What Does the Wells Fargo Debacle Mean for Incentive-Based Compensation?

incentive-pay-10-31-16.pngWith all of the recent press coverage from the Wells Fargo & Co. phony account scandal, you’d have to be living in a cave not to have heard about it. As the details come to light, I’m certain it will be a test case for how not to design an incentive-based compensation program. But, does it mean that incentive-based compensation is a bad thing? In my opinion, a properly designed program can be well within the measure of safety and soundness, can create proper inducements for the appropriate segment of your workforce, and, can avoid creating the negative results that were realized by Wells Fargo.

In our firm, Bank Compensation Consulting, one of the most common short-term, incentive-based compensation designs has at its heart a deferral component. When a participant obtains a bonus based on achieving the goals set forth in the design, all or a portion of that bonus is deferred until some point in the future, say, five years from earning it. The deferral component accomplishes a number of goals. For one, it creates a reason for the participating employee to continue to remain employed with the bank If the employee leaves the bank prior to receiving the deferral amount, it is forfeited. Also, it allows the bank to comply with clawback rules requested by the regulators. Since the unvested portion has not yet been remitted, it can more easily be “clawed back” should there be a violation of terms outlined in the plan document.

Would this deferral design have helped in the Wells Fargo situation? As of this writing, the answer to that question is unclear. I will say that, when I consider how many years I’ve been working with banks and non-financial institutions to implement incentive-based compensation programs, and I consider how many of those haven’t had the result that Wells Fargo has, I think the answer is clear. As a CPA who did his requisite time at one of the large accounting firms, I have to ask myself questions like: What types of internal controls exist at Wells Fargo? What management oversight is in place to ensure an employee can’t easily create a fake account? Weren’t there ‘red flags’? Certainly, when your inventory is cash, there is always an element of temptation that some people simply cannot overcome. But, the sheer volume of the fraudulent accounts created indicates, at least to me, that at some level Wells Fargo management was sending the wrong message to the staffers involved. The corporate culture in the division of Wells Fargo where this took place must have played an enormous role.

The fact that an incentive-based compensation program existed shouldn’t mean that its utilization was the culprit that induced employees to create fraudulent accounts. For me and my colleagues, we feel that the malleability of such programs is extremely advantageous when trying to encourage certain actions by one or a group of employees. However, care and experience should be used when creating a safe and sound incentive-based compensation design.

You might just want to get inside a cave if you were an executive at Wells Fargo right now. Designing an effective and safe incentive-based compensation program and making sure it’s implemented correctly is one way to avoid the glare of bad publicity.

Bank Compensation and Wells Fargo: The End of an Era

compensation-10-21-16.pngOne of the biggest scandals among big banks in years is still unfolding as Bank Director heads into its annual Bank Executive and Board Compensation Conference Oct. 25 to Oct. 26 on Amelia Island, Florida. Wells Fargo & Co. announced last week the immediate retirement of CEO John Stumpf, with Chief Operating Officer Tim Sloan taking on the CEO job, as the board struggled to deal with public outrage over accusations that the bank’s employees had opened more than two million fraudulent accounts on behalf of customers to game aggressive sales goals.

The case raised questions about compensation and governance at the most basic level: What impact did the bank’s incentive package have on employee behavior, if any? What impact did the bank’s sales culture and sales goals have on the behavior of employees? What did the bank’s management know about fraudulent account openings and what did it do to stop it? If management failed to stop the fraudulent activity and benefited financially from it, should compensation be adjusted for those individuals, and if so, by how much?

These are all issues of extreme importance to Wells Fargo’s board, whose independent members are conducting an investigation, but also, to any board. No one wants to have a scandal of this magnitude take place while they serve on a board. If employees are complaining about bad behavior and bad culture, how does your bank handle it? How are you ensuring that complaint patterns from employees and customers are recognized and reported to upper management? Should the board also get these reports? What types of behavior are your incentives and sales goals motivating?

Wells Fargo’s board and now, Tim Sloan, are in the unenviable position of having to change the bank’s consumer banking culture even as they try to assess what went wrong. The pressure is strong to show the public and government officials that it is taking action quickly. Wells Fargo has said that as of Oct. 1, it had ceased all sales goals for branch-level employees and instead will start a new incentive program based on metrics related to customer service and risk management.

Since the sales culture had been very much a part of Wells Fargo’s identity, and higher than average profitability, investors are wondering how this will impact the bank’s financial performance. Keefe, Bruyette & Woods analysts Brian Kleinhanzl and Michael Brown downgraded the stock to market perform and wrote last Friday that “Wells’ management doesn’t know what the consumer bank will look like in the future.”

The stock price has fallen to $45 per share as of Wednesday afternoon from $50 per share at the start of September, before the announcement of a $185 million settlement over the issue with regulators and Los Angeles officials, who had sued the company. Is this the end of an era for Wells Fargo? I think so, as major changes will need to be made.

Community bankers tend to point to scandals like this as a way to differentiate themselves from the big banks. Many of the community banks I know don’t have an aggressive sales culture, let alone sales quotas. It’s also easier to know what’s going on in a small bank than one with more than $1 trillion in assets. Still, many bank boards in the wake of the scandal may be asking questions about their own sales culture, their incentive packages and compliance with company policies and ethical standards. Regulators are certainly asking these types of questions of banks, and I expect this to continue in the wake of the scandal. For more on the topic of culture, and determining your bank’s culture, see Bank Director magazine’s fourth quarter 2015 issue.

When we talk about compensation, we may talk about salaries, stock grants, deferrals and clawbacks. But what we’re really talking about is how to motivate employees to do a good job for the bank. And if you don’t have the culture to match what’s good for the bank and your shareholders, you don’t have much.

Addressing Problems with SERPs in Benefit Plan Designs

SERPs-8-5-16.pngSupplemental Executive Retirement Plans (SERPs) are a valuable compensation tool that banks can use to attract and retain executive talent. SERPs are nonqualified deferred compensation arrangements that are non-elective, meaning the company is responsible for contributions to the plan. Unfortunately, improper design of these plans can result in significant expenses for banks without providing the intended retention value. As a result, SERPs have gained a lot of negative press (particularly during the economic downturn), but if used properly, they can be a powerful tool in compensation. Here’s what you need to know about executive retirement benefits and how banks can avoid the common issues that arise with SERPs.

SERPs have some lingering reputational issues, although this isn’t entirely fair. Many banks do their due diligence and pay close attention to the expenses they will incur as a result of their benefit plans, but this hasn’t always been the case. When SERPs rose in popularity, many banks entered into inappropriately designed plans without understanding their implications. A poorly designed SERP can accelerate vesting schedules in the event of early retirement or cause banks to pay benefits in excess of 100 percent of final salary. Problems also arise due to IRC Section 280G (which deals with golden parachutes) in the event of a change of control. Additionally, many of these SERPs were designed solely with the placement of Bank Owned Life Insurance (BOLI) in mind, ignoring the strategic purpose and future impact. Fast forwarding to 2016, we see a number of problems related to SERP plans. The primary concerns are the following:

  • Banks absorbing mortality risks for lifetime benefit plans.
  • Defined benefit structures whereby a SERP benefit is contingent upon a final pay calculation.
  • Not considering 280G excise tax concerns in the case of M&A activity.
  • Unreasonable benefit structures that are either too lucrative or conservative.
  • Equity-based SERP designs.

Many boards have been soured by a bad experience and vowed to never implement another SERP plan at their bank. From a strategic perspective, this is a mistake that will hinder the bank’s ability to retain and recruit the talent necessary to stay competitive.

The real problem isn’t SERPS—its poor design. A SERP isn’t the answer to all the retention or recruitment issues, but it is a tool that should be used to complement the other components of compensation. SERPS themselves are not the problem; poorly designed SERPs are. Let’s address a few key design considerations:

  • Know what your expense is going to be. The benefit should be fixed day one, plain and simple.
  • Understand the potential 280G impact, regardless of the probability of a change in control.
  • Know that financing tools exist to reduce plan expense and provide a lifetime benefit with a fixed cost through proven methodologies. Explore all financing options—BOLI is not the only tool available for bankers.
  • Understand the strategic purpose behind the benefit plan structure, and conduct peer compensation studies to ensure that the benefit and compensation are reasonable and competitive.
  • Make sure the bank is protected in the event of premature death, but don’t allow life insurance to drive the design of your plan.

If your plan does not incorporate some of these features, it’s time to take a hard look at your plan design. Although IRC 409A (which regulates the tax treatment for nonqualified deferred compensation plans) imposes limitations on plan design changes, there are a number of strategies to help reduce the general plan expense, mortality risk concerns, 280G exposure and other issues without violating IRC 409A. There are hedging vehicles in the market to generate efficiencies at the benefit expense level. Consult with a compensation professional to help you navigate these waters.

Many banks continue to use SERPs effectively. A bad experience should not deter you from exploring the plan’s positive benefits. That said, a SERP can be complex and should be designed objectively by compensation professionals. If you explore all financing tools to make sure the bank is getting the most efficient design, your bank will be in an excellent position to accomplish your goals.

Director Compensation: Consider Adopting These Big Company Practices at Your Bank

director-compensation-2-29-16.pngThe evolution of pay and governance practices tends to be led by large companies—organizations that are under the watchful eyes of institutional shareholders, proxy advisors and the media. Smaller organizations have less visibility, fewer constituents, and can afford to take more time evaluating whether or not to adopt emerging pay practices, some of which may take years to be adopted or ultimately rejected due to unwarranted complexity, cost or irrelevance. But certain current pay and governance trends are worth considering right away, regardless of company size.

Pearl Meyer recently completed its annual Director Compensation Report analyzing director pay practices for 1,400 public companies. We have identified three practices that are nearly universal among the largest 200 companies in the S&P 500 (we’ll call them the Top 200) that we believe transcend company size and deserve consideration at banks, both large and small:

  • The shift toward retainer-based pay;
  • Delivery of over half of pay for board service in stock; and
  • The adoption of stock ownership guidelines.

Shift from Attendance-Based to Retainer-Based Pay
The largest companies generally have the most complex compensation structures. But on rare occasions, they actually lead the way toward greater simplicity in pay practices. One example is the shift from a retainer plus meeting fees structure to a retainer-only approach. This simplification of director pay has been an increasing trend among large public companies for a decade. Today, fewer than one in five Top 200 companies now pay meeting fees for board service, while roughly 40 percent of companies with revenues of $50 to $500 million (so-called micro companies) continue this practice.

The most compelling argument for retainer-based compensation is the investor expectation that a director’s full commitment to attend all meetings should be a given. A retainer structure emphasizes that directors are compensated for the skills and experience they bring to the position, an expectation just as relevant for small companies as the Top 200. A side benefit of this approach is its greater simplicity, something community banks may find attractive.

Increase in Equity Pay
A long-promoted principle of the National Association of Corporate Directors (NACD) is to align director compensation with the interests of the shareholders they represent, in part by delivering at least half of director pay in the form of stock. Two-thirds of all companies studied, and nearly 90 percent of the Top 200 companies, comply with this guideline. Practices among banks in the study were similar to the general industry. The prevalence of companies meeting this threshold generally increases with the size of the organization.

With certain exceptions (mutual organizations, family-owned, closely-held, etc.), the rationale for paying at least half of director compensation in equity is no less compelling for community banks than for large corporations:

  • Directors at community banks are equally responsible for representing their shareholders;
  • The governance practice of aligning director pay with the long-term interests of shareholders is universal; and
  • Stock-based compensation is more capital-friendly than cash, which may add special appeal for banking organizations.

Community bank boards may include a diverse group of directors and demographics, and cash-focused director pay may at times be more appropriate. However, the benefits of a greater mix of equity-based compensation may be appropriate for your organization.

Director Stock Ownership and Retention
Larger companies have almost universally adopted stock ownership guidelines requiring directors to accumulate or retain shares received over a defined period of time. The rationale is consistent with the purpose of stock-based pay—greater alignment with the long-term interests of shareholders. This is a reasonable objective for stock companies, regardless of industry or size.

While ownership requirements vary from company to company, they are typically attainable through retention of shares received under the compensation program. A common structure might require ownership equal to a multiple of the annual cash retainer (for example, three to five times the retainer), with retention of at least 50 percent of shares until an ownership level requirement is met. For community banks looking to score points within the governance community, adopting modest, achievable stock ownership guidelines can be a relatively easy win.

Community banks aren’t known to be early adopters of pay trends, and that’s a good thing much of the time. But the three director compensation trends discussed above have been tested and refined at large companies for many years and they have direct and immediate applications to smaller organizations. Consider exploring the merits of these big company director compensation practices for your bank in 2016.

Executive Benefit Plans in 2016: Emerging Trends

benefit-plan-1-27-16.pngSince the credit crisis, most community banks have been able to grow and improve their financial condition. According to the Federal Deposit Insurance Corp. (FDIC), almost 60 percent of community banks reported higher year-over-year earnings for the period ending in the third quarter of 2015. In addition, community banks have increased assets by 5.6 percent and total loans and leases by 8.5 percent for the same period adjusted for mergers. While these growth numbers do not represent the pre-credit crisis years, the industry is showing an improvement. The percentage of unprofitable community banks are at the lowest level in many years. Community banks are defined by the FDIC Community Bank Study, December 2012, and one of the criteria is that these banks are “likely to be owned privately or have public shares that are not widely traded.”

What do improving conditions mean to banks and their compensation plans? Some banks have seen challenges in retaining key officers given increased competition for top talent, while other bankers believe they are now in a position to invest in additional key talent to grow their organization. For banks that have implemented various types of compensation plans, it may mean including an additional key officer in these plans. Attractive executive compensation plans include market-based salary, annual bonus based on performance, stock options or restricted stock (where applicable), reasonable contributions to a 401(k) or other qualified retirement plan, medical care and other standard benefits, change- in-control agreement and a custom-tailored nonqualified retirement plan.

Another important trend is the disruption created in many markets by mergers. The purchasing bank wants to retain the top lenders and others revenue generators, but the change in ownership can cause those individuals to consider other options. Competing banks that have developed a game plan for such situations will be positioned to hire some of these talented individuals. A nonqualified plan (customized for each executive) can play a vital role in attracting and retaining these individuals.

Another trend that has been taking place is an increase in the number of community banks that previously only offered salary and annual bonus plans, but are now providing more comprehensive compensation packages for key executives. This is a result of increased competition for executives as well as improved earnings.

Nonqualified plans need to be tailored to meet the needs of the individual. For example, a younger officer in his or her 30s may not see the value of a retirement benefit targeted at age 67, but would see value in a plan that allows for earlier cash distributions to pay for a child’s college education or that allows for early retirement at age 55. Many organizations use a combination of plans and approaches to attract and retain their key people. Here are some examples of situations and challenges bankers have faced when contemplating compensation plans:

  1. You have an executive in his mid-50s who has contributed to leading and growing the organization but has not yet been rewarded for his efforts. This executive’s compensation focus is now being more directed at retirement and wealth building rather than solely increases in current cash compensation. Consider a supplemental executive retirement plan (SERP) plan and perhaps a long-term incentive plan. He may also be interested in deferring current salary.
  2. You have young officers in their 30s and 40s who are high producers and need to be compensated for their efforts with more than just base salary and annual bonus amounts. Consider a performance-based nonqualified benefit plan or a combination of a SERP and performance-based nonqualified plan. It is important to tie these individuals to your bank if you remain independent, but it can also enhance the sales price if these individuals stay with the purchasing bank in the event your bank is sold. Properly designed nonqualified plans can substantially increase the probability they will stay in either scenario.
  3. For closely held banks that would like their management team to think like owners, consider nonqualified plans using a phantom stock or stock appreciation rights approach or, if another type of deferred compensation plan is adopted, consider linking the interest credited to the executive’s account to the bank’s return on equity.

With an improving economy and asset growth of community banks, along with a higher than normal level of merger activity, banks have been adding officers to existing long term incentive and nonqualified benefit plans or developing and implementing new plans to compete with other banks for talent. Utilizing more than one compensation strategy or plan can be an important element in attracting and retaining talent. The bank’s franchise value is dependent on its level of success in attracting and retaining key executives.

Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc.

Playing Your Cards Right With Executive Compensation Disclosures

proxy-season-11-13-15.pngAs the 2015 calendar gets shorter, are you hedging bets that your next Compensation Discussion & Analysis (CD&A) will wow shareholders and ensure a strong say-on-pay vote next year? Or are you hoping to bluff your way through the next proxy season? Between regulatory changes and a high level of public scrutiny, it’s never too early to begin focusing on your executive compensation disclosures. 

Why Communication Strategy Matters More Than Ever
Effectively communicating your compensation plan and its link to the bank’s business and leadership strategies is a growing priority among boards and management teams. As we all know, executive compensation—and the regulation surrounding it—is increasingly complex. A well-planned and artfully delivered disclosure document can improve chances of a favorable say-on-pay outcome and potentially bolster your defenses against shareholder activism. At a minimum, it can help improve overall shareholder engagement and build communication between the board, management and other stakeholders.

The Ante: Emerging Compliance Requirements
Unfortunately, the Dodd-Frank Act’s many provisions are still looming and it’s only a question of time before the final proposals on matters such as the CEO pay ratio, pay-for-performance, and clawbacks are implemented. These fast-changing rules can make it difficult to keep up from a communication perspective. How might these new mandates complicate or conflict with your compensation strategy and how can a public bank ensure they’re fully compliant, while delivering the most effective story to shareholders and employees about the executive pay programs?

Remember—balance is the key. With so many requirements coming, it will be necessary to offset the potential complication of your message with clear details on your compensation design and its alignment with the bank’s business strategy. Within the regulatory context, there’s an opportunity to discuss:

  • How executive compensation supports your business strategy and leadership talent goals;
  • How compensation is defined;
  • How performance is viewed;
  • How sound governance and risk management is practiced; and
  • What you pay your executives and why.

It’s not just public banks that face these issues. While private entities aren’t required to disclose, many feel the resulting public pressure to communicate more and can benefit from the following guidelines.

The Winning Hand: Moving Beyond Compliance to Tell Your Story
Obviously, compliance is important, but companies need to continue shifting program design focus from compliance to a compensation philosophy that supports the long-term business strategy.

Results from Pearl Meyer’s 2015 OnPoint Survey: The New Normal of Annual Compensation Disclosure, offer several points to consider as you begin the CD&A development process. Perhaps most surprising is that ”reader-friendliness” of the CD&A is just as important to compensation committees as technical accuracy. In fact, making the content easier to read/understand ranked as the number one request compensation committees make to staff regarding the CD&A. Survey results also indicate those companies who rate their CD&A as “excellent” or “very good” experience a higher percentage of yes votes for say-on-pay from shareholders than companies who don’t rate their CD&A as high.

There are three ways to ensure you “win the hand” in regards to your pay communications to shareholders:

  1. Take advantage of emerging trends for content and design.  There have been big changes over the past five years in how information about pay is presented within the CD&A. Content needs to be accurate, complete and concise while keeping in mind that shareholders are the target audience. Incorporating elements such as executive summaries and visuals that illustrate year-over-year pay levels, mix of variable versus fixed pay, and realizable/realized pay help organize the story and pull the reader through the document. The survey results show a clear pattern: companies with favorable views of their communication use these methods far more than companies who believe their CD&A is only fair or needs improvement.
  2. Leverage the experts to develop and deploy your message. Using internal corporate communications practitioners, graphic designers, and external writers can be worth the expense. Survey results show that companies who have relied on communication experts to help develop content typically have excellent or very good communication effectiveness and almost 80 percent of these companies are using at least one professional resource.
  3. Adjust your timeframe. The quality of executive compensation disclosure is more important today than ever and the quantity of information required is growing. Therefore, it it’s never too early to get started! Our survey confirmed that those who began working on their disclosures before the close of the fiscal year reported excellent or very good communication effectiveness. It’s a safe bet to follow their lead.

Taking this disciplined approach to communicating the value of your programs should pay off in the long-term and can help your board successfully move ahead with strategy-based design.

Six Steps for Creating the Ultimate 2016 Producer Incentive Plan

compensation-plan-06-23-15.pngThere will always be strong demand for high performing producers. Incentive plans, when designed correctly, can help attract, motivate and reward the employees who are key to driving the bank’s success.

It may seem straightforward, but if this were an easy and predictable process, banks would spend much less time and energy reviewing and modifying their plans each year. In reality, it’s not easy, but it is critical to create an incentive program that aligns with current business priorities while also considering the factors that motivate your top sales staff.

Keep this list handy because while summer is just beginning, the fact is, it won’t be long before it’s time to recalibrate your plans for 2016.

  1. Know Where You’re Going.  Establishing guiding principles for the incentive plan is often an underappreciated step, but it aligns design decisions with the important operating goals of the bank. Be clear about exactly what you are trying to accomplish. Enhance revenue growth? Sell to new customers or deepen current relationships, or both? Perhaps you simply want to push your best performers to operate at an even higher level than in the past, or for strategic business reasons, you want this same group to shift focus toward a new market. Revisiting these principles will help establish and reinforce the underlying basis for the incentive plan.
  2. Determine the Plan Type. There is often considerable deliberation about the type of plan to deploy. Will a goal-based team plan provide your sales staff with a collaborative environment to motivate them to meet their sales objectives or will an individual production plan work better? How about a hybrid of the two? Identifying the approach that fits your culture and operating unit best will drive the right behavior.
  3. Simplify the Measures. Performance metrics will directly influence behavior. Should a commercial relationship manager be compensated for gathering deposits, increasing loan growth, referring mortgage customers, cross-selling wealth services, and doing so with the highest level of customer service? Well, yes. But should they be compensated for each of those measures or will individual measures for each slice unwittingly shift focus from the top priority goal? It is important to identify the most direct drivers of business success, while recognizing the potential impact of trying to cover too much ground.
  4. Calibrate Payout with Production. Understand the historical levels of production for your sales staff and the required output for the coming year, and align these expectations with appropriate payout opportunities. Are you willing to pay for breakthrough performance and if so, how much? What level of production are you not willing to pay for? And do these hurdles align with the revenue required to meet the business unit’s financial goals?
  5. Test for Risk. Do your own stress-testing to ensure the design will generally meet risk review tolerances before the plan is evaluated for risk. Ask the following questions: How much leverage is in the plan? Are the measures balanced and not placing too much emphasis in one area? Is there proper administrative and governance rigor? Does payout frequency align with the product life horizon? Are holdbacks or deferrals necessary in order to provide a means to adjust awards based on quality?
  6. Ensure Differentiation. The conservative nature of the industry often leads to final plan decisions that simply don’t provide for differentiated incentives, meaning there is not enough “pay daylight” between top and average performers. Providing meaningful differentiation is one of the principles behind well designed incentive plans—it will ensure your producers who lead the pack will be well compensated and highly motivated.

The potential impact to the bank if incentive plans underperform can be the difference between meeting and missing targets. Running through this checklist may help to identify enhancements that can optimize your plans and create a path to success.

Designing The Bank’s Incentive Plan

12-6-13-Meridian.pngIncentive plans are a critical component of a bank’s compensation program. They help drive business results, provide competitive compensation opportunity and ensure an appropriate linkage between pay and performance. For publicly-traded banks, disclosure of incentive plans also serves as an important communication to shareholders of the bank’s priorities and commitment to pay-for-performance. With 2014 just around the corner, now is the time to determine the appropriate structure of your incentive plans for the new year.

Annual Incentives

Annual incentives help drive business results by linking compensation to the accomplishment of annual goals that support strategic priorities and ultimately create shareholder value. Key objectives of annual incentive plans include:

  • Driving business strategy – The choice of incentive measures and performance goals communicates to participants the results, behaviors and success factors needed to achieve business objectives. Banks should review their incentive plan measures each year to ensure they are aligned with the business plan and driving progress toward long-term goals.
  • Rewarding performance – Annual incentives should ensure that executives are appropriately rewarded for results. Plans should have threshold, target and maximum performance levels, with appropriate leverage in the payout ranges to ensure that reward levels are appropriate for the performance achieved (whether above or below expectations). Historical payouts should be assessed to determine if the plan is resulting in an appropriate pay-performance relationship.
  • Mitigating excessive risk taking – Bank regulators are focused on ensuring incentive plans, measures and payouts ensure participants are not incentivized to take excessive and/or inappropriate risks. This assessment should be conducted annually and whenever a new plan or changes are being proposed.

Choosing the right performance measures is essential to ensure that annual incentives support the key business objectives. While earnings (e.g., earnings per share, net income) is the primary focus for most bank annual incentive plans, including additional measures ensures a more balanced plan and provides the opportunity to directly link incentives to strategic priorities. Depending on a bank’s priorities, it may be appropriate to focus on growth, expense control, capital levels and/or credit quality.

It is also important to consider to what extent the annual incentive plan will reward performance at the company, business line and individual levels. Typically, a higher percentage of annual incentives are based on bank-wide results for senior executives to reinforce the team approach. Incentive plans also can provide some level of individual accountability by allocating goals specific to each executive’s role. Executives should meet to discuss their respective individual goals for the upcoming year to ensure appropriate coordination and interaction as needed.

Long-Term Incentives

Long-term incentive plans, which are typically delivered primarily through equity awards, should motivate and reward the creation of long-term shareholder value. Long-term incentive plans do this by enhancing alignment with shareholders, rewarding sustained long-term performance and creating retention “hooks” for high performers through the value of unvested awards.

Banks can choose from a variety of vehicles to deliver long-term incentives, including time-based restricted stock, stock options, performance shares (restricted stock that requires achievement of performance goals to vest) and long-term cash plans. Each vehicle has its own strengths and weaknesses in accomplishing the objectives of long-term incentive programs. Stock options and performance shares promote shareholder alignment and performance, while time vested restricted stock promotes stock ownership and retention goals. Most banks seek a balanced approach that allows them to achieve the multiple goals discussed above. As a result, an increasing number of banks are choosing a portfolio approach to long-term incentives, providing on average two components (e.g. stock options and time-based restricted stock or performance shares and time-based restricted stock).

For awards with performance vesting criteria, incentive measures should represent shareholder return or long-term value creation. Performance measures can be based on absolute results, relative comparisons to other banks or both. Absolute goals should align with a bank’s strategic plan. Relative measures avoid the challenge of multi-year internal goal setting, but require the selection of an appropriate comparative group of banks.


Given the significance of incentive plans, it is important to begin discussions about the design of programs well in advance of the new performance year. Banks should ensure that their programs support strategic objectives, motivate participants to drive the success of the bank and align pay outcomes with performance results. Annual evaluation of prior year results can also ensure plans are effective and provide input for realigning the plans if appropriate.