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.

Next Steps for Compensation Committees


As our annual Bank Executive and Board Compensation event came to a close, I had a chance to catch up with Todd Leone, president & founder of Amalfi Consulting, to get his perspective on what directors should do once they leave the conference. With so much advice and recommendations communicated over the two-day event, I couldn’t help but wonder where do compensation committee members go from here. 

Here is what Todd had to offer:

Compensation Down the Ranks


It’s no real secret that the key to a successful organization is a strong and talented team of people. However, in today’s competitive and changing market, recruiting, rewarding and retaining top employees is a challenge. On the last day of our annual Bank Executive and Board Compensation event held at the InterContinental hotel in Chicago, this session focused on the role the compensation committee should take when planning competitive yet acceptable compensation plans for employees past the CEO.

Moderated by Jack Milligan, editor for Bank Director magazine, our panelists included Gayle Applebaum, managing director and founder of Amalfi Consulting, Kimberly Ellwanger, compensation committee chair at Heritage Financial Corp. in Olympia, WA and Donald Norman, partner at law firm, Barack Ferrazzano.

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Oversee Not Micro-Manage

To begin the session, panelists addressed the less than obvious question of the compensation committee’s role when it comes to employees below the senior management team. With the liability now resting on the compensation committee, their responsibility for managing performance incentive plans now requires a more holistic approach. As Applebaum points out, the responsibility of the board is not to micromanage each plan, but rather to be aware of how they are designed. Compensation committees should actively review and evaluate the structure of all plans from the executive team down to the teller staff.

Don’t Have to Go it Alone

Sounds overwhelming? It can be, although the panelists agreed that the burden should not rest on the compensation committee alone, and that committee members should work in conjunction with the management team. While the board is ultimately responsible for oversight, they will most surely need input from the CEO and other senior team members.

The concern of some audience members was how to determine who was objective and well-versed enough in the requirements to help the board evaluate these plans thoroughly. Ellwanger openly shared that Heritage Financial Corp. had taken on a Chief Risk Officer whose responsibilities included sharing the list of all compensation plans semi-annually with the board for review. For those banks with limited resources, the following personnel should be able to help committee members analyze the plans on a regular basis:

  • Chief Risk Officer
  • Human Resources Officer
  • CEO/Executive Team
  • Inside Legal Counsel
  • Outside Compensation Advisor

Global Metrics Less Risky

Of course, assembling a qualified team of people to review and oversee all significant compensation plans at an institution is only part of the equation. Designing plans that are attractive to top talent is a critical piece of the puzzle. The panel encouraged smaller banks to not be hasty by cutting out bonuses and raising salaries as this would certainly result in the loss of key employees. Instead, banks should consider varying the levels of performance in their incentive plans by employee rank and then base those on individual and/or company-wide goals. Ellwanger provided the following example:

  • Top Level Team (Executives) = Metrics are driven by corporate performance
  • Next Level Team = Metrics are driven by bank and individual performance

As it turns out, regulators tend to lean more towards global metrics used in compensation plans as these are deemed less risky than behavioral based incentive plans.

Document, Document and then Document

Norman suggested that boards conduct at least a semi-annual risk analysis to evaluate the risks, goals and metrics developed. Throughout those sessions, it’s important to document thoroughly including meeting minutes, review changes and anything that speaks to the thought process behind the plans. A constant theme heard throughout the two-day conference was again reiterated in this session — be prepared to tell your story.

Navigating the Sea of Financial Reform


navigate.jpgRecently, Bank Director and the American Banker presented the 2nd annual America’s Bank Board Symposium tailored to provide bank boards with the knowledge to develop, implement, and monitor strategies for their institutions. Several key industry speakers joined CEOs, board members and experienced financial leaders in Dallas to help navigate the sea of challenges facing bank directors today.

On the heels this event, I had the chance to catch up with one of the presenters, Susan O’Donnell, Managing Director with Pearl Meyer & Partners, an independent compensation consulting firm, to further explore her insights on what she believes are the top three issues concerning directors. Below is what she shared with me via email:

1. Responding to a Rapidly Changing Regulatory Environment
New regulations and requirements are coming at bank directors at an unprecedented pace, particularly in the last decade. Whether Sarbanes Oxley, recent banking regulatory agency guidance on risk assessment of incentive compensation practices, or new proxy disclosure requirements under the Dodd-Frank Act – there is a much greater need for board members to keep up with the rapid and constantly changing regulatory environment. This is particularly true of public banks that now have to meet even more disclosure requirements.

2. Understanding Changing Executive Compensation Trends, Including the Role of Risk Management
Keeping informed of the emerging best practices has also become a major challenge, as boards today must ensure their executive compensation practices reflect sound risk management, pay-for-performance alignment and align with shareholder interests. Board members (particularly compensation committee members) need to adapt their institution’s compensation practices, where appropriate, to reflect the new regulations and emerging best practices, while continuing to support their unique compensation philosophy.

What was ‘acceptable’ practice several years ago might be considered inappropriate today. For example, incentive compensation programs that place significant (or sole) focus on profits and top line growth may be perceived as potentially diverting banks’ focus on safety and soundness. Regulators are reviewing incentive plans with a new “set of glasses” and board must also review their executive compensation programs through these new lenses.

Severance/change in control benefits are also changing in response to increased scrutiny and transparency. Provisions such as the gross-up payments to cover the taxes to the executive under certain situations used to be common several years ago, but are no longer considered appropriate. And companies that continue to put such provisions in place with new contracts will come under increased pressure from shareholders and shareholder advisory groups, potentially impacting future Say on Pay votes. Boards need to be aware of these changing perspectives and the potential reaction from regulators and shareholders.

As executive compensation is under increased pressure, boards need to be ready to respond to the new level of scrutiny. More importantly, they will need to articulate their own compensation philosophy and develop programs that address their own unique needs, rather than chase historical market practice, which in many cases is no longer applicable or appropriate.

3. Responding to Increased Transparency, Disclosure and Shareholder Influence
The new disclosure requirements, starting in 2006 and culminating with many new requirements enacted through the Dodd-Frank Act, are placing a greater spotlight on executive compensation (and governance) practices. With a brighter light comes increased scrutiny.

With Say on Pay, shareholders will have an opportunity to vote their approval (or disapproval) of bank compensation programs. While non-binding, the votes will be public information, subject to media scrutiny. As such, boards will need to listen and be prepared to adapt or change in response to the feedback they receive.  It is critical that boards today focus on ensuring their proxy disclosure effectively communicates their compensation philosophy, programs, decisions, rationale for decisions and pay –performance alignment.

Boards will also need to know and understand their shareholders better. Say on Pay, Proxy Access and the loss of the Broker vote will increase shareholders’ influence on compensation programs and banks should be prepared for this new level of transparency and disclosure.

The Characteristics of Success

With all the new regulations and increased scrutiny within the financial industry, I was curious to know what characteristics would separate the winning banks from the losing ones over the next five years. O’Donnell highlighted these top three traits that she recommends bankers will need to make it through this period of reform:

1. Adaptability: Bank boards will need to be responsive to all the changes going on in the industry, including the new economic, business and regulatory requirements.

2. Leadership: Boards that exercise strong leadership as they navigate the bank through challenging times will more than likely come out on the winning side.

3. Focused: Boards must have clearly defined goals and strategies, knowing what needs to be done to execute them effectively.

One thing I’ve learned very quickly since joining Bank Director is that these are without a doubt some of the most challenging times the U.S. banking industry has experienced in quite some time. But with knowledge, flexibility and effective execution, I am confident that smart bankers will continue to excel at growing their financial institutions.