The Evolution of Strategic Business Objectives in Annual Incentive Plans


incentive-8-19-19.pngBoards are increasingly looking for ways to appropriately align pay and performance for bankers in the face of the disruptive changes in the industry.

Post-financial crisis, many bank boards shifted to a scorecard approach as a way to improve their compensation governance and accountability. However, industry disruption has sparked an evolution of the scorecard itself.

Before the financial crisis, determining annual bonus payouts at banks was a singular, annual event. The compensation committee and the CEO compared the bank’s current financial results to the prior year, assessed the operating environment, considered last year’s bonus pool and adjusted bonus accruals accordingly. Higher performers got a little more than prior year; poor performers looked for new jobs.

Following the financial crisis, a search for improved compensation governance and accountability ushered in a movement to construct incentive plans with payouts specifically tied to financial outcomes. This resulted in the popular financial scorecard approach used by many banks today.

Most scorecards include “hardwired” financial goals (usually earnings per share, net income and return on equity), banking-specific metrics (deposits, credit quality metrics and expense management) and a component that reflects “individual” or “discretionary” evaluations of performance.

Scorecards have served the industry well and addressed concerns that the lack of transparency into banking incentive plans resulted in shareholders being unclear of exactly what performance they were rewarding. The industry is now in the midst of a new phase of disruption that has banks reexamining their business models and entering a period of significant transformation.

In response, boards are increasingly enhancing the qualitative component of their scorecards to add balance and encompass the progress executives have made against clearly articulated strategic business objectives (SBOs). These strategic components balance the “backward-looking” nature of financial metrics with a “forward-looking” assessment that focuses on improving future financial performance.

Trends in Strategic Business Objectives
An SBO is a goal or metric that generally supports a key business priority and can be measured and objectively evaluated. For many boards, delivering against SBOs is critical to ensuring sustainability of their franchise. While growing earnings per share is a proven measure of current business success, achieving other critical outcomes is essential to creating long-term value for shareholders.

Detailed SBOs are specific to each bank and reflect where the bank is in its life cycle or period of transformation. Recently, we have observed banks incorporating the following eight categories into their SBOs for bank bonus plans:

  1. Executing the Digital Strategy: Depending on the bank’s current digital state, this category evaluates the success of critical milestones, such as percentage of paperless customers, “app” rollout and usage rates and expansion of service offerings through the digital interface.
  2. Technology Enhancements: This can include initiatives such as cybersecurity upgrades, automated fraud detection and general infrastructure enhancements like enterprise resource planning rollout.
  3. Corporate Development: This objective centers on the bank’s execution of its M&A strategy. It reflects the board’s evaluation of acquisitions, divestitures and integrations throughout the year. Banks often set goals based on quality, rather than quantity, to avoid incentivizing “bad deals.”
  4. Branch Strategy: This rewards the expansion, contraction or footprint-specific goals tied to the bank’s strategy for brick-and-mortar branch presence.
  5. Fee-Income Initiatives: Boards want to compensate for successful growing non-interest income from existing products, new products and complimentary service offerings.
  6. Customer Metrics: This can be measured through various means, such as net promoter score, internal customer satisfaction ratings, call center resolution rates and client retention statistics.
  7. Compliance: This generally focuses on the performance against anti-money laundering (AML) objectives and other regulator-specific compliance priorities.
  8. Risk Management: Boards define this SBO by evaluating process-related rollouts, infrastructure enhancements and talent upgrades across the risk function.

Banks are looking to drive their key initiatives during this time of significant transition in the industry. To do so, they are increasingly using SBOs to underpin the strategic drivers of future value creation in their business. Linking these initiatives to annual incentive compensation can communicate the importance of the strategies to the organization, and align compensation to the successful execution of these strategies.

A Compensation To-Do List For Your Board

Is your board effectively addressing the risk embedded in the bank’s compensation plans? McLagan Partner Gayle Appelbaum outlines a to-do list for boards in this video, and shares why new rules around hedging policies should be on your board’s radar. She also explains what banks need to know about these rules, along with considerations for your board’s annual compensation review.

  • Compensation Issues to Watch
  • New Rules on Hedging Practices
  • Other Practices to Address

Driving Accountability in Incentive Compensation Governance


compensation-7-17-19.pngI once flunked a math test because I didn’t show my work. Turns out, showing your work is important to both math teachers and bank regulators.

To drive accountability, it is important to document and “show your work” when it comes to governance of incentive compensation plans and processes. The largest banks, due to increased regulatory oversight, have made significant strides in complying with regulators’ guidance and creating robust accountability. Here are some resulting “better practices” that provide food for thought for banks of all sizes.

While the 2010 interagency guidance on sound incentive compensation policies is almost a decade old, it remains the foundation for regulatory oversight on the matter. The guidance outlined three lasting principles for the banking industry:

  • Provide employees incentives that appropriately balance risk and reward.
  • Create policies that are compatible with effective controls and risk management.
  • Support policies through strong corporate governance, including active and effective oversight by the organization’s board of directors.

Most organizations used the release of the 2010 guidance to take a fresh look at their incentive plans. It proposed a non-exhaustive list of risk-balancing methods, such as risk adjustment of awards and deferral of payment. Many banks changed their plan structures and provisions to increase sensitivity to, and better account for, risk. The changes made sense pragmatically but largely addressed only the first principle.

After the financial crisis, boards were expected to engage in the oversight and review of all incentive arrangements to ensure that they were not rewarding imprudent risk taking. However, most institutions quickly realized it was not practical for directors to be in the weeds of all their broad-based incentive plans and thus delegated that task to management.

Compensation committees outlined expectations for senior management regarding incentive plan creation, administration and monitoring in a formal document. Their expectations would include, for example, the process for reviewing incentive plan risk.

Comp, Risk Committees Cooperate
Banks also developed stronger communication or information sharing between the compensation and risk committees of the board. This was sometimes accomplished through cross-pollinating members between the committees or conducting joint meetings on the topic. It also became standard for the chief risk officer to participate in compensation committee meetings and present on incentive compensation risk, as well as the overall risk profile of the organization.

Incentive compensation review committees, made up of the most-senior control function heads such as the chief financial officer, chief human resource officer, general counsel and chief risk officer, are often delegated primary oversight responsibilities. To create accountability, this management committee operates under a formal charter, oversees the entire governance process, provides for credible challenges throughout and annually approves all non-executive plans. A summary of their activities and findings is presented to the compensation committee annually, at minimum.

Working groups representing various business lines and broad control functions support the management committee in actively monitoring incentive compensation plans. Every activity in the governance process—from plan creation or modification to risk reviews and back-testing—has a documented process map with roles and responsibilities.

These large bank practices might be overkill for smaller organizations. However, some level of documentation and process formalization is a healthy process for any size. My advice: Don’t get fixated on the red tape, as proper governance and controls can be scaled to the size and complexity of each individual bank.

Formalize the Process
The second and third principles of the 2010 guidance are aimed at driving greater accountability and efficient oversight, including enhanced information sharing. Formalizing the process simply helps to crystalize expectations for those involved and safeguards against the dodging of responsibilities.

Plus, regulators—just like that math teacher—want to see the work. It’s not enough to simply have the right answer. You must be able to document the process you went through to get there.

Review Your Director Equity Plans


equity-4-17-19.pngOutside director compensation has been on the minds of shareholders and compensation committees after a 2017 court decision and a continuing focus of proxy advisory firms that recommend how institutional investors vote on matters presented to public company stockholders.

In late 2017, the Delaware Supreme Court issued a decision involving claims of excessive nonemployee director compensation at Investors Bancorp, a Short Hills, New Jersey-based bank. In that case, the court applied a higher legal standard to decisions made by directors about their own compensation.

Since the 2017 decision, other cases have been settled involving similar claims against public companies, and more new cases were filed in 2018. The two primary proxy advisory firms have also shown an enhanced focus since the 2017 decision on compensation awarded to outside directors.

With these cases in mind, focus on outside director compensation continues, and public companies especially should review their decision-making processes about discretionary stock equity plans and non-employee director compensation.

Stockholder claims concerning the conduct of directors generally are subject to review under the business judgment rule, where the presumption is that the board acted in good faith, on an informed basis and in the best interests of stockholders.

In cases where the business judgment rule applies, the court will not second-guess a board’s business decision.

Before the Investors Bancorp decision, this was the standard applied to cases challenging director compensation decisions, with a few exceptions. In the cases where the Delaware courts reviewed challenges to director compensation approved by directors themselves, the courts recognized a stockholder ratification defense for director compensation in cases in which stockholders had approved the following:

  • An equity plan that provides for fixed awards
  • The specific awards made under an equity plan
  • An equity plan that includes “self-executing” provisions—awards that are determined based on a formula specified in the plan without further discretion by the directors
  • An equity plan that includes “meaningful limits” on director compensation—a cap on the awards that could be made to nonemployee directors

In cases where a company can take advantage of the stockholder ratification defense, the company can seek dismissal of the stockholder claim under the business judgment rule.

In the Investors Bancorp case, the Delaware Supreme Court considered the scope of stockholder ratification of director compensation decisions for the first time in more than 50 years, and in doing so limited the ratification defense when directors make equity awards to themselves under an equity incentive plan.

The Delaware court determined that the more onerous rule—the “entire fairness” test—applies, where a plaintiff can show a majority of the board was interested or lacked independence regarding the decision, or would receive a personal financial benefit from the decision.

For equity grants awarded to directors under the plan, that test requires the board to prove equity incentive awards they grant themselves are fair to the company and its stockholders. The Delaware court found that while the stockholders in the Investors Bancorp case had approved the general parameters of the equity plan that contained a limit on the aggregate amount of stock awards that could be made to directors, they had not ratified the specific awards to directors and, therefore, the business judgment rule did not apply.

The decision therefore calls into question whether the ratification defense is still feasible for plans that contain only “meaningful limits” on director awards. The Delaware Supreme Court sent the case back to the lower court to review under the entire fairness standard, and that case is currently pending.

Key Takeaways
Boards and compensation committees should consider the following to mitigate potential risks in implementing equity incentive plans or making awards to directors under existing equity incentive plans:

  • Careful consideration of peer group selection
  • Retention of a compensation consultant experienced in banking
  • Whether to include director compensation limits in equity plans
  • Ensuring that director compensation decisions are made after a robust process that accounts for market practices and peer group practices

And finally, boards and compensation committees should carefully describe the decision-making process and other key factors for equity awards to nonemployee directors in the company’s annual proxy statement.

What Your Compensation Committee Calendar Should Look Like


compensation-3-12-19.pngA goal-oriented calendar can be the difference between a productive year and a nonproductive one for compensation committees.

Planning for the year goes beyond scheduling meetings. Compensation committee chairs should have a thoughtful plan that encompasses the goals of the committee for the year. A detailed and in-depth calendar can help both new chairs and experienced chairs craft a plan for the year that considers the short- and long-term needs of the bank.

This article provides planning tips and a cheat sheet for the core topics that should be on the committee’s annual schedule. Though the cheat sheet is specific to public banks, private banks can use the list as well.

What’s on The Agenda
The old saying goes “what gets written down, gets done.” Having a written document sets a roadmap for the year and provides your committee a timeline to stay on track. You don’t need to reinvent the wheel.

Start with the committee charter, which provides a job description for the committee’s responsibilities. Review the past year’s calendar, agendas and meeting minutes for a head start in creating your annual agenda and stick to it throughout the year.

Identifying key topics at the beginning of the year allows for communication across all stakeholders: members of the committee, your management team, and outside legal and compensation advisors.

Topics should cover both short-term and long-term items. For example, if you are looking to request more shares for your equity plan, this process should start well in advance, and may include updating your equity plan document, modeling ISS and Glass Lewis share guidelines, and redesigning your grant methodology.

Getting your outside advisors involved early can help you avoid last-minute surprises.

Frequency of Meetings
Typically, public banks hold four to six meetings in a year. This allows the committee sufficient time to cover key topics and to review the goals of the committee. In any given year, the agenda may require additional meetings for special events including merger and acquisition activity, creation of new incentive plans and other events.

committee-numbers.png

What (And When) Should Be on The Calendar
Below are key topics that should be on the regular calendar for public banks as well as additional items for consideration any time during the year. The sample covers a typical schedule, however, there is flexibility depending on the subject.

In any given year, items should be evaluated both in terms of the current short-term and the longer term needs of the bank 24 months or more from now.

compensation-calendar.png

How To Prepare Compensation Plans For An IPO


IPO-11-5-18.pngThe decision to take your bank public will set the course of your company for years to come. There are several critical steps to prepare your compensation program before the IPO and before your bank is a public company.

Steps to prepare for the IPO

1. Assemble Your Compensation Team
Determine the team focused on compensation matters. If you have employees with IPO experience and compensation plans, they could be a key asset. Similarly, if you have employees without IPO experience but have public company experience, they could be a key team member as well.

2. Create Your IPO-Related Task List
Your bank may have implemented many compensation and governance related items already, but they should be reviewed for their appropriateness for a public company.

Key tasks required prior to the IPO will vary, however, here is a list of compensation tasks on every pre-IPO list.

  • Develop an executive compensation philosophy and key objectives – What is your bank’s strategy? Where do you target compensation? Is your pay aligned with performance? What are the objectives of your compensation program? What message do you want to send to shareholders? Craft overarching guidelines to support the process going forward.
  • Evaluate and establish appropriate executive and director compensation levels – Prior to the IPO, your company will have to disclose its executive and director compensation. You want to be sure your compensation programs are reasonable, competitive, and based on peer group data. Establishing a suitable peer group and incorporating the data into your process is key.
  • Equity plan considerations – Will a new equity plan be required, and when will you need shareholder approval? How will you determine the share pool so long-term incentive and equity grant needs can be met for three to five years? Have you evaluated the shareholder advisory firms’ current standards to receive favorable support? Avoid any pitfalls that would result in a “no” vote recommendation.

    If the company is considering one-time IPO-related equity grants, evaluate these in light of market trends, shareholder expectations, retention concerns, financial impact to the company and dilution. Many institutions consider sizeable one-time grants a front-loaded award, and decide to wait before awarding additional equity. Such decisions are based on share pool impact, financial implications, and size of the one-time grants. Carefully determine the value of these awards to minimize risks of unfavorable optics and legal actions.

  • Design ongoing annual and long-term incentive plans – As a public company, it is important to have annual and long-term incentive plans that align pay and performance, are competitive, consistent with company objectives and provide an appropriate mix of pay. As new incentive plans are designed, know that plan details will be disclosed in future public filings. Private banks are accustomed to implementing plans that are regulatory compliant and competitive, but public disclosure has not been required.
  • Implement executive agreements – In many cases, new employment and change-in-control agreements are put in place, often the case even if similar agreements were in effect before the IPO. Several details, including the terms, are subject to public disclosure. Shareholder advisory firms take issue with certain terms and, and having them can automatically result in ‘no’ vote for Management Say on Pay and the re-election of the board’s compensation committee. It is critical to be aware of these pitfalls and avoid them whenever possible.

3. Determine appropriate technical and governance actions
There are key technical and governance issues to evaluate. Some items are required while others are not. Many are considered best practices and important to achieving strong governance. Some of the key items in this category include:

  • Drafting of the SEC required filings including the CD&A (Compensation Discussion and Analysis), compensation tables and other requirements. Reporting errors and omissions can delay the IPO.
  • Determining company stock ownership guidelines – Many new public banks do not adopt stock ownership guidelines immediately, however, if one-time equity grants are awarded, adopting such guidelines immediately sets the parameters for holding these shares. Determine who will be covered by the guidelines (e.g., executives, Section 16 officers, non-employee directors), what the required holdings are, the timeframe permitted, and other terms.
  • Drafting the Compensation Committee Charter – A charter establishes the role and responsibilities of the committee, how it will interact with the board and management, and its ability to engage outside advisors. The charter is typically published on the company’s website.

4. Create a compensation committee calendar after the IPO
Once the IPO is completed, it is important for the compensation committee to focus on its new role, responsibilities and annual tasks. Setting up a calendar of activities supports effective management and should include all areas of committee oversight.

Taking your bank public can be a very exciting endeavor. Do not underestimate the number of new issues management, the compensation committee and the board will have to become familiar with to complete a successful IPO and operate a public company. Being organized, having the right knowledge and support and a flexible timeline will be great tools to help your organization get through this process.

Compensation Governance in Today’s Economy



Despite recent shifts in the economic and regulatory environment, bank boards still need to keep a close eye on many of the same issues—including risks related to your bank’s compensation practices, as McLagan Partner Gayle Appelbaum explains in this video. She also spells out how talent pressures, and the expectations of regulators and investors, will continue to keep banks on their toes.

  • Key Practices for Boards and Compensation Committees
  • Why You Can’t Relax in Today’s Strong Economy
  • The Need for Heightened Corporate Governance

Executive Compensation: Understanding the Tax Law’s Full Impact


compensation-3-12-18.pngOn December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act, which amended certain provisions of the Internal Revenue Code of 1986. Bank boards and management teams should take time to familiarize themselves with these changes, as several amendments to the Code relate to the payment of executive compensation.

For corporate executives and compensation committees, the change to the Code that has garnered the most attention concerns an amendment to Code Section 162(m). Prior to the Act, Section 162(m) imposed a $1 million cap per executive on the tax deduction a public company could take on compensation paid to its chief executive officer and three other highest paid executive officers, excepting the chief financial officer—generally, the “named executive officers” included in the company’s annual proxy. Historically, most companies relied on an exemption for performance-based compensation to avoid this limit, which was fully deductible even if it exceeded $1 million. The new tax law has eliminated the performance-based compensation exemption.

In addition, the tax law has expanded coverage of Section 162(m) to apply to all Securities and Exchange Commission (SEC) reporting companies (i.e., companies required to file reports under Section 15(d) of the Securities and Exchange Act of 1934, which includes many companies required to file due to public debt), rather than solely those whose common stock is registered with the SEC. It also expanded the group of executives subject to the deduction limit to include not only the named executive officers during the current taxable year—now including the CFO as a “named executive”—but also any person who was a covered executive for any prior taxable year beginning after December 31, 2016. Companies subject to Section 162(m) should review their incentive plan documents, incentive award agreements, severance agreements and employment agreements in light of the removal of the exemption for qualified performance-based compensation because these documents may have been drafted to account for the Section 162(m) performance-based compensation exemption that no longer applies.

In addition, the Act amended Code Section 83 by adding a new subsection (i) regarding deferred taxation of equity compensation. Section 83 generally governs the amount and timing of income inclusion for property, including employer stock, transferred to an employee in connection with the performance of services. Under Code Section 83(a), most individuals must recognize income for the tax year in which the employee’s right to the stock is transferable or no longer subject to a substantial risk of forfeiture. This changes for some employees with the new Section 83(i), which allows non-executive and non-highly compensated employees of privately-held corporations to elect up to a five-year deferral in the taxation of illiquid shares issued to them upon the exercise of nonqualified options or the settlement of restricted stock units (RSUs), if certain conditions are satisfied. The options or RSUs must be granted under an equity compensation plan in which at least 80 percent of a company’s full-time U.S. employees are granted awards with the same rights and privileges. The amounts of the awards may vary by employee as long as each employee receives more than a “de minimis” grant—i.e., all participating employees must be eligible to receive a legitimate economic benefit. This deferred tax election is not available to the CEO or the CFO—or to certain persons related to them—or to any person who within the past 10 years was one of the four highest paid officers of the corporation or an employee that holds 1 percent of the company’s stock. Under this new regime, eligible employees of private companies receiving stock through equity compensation arrangements may consider making an election under Section 83(i) to defer taxation on such compensation.

The IRS is expected to issue guidance on these changes, particularly the amendments to Section 162(m). Stay tuned.

Getting Ready for Proxy Season: Changes to Section 162(m)


proxy-2-17-18.pngThe tax law signed by the president on December 22, 2017, makes a significant change to the ability of public companies to deduct compensation paid to top executives.

Section 162(m) of the Internal Revenue Code limits a public company’s ability to deduct compensation of “covered employees” in excess of $1 million each year, but the old tax law provided a broad exception for certain types of performance-based compensation. A “covered employee” had been defined as any employee who, as of the last day of the taxable year, was the chief executive officer (or individual acting in that capacity) or an employee whose compensation is required to be reported to shareholders in the proxy statement because he or she is one of the four highest compensated officers, other than the CEO. As board members and compensation committee members of public companies are aware, the nuances and exceptions to section 162(m) limits were an important consideration in setting annual and long-term compensation for executives.

Below, we briefly explain the new limitations on the deductibility of executive compensation under Section 162(m), and offer some next steps for boards and compensation committees to consider in the first quarter of 2018. Public boards and compensation committees will need to take action on this before proxy season.

Performance-Based Compensation Exception Repealed
Historically, performance-based compensation, such as stock-option income and compensation paid only on the attainment of performance goals, was excepted from the $1 million deduction limitation. The new law repeals this exception, and may change the approach of compensation committees regarding the mix of salary, bonus, performance awards and equity grants in compensation. Also, some plans that required shareholder approval due to the performance-based compensation exception will no longer require shareholder approval for deductibility.

CFOs Again Subject to Section 162(m)
The new law amends Section 162(m) to specifically include a publicly-held corporation’s principal financial officer as a “covered employee” that is subject to Section 162(m). This corrects an unintended gap that had left CFOs excluded from Section 162(m), due to changes in 2007 to the Securities and Exchange Commission’s executive compensation disclosure rules. For companies that had already included their CFO as a “covered employee,” this will not result in a change. However, for companies which had not included the CFO as a “covered employee,” this change limits the deduction for that executive.

Once Covered, Always Covered
If an executive is a “covered employee” subject to Section 162(m) in 2017 or any later year, the new law provides that he or she remains a “covered employee” for all future periods, including after termination of employment for any reason, including death. This eliminates the ability to deduct, for example, severance payments made after termination of an executive’s employment, to the extent that the severance results in compensation in excess of the limit.

Expansion of Covered Companies
Previously, Section 162(m) applied to a company issuing any class of common equity securities required to be registered under the Securities Exchange Act of 1934. The definition of a publicly held corporation subject to Section 162(m) is expanded by the new law to include any corporation “that is required to file reports under Section 15(d) of [the Securities Exchange Act of 1934]”. This change would subject private corporations with public debt that triggers Section 15(d) reporting to the $1 million deduction limitation.

Limited Grandfathering Rule
The new law grandfathers in compensation provided pursuant to a written binding contract in effect on November 2, 2017, so long as it was not modified in any material respect on or after November 2, 2017.

Next Steps
These rules are complicated and, with the grandfather rules, will require close attention by companies in advance of preparing their 2018 proxy statement. We recommend that boards and, as appropriate, compensation committees, do the following.

  • Educate the compensation committee on changes to the tax code.
  • Review all employment agreements, change in control agreements, severance plans, equity plans and cash bonus plans to determine if they qualify for grandfathering.
  • Evaluate the impact on bonus payment decisions for 2017.
  • Evaluate the non-equity bonus plan design for 2018.
  • Begin to redraft the Compensation Discussion and Analysis (CD&A) and other relevant sections of the proxy statement.
  • Determine which plans will be subject to shareholder approval going forward.

In addition to the changes that will need to be made to proxy statements to reflect the updates to Section 162(m), the SEC’s pay ratio disclosure requirements were not modified by the new tax legislation and are in effect for the upcoming proxy season as well.

Compensation Strategies to Attract, Retain and Motivate Millennials


compensation-9-18-17.pngDistinguishing between retirement plans for a bank’s older executives and other key high performers and shorter-term incentives for its younger millennials, who are the bank leaders of the future, continues to be an important strategy for boards of directors. Compensation committees are willing to provide some type of mid-term incentive plan as a retention strategy focused on their younger workers. Boards also want to have both short- and long-term, performance-driven plans in place that are aligned with shareholder interests and retaining their key officers.

As with most employees, effective compensation plans and performance management programs can help attract, retain and motivate millennials. Providing a competitive base salary may not be at the top of their priority list, but certainly being rewarded for performance is important.

The next generation of leaders have been impacted by the recession, both from watching their relatives endure job loss and financial stress and from experiencing the post-recession economy directly. They are also the largest group carrying student loan debt. As a result, money is very important to them and while they may not be worrying about retirement, they are focusing on shorter term financial needs.

While millennials have essentially the same financial needs as the generations preceding them, their time horizon to retirement can be 30-plus years or more, which is too far into the future for them to focus on when faced with immediate financial planning decisions, like retiring student debt, purchasing a home and providing for their children’s education.

Nonqualified benefit plans including deferred compensation plans can be an effective tool for attracting and retaining most key bank performers—both those focused on retirement as well as more interim financial needs—because of their design flexibility. According to the American Bankers Association (ABA) 2016 Compensation and Benefits Survey, 64.5 percent of respondents offered some type of nonqualified deferred compensation plan for top management (chief executive officer, C-Level, executive vice president).

For this next generation of leaders, boards should consider a type of plan that allows for in-service distributions timed to coincide with events such as a child entering college. Plan payments made to the participant while still employed can be made at some future point such as three, five or 10 years.

These plans could be used in lieu of stock plans with a similar time duration and are important to younger leaders looking to shorter, more mid-term financial needs in a long-term incentive plan. Plans with provisions linking plan benefits to the long-term success of the bank can help increase bank performance and shareholder value as well as to reward key employees for longer-term performance. Defined as either a specific dollar amount or percentage of salary, bank contributions are discretionary or dependent on meeting budget or other performance goals. Interest can be credited to the account balance with a rate tied to either an external index or an internal index such as bank return on equity.

The plan can also include a provision that the account balance, or a portion thereof, is forfeited if the key employee goes to a competitor. In addition, it is typical to see events such as a change in control or disability accelerate vesting to 100 percent.

Let’s look at two examples, one for a retirement-based plan and the other for an in-service distribution to help pay for college expenses.

Assume that the bank contributes 8 percent of a $125,000 salary for a 37-year-old employee each year until age 65. At age 65, the participant will have $1,370,000 in total benefits, assuming a crediting rate equal to the bank’s return on assets, with an annual payment of $130,000 per year for 15 years. This same participant could also have had part of the benefit paid for out via in-service distributions to accommodate college expenses for two children. Assume there are two children ages three and seven and a desire to have $25,000 per year distributed for four years, for each child. Thus, these annual $25,000 distributions would be paid out when the employee was between the ages of 49 and 56. The remaining portion available for retirement would be an annual benefit of $78,000 for 15 years beginning at age 65.

Regardless of the participant’s distribution timing goals, both types of defined contribution plans can be tied to performance goals. The bank contribution percentage to each participant’s account could be based on some defined performance goal. Again, the ABA’s 2016 Compensation and Benefits Survey results showed that bonus amounts were based on several factors including: 85.6 percent bank; 74.9 percent individual; and 26 percent department/group. Aligning the bank’s strategic plan goals with the participant’s incentive plan provides a better outcome for both shareholder and participant.

In addition, many banks have implemented defined benefit type supplemental retirement plans as a way to retain and reward key executives. These plans can also be structured as performance based plans.

Regardless of a participant’s time horizon, it is important to reward both your older and younger leaders with compensation that is meaningful to them and will help them accomplish their personal financial objectives, while balancing the long-term interests of shareholders.