Why Directors Should Not Fear Board Evaluations


governance-1-23-19.pngIn governance circles today, the conversations about board performance and evaluations continue to advance.

Governance advocates, proxy advisors and institutional investors encourage varying approaches to evaluating directors, assessing board effectiveness, and raising the bar on expectations for director contributions and performance.

Many community bank directors, however, are reticent to go down the board assessment path, fearing that the process will somehow result in their removal from the bank’s board. The goal of any evaluation, however, should not necessarily be to weed out directors, but rather to highlight areas for board and director improvement, and encourage continual forward movement on good governance.

In our view, there are three general types, or levels, of board evaluation to consider:

Level 1: A general assessment of the board overall and how the group is functioning. This evaluation might include areas such as:

  • Do we have the right committee structure, leadership and meeting frequency?
  • Are we as a board focusing our time on the correct and critical topics?
  • Do we have an appropriate and valuable range of skills and experiences around the board table to govern effectively in today’s industry climate?

Level 2: This typically involves an element of “self-assessment,” focused on what individual directors believe they contribute. This analysis highlights contributions of a technical, industry, business, community or other relative area. Self-assessments also aggregate the collective skills sitting in the boardroom, and help to inform the board about where there are critical gaps in the needed skills.

Level 3: This is where some trepidation arises—the individual evaluation. This assessment involves each director providing confidential feedback on their fellow directors, and should always be facilitated by a third party. Using an outside resource to review and compile the data provides a level of professional insulation between directors, and ensures anonymity of the assessments.

Peer evaluations can serve an important function by informing directors as to how their peers view their contribution. When viewed in conjunction with self-assessment output, it can provide a comprehensive, objective look at how each director views their contribution relative to how their contribution is viewed by their colleagues.

Many board members fear an assessment will expose shortcomings as a director. However, the goal of evaluations is to highlight areas for improvement and strengthen governance—not necessarily cull the herd. There are plenty of examples of directors whose contribution had slipped a bit due to personal or business distractions without realizing this shift occurred. In these instances, peer feedback was instrumental in helping that director return to highly engaged participation.

It’s also common to see individual feedback highlight areas where directors needed updated training or a refresher course in bank operations or oversight, often resulting in additional training for all directors.

One of the hallmarks of the most effective boards is a desire for continuous improvement, and striving to become a “strategic asset board.”

To be sure, board members whose contributions have declined considerably and remained below expectations for an extended period might need a “tough love” conversation. A board seat is a precious thing, and every director must bring current and valuable skills and experiences to the board table.

Directors whose lengthy tenure or legacy contributions are simply not up to current needs and governance standards—and who lack the fortitude for improvement—should ask themselves whether the bank would be better served by a different individual in that seat. It takes real maturity, self-awareness and a view for the “greater good” for a director to make such a determination.

Boards have long held to age limits more than term limits as a vehicle to repopulate their boardroom. Yet as directors age, many institutions are raising or waiving the age requirements to retain experienced directors. Good reasons exist to keep veteran directors, but a board seat should be earned through performance. Seats should not be “institutionalized“ to an individual or family if those representing select interests are not qualified to contribute in a meaningful way and put the institution’s interests above their own.

The highest performing boards make it a policy to conduct some form of evaluation on a regular if not annual basis. Whether though a general, self or peer assessment process, more informed boards make better decisions around board composition and continued director service.

Boards with the strongest, most capable and engaged directors will have the greatest ability to survive and thrive in a consolidating industry. Boards that utilize some form of assessment are more likely to be among the survivors going forward.

2018 Compensation Survey: Board Composition a Key Issue


compensation-6-4-18.pngAn effective board starts with having the right members, making board composition a key issue for today’s banking industry. Forty-five percent of the directors and executives responding to Bank Director’s 2018 Compensation Survey, sponsored by Compensation Advisors, a member of Meyer-Chatfield Group, say that developing a board succession plan is a top challenge related to board composition, followed by the recruitment of tech-savvy directors, at 44 percent.

More than 200 chief executive officers, human resources officers, senior executives and board members participated in the survey, conducted in March and April 2018, which examines the talent challenges faced by the banking industry. The survey also includes data collected from proxy statements to reveal how—and how much—CEOs, directors and chairmen were compensated in fiscal year 2017.

Thirty-five percent of respondents cite the recruitment of female directors as a top board challenge, an area where the industry appears to have made some improvement. Seventy-seven percent of respondents indicate that their board has at least one female member, up from two-thirds last year. However, boards still have progress to make, with just 14 percent indicating that their board has three or more female members. And boards still struggle to represent diverse ethnic backgrounds—77 percent report that their board doesn’t have a single ethnically diverse director. They also need to gain more age-diverse views, with just 16 percent reporting they have a director who is aged 40 years old or younger.

Conducting an effective board evaluation—which rates the effectiveness of individual directors, as well as the board—is cited by 42 percent as a top governance challenge. Board evaluations are often touted as effective tools to fuel board diversity efforts, because they identify ineffective directors and help push them out of the boardroom, leaving empty seats to be filled with the skill sets, expertise and backgrounds needed by today’s board.

Other key findings:

  • Commercial lenders remain in high demand, cited by 68 percent of respondents as an area where they expect to actively recruit employees in 2018, followed by technology, at 38 percent.
  • Forty-seven percent indicate their bank has increased salaries over the past three years to attract younger talent. Twenty-seven percent offer more equity compensation or profit-sharing incentives.
  • Forty-four percent indicate their bank has dedicated more resources to train young employees. Overall, 80 percent offer external training as a benefit to employees, and 74 percent say their bank has an in-house training program.
  • The median age of a bank CEO is 58 years old. The median CEO salary in FY 2017 was $370,232, with total compensation at $621,000.
  • Paying board members appears to be a low-level concern: Just 14 percent indicate that offering a competitive director compensation package is a top challenge faced by the board.
  • Seventy percent of non-executive chairmen and outside directors receive a meeting fee, at a median of $1,000 per board meeting in FY 2017. More than three-quarters of non-executive chairmen, and 71 percent of outside directors, receive an annual retainer, at a median of $35,000 and $24,000, respectively.
  • Fifty-one percent most recently increased director compensation in 2017 or 2018, and one-quarter raised director pay in 2016.

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

Should TBV Dilution Be Dead?


TBV-5-29-17.pngAs bank executives look to add value through mergers and acquisitions (M&A), a recurring source of frustration is the tendency of investors and analysts to rely on narrow metrics to measure a deal’s value. Simple metrics are inadequate for evaluating the true value of a transaction. One widely used but misleading metric is the dilution of tangible book value (TBV) that occurs as a result of a transaction, coupled with the TBV earn-back period. TBV dilution and earn-back are poor indicators of a transaction’s full effect on the overall value of an organization.

Rather than using a single number to evaluate the success of a transaction, shareholders, boards and analysts should strive toward more comprehensive evaluations. Broader measures, coupled with a more qualitative evaluation of a transaction’s effects on bank strategy and shareholder value, can provide a holistic understanding of the relative worth of a merger or acquisition.

Gaps and Challenges
Despite its widespread use, TBV dilution earn-back can produce an incomplete measure of the viability of a bank M&A transaction. Reliance on simple metrics produces gaps and challenges such as the following:

  1. M&A structure: TBV dilution earn-back and other popular metrics are significantly affected by the way an acquisition or merger is structured. An all-cash acquisition will have a different effect on book value and earnings metrics than a deal that involves the issuance of new stock.
  2. External factors: Management actions such as post-deal stock repurchases can influence TBV dilution earn-back and various other earnings-based metrics. These metrics also are shaped by numerous external factors that can affect stock price, such as the run-up in bank stock values in the month after the 2016 election, when the markets began to anticipate regulatory reform.
  3. Regulatory expense: Despite expectations of future regulatory relief, regulatory expense will continue to contribute to banks’ financial pressures in the near term, reinforcing the need for continued growth in order to spread compliance-related costs across a larger base. Moreover, many banks still are likely to find it challenging to price deals fairly, due to the constraints of regulatory capital requirements.
  4. Indirect consequences: The market’s reliance on simple metrics can pose less immediate—but equally serious—indirect consequences. For example, negative perceptions about prior deals can limit a publicly traded bank’s growth opportunities, since its ability to compete in future deals often hinges on the value of its stock. This limitation can be damaging for banks and thrifts whose growth strategies are built around continuing M&A activity.

Measurable Success
Serious investors begin their evaluations with an estimate of the deal’s impact on earnings and earnings per share (EPS), but they also consider factors such as projected cost savings, expenses related to the transaction itself, and the speed and costs associated with a successful integration of the two organizations.

Management should lay out meaningful steps with measurable indicators of success. When evaluating cost savings, both the recurring savings and the one-time expenses that will be incurred to achieve them must be considered. An equally stringent standard also should be applied to projected merger-related expenses, such as professional fees and operational costs.

The totality of these various projections should be compared to the actual results achieved in prior transactions. If they vary significantly—or if earlier deals failed to achieve promised results—management should be able to explain the variations and rationale for the current projections.

The financial impact of an M&A transaction also should be compared with its potential return. Management should outline the rationale for the deal compared to alternative uses of capital, and it should be ready to present complete and relatively detailed plans, timetables, and targets. This analysis might be time-consuming, but it produces a clearer picture of a transaction’s true value.

A Comprehensive Approach to Deal Valuation
A complete analysis involves studying factors such as a deal’s impact on capital ratios, management’s integration plans and benchmarks, projected cost savings, and the management team’s track record and credibility. Thorough analysis also takes into account unpredictable external factors such as general economic conditions, changing interest rates, new competitive pressures, future technological advances and the changing needs of bank customers.

When management demonstrates a history of competence and a clear and credible rationale for its planned actions, it makes a more compelling case for investor confidence than simple metrics can offer. This more analytic approach can help investors, analysts, and other stakeholders—and ultimately bankers—by encouraging a more disciplined and comprehensive approach to deal valuation.

CEO Evaluations: Positioning the Bank for Success


11-19-14-Emily-DC.jpgA surprising number of boards don’t have a process in place to evaluate their most valuable player: the chief executive officer. But every bank should have a process in place, to provide the CEO not only with recognition for his accomplishments, but also to provide feedback, support and direction.

“I think a board that is undertaking a CEO evaluation should be applauded because I’m amazed how many boards do not,” says Jim McAlpin, a partner at Bryan Cave LLP. Gayle Appelbaum, a principal with compensation consulting firm McLagan, has talked to CEOs with long tenures at their institutions that have never had a performance evaluation.

Banks taking those first steps toward evaluating the CEO should view the process as an opportunity to discuss where the board wants to take the institution, what goals need to be met in order to get there and how the CEO will be compensated for achieving those goals, McAlpin adds.

While the board should have input, the responsibility for the evaluation process should ultimately fall on a designated independent board member—the chairman, or if the chairman is the CEO, then the lead director or the compensation committee chairman. How the board provides that input back to the CEO will differ based on the bank’s governance structure. If the evaluation falls under the realm of the compensation committee, for instance, the compensation committee chairman would ask these committee members to complete an evaluation form and return it to the chairman, who would then use those forms to complete the overall evaluation. The committee chair would then meet with the CEO to discuss the evaluation, perhaps with the board chairman or lead independent director present as well. And while some banks may consider the compensation committee, or even the full board, responsible for the evaluation, McAlpin recommends that one person communicate the message to the CEO.

“It’s a much smoother process if there’s one person that can be the focal point for the conversation with the CEO, as opposed to a committee talking to the CEO. Whatever message the board wants to convey needs to be clear [and] needs to be thought out in advance. In my mind, it’s much better if one person is conveying that message,” says McAlpin. “You want expectations to be very clearly set.”

Of course, the board will need to determine what it expects of its CEO in advance of conducting the evaluation. The board, through its designee, should communicate the areas in which the CEO is expected to improve, as well as the goals he or she is expected to accomplish in the upcoming year. As such, the evaluation should not be a static form. As the board’s goals for the CEO change, the board will want to modify the criteria that form the basis of its assessment. Appelbaum notes that the areas the board wants to focus on for the evaluation will differ based on each CEO and the bank’s needs, but would likely include:

  • How well the CEO leads the organization, including development of staff and planning for succession
  • Employee and customer satisfaction scores, if the bank has that information available
  • Relationship with the board, including how well the CEO communicates with board members and how open he or she is to feedback
  • Community involvement, including how the CEO is supporting and promoting the bank within the community
  • Fulfillment of key objectives within the strategic plan, including the bank’s financial performance.

Seventy-two percent of respondents to Bank Director’s 2014 Compensation Survey tie CEO compensation to performance indicators, with asset quality, return on equity and return on assets the most common metrics used. However, Appelbaum says that these quantifiable factors, which are tied to the CEO’s bonus, should be distinct from the more intangible elements discussed in the evaluation, which dig more deeply into board expectations of the CEO’s role within the organization.

It’s important to align the evaluation, and compensation, with the bank’s strategic plan. Directors from institutions of all sizes consistently indicate—most recently in the 2014 Compensation Survey—that tying the compensation of top executives to performance remains a top challenge. Yet less than half of the respondents to that survey—bank senior executives and board members of U.S. banks of all sizes—tie CEO pay to strategic goals. How will the CEO know how to effectively lead his institution without clear direction from the board?

An important final factor for boards to consider is ensuring the right amount of communication with the CEO, as well as providing the support that the CEO needs to achieve the strategic goals of the bank. “The board should ask the CEO what support he or she will need in achieving the goals [and] what additional resources might be needed,” says McAlpin. If the board is setting goals that the CEO believes are unachievable, or if the CEO feels that additional personnel or resources are needed, this can be discussed at this time. The CEO should feel supported, but the members of the board should also remember that they represent the shareholders, not to the CEO, he adds. “It’s incumbent upon the CEO and the board to have the bank achieve the best results possible and maximize shareholder value.”

Appelbaum recommends, at minimum, that the board conduct a midyear evaluation to provide the CEO feedback on progress. In turn, the board’s constructive comments could give the CEO the opportunity to course-correct in order to do what he or she has been tasked to do.

Additionally, the board chairman or lead director may consider meeting the CEO regularly, even monthly, to discuss what the CEO needs from the board in terms of support and what issues are top of mind. “You have to let the CEO run the bank, and you can’t allow the board to micromanage the bank or run the bank on a daily basis” says Appelbaum. “But you want the organization to win, and making sure your CEO has all the right information, all the skills [and] all the resources available to make that happen makes for a much better organization.”

An effective evaluation process positions the bank for success in the long run, not only due to the attention and care to its top executive’s performance, but also furthering communication and focus on what the bank needs to do to achieve its strategic vision. “A lot of bank boards are not used to that level of interaction with the CEO in setting goals and objectives,” says McAlpin.

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.

Looking Beyond the CEO: How Well Does Your Board Evaluate High Potentials?


performance.jpgAs boards seek to improve oversight of key elements of their companies, many directors would agree that they need to take a far more active oversight role in overall management succession, not just in CEO succession. The question is: how?

Taking the Lead

In the past, boards typically focused narrowly on chief executive officer succession, looking for the emergency replacement and among the direct reports to the CEO.  They paid far less attention to succession in other C-level roles (CFO, CHRO) and almost none to learning more about high potentials, or good candidates, further down in the organization.  Today, however, boards—especially bank boards—are expected to exercise far more oversight of the larger succession management process.   In January 2012 already, we have seen federal bank regulators ask one of our bank clients for a better understanding of how the board was monitoring talent development and succession for several critical roles under the CEO. 

Many boards are not just reacting to federal scrutiny, but are proactively increasing their oversight while taking care not to overstep governance boundaries.  They want to ensure that the organization has adequately planned for contingencies regarding succession in particularly critical roles such as risk, finance and legal—often referred to as control leaders.  

For example, in the past eighteen months, while working with boards on leadership and succession issues, I witnessed three instances in which a Fortune 500 board strongly urged the CEO to remove a senior executive.  The case of one CFO is typical.  He had performed well in the past; he was highly talented and the company was not in trouble, but not thriving.  However, in looking at the company’s long-term strategy, the board reluctantly but firmly concluded that he did not have the right competencies to help take the company where it needed to go.  The CEO concurred and, following careful planning and communications, he departed just over 90 days later.

Where to Start

For boards eager to get on top of the issue, the place to begin is with 360-degree evaluations of executives from the C-level down through the next two layers of management.  The board should ask management to undertake a comprehensive assessment of the strengths and weaknesses of all of those executives. Whether conducted with internal resources or with external assistance, these evaluations should not simply be generic appraisals, but full assessments of each leader with multiple inputs and an in-depth assessment interview of each leader.

The executives should be evaluated against the requirements of their particular roles as well as in the context of the company’s long-term strategy and objectives.  Do they have the skills, experiences and leadership behaviors that will be required to successfully execute against the strategy over the coming years? Less proactive boards, especially at troubled banks, may find themselves conducting such evaluations anyway.  Increasingly, we have seen the Federal Reserve, the Federal Deposit Insurance Corp.  and state banking regulators request full assessments of executives (and in some cases directors) at banks with capital or loan exposure issues.

Supplement Evaluation with Exposure

Few people would deny that formal evaluation is an indispensable element in succession management at any level.  But formal evaluations of executives beyond the CEO and heirs-apparent could be greatly enhanced through more direct exposure between company leaders and the directors.

However, boards are usually exposed to only a handful of top executives—the CEO of course, and usually the chief financial officer the head of human resources and the general counsel/corporate secretary.  Contact with other executives is often limited for timing and other reasons. That’s unfortunate because directors are typically leaders whose success is based on their ability to judge top talent at first hand.  Direct contact with high potentials would enable directors to exercise their judgment, bring evaluations to life, and take the measure of these executives as individuals and as leaders. There are a number of natural opportunities for these interactions, including:  

  • Board presentations:  Have more high potentials appear before the board to present business reviews, participate in Q&As, or otherwise engage in substantial business discussions with the directors.  Boards of course have to balance these additions to their already crowded agendas with the need to keep the length of their meetings manageable. 
  • Strategy offsites:  Most companies conduct annual offsites, where leadership comes together for a couple of days to review and, if necessary, revise company strategy.  As with increased board presentations, these sessions offer opportunities for getting a grasp on the business acumen of high potentials.
  • Site visits: Board members can visit high potential leaders where they actually work—at the divisions they run or in the geographies for which they are responsible.  Tour the sites; get to know these executives and the business more in-depth.   In fact, it’s a good idea to have new directors make such site visits as part of the onboarding process.
  • Board dinners: The two to three hours of a dinner offer an ideal opportunity for directors to get a feel for high potentials as individuals and for those intangible characteristics that are so important for leadership.  It’s a simple matter of seating and subject matter: intersperse the executives and directors at the table and forgo the discussions of golf in favor of topics that get at who these executives really are.
  • Special events: When there are special events relevant to directors, such as an occasion of honoring one of them, invite high potentials to participate.  Such occasions can provide directors with informal opportunities to glimpse another aspect of an executive that they had not previously appreciated.  

All of these interactions are win-win.  Directors gain an understanding of what is really taking place deep in the company’s talent pool, greater knowledge of the business and a multi-dimensional basis on which to judge talent and offer advice on managing it.  High potential executives develop earlier in their careers the ability to work with the board.

Ask Yourself How Well You Really Know These Executives

It is of course unlikely that your board does none of the things being suggested here.  The real question, however, is not how many of the boxes you may have checked. It is whether you are doing these things in a systematic, comprehensive way that yields substantive, multi-dimensional, and actionable knowledge of the company’s cadre of high potential leaders.  

For example, consider the substance and multi-dimensionality of your knowledge with regard to key executives and risk management.  Do you know the capabilities in risk management of each of those executives?  Do you have some idea of each individual’s appetite for risk and how it fits with the bank’s strategy? 

To gauge quality of your current ability to evaluate high potential executives, ask yourself these simple yes-or-no questions: 

  • Is the board regularly provided with a summary of 360-degree evaluations of all direct reports of the CEO and selected high potential/ successors below that tier?
  • Are the evaluations based on company’s forward looking strategic needs as well based on regular job and role requirements?
  • Do you know who is in the pipeline not just as possible CEO successors, but also for other critical C-level roles—particularly those roles deemed critical by regulators?
  • Do you feel you have enough information to evaluate those executives in terms of both their business and technical capabilities and their leadership ability?
  • Do your current interactions with high potential executives fail to address any of the four or five chief criteria by which you think executive potential should be judged?

If you answered “no” to any of those questions, then it may be time for your board to adopt practices that provide more satisfying answers and better oversight.