Boards are cultivating a more diverse slate of directors that includes different backgrounds, experiences and skills. In 2021, over 45% of new directors in the Russell 3000 were women. Directors of different ethnic groups also made steady gains. Moreover, bank boards are seeking specific skill sets such as risk, cyber and financial markets expertise to supplement traditional CEO and CFO disciplines.
Attracting and retaining a new breed of diverse directors, many of which are younger than traditional directors and may still be working, requires forward thinking. Boards with compensation programs that are unclear, overly restrictive or developed as a “one size fits all” program may encounter recruiting and retention issues. Just as director experience needs to be more diverse to oversee modern banking, director compensation practices must adapt and change to address varied perceptions and needs. Banks can take five actions to position themselves for greater success.
1. Ensure Compensation Programs are Up-to-Date.
Director pay has continued its upward trend after a brief hold during the pandemic. Furthermore, banks are adopting practices more consistent with general industry practices:
Consider a retainer-only approach. Eliminating meeting fees creates greater clarity around the total compensation a director receives while streamlining administration.
Grant restricted stock. Governance advocates and regulators alike consider full-value shares to be more appropriate for director pay, compared to stock options, since shares provide ownership without the potential for leveraged gains. The most common vesting period for equity retainers range from immediate up to one year after grant.
Eliminate “old school” practices. Certain practices may carry the perception that a bank board is out of touch with market practice and governance norms. These include director retirement and benefit programs, meeting fee reductions for committee meetings held on the same day as the board meeting or for meetings held “telephonically,” reimbursement of spousal travel and paying executives board fees.
2. Consider Pay Mix and Timing.
Coordinate cash and equity vesting. Governance advocates encourage companies to pay a minimum of 50% of board fees in the form of equity. In most cases, equity compensation is welcomed by directors but taxes can be an issue. Timing cash, such as board and committee retainers, alongside equity award vesting is helpful; this is especially true if open window periods to sell equity are limited throughout the year.
Consider immediate vesting. Even a one-year vesting can create unexpected tax consequences with share price movement. If a bank’s share price increases substantially over the vesting period, the tax liability at vest may be substantially higher than planned. This tax liability can create a burden on directors, especially when combined with ownership requirements and sales restrictions.
Rethink long holds and other restrictive policies. Stock retention and ownership guidelines are the market norm. And while welcomed by shareholders, less prevalent practices such as mandatory deferral policies and other stock retention provisions that defer stock vesting until director retirement may receive pushback from candidates and reduce the potential pool of directors.
3. Review Equity Grant Levels, Stock Ownership Guidelines.
Banks should model stock ownership requirements to ensure that directors can reach the guidelines through the compensation program within the prescribed timeframe and on an after-tax basis. Rarely are directors expected to pay out-of-pocket to serve on a public company board. If the annual equity retainer alone is deficient, banks can grant sign-on awards to give new directors a head start in achieving the ownership guideline and to support recruiting efforts.
4. Provide Programs That Let Directors Manage Cash Flow.
Board diversity may lead to varying financial objectives, which banks can address by implementing choice programs that are flexible in form of payment and tax timing.
a. Stock programs that allow directors to receive cash retainers in stock. These programs typically allow a bank to pay cash board retainers as shares. Some provide a “kicker” incentive of 10% to 20% to directors that opt for stock over cash.
b. Voluntary deferral programs. These programs may include voluntary deferrals of cash retainers and/or equity awards that may be held in company stock, an interest bearing account or in diversified investments.
5. Employ More Mindful Recruiting Efforts.
Executive recruiters and board-directed searches often resort to drawing from the same limited pool of sitting board members to fill new seats rather than broadening to other sources of talent, such as women executive groups, ethnic chambers of commerce and affinity groups. A larger recruiting pool places less pressure on the board compensation program.
Board compensation programs can act as an enticement or deterrent when banks are recruiting diverse candidates. Banks put themselves in the best position when compensation programs are clear, market-based and provide flexibility for varying life stages and financial positions.
Recruiting the right members for the board is becoming an increasingly crucial task. The workloads of boards have increased, making ineffective members more of a drag on the other directors. Regulators are emphasizing the quality and effectiveness of boards in exams. The board’s performance is an important part of a bank’s CAMELS score, the rating system regulators use to assess the health of a bank. It is challenging today for banks to make and sustain a return on investment that will satisfy shareholders, making the board’s job of overseeing management more important.
Assessing their own performance and recruiting new members are critical tasks for boards as they try to survive in the new banking landscape, which is heavy with regulation and in many markets, short on growth. Choosing wisely on a new director is a critical factor in board performance, and yet many boards wait too long to beef up the quality and effectiveness of their boards, say many governance advisers.
Jim McAlpin, a partner at the law firm Bryan Cave LLP in Atlanta, who has decades of experience working with boards, says that out of 10 board members, typically only three to four make a difference. They are the ones who serve on multiple committees and make sure the board’s work gets done. They are the ones who drive decision making and add value to the institution. Everybody else? Well, they serve, but definitely in a secondary role. Boards often rely on age limits to gently roll off an underperforming board member, but since age limits have risen in the past few years, that can take too long.
“We really haven’t challenged people to become effective,’’ McAlpin says. In some cases, there may be a legitimate reason for that. A family owned bank might want to have multiple family members on the board for reasons other than overseeing the management team. High profile members of the community may serve an important role in representing the bank in the community and at charitable functions. Historically, for many banks, this has not been a problem. But for boards that want to improve their bank’s profitability, now is the time to beef up their own performance.
There are three steps to building a strong board: assessing what your board needs, recruiting people with the right skills and backgrounds, and getting rid of ineffective directors.
Assessing the Board’s Needs
First of all, not every bank wants the same thing out of its board. Community banks may emphasize the role of board members in bringing business to the bank, for example. Larger banks, certainly those well above $1 billion in assets, are going to look to other leadership qualities and certain skill sets as being more important than recruiting business to the bank.
Assessing what the board needs most could be accomplished with a simple grid listing the names of the directors followed by the skills the board needs, (e.g. financial expertise, M&A expertise, industry experience), the governance experience of each member (e.g. nominating committee or public company experience), and individual qualities (e.g. age, gender or racial diversity, retired). The chairman or lead independent director can check off which director fits the different boxes in the grid to get an overall view of the board’s composition and what it needs.
The Skills You Need on Your Board
Differing committees will need different skills.
As a sound governance practice, all boards should have a non-executive chairman or, if the CEO is also the chairman, a lead independent director, says Peter Crist, chairman of the board of $17-billion asset Wintrust Financial Corp. in Chicago and chairman of Crist Kolder Associates, an executive recruiting firm that does a lot of board recruiting. That creates checks and balances between management and the board, and ensures the board is operating effectively. A respected executive with broad business acumen and who is also a strong communicator with excellent interpersonal skills is perfect for this role, says Crist. However, the role is not for someone with an ambition to run the company. If the chemistry between the CEO and lead independent director or non-executive chairman is poor, the function of the board suffers. The lead independent director or chairman also acts as a buffer between management and the board, making sure the board doesn’t intrude on management’s duties.
Bank boards also need members with financial expertise who can serve on the audit committee and know accounting rules and how to read a financial statement. The Federal Deposit Insurance Corp. Improvement Act requires banks with $3 billion or more in assets to have at least one person on the audit committee with banking or related financial management experience. The Sarbanes-Oxley Act requires public filers with $500 million or more in assets to disclose in their annual report whether they have someone on the audit committee who meets the definition of a financial expert. The audit committee chairman is a critical role on the board, and should engender confidence in the company at the board, management and investor levels, says Crist. This person should probably qualify as an independent director with the time to commit to this demanding role. Ideal candidates include retired executives who have been CEOs with strong financial skills, or a public company chief financial officer, or perhaps a broadly experienced audit firm partner.
Boards can also benefit from having members with CEO or chief operating officer experience and can support the bank’s CEO by bringing a level of experience handling strategic matters or mergers and acquisitions, for example. A properly functioning board acts as a sounding board for the CEO, says William Reeves, senior member of recruiting firm Spencer Stuart’s global financial services practice. “The CEO needs to feel the board is an advisor,’’ he says. “The best boards are interactive with the CEO in terms of strategy. They should be accessible and engaged.”
While it is difficult to find a current CEO to serve on the board, a second in command is often a good option and might very well become a CEO soon, says Crist. Sometimes tough to find is risk management experience on the board, as boards are responsible for overseeing the bank’s risk management, and people with deep knowledge of banking and credit can be useful in this area, including retired bank CEOs and chief financial officers. Regulators are putting pressure on banks to expand and improve management of the bank’s enterprise-wide risks and consider the board responsible for holding management accountable.
Also tough to find are board members with executive-level technology experience who can help a board address its various technological challenges, both today and in the future. Banks are finding diminishing traffic inside their branches, and are making important decisions about delivering bank services via the web or through mobile applications. Even if you can’t get Google’s chief operating officer to serve on your board, you can find someone with an interest in technology and its application to banking, says McAlpin. Don’t make the mistake of assuming this is a function of age rather than knowledge and interest level.
Moreover, Crist believes every board needs a diversity of backgrounds and perspectives. If everyone is a white, retired male, then the board isn’t hearing perspectives that might very well represent the bank’s customers and community. These days, boards are increasingly looking for women and minority candidates who bring other, much needed knowledge and experience to the board, including financial expertise, public company compensation oversight experience, or technological acumen.
Aside from hard skills such as financial expertise or human resources experience, there also are soft skills that are probably even more important. Some boards get so caught up in looking for a specific skill set, they forget about that. Are your board members good communicators? Do you have a board member who is disruptive to the conversation or dominates it, without letting other views in? Are they curious about the bank’s business and do they ask questions? Do they spend time learning what they don’t know about banking? Are the board and management helping with board training, perhaps having a part of every board session devoted to board education?
In addition to educating themselves and asking questions, McAlpin thinks a critical skill for board members is courage. “Courage is reflected in the ability to ask difficult questions,’’ he says. “That is a rare quality in my experience, someone who will sit there and say: ‘I don’t know why we’re doing it this way, can you explain?’’’
Are your directors comfortable with change? This could be a critical skill for a changing industry that really must keep up a changing population and consumer demands. “There is a problem with boards uncomfortable with change,’’ Crist says. “ You need to have people on board who have seen things and can get you through the changes.”
But who gets to decide who makes it on the board? Should it be a consensus decision after a round of interviews with fellow board members? Should the CEO decide?
The CEO’s Role in Board Recruiting
Historically, the bank CEO has always taken the reins in recruiting board members and assessing who is needed on the board. That’s often still true today. Good governance, however, gives the board and nominating committee the lead role in board recruitment and assessing the board’s performance. The nominating committee and bank CEO should be in lock step, however, in deciding the board’s needs.
“In the old days, the CEO would call me and say I need a new board member,’’ says Crist. “Now it’s the nominating committee.” Hiring a recruiting firm can help broaden the candidates available for the bank board, which can be needed if particular skills or backgrounds are hard to find. Of course, if a community bank only wants board members from a certain community who are well known by the board, hiring a recruiting firm is not needed.
For companies listed on a public exchange, there are specific restrictions on the CEO’s role. The New York Stock Exchange, for example, requires that all listed companies have a governance/nominating committee comprised only of independent directors who must nominate directors for shareholder approval. For NASDAQ OMX-listed companies, a majority of the independent directors of the board or a nominating committee comprised entirely of independent directors must nominate directors. Both also allow a company to provide investor-nominated candidates to the board as well. There is no prohibition against the board consulting with management on director candidates. The decision must be made by the independent directors, however.
Getting Rid of Someone on the Board
Recruiting is fairly easy compared to getting rid of someone on the board who is no longer effective or has become disruptive. Some boards try to handle this through age limits, relying on someone no longer contributing very much to age his or her way off the board. However, this is an ineffective strategy by itself, as many board members can and do serve effectively regardless of age. The best boards try alternative strategies in addition to an age limit. Board evaluations are an effective strategy for nudging poorly performing board members off the board. The chairman or lead independent director should handle the discussion of letting someone go.
Regardless of whether there’s a need to get rid of a poor performing board member, a best practice at all banks is to conduct a review of the board’s performance either yearly or, at the very least, every few years. This can take the form of self-evaluations, similar to what employees of the bank do, followed by a one-on-one conversation with the bank’s chairman or lead independent director. Such a practice can encourage board members to think about their own effectiveness as directors, and often leads to board members voluntarily stepping down when they realize they are no longer needed or not contributing as they had in the past. Another type of review is a 360 degree evaluation, where board members not only rate themselves, but everyone else on the board and the overall board’s performance. Lastly, boards can bring in an independent third party to help with the board evaluation, which can be a good practice if leadership wants a fresh look. However, third-party evaluators can engender suspicion and distrust among the directors, says Crist. He believes the board chairman or lead independent director should lead the process of evaluation.
The surprising thing is that many banks don’t do any sort of evaluation at all, says McAlpin. Evaluation should be done regularly, and not just in conjunction with a pending retirement. Boards tend to wait to recruit new directors until an older director retires, but Reeves encourages boards to think about what would help the business most. “We encourage people to reassess the strength of the board and think about what the weaknesses are,” he says.
Requiring that every board member stand for annual elections is becoming more common, as opposed to staggered elections for a class of directors every few years, says Crist. However, the company’s own bylaws may require staggered elections as a poison pill to prevent hostile takeovers. Another option to get rid of poor performing directors is to require an offer of resignation when there is a change of employment, such as a retirement or the loss of a job. Boards can always make an exception, but at least that provides the board with opportunity to review an individual’s service when that person’s status has changed.
The Value of a Strong Board
Determining who should be on your board (and getting rid of those who aren’t contributing at a high level) is a defining characteristic of strong boards. Reeves believes that poor board leadership was a factor in the failures of many banks during the financial crisis. Boards that lack any directors with long-term experience in banking, or the courage to ask important questions, or the financial expertise to see what was going wrong, can really sink a bank. A strong board, conversely, can help the institution thrive.
Recruiting the right members for the board is becoming an increasingly crucial task. The workloads of boards have increased, making ineffective members more of a drag on the other directors. Regulators are emphasizing the quality and effectiveness of boards in exams. The board’s performance is an important part of a bank’s CAMELS score, the rating system regulators use to assess the health of a bank. It is challenging today for banks to make and sustain a return on investment that will satisfy shareholders, making the board’s job of overseeing management more important.