It’s More than Just the Money

Offering competitive compensation programs is an important factor in employee satisfaction and retention. But is it the most important thing? First Financial Bankshares Chairman, President and CEO Scott Dueser believes that the culture of your organization and how you treat your employees are even more important. In this presentation, one of the country’s top bankers explains how his company motivates its employees to perform at the highest levels.

It’s a New Day in Executive Pay

12-3-14-Naomi.jpgEver since the financial crisis, bank boards have been operating under a tremendous amount of scrutiny, and that is leading to substantial changes in pay packages. Changes that at first only impacted the largest, global banks are cascading down to smaller community and regional banks.

People such as John Corbett, the CEO of the $3.9-billion CenterState Bank of Florida, headquartered in Davenport, Florida, say their banks are paying executives more of their total compensation in long-term equity. If the bank’s shareholders do well, so do the executives, so the thinking goes. Half of the stock is time vested, meaning it takes a few years before executives have access to it. The other half is tied to performance goals. Also, the bank’s annual bonus plan for top executives is a mix of cash and stock, and the bonuses are deferred for three years in case the credit quality of the bank’s loan portfolio deteriorates.

Corbett spoke at Bank Director’s Bank Executive and Board Compensation Conference last month in Chicago.

Kevin O’Connor, president and CEO of Bridge Bancorp, Inc. in Bridgehampton, New York, also spoke at the conference and said his more than $2-billion asset banking company has made substantial changes, adding long-term incentives in the form of equity, tying those to individual and corporate performance, and requiring vesting periods for the stock.

O’Connor said not all banks provide employees with as much transparency into exactly how the bonus plan works as Bridge Bancorp does now. But his bank’s plan has generated more discussion about how to reach corporate and individual goals, and he feels good about that result.

“[Employees] want to know what the corporate goals are,’’ O’Connor said. “They want to know how they can affect it. What I like is there is actually a dialogue now with the manager as to what they should be focused on.”

Other changes that are happening in bank pay plans include:

  • More publicly traded banks are using restricted stock. The stock typically vests over a three-to-five year period, to provide a retention tool, or vests based on achievement of specific performance measures. Common performance measures include the company’s shareholder return relative to a peer group, return on assets, or earnings per share. Goals for the highest executives tend to be focused on corporate performance, while lower level employees have more weight given to individual and department goals. Private companies can offer incentives in the form of “synthetic stock” or “phantom stock” that increases in value with the company’s value, and is ultimately paid in cash.
  • Long-term incentives are an increasingly important part of the average executive’s pay, but the percentage varies greatly by size of bank. For example, CEOs at banks above $1 billion in assets on average receive 26 percent of compensation in long-term incentives, typically stock, according to a review of about 150 publicly traded companies by Blanchard Consulting Group. For banks between $500 million and $1 billion in assets, the percentage of total compensation that is long-term is 12 percent.
  • Stock options are going away. Regulators have a “stated disdain” for stock options, according to compensation consultant Todd Leone of McLagan. “They have been slowly dying on the vine,’’ he said. Powerful shareholder advisory groups, such as Institutional Shareholder Services and Glass Lewis & Co., don’t consider stock options tied to performance.
  • Gone are the days of executives getting change-in-control payouts when a sale occurred even when they didn’t lose their jobs. The payouts also are smaller, in the range of two to three times base pay, rather than four or five times base pay as was common five or six years ago, said Barack Ferrazzano attorney Andy Strimaitis.

Figuring out how to pay top executives has always been a huge challenge for the board. You don’t want to lose top talent to competitors, but you also don’t want to give overly lavish pay packages, either. There is no one way to do this. There are plenty of ways to get your bank in trouble with regulators or ensure a negative say-on-pay vote at the annual shareholders’ meeting, but each board has to come to its own decision about what makes an optimal pay package.

Banks Increasingly Use Restricted Stock

11-10-14-Blanchard.jpgEquity compensation practices at community banks have shifted significantly during the past 10 years. This shift has focused primarily on the type of equity, the way in which equity is granted, and the prevalence of equity use for both executives and directors. While some of the changes have been triggered by regulatory bodies, I believe some of the changes have also been the result of common sense and experience.

Executive Equity Grant Trends
In the early 2000s, before the implementation of stock option accounting, stock options were the most prevalent form of equity compensation. But with the implementation of stock option accounting under FAS123R (now ASC 718), companies now had to recognize a stock option expense and there was the chance that the executive never recognized a reward if the stock price declined after grant. In the late 2000s, numerous stock options were “underwater,” or no longer accomplishing the goals of equity compensation for executives, including reward, retention and link to shareholders. As such, the last five years have seen a significant rise in grants of full-value shares (commonly, restricted stock units or RSUs). These full-value shares will:

  1. Always have value (so long as the underlying stock has value). They can’t go “underwater.”
  2. Create executive shareholders. They are stock grants and executives become shareholders upon vesting.
  3. Promote retention if vesting provisions are included, with vesting typically ranging from three to five years.

In a Blanchard Consulting Group study of approximately 200 publicly traded banks, 86 percent of those that granted equity to the top executive in 2013 used restricted stock, 39 percent used stock options, and 24 percent used a blend of both. Restricted stock has clearly become the preferred equity compensation vehicle.

Another trend with executive equity grants is the use of performance criteria in determining the amount and/or vesting of the equity grant. Historically, equity was often granted on a discretionary basis and not tied to any performance criteria. Today, I see banks using performance-based grants, where the bank determines specific levels of performance that will result in equity awards if achieved. After the performance cycle is complete, the resulting equity award is granted, typically with additional time vesting. Performance-based vesting is also being utilized in larger banks and Fortune 500 companies. Under this concept, a number of shares are granted, but shares will only vest if performance levels are achieved. I have not seen a high prevalence of performance-vesting in community banks (time-based vesting is more common), due to some complexities with the performance-vesting methodology and accounting. However, banks certainly tie equity grants more frequently to performance than they did in the past.

Director Equity Grant Trends
Ten years ago, the use of equity grants for directors was somewhat sporadic. I have seen this change significantly in recent years, as bank boards decide that director pay should be based on time spent, as well as value and expertise brought to the board. There also is an increased need to attract qualified directors with specific skill sets to help assess risk and handle increased regulatory scrutiny.

These changes to the typical community bank board have created a situation where banks are granting directors equity, commonly as restricted stock. Often, this stock is granted in the form of an annual retainer with either immediate or very short vesting periods, often just a year. Blanchard Consulting Group conducted a study of approximately 150 publicly traded banks and found the following:

  • 75 percent of the banks have an equity plan in place for directors
  • 49 percent of the banks granted equity to directors in 2013
  • 90 percent of those banks which granted equity to directors utilized restricted stock

The goal is to provide directors with a specific amount of remuneration for their annual service on the board, and restricted stock retainers with quick vesting are the best way to tie a specific dollar value to director service. It also makes new directors shareholders and further links them to the people they represent. Our study also found 38 percent to be the median value of equity as a percent of total director compensation.

Another area that is gaining traction in larger organizations and among shareholder advisory firms is executive and director equity ownership guidelines and holding requirements. I have yet to see these items reach a significant prevalence level in community banks, but I expect a gradual increase in upcoming years.

In summation, community bank equity practices have shifted. The shift has been to full-value equity vehicles and restricted stock has become the clear choice. We will see what the future holds.

Negotiating Complexity: Executive Compensation Issues in M&A

10-31-2014_BryanCave.jpgUpon reaching a letter of intent to acquire or sell a financial institution, many bank directors will breathe a sigh of relief. Following the economic challenges of the past several years, the directors of each institution have charted a course for their banks that will likely result in their respective shareholders realizing the benefits of a strategic combination. Although directors should be focused on “big picture” issues during the negotiation of a definitive agreement, they should not overlook the resolution of the many issues that can arise from executive compensation arrangements in a potential transaction. While often seemingly minor, compensation matters can raise unexpected issues that can delay or de-rail a transaction.

Procedural Issues
In addition to considering the economic features of a proposed merger, directors should also consider their individual interests in the transaction, including the potential payout of supplemental retirement plans, deferred fee arrangements, stock options, and organizer warrants that are not available to the “rank and file” of the company’s shareholder base. These arrangements may pose conflicts of interest for members of the board and are subject to different types of disclosure:

  • Disclosure of potential conflicts: Early in the negotiation of a potential sale, individual directors should identify deal features that may create the appearance of a conflict of interest or an actual conflict of interest. With help from legal counsel, these personal interests should be disclosed and documented in the board resolutions approving the transaction. Appropriate disclosure and documentation of these actual or potential conflicts usually resolves these issues, but if significant conflicts exist, counsel may advise the use of a special committee or special voting thresholds for the transaction.
  • Shareholder disclosures: While specific requirements may vary for private and publicly-traded companies, compensatory arrangements for directors and officers will need to be disclosed in detail as part of proxy materials mailed to shareholders. In particular, the SEC has begun requiring detailed compensation disclosures for directors and officers, even for deal consideration issued to these individuals simply by virtue of being a shareholder.

Cultural Issues
Directors of the selling bank should also monitor the negotiation of new employment contracts for selected members of its management team. Typically, these contracts will be completed prior to the seller’s entry into a definitive agreement and will indicate which members of its management team will be retained for a transition period or even long-term following the completion of the transaction. The cultural issues arising from the negotiation of these contracts can also require additional attention be paid to those who will not be offered positions following the transaction. These short-term employees can play an important role in preserving the value of the organization prior to closing and may even have value in terms of assisting with the integration of the two institutions, so providing them with clear roles and concrete expectations early in the process can resolve many issues.

Tax Issues
Responsible choices made to manage the economic crisis, including the suspension of director pay, may give rise to unexpected tax issues that must be resolved as the definitive agreement is negotiated. Here are some examples:

  • “Golden parachutes:” If applicable, Section 280G of the Internal Revenue Code will treat most transaction-related payments or accelerated vesting of options or warrants for directors or officers as parachute payments. If these payments exceed a certain percentage the individual’s average compensation over the past five years, then both the individual and the bank will be subject to significant tax penalties with respect to those parachute payments. When financial institutions have previously suspended director compensation, 280G presents an even greater challenge because directors in those situations have little or no average compensation history.
  • Restrictions on changes to existing compensation arrangements: Changes in the timing or form of payment of existing compensation arrangements contemplated or revealed as part of a transaction can also result in significant additional tax liability under Section 409A of the Internal Revenue Code. Few compensatory arrangements are free from 409A issues, but the amendment or termination of employment contracts, bonus plans, supplemental retirement plans, and equity awards are among the deal-related events where this tax liability can be triggered.

Existing compensation arrangements are often highly problematic for a transaction, so developing a strategy for managing the procedural, cultural and tax implications of these arrangements early in the negotiations is key. Resolving these issues can take time and effort, but if the parties do so successfully, they will have taken an important step toward consummating a successful transaction.

What’s New for Change-in-Control Agreements

10-29-14-Meridian.jpgIn the banking industry, where mergers and acquisitions are common occurrences, change-in-control (CIC) arrangements can be a critical part of executive compensation programs. However, these arrangements are currently under scrutiny from shareholders, institutional investors, the media and most notably, proxy advisory firms. While market practices in this area can be slow to change, as they tend to be part of longer term agreements or contracts, the external pressure has caused many public companies to change their CIC arrangements in a number of areas.

Purpose of CIC Arrangements
CIC arrangements are generally provided to keep executives neutral to job loss while they consider potential transactions, retain key talent during periods of uncertainty, provide a market competitive benefit and be fair to executives in the event of job loss. CIC arrangements generally cover senior executives who seek out and implement corporate transactions, as well as key executives that may be at particular risk of job loss in the event of a CIC.

Current Trends in CIC Arrangements
Meridian’s 2014 Study of Executive Change-in-Control Arrangements, when compared to our 2011 study, revealed key trends in the following areas: 1) the overall structure of CIC protection, 2) cash severance provisions 3) equity vesting acceleration and 4) excise tax treatment.

Overall Structure of CIC Protection: Shift to CIC Plans
Companies are shifting away from individual CIC agreements and towards CIC Plans. CIC Plans, as opposed to individual agreements, cover multiple executives under one plan. Similar to a general severance plan, the plan terms and conditions are the same for all participants with differentiation of severance multiples based on level. A CIC Plan, instead of individual agreements, ensures consistent application and provides easier administration.

Cash Severance: Decrease in Severance Multiples
A large majority of companies provide cash severance benefits upon a qualified termination following a CIC. The amount of cash severance is typically determined as a multiple of pay, which generally includes both base salary and annual bonus (either target or average of recent payouts). Cash severance multiples are trending down, especially for executives below the CEO level. While 3x multiples remain majority practice for CEOs, 2x and lower multiples are becoming more prevalent for other top executives. This decrease in severance multiples is a direct result of shareholder pressure against large payouts or what is commonly known as golden parachutes.

Equity Awards: Elimination of Single-Trigger Vesting
Historically, the vast majority of companies have provided for equity awards to vest in full immediately upon a CIC (single-trigger). Critics have argued that this creates an inappropriate windfall for recipients, and have argued that vesting should not accelerate absent a qualifying termination following the CIC (double-trigger). A double-trigger provision means that equity immediately vests only if there is a CIC and the executive loses his or her job as a result of the CIC.

Pressure from institutional shareholders and their advisors has led to significant change in the treatment of equity awards upon a CIC. While single-trigger provisions were majority practice in our 2011 study, it applied to only approximately one-third of equity awards in our 2014 study. The most common treatment in our study was double-trigger vesting. However, our study indicates that an emerging practice is to include a caveat on double-trigger vesting: equity will vest immediately if the equity is not assumed or replaced by the acquiring company.

Excise Tax Treatment: Elimination of Gross-Ups
Federal tax regulations trigger a 20 percent excise tax when CIC benefits exceed a specified threshold. Because the tax can have disparate impact on executives depending on their past earnings, many companies have provided tax gross-ups to mitigate its impact. However, these provisions have faced tremendous scrutiny and criticism, which has led to a sharp decline in their use. While many companies have been promising to exclude gross-ups from future agreements for several years, we are now seeing some companies remove them from current arrangements. This has accelerated the movement away from gross-up provisions, as they are now present at about only one-third of companies in our survey.

Gross-ups have generally been replaced with a “best net benefit” provision, which is now the most common excise tax treatment. Under a best net benefit provision, an executive will receive the greater of 1) a capped benefit, with the amount reduced just below the threshold for triggering the excise tax, or 2) the full benefit, with the executive personally responsible for paying the excise tax.

Change-in-control benefits continue to provide several important benefits to banks, but it is important to ensure that provisions balance shareholder and executive concerns. As market practices continue to evolve, it is important to periodically assess your CIC benefits and ensure they remain appropriate and effective.

Say-On-Pay Trends at Banks: Proxy Firms Increase “No” Recommendations

What should public bank boards know about proxy firm recommendations? McLagan evaluated Institutional Shareholder Services’ (ISS) recommendation patterns for management say-on-pay (MSOP) votes at bank shareholder meetings this year. ISS’ “no” vote recommendations were up from 2013 to 2014, summarized in the chart below:McLagan_linechart.png

Larger banks receive greater scrutiny from ISS and are more likely to get a negative recommendation. Banks with assets greater than $5 billion received “no” recommendations almost twice as frequently as banks below $5 billion.

Despite the increase in negative recommendations, overall shareholder approval remained high. Nearly 75 percent of banks received greater than 90 percent support for MSOP, and half were above 95 percent approval.

Caution! Receiving a negative recommendation can have a dramatic impact on the level of shareholder approval. McLagan performed an analysis of actual shareholder votes after ISS had made a recommendation on pay practices, either “for” or “against.” The table below shows a distribution of vote results.

MSOP Vote Results
Percentile ISS Recommendation
For Against
25th Percentile 92% 59% 
50th Percentile 96% 75%
75th Percentile 98% 85%

At the median, those banks receiving a “for” vote recommendation from ISS also received a 96 percent approval vote from shareholders. In contrast, a bank receiving a “no” vote recommendation only received a 75 percent approval vote—a drop of 21 percentage points at the median! The drop was even more significant at the 25th percentile, where a “no” vote recommendation resulted in an approval rating of only 59 percent, down 33 percentage points from banks that received a “for” vote recommendation.

Here are the landmines to watch out for that can trigger a “no” vote recommendation.

Top 3 Reasons for ISS “No” Recommendation
Pay for Performance Disconnect
Mega-grants of Equity (e.g. sign-on or retention bonus)
Problematic Pay Practices (e.g. excise tax gross up or re-pricing options)

An example of a pay for performance disconnect is when the CEO is paid above the 75th percentile of ISS’ comparative group, but the bank’s performance as measured by total shareholder return (TSR) is below the 50th percentile. Another example would be an increase in CEO compensation as TSR decreases.

Some banks escaped receiving a “no” recommendation in 2014 even though their pay practices would presumably have merited one. The reason? One example is TSR for a bank may have improved and been relatively strong compared to the comparative group; as a result, some pay practices might be given a pass. But, if TSR slips, these banks may well receive a different recommendation.

In summary, don’t take your MSOP vote results for granted. Be proactive in making appropriate adjustments to executive compensation and watch out for the top 3 reasons for “no” vote recommendations, especially if your bank’s TSR is decreasing. It’s much easier to fix the problems before receiving a failing MSOP vote result.

The Hidden Value in Performance Evaluations

10-22-14-meyer-chatfield.pngI am not sure when performance evaluations became standard practice in business, but I can say with confidence I have never met one executive, director, manager or employee who relishes the process. It is laborious, and in many circumstances, antiquated. The reason is pretty simple: It is often a cold, process-driven meeting, with little intellectual or emotional investment beyond checking off a few boxes on a performance evaluation software application and giving a rah-rah speech to the employee. In other words, it’s something you just have to do.

There is no question that performance evaluations have a role to play within organizations. However, employees who are performing tangible, quantifiable tasks will be more suited to a traditional evaluation than more relationship driven, strategically focused employees—but a company still needs to know how these individuals are performing in respect to their job duties. I am not suggesting that performance evaluations should be abolished, but at the very least, they should be complimented with a different approach to achieve maximum value from the process no matter the level of responsibility of the employee in the organization.

The suggestions that follow are not solely my own, but rather blended insights from our experience in the banking industry and the experience of other successful business leaders, such as Andy Stanley, founder of North Point Ministries in Alpharetta, Georgia, who uses a similar approach in his organization.

Some employers, such as North Point Ministries, have developed questions that replace the standard evaluation for senior level managers who typically interact on a daily basis, may know each other well and have a high degree of accountability to other members of the team. What is the true purpose of an evaluation where the executives know how they are performing and the board of directors knows how they are performing? To formalize what is already known? Shouldn’t we want to accomplish more?

That brings us to the Employee Evaluated Experience. As opposed to checking a few boxes in a standard evaluation form, try developing a set of questions that drills down into the employee’s experience. Below are few examples—there is no right or wrong here.


  1. What are you most excited about right now?
  2. What do you want to spend more time on?
  3. What’s most challenging?
  4. Anything bugging you?
  5. What can I do to help?

These are designed to be permission giving questions, providing the opportunity for the employees to share experiences with the company through his or her manager in a safe environment. The importance of safeness cannot be overstated. If employees don’t trust the process and fear that candor could put their jobs at risk, they will be very reluctant to express their true feelings. As you begin to ask employees these questions, patterns will emerge that will provide tangible insights into the organization. And if acted on, this insight will begin to fundamentally strengthen the organization.

A word of caution: These questions are not meant to be answered all in one sitting during a two-hour timed session, in a group setting or in a hurried, ‘let’s-get-this-over-with’ manner.

The intent behind these questions is to integrate them into natural conversations—perhaps over an evening cocktail or a morning cup of Joe. But even in a slightly more formal setting, the employee is still engaged and is typically excited to share their experiences. Leaders, be ready for what you may hear and do not take the conversation lightly because that will only undermine the authenticity of the conversation.

No matter what your set of questions, always end the conversation with question number five. The role of a leader within any organization should be to remove obstacles that infringe upon the ability of people to do their job. Take this role seriously and help your associates, team members and colleagues accomplish more.

As an experiment, try asking these questions informally of your executive team members, managers and line employees. Perhaps even board members should be asked these questions. Why would you not want to know what excites your board members about the company you’re leading? Start with those trusted confidants. See what answers begin to pop up. You may learn something you did not know, or confirm something you already did. Regardless, the exercise of giving your employees permission to provide their Evaluated Experience will only provide added value to you and your organization.

Deciding on the Right Retirement Plan for Executives

9-19-14-Equias.pngBanks are challenged to attract and retain both key executives and key producers. While cash compensation plays a major role in this process, many community banks use nonqualified benefit plans, which provide supplemental retirement income as an attractive recruiting and retention tool.

According to the American Bankers Association’s 2013 Compensation and Benefits Survey, 64 percent of banks offer some type of nonqualified deferred compensation plan. These plans are limited to select management or highly compensated employees. Nonqualified plans are generally categorized as either defined benefit plans or defined contribution plans.

With different types of nonqualified plans available, how do you decide which plan your bank should provide?

In a typical defined benefit plan, the executive is promised a fixed dollar amount or percentage of final pay at retirement as the plan is designed to overcome a retirement shortfall or achieve a specific wage replacement ratio. The executive receives a stated amount (e.g. $50,000 per year) for a stated period of time (e.g. 15 years) beginning at separation from service, or a specified date or age.

Defined contribution plans vary in design. The executive’s deferred compensation balance might consist of all bank contributions, all executive contributions, or a combination of the two. Bank contributions might be predefined, such as a specific dollar amount or percentage of salary each month, or they may vary based on achievement of certain performance goals (often called performance-driven retirement plans). The deferral or contribution is credited with interest by the bank and the accrued amount is paid beginning at separation from service or a specified date or age.

On the surface, it may seem that the performance-driven designs provide more alignment of the executive and shareholder interests; however, that may not be the case for the following reasons:

  1. Executives generally prefer defined benefit plans over performance-driven plans. The defined benefit plans provide a base level of retirement income to supplement the variable/uncertain amount of retirement income from the executive’s 401(k) plan and stock awards. The executive may favor the employer that offers the defined benefit SERP and may be willing to take a lower retirement benefit because of the higher degree of certainty.
  2. Once implemented, properly designed defined benefit plans are easy to administer and the expense can be budgeted for years to come.

Both benefit plan types require various terms and conditions to be documented in a contract between the bank and the executive. The contract should provide strong retention hooks, as described in a recent Bank Director article.

A couple of recent examples will help illustrate the board’s rationale for the implementation of both types of SERP:

Defined Benefit
Bank A conducted a nationwide search to hire a CEO. As part of the CEO’s compensation package, the board of directors agreed to provide a SERP designed to replace 70 percent of his final compensation, after taking into consideration his 401(k) and social security benefits. The board considered various alternatives but believed the defined benefit SERP was the most effective method to achieve its objective. Since the executive was only 50 years old, he would earn the SERP over the next 15 years. The executive was incentivized to take the position, in part, because of the promise of a stable retirement income, which would allow him to focus his energy on bank performance. In addition, the executive was provided with restricted stock that would provide alignment of the executive’s and shareholders’ interests. Lastly, the board favored the stability of expense the defined benefit SERP provides and the fact that the design does not promote excessive risk-taking.

Performance Driven
At Bank B, the board felt strongly that supplemental executive retirement benefits should be provided using a performance-driven design. The board believed that to maintain a high-performance culture that aligns management and shareholder interests over the long-term, a defined contribution approach was the best fit. The plan provided that annual contributions would be measured based on performance targets established by the board. To provide additional protection against excessive risk-taking, the benefit payments would not begin until age 65 and would be payable in monthly installments over a 10-year period. All benefits would be forfeited if the executive was terminated for cause, if there was a material misstatement of the financial statements, or if the executive competed with the bank after termination of employment.  

There is no one size fits all approach with regard to nonqualified benefit design. The facts and circumstances of the case, including bank culture and objectives, will dictate the best design for any given bank and executive. For more information on this topic, please see: “Is Your Compensation Plan Generous Enough?

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

Compensation Regulation and Dodd-Frank: Where Are We Four Years Later?

9-12-14-McLagan.jpgWhere were you on July 21, 2010? If you were working for a bank, or in compliance for a publicly traded company, you know the world got much more complex on that date. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) was signed into law, all 2,315 pages of it. Four years later, it makes sense to ask the status of the various regulations coming out of the Act, especially in one of the most complex areas, compensation.

There were six items in the Dodd-Frank Act that specifically focused on compensation. Of these six, five applied to all public companies; only one was focused specifically on financial institutions—incentive compensation. Four years later, only two of these six have been implemented. While this speaks to the general level of gridlock in Washington, D.C., at our regulatory bodies, it is important to understand what has been implemented, what is coming and how it impacts your bank.

If you are a publicly traded bank, say-on-pay has been with you for four years and has had a very direct impact on executive compensation. This fall, we may get final regulations on the pay ratio disclosure, which requires public companies to report the ratio of CEO pay to the median pay of all other employees. This could go into effect in 2015, which could impact proxy statements in 2016. Also, we may see proposed regulations on clawbacks this fall.

Most bankers are awaiting final regulations on incentive compensation arrangements; a regulatory item that has been in a proposed state for more than three years. However, there is related final guidance on a similar subject—Sound Incentive Compensation Policies. Although this joint regulatory guidance did not come out of the Dodd-Frank Act, it is in effect today and applies to all banks and thrifts, regardless of whether they are public or private and regardless of size.

Section Provision Shorthand Applicability Status
951(a) Shareholder Vote on Executive Compensation Say-on-Pay All public companies Effective, January 2011
951(b) Shareholder Vote on Golden Parachute Compensation Say-on-Golden-Parachutes All public companies Effective, January 2011
953(a) Pay Versus Performance Disclosure All public companies Not proposed
953(b) Pay Ratio Disclosure CEO Pay Ratio All public companies Proposed, September 2013
954 Recovery of Erroneous Awarded Compensation Clawbacks All public companies Not proposed
956 Enhanced Compensation Reporting Structure Incentive Compensation Arrangements All banks and thrifts >$1 billion in assets  Proposed,
May 2011

Say on Pay
In the 2014 proxy season, there were five banks who failed to receive majority shareholder support for their executive pay plans, or say-on-pay. Collectively in the 2012 and 2013 proxy seasons, there were a combined five banks that failed. The frequency of failed say-on-pay votes has increased.

What four years of say-on-pay has taught us is that you don’t want to fail your say-on-pay vote, and compensation that is extraordinarily high will get highly scrutinized. Plus, institutional investors have created their own governance groups and fighting a failed say-on-pay vote is expensive.

If your firm has a less than 70 percent positive vote for say-on-pay you have some homework to do for the next year. Also, having a healthy dialogue with your institutional investors has never been as important as now.

There have been no proposed regulations on clawbacks to date. This section would require that a company recover compensation that should not have been paid because of a restatement of earnings. This applies to current and former executive officers for the preceding three years after the restatement of earnings.

This absence of a proposal is striking given this is already a rule for the chief executive officer and chief financial officer as a result of the Sarbanes-Oxley Act.

Incentive Compensation Arrangements
Section 956 is the one area which specifically focuses on financial institutions. This provision applies to all banks greater than $1 billion in assets—public or private as well as credit unions over a certain size, all farm credit agencies and broker dealers.

The essence of the provision requires reporting to a firm’s primary federal regulator within 90 days of the end of the fiscal year. What has to be reported relates to a firm’s incentive compensation arrangements, primarily a description of all incentive compensation plans (including equity and post-retirement benefits), governance structures in place to ensure excessive compensation is not paid, and changes in incentive compensation from the previous year.

In addition for firms with assets greater than $50 billion, 50 percent of all incentive compensation has to be paid over a three year period.

Interestingly, Section 956 was proposed in April, 2011 it still has not been finalized more than three years later.

Still, banks should get prepared. All banks covered under the rule should have a formal review process of incentive compensation: Identify covered employees, review the plan designs and how compensation is paid over time; and make sure you have proper internal risk controls in place. The compensation committee of the board should oversee this review.

In the end, much of Dodd-Frank has not been finalized, but you can help prepare now by educating yourself about what is coming down the pike.

Aligning Pay with Long-Term Strategy

2014-Compensation-Survey-White-Paper.pngWhile bank boards recognize the need to tie compensation to the performance of the bank in the long term, they continue to struggle with how to get the pieces in place to attract and reward the best leaders to meet the institution’s strategic goals. Many of the directors and senior executives that responded to Bank Director’s 2014 Compensation Survey, sponsored by Meyer-Chatfield Compensation Advisors, confirm that getting pay for performance right continues to challenge their boards. Less than half tie CEO pay to the strategic plan or corporate goals, and more than one-quarter of respondents say that CEO compensation is not linked to the performance of the bank. Flynt Gallagher, president of Meyer-Chatfield Compensation Advisors, says that boards should always keep the strategic plan and long-term goals in mind when determining compensation for executives, but many boards aren’t specific about the goals and objectives they expect the top executives of the bank to achieve.

Meyer-Chatfield Compensation Advisors offers the following advice for boards based on the results of the survey:

  • Executive performance goals should be clearly defined and tied to the bank’s strategic plan.
  • Make sure the bank is planning for the future and has a succession plan in place. Forty-two percent of executive hires were driven by executive departures in 2013.
  • Competitive pay is critical to attract and retain key talent, but it is not the determining factor. Culture can be the intangible that drives talent to—and from—an organization.
  • The board must determine its own pay—not the CEO.
  • Evaluate whether the board’s pay is fair and aligns with market practices.

For more on these considerations, read the white paper.

To view the full results to the survey, click here.