t use stock options as a form of equity compensation, no matter what the bank size is.
  • The larger the bank, the more frequent the use of equity compensation.
  • Banks are increasingly using credit quality measures in performance plans.

Bank CEO pay increased last year as the economy strengthened and bank balance sheets improved, although most of the increases were tied to cash and equity incentives, Leone said. The biggest pay increases were for CEOs at the largest banks, who saw their paychecks drop substantially in 2008 and 2009 following the financial crisis. The median cash compensation for big bank CEOs is now roughly what it was in 2006, $2.3 million, according to McLagan’s analysis of 717 publicly traded bank proxy statements, 41 of them banks with more than $15 billion in assets.

The following table shows the breakdown in CEO pay last year:

Median 2010 CEO Compensation


*Cash compensation is salary plus all other cash incentives, like bonuses. Direct comp is  cash compensation plus equity. Total compensation adds direct compensation, retiree benefits and all other compensation.

Source: McLagan

You Are Not Alone: Reflections on Compensation and Succession Planning Problems

In connection with another successful Bank Director & Bank Executive Compensation conference, I thought it would be helpful to recap three important issues raised by the attendees, as well as some of the action items that need to be addressed in the short time left before year-end.

You are Not Alone

During the day-long Peer Exchange held prior to the conference, compensation committee directors met in small groups to discuss issues of common interest.  One of the universal feelings was that the directors are feeling awash in new regulations and regulatory guidance that are making it very difficult to do their jobs.  One director noted, to everyone’s agreement, that focusing so heavily on all of the new rules has materially detracted from time spent on truly strategic matters.


Consistent with prior years, directors conveyed that their time commitment to board activities and the complexity of the rules they have to work through in compensation continue to increase.  When this is combined with the minimal annual increases in director compensation and the increasing threat of personal liability, it is a wonder that these directors continue to be as focused and committed to their institutions as they are.

Succession Planning at the Board Level

Though most directors felt that their boards are in a position to actively oversee their senior executives, including the wherewithal to replace underperforming or otherwise problematic individuals, there was almost universal agreement that this is very difficult (and increasingly more difficult) to do so at the board level.  The smaller the institution, the more likely it is that any given director may be either a founding investor, major business producer or both.  Though many directors indicated they had some level of succession planning for their executive ranks, few have actively planned for succession at the board level, other than using a mandatory retirement age for directors, which only guarantees transition rather than improvement.  This is consistent with the difficulties faced by many of our clients.  We frequently meet with board members to discuss proper succession planning at both the executive and board levels.


The directors agreed that one of the best methods to surface these issues is to perform a review of each board member and the functionality of each committee.  Prior to nominating board members for each successive term, a summary of these reviews should be considered by the board, or its nominations committee.  If necessary, to arrive at the conclusion to remove a board member, it can be helpful to have a third party involved in the evaluation process.  A third party can take an independent role in the process and may also have a much more robust review process than would otherwise be developed internally.  The resulting evaluation report should be circulated to the relevant board members as part of the annual nominations process.  One director noted at the Peer Exchange that after the first 360-degree review was completed at the board level, the CEO/chairman decided it was best to keep the results of future reviews confidential from the other board members, so as to avoid conflict.  Unfortunately, this is not the end result you would hope for.

Risk is All Around Us

Not surprisingly, the general theme of the conference seemed to be risk.  The issue of risk, as it relates to compensation, was raised and discussed in almost every presentation and each director exchange.  This echoes our experience with our own clients over the past year.  For public and private banks of all sizes, the universal set of rules applicable to incentive compensation and risk is the Joint Guidance on Sound Incentive Compensation Policies (effective June 2010).  This guidance provides the principles-based approach to identifying, monitoring and mitigating risk as it may exist in your incentive compensation plans.  Subsequent risk-based rules found in Section 956 of Dodd-Frank and the proposed Interagency Guidance on Incentive-Based Compensation Arrangements (proposed April 2011) provide great direction on how Congress and the regulatory bodies will look at the risk associated with incentive compensation plans for banks with assets in excess of $1 billion, though they are not all currently effective. 


Consistent with the Joint Guidance that is currently effective, every banking organization should be reviewing their incentive compensation arrangements to assess the risk such arrangements may pose to the institution.  The company should insure that proper oversight and controls are in place with respect to each plan to monitor ongoing risk and to participate in the design and development of new plans in a manner so that risk is fully understood and actively managed.  Lastly, the board, or a committee of the board, should regularly meet with the individuals responsible for the oversight and controls of these plans and the board minutes should reflect this process.  Together, they can properly judge whether changes need to be made to either the incentive compensation arrangements, or to the procedures and controls to monitor such programs, in order to protect the institution from unreasonable risk.  The board must be actively engaged in this process and have a good understanding of each element of incentive compensation as it exists at the bank.

Bank Salaries Creeping Upward

Accounting and consulting firm Crowe Horwath LLP has conducted an annual review of bank compensation every year for 30 years. This year’s results from 280 banks show a modest increase in bank employee salaries, while CEO pay has rebounded after declining the year before. Crowe Senior Consultant Timothy Reimink, who is in charge of the survey, talks about the results.

What surprised you about the findings this year?

We were somewhat surprised to see how quickly financial institutions have shifted priorities from containing costs to developing employees.  It seems to be a good sign of the health of the financial industry.  Respondents to our survey cite “containing costs” at a lower level of priority in 2011 than in 2009 or 2010.

What general trends are you seeing in terms of compensation?

Pay increases continue to be modest.  Since the onset of the recession, banks have slowed salary increases for employees.  The average salary increase for officers in 2011 was 2.4 percent, the same as in 2010.  For non-officers, salary increases in 2011 were also comparable to 2010.  Increases planned for 2012 are only 2.5 percent.

This change in salary practices appears to be part of a fundamental shift in strategy, to have compensation more in line with competitors.  Only 12 percent of banks have a strategy of paying above market compensation, compared to 17 percent in years prior to the recession.

What about CEO and executive level pay?

We saw CEO compensation rebound in 2011, with total compensation increasing 6.5 percent from 2010, after declining in 2010 from 2009.  The increase was in base salary.   Bonuses as a percentage of base salary were 9.8 percent in 2011, similar to 2010 levels.  Growth in total compensation for CEOs had been slowing during the prior three years, reflecting the decline in financial institution performance during the last three years.  As the economy and financial condition of banks have both stabilized, CEO compensation appears to be on the upswing.

Do you have an opinion on how banks might change their compensation practices to better attract and retain good employees?

Financial institutions should reward above-average performers by increasing their salaries at a significantly faster pace than for average performers.  While 87.7 percent of financial institutions say they have a pay-for-performance program, their actual practices in granting merit pay increases don’t appear to support their expressed objective.  There appears to be little difference between salary increases for average performers and above-average performers.  Banks rated 26.9 percent of their employees as “exceeded expectations” in 2011, and on average gave a 3.2 percent salary increase.  This level of salary increase is not much more than the average 2.6 percent increase given to those employees meeting expectations.

Pay-for-performance may be primarily a downside phenomenon, with average increases of only 0.5 percent given to the 5.9 percent of employees rated as “below expectations.”

How have regulatory changes influenced pay trends?

Executive compensation has certainly been a focus of attention for the regulators and the media in recent years.  The most controversial pay practices have been at large banks and investment firms.  In contrast, for the majority of financial institutions, 55 percent, these regulatory changes have required no change in compensation practices.  Of our survey participants, 42 percent have reviewed their compensation practices, but only 21 percent have made changes because of regulatory concerns.  Our review of the trends indicates that there has been a shift away from cash bonuses and toward restricted stock as a form of incentives for executives.

So, you thought you were done with TARP? Post-repayment compensation surprises.

ball-chain.jpgDon Norman and Andy Strimaitis, partners in Chicago-based law firm Barack Ferrazzano who specialize in executive compensation matters for financial institutions, will be speaking at Bank Director’s compensation conference November 8-9 in Chicago.  Here, they discuss the legacy issues from the TARP compensation limits that may remain after repayment of TARP funds.


When a banking organization participating in Treasury’s Troubled Asset Relief Program, better known as TARP, considers repayment, it is commonplace to presume that the organization will be free from the shackles of various compensation limitations, governance rules and reporting requirements that applied during the TARP period. Unfortunately, upon closer examination, it becomes apparent that several areas will require ongoing vigilance to ensure full compliance with the TARP rules.

Generally, following the repayment date, the organization and its employees will no longer be subject to the TARP rules with respect to future compensation decisions (i.e., with respect to time periods following the repayment date).  There are, however, a few important exceptions and distinctions to note with respect to this general rule.

Bonus Restriction.  Even after the repayment date, an organization will continue to be prohibited from paying to, or accruing on behalf of, any employee who was subject to the bonus prohibition any bonus, retention award or incentive compensation with respect to the time period during which that employee was subject to the TARP bonus restriction.  This is supported by an interpretive letter from the Secretary of the Treasury Timothy F. Geithner to Elizabeth Warrren, then-chairman of the Congressional Oversight Panel, dated February 16, 2010, concerning certain aspects of the TARP-related executive compensation restrictions.

For example, assume that for 2011, Joe Smith is the highest paid employee of XYZ, Inc. (based on 2010 compensation).  Further, assume that XYZ, Inc. repays 100 percent of its TARP funds on June 30, 2011.  In determining annual bonuses for 2011, XYZ, Inc. could pay to, or accrue on behalf of, Joe Smith a bonus with respect to the performance period from July 1, 2011 through December 31, 2011.  However, even though its TARP funds have been repaid, it could not pay to, or accrue on behalf of, Joe Smith a bonus with respect to the performance period from January 1, 2011 through June 30, 2011. 

The same treatment also applies to equity awards that were granted during the TARP period and after February 17, 2009, to employees who became subject to the bonus prohibition during a year following the year of grant (these awards would not be qualified “long term restricted stock” awards, as they would have been granted to employees not subject to the bonus prohibition).  In this case, while the employee was subject to the bonus prohibition, the employee could not continue to vest in the equity award.  Once the employee is no longer subject to the bonus prohibition (because TARP was repaid, or the employee was no longer one of the highly compensated employees subject to the prohibition), the employee cannot “catch up” the vesting that was tolled during the bonus prohibition period.  Thus, an equity award that may have had a five-year vesting period, will now have a total vesting period equal to five years plus the period the employee was subject to the bonus prohibition.

Severance Restriction.  Pursuant to the TARP rules, a “golden parachute” payment (i.e., severance) is considered to be made at the time of termination rather than at the time of payment.  As such, after the TARP repayment date, an organization cannot revisit a termination that occurred during the TARP period and make a severance payment or provide other post-termination benefits to an employee who left the company while subject to the TARP severance restriction. 

Deduction Limitation.  A TARP participant is also prohibited from deducting, with respect to its “senior executive officers,” more than $500,000 of compensation expense per year during the TARP period.  Under the TARP rules, the deduction limitation applies to currently available compensation as well as deferred compensation earned during the TARP period.  As such, an organization participating in TARP is obligated to continue to track, post-TARP repayment, the deduction limitation with respect to compensation earned during the TARP period even if those amounts are paid after the repayment date. 

Reporting Requirements.  After the end of the year that includes the TARP repayment, the organization will be required to submit its annual PEO/PFO and compensation committee certifications, risk assessment analysis and narrative and other disclosures with respect to the period preceding the repayment date.  For public companies, this will include attaching the PEO/PFO certifications to the annual Form 10-K and also including the compensation committee certification and narrative summary in the annual proxy statement.  For public and private organizations, all required disclosures will also have to be submitted to the Treasury electronically, and in some cases, to the organization’s primary federal regulator.

Five Questions the Compensation Committees Should Consider when Evaluating the CEO

When it comes to determining what your CEO is worth, the compensation committee must balance the need to attract, reward and retain top executive talent with the shareholders concern that performance is in alignment with pay.

The latest round of regulations will start to mandate that bank boards understand the pay-performance relationships, whether they exist and whether they motivate risk taking. As banking regulators begin to demand further risk analysis or modeling to better meet these needs, Susan O’Donnell, managing partner for Pearl Meyers & Partners suggests compensation committees consider conducting five types of additional scenario analysis or modeling.

  1. Do you know the full range of potential compensation that might result from your programs in aggregate and under different performance scenarios? For example:
    • What is potential upside/downside if both short and long-term incentive plans paid out at threshold and max performance?
    • What is total realized value of compensation received including stock value under different stock price assumptions over the next several years?
    • The totals should be understood by the compensation committee and the recipients. It is different than what is disclosed in the proxy which only shows grant value (which may be worthless in the long run if performance of stock/goals is not achieved).
  2. Do you know how compensation might change under different risk scenarios? (e.g. impact of interest rates, economy, customer retention, etc.)
  3. Can you show a link between pay and performance? Relative to the annual decisions you make, but more importantly the long-term accumulation/rewards and alignment.
  4. Do you know what retention hooks you have on your high performing executives? How much unvested, in the money value they would leave on the table if they left? 
  5. Do you know how much equity/ownership your executives have? Is it sufficient to ensure their alignment with shareholders? Do they hold and retain stock over the long-term?

Compensation committees will need to be ready to answer these questions in the coming months. It’s how you can communicate a CEO’s worth, ensure a proper relationship between pay-performance, increase the likelihood of retaining your top performers and mitigate risk in your compensation programs.