The Future of Executive Compensation


fortune-cookie.jpgEveryone from shareholders to regulators wants a “say on pay” these days, but compensation committees must continue to ensure their programs attract, retain and motivate executive talent in a way that is aligned with the bank’s strategy and culture.

Meridian recently completed a study of CEO compensation practices at 58 publicly-traded banks with assets between $1 and $5 billion. Based on our work with clients and the results of our research, we anticipate the following will be some of the key trends in executive pay as compensation committees work to balance competing expectations.

Increase in percentage of pay delivered through incentives.  In our study, on average, base salary comprised half of CEO total direct compensation (base salary, annual incentive and long-term incentives). Incentives have become a larger component of total pay over the past few years, and we anticipate that trend will continue as shareholders expect a more direct alignment of pay and performance. The majority of this increase will likely come through equity-based long-term incentives, which defer compensation through multi-year vesting and payment schedules and help mitigate the overall compensation risk.

Broader view of performance. With the rising regulatory focus on the perceived risk of compensation programs, committees are using a variety of performance factors to determine incentive payouts. Some committees use a fully discretionary approach to determining incentive payouts, which typically involves a holistic review of performance. Banks with formulaic approaches to annual incentives are increasingly using multiple measures, and we expect the trend to continue. Almost half of the banks in our study included four or five measures in their formula, while only 20 percent rely on just a single measure. While earnings measures (e.g. earnings per share) remain prominent, banks are also including measures focused on returns, capital levels, credit quality, and growth.

Increased rigor around discretion.  Regulators have recognized that discretion can play an important role in ensuring that payouts appropriately reflect risks taken during the performance period, as well as make it less likely that executives will manipulate performance results to increase payouts.  However, they expect sufficient structure around discretion so that decisions can be justified and made consistently. Shareholders and their advisors generally prefer formulaic plans, but will accept the use of discretion if it is reasonable and well explained. More than 80 percent of the banks in our study indicated that their committees use discretion in determining incentive payouts. We anticipate committees will refine their use of discretion to include the development of scorecards that reflect a variety of measures from both an absolute and relative perspective, as well as principled guidelines that specify the types of circumstances that will trigger discretionary adjustments.

Use of multiple long term incentives, with increasing use of performance-based vesting.  Among banks in our study, the prevalence of performance-based vesting on long-term incentives doubled from 17 percent to 34 percent between 2009 and 2011. We expect this trend to continue in response to shareholder expectations and broader industry trends. While we expect the use of performance-based long-term incentives to increase, we do not anticipate the elimination of time-based awards. We expect most banks will choose to grant a combination of awards—both performance-based and time-based. Many shareholders and their advisors expect a minimum of 50 percent of long-term awards to be performance-based, but the inclusion of time-based awards can help provide balance. Additionally, many time-based awards will likely begin to include provisions that provide for reductions if poor risk outcomes occur during the vesting period. 

More transparency.  Say-on-pay has given public company shareholders an advisory vote on executive compensation, and their expectations for insight into the committee’s decision making have increased. Likewise, the Securities and Exchange Commission is expecting clear disclosure of performance targets in most circumstances. We expect proxy disclosures to increase their clarity as to how compensation decisions are made, particularly how performance criteria were established and how those performance results led to incentive payouts.   

The banking industry continues to be on the forefront of change in executive compensation due to scrutiny from both regulators and shareholders. Compensation committees must remain vigilant to ensure their executive pay programs balance the increasing expectations of regulators and shareholders while continuing to support bank objectives.

Bank Directors Weigh In on Executive Pay at Chicago Conference


With the close of 2012 fast approaching, directors and compensation committees continue discussions on how to produce acceptable growth under the weight of banking reform legislation.  Understandably, banks are nervous. In the face of regulatory actions, weak performance, or cuts in compensation, valuable bank officers may opt to move elsewhere. 

In spring of this year, Meyer-Chatfield Compensation Advisors and Bank Director conducted a comprehensive survey to understand industry viewpoints on executive and directors pay.  Download Full Report.  To further validate our findings, we identified six questions from the original spring survey, and re-surveyed the audience of bank directors and executives in attendance at the Bank Executive & Board Compensation conference in Chicago in November this year.  William MacDonald, advisory board member for Meyer-Chatfield Corp., the parent company of Meyer-Chatfield Compensation Advisors, talks about the survey results and trends in compensation, including the increasing use of stock in director compensation and the movement away from Supplemental Executive Retirement Plans (SERPs). 

1. How well do you believe your bank’s board is managing its executive and director compensation? 

Board members at the November conference felt they were doing a better job handling compensation than board members felt in the spring survey. In my opinion, the improvement in numbers is due to compensation committees and board members getting their arms around the changes, and developing a process to deal with the issues. 

 

Very Well 

Well 

Not Well At All 

Spring Survey 

26%

35%

13%

November Survey 

37%

13%

2%

 

2. What is your top compensation challenge for 2013? 

The top challenges in both the spring 2012 survey and November Chicago conference were “tying compensation to performance” and “retaining key people.” Historically, bank incentive plans have been tied to financial performance using matrixes such as return on assets and earnings per share. 

3. Do you have stock ownership guidelines for your directors? 

More than half (58 percent) of the Chicago survey group have directors’ guidelines in place, compared to 47 percent of the spring survey. Many banks use deferred compensation plans to offer restricted stock compensation for directors, and pay directors a larger portion of compensation in stock than they have historically.

4. If you have stock ownership guidelines for directors, what are the ownership requirements? 

In the annual spring study, most respondents who had stock ownership guidelines had guidelines requiring a minimum or fixed number of shares, while the Chicago group more often had a multiple of retainer or annual compensation.  I think a multiple is a better idea.  Not all directors are financially able to meet a fixed amount of shares. 

5. Who is primarily responsible for setting directors compensation levels at your bank? 

To follow high standards in corporate governance, a board should work with an outside consultant with access to meaningful data and best practices.  All parties need to weigh in on this subject; the chairman, full board, the compensation committee, as well as the bank CEO.

meyer-chart.pngSource: Bank Director and Meyer-Chatfield Compensation Advisors spring 2012 survey on director compensation.

6. Does your bank offer a nonqualified retirement benefit to your management team? 

Both survey groups weigh in at 60 percent roughly offering a nonqualified retirement benefit.  Nonqualified plans are effective tools for banks to attract, retain and reward key people. 

Many community banks structure supplemental executive retirement plans (SERPs) for senior management. SERPs became prevalent at community banks as a way to compete with major banks. Now, SERPs are on the chopping block. Institutional investors, shareholders and many boards are focused on inherent plan costs. Most SERPs are fixed defined benefits, and expensive from a profit and loss standpoint. During the conference and in a break-out session with Flynt Gallagher, president of Meyer-Chatfield Compensation Advisors, we discussed ways banks are maintaining these plans with much lower costs. In some cases, the bank can maintain the benefit at a 50 percent reduction in the expense that must be recorded for employee pensions (FAS 87). 

Going Forward

Compensation for executives and directors will remain a hot topic in 2013. Look for incentive compensation to gain momentum as banks align interests of executive teams with shareholders. What’s more, I envision the sprouting of new measurements to better balance shareholder and regulatory interests.  I would also watch for shareholders to require executive and director benefit plans do more heavy-lifting in the war for talent, because flexibility trumps tradition hands-down.

Linking Long-Term Pay to Performance


applause.jpgIn an age when shareholders get an advisory vote on executive pay, there is an increased focus on pay-for-performance.  As a result, more banks are using long-term performance plans.  Unlike traditional restricted stock and stock option awards that vest solely over time, long-term performance plans also include pre-established performance goals that must be met for awards to be earned.

Meridian’s 2012 study of chief executive officer incentive plans at publicly traded banks with assets between $1 and $5 billion indicates that 34 percent include performance-based awards in their long-term incentive program, including more than half of the banks larger than $2 billion in the study. 

We anticipate the use of long-term performance plans will continue to increase. Shareholders and proxy advisors (such as Institutional Shareholder Services) typically respond positively to the implementation of long-term performance plans.  Additionally, well designed performance-based awards help provide balance and risk mitigation to incentive programs.  Many companies have used performance plans in their long-term incentive program to replace stock options, which regulators have discouraged as a riskier way to reward performance. Following are some of the key design elements to be considered in designing a long-term performance plan:

  • Award vehicle.  Banks predominately use full value shares (restricted stock or restricted stock units) in their long-term performance plans.  The number of shares ultimately awarded may vary based on different levels of achieved performance (e.g., threshold, target, and maximum).  While less common, programs can also be cash-based. 
  • Performance period.  Seventy-four percent of performance plans in Meridian’s study use three-year performance measurement periods.  Typically, three-year performance objectives are established at the beginning of the performance period, and awards are paid out based on actual performance at the end of the three-year period.  However, it can be challenging to establish appropriate three-year goals, particularly in an era of high economic uncertainty.  To avoid this challenge, some plans are structured for annual goals to be set each year of the three-year vesting period, while others only establish one-year goals but require additional service before awards are paid out.
  • Absolute and/or relative measurement.  Performance criteria can be absolute goals based on internal expectations, or they can evaluate performance relative to a peer group of companies.  Relative goals can make it easier to establish long-term performance goals, but provide less direct line-of-sight for executives and require a relevant group of companies to use for comparison.  Practices among banks in Meridian’s study are mixed—35 percent use absolute goals, 35 percent use relative goals, and 30 percent use a combination of both.
  • Performance measures.  Measures should tie to key corporate objectives that will drive long-term shareholder value.  Return measures (e.g., return on assets, return on equity) are most common among banks, followed by earnings measures such as earnings per share and net income.  Some banks measure shareholder value directly, tying payouts to the company’s total shareholder return ranking relative to a comparator group.  Most banks use two or three performance measures in their plans.
  • Mix and match.  While performance plans can be a critical part of a bank’s long-term incentive program, they may not meet all of the program’s objectives.  Performance plans are often used in combination with time-based equity grants (e.g., stock options and restricted stock) to provide a balanced program and limit compensation risk.  In most cases, the performance plans are used to deliver 50 percent or more of the target long-term incentive value for senior executives, but are often combined with other award vehicles such as time-based restricted stock.

Several other items must also be considered when designing a long-term performance plan, including: Who will be eligible, how will it be disclosed, what is the accounting expense, what are the tax consequences, and will shareholders approve of the plan? While performance-based long-term incentives require many decisions, they can enhance pay-for-performance and create a balance between short-term and long-term objectives.  Banks that do not currently have long-term performance plans should consider whether introducing one would improve the effectiveness of their executive compensation program.

Overworked, Underpaid and Unappreciated


Bank directors face familiar compensation challenges this year, but frustration with the board’s ability to handle these challenges appears to be increasing. That is according to the results of Bank Director’s 2012 board compensation survey co-sponsored by Meyer-Chatfield Compensation Advisors, which included nearly 550 CEO and director responses.

This year, only 58 percent of respondents feel their board is managing executive compensation well or very well, compared to 63 percent last year and 74 percent in 2010. Similarly, only 53 percent feel director compensation is being managed well or very well, compared to 56 percent last year and 68 percent in 2010.   

Meyer-Chatfield Compensation Advisors President Flynt Gallagher says that some of this dissatisfaction is the result of increased scrutiny from shareholders, regulators and the market.

In some cases, this increased scrutiny may be translating to increasing workloads for directors. The median hours spent on the job for institutions of all asset sizes remained the same this year as last year at 15 per month, but there were large changes in the hours reported by banks in the highest and lowest asset categories. While directors from the largest banks reported working fewer hours this year, the opposite was true for their small counterparts. Directors at banks with under $100 million in assets report working 20 hours per month this year; that is 5 hours more than they reported working last year and double the year before.

Justin Heideman, a director at Town & Country Bank in Saint George, Utah, a de novo institution with less than $70 million in assets, says he has no doubt directors at these smaller institutions are putting in more hours. He says the main reason is compliance.  “We have the same requirements on the [information technology] side in terms of safeguards that a major bank has,” says Heideman.  “It’s nonsensical the amount of time that is required to make sure that compliance is appropriate and to make sure we do all of our training. We have to do pop quizzes like I was in second grade during board meetings to make sure our training is done and to prove we are being trained.  It’s ridiculous.”

On a positive note for directors, more respondents (32 percent) expect director compensation at their banks to increase in 2013 than in 2012 (28 percent). Only 1 percent of respondents expect a decrease in compensation in 2013, and 67 percent expect director pay to stay the same.

Gallagher says the financial performance of many banks is showing an improvement after struggling with asset quality issues, lower margins and lower profits in recent years. With this improvement some banks are feeling relief and even optimism. 

The median board meeting fee for outside directors stayed the same this year as last year at $600 per meeting, while the median meeting fee for a chairman rose slightly from $600 last year to $675 this year. 

And yet, even as compensation holds steady or even increases, benefits for directors continue to erode. The number of banks offering zero benefits to outside directors has significantly increased—46 percent this year compared to 39 percent last year and only 28 percent the year before. 

Making cuts to benefits while keeping compensation steady might make sense for many banks, as it seems to align with what directors find most important when considering a new board seat. When asked to rank the importance of types of benefits and compensation when considering a new board seat, 51 percent of directors assign little or no importance to retirement plans while only 27 percent find them important or very important. Similarly, 44 percent of directors assign little or no importance to insurance benefits, while 28 percent find them important or very important.

It is important to note that many respondents report liability and potential growth of the institution are even more important factors when considering a board seat than the compensation or benefits package. Clyde White, chairman and CEO of Ouachita Independent Bank, a commercial bank in Monroe, Louisiana, with $570 million in assets, had this to say: “If I were considering joining a bank board, I would want to know what investment opportunity I would have and what the potential for growth is of that investment. I would also want to know what value I would be expected to bring to the table [i.e., business development activities, business acumen].”

The compensation survey was emailed throughout April and May to CEOs and directors at banks ranging in asset size from under $100 million to more than $5 billion. The response rate was 5.7 percent, with 549 responses. Of the banks represented, 9 percent have less than $100 million in assets, 25 percent are between $100 million and $250 million, 24 percent are between $251 million and $500 million, 17 percent are between $501 million and $1 billion, 18 percent are between $1.1 billion and $5 billion and 6 percent have more than $5 billion in assets. Of the respondents, 40 percent are publicly traded, 56 percent are private and 4 percent are mutual. Only 14 percent are de novo banks. 

For the survey report including committee fee pay breakdowns, click here.

Pay at the Biggest Financial Companies: Trends, Practices and Outlook


Regulators now need to sign off on compensation program design for all covered employees among the 25 largest complex banking organizations (LCBOs). Based on client experience and a review of 2012 proxy statements for these institutions, consultants from Compensation Advisory Partners identified key themes among these largest financial companies.

Key themes found in the report:

1. Regulators are highly involved in the compensation design process at large bank holding companies for a sizeable number of employees (ranging from senior executives to employees well below that level).

2. A majority of variable executive compensation is linked to long-term performance and risk outcomes; it is now typical that more than the required 50 percent of incentive pay (annual + long-term) be deferred over at least three years.

3. Performance adjustments are now expected before and after the grant of incentive compensation, and the role of the risk function and formal risk assessments in that process has increased.

4. Long-term incentive goals must now balance business plan and shareholder goals (earnings per share, total shareholder return, etc.) with risk-based ex-post performance features (capital goals, etc.).

5. It is majority practice to have stock ownership requirements for senior executives that go beyond a more traditional guideline (multiple of base or number of shares achieved within a certain number of years).

6. Clawback provisions go beyond what is required by Sarbanes-Oxley or expected under Dodd-Frank.

For the full report, click here.

Will Citigroup Shareholders’ “No” Vote Change the Compensation Game?


monopoly.jpgIn its discussion of its pay package this year for Vikram Pandit, Citigroup’s chief executive officer, the company extolled the accomplishments of the man brought in to clean up the mess that was left in the midst of the financial crisis.

Citigroup has been profitable for eight consecutive quarters. It has repaid the government’s Troubled Asset Relief Program money. Pandit had gone two years without drawing a salary in the midst of the company’s trouble, and was rewarded in 2011 with a salary and a bonus. Plus, the company had taken steps to align its incentive pay with future performance: 60 percent of top executives’ bonuses will be deferred over a four-year period based on performance.

None of this was enough to please investors and shareholder advisory groups such as Institutional Shareholder Services (ISS). Investors voted down this week the CEO’s pay by 55 percent in an advisory vote made possible by the Dodd-Frank Act.  ISS claimed Pandit’s compensation was misaligned with total shareholder returns (Citigroup’s stock price was down 23 percent during the past 52-week period and it was down 93 percent during the past five years.) Future bonuses would be “essentially discretionary” based on a variety of factors such as execution of long-term strategic goals and return on capital, according to ISS.

Basically, the pressure is on for Citigroup and other publicly traded companies to tie incentive pay to specific metrics that benefit shareholders, rather than more vague goals that give the board wide discretion.

It didn’t help matters that Citigroup was one of few big banks to fail the federal government’s stress tests this year, meaning it won’t be able to return capital to shareholders in the form of dividends or stock buybacks.

Plus, ISS determined that Pandit would be paid more than his peers at other big financial firms. Although Citigroup reported that his total compensation for fiscal year 2011 was $15 million, ISS determined that future awards could be worth as much as $34 million. A $10 million award is tied to the company earning pre-tax income for a two-year period of at least $12 billion, which “does not appear challenging given that the company’s income from operations exceeded $15 billion in each of the last two fiscal years.”

Citigroup may be scrambling to deal with the bad publicity now from the “no” vote on pay, even if technically, the advisory vote is non-binding. But will other banks scramble to make sure they don’t suffer the same fate?

Maybe not, says Peter Miterko, a managing director in New York City for Pearl Meyers & Partners, a compensation consulting firm.

“It may be a more subtle impact, rather than everyone saying ‘Let’s redo our pay packages,’’’ he says.

Most banks already have sent out their proxy statements for the year, making it hard to revamp any pay practices. But Miterko thinks the publicity will encourage companies to communicate better in the future with shareholders about why they pay what they do.

A typical problem in proxy statements is that it’s not clear to shareholders what performance metrics must be met for an executive to get incentive pay, he says.

“The positive development [with say-on-pay] is that shareholders tend to see a lot more clear connect with how they’re better off,’’ he says. “Shareholders want to know that executives are told in the beginning of the year, ‘This is what you have to do to get your bonus.’ They want to know the goals are stretch goals and the financial improvement will warrant the incentive payment.”

Don Norman, an attorney for Barack Ferrazzano Kirschbaum & Nagelberg LLP in Chicago, who handles compensation issues for community banks, says many banks have already made changes in order to defer a portion of incentive pay for executives and many have tied it to specific performance that benefits shareholders.

Much of that was set in motion following regulatory guidance on incentive pay in the aftermath of the financial crisis and the compensation rules for banks that received Troubled Asset Relief Program money.

But tying pay almost entirely to shareholder returns can place too much emphasis on short-term performance and thereby create undue risk, he says.

“The market doesn’t have a long-term focus,’’ he says. “It’s ‘what have you done for me lately?’”

Instead, he thinks it is not unreasonable for bank boards to maintain some level of discretionary decision-making over bonuses.   This is much easier in the private bank setting.

“If there’s no discretion, why do you need a compensation committee?” he says. “You have an intelligent and educated group of board members for a reason and there should be some level of deference to their judgment. There are management efforts that should be rewarded that are not always reflected in formulas.  Good or bad, this should be part of any pay assessment.”

Banks without a lot of institutional ownership will have less reason to worry about shareholder advisory groups such as ISS. Still, no one wants to find a majority of their shareholders voting down their pay packages.

Last year, 41 firms in the Russell 3000 (or less than 2 percent of the total index) reported that they failed to win majority approval from investors on pay, according to ISS. This year, 175 companies have had proxy votes and the average shareholder vote has been 90.4 percent in favor, ISS says.

So ending up as one of the firms with a no vote doesn’t look so good.

McLagan, another compensation consulting firm, offers some advice to avoid a “no” vote:

  • Analyze the shareholder base to determine the level of ISS or other advisory firm influence.
  • Monitor changes in each of your institutional investor’s proxy voting guidelines.
  • Audit your compensation and governance plans and programs for any potential exposure to guidelines of proxy advisor groups and institutional investors.
  • Track 1-year, 3-year, and 5-year total shareholder return relative to your ISS-established peer group.
  • Use the proxy compensation discussion section to clearly tell the “story” of executive pay and explain pay and governance decisions.
  • Be prepared to engage in meaningful dialog with shareholders.

Directors’ Accountability for Ensuring Risk-Based Compensation Programs


gameplan.jpgEffective June 2010, regulators covering the majority of banks in the U.S. jointly issued guidance requiring institutions to comprehensively review their compensation programs and ensure they do not motivate unnecessary risk taking.  Emerging regulations under Dodd-Frank, due to be finalized later this year, will place even greater pressure on banks, particularly those over $1 billion in assets. There will be increased expectations that banks ensure proper board oversight, implement enhanced controls and policies, improve documentation and revise their incentive plans to consider risk mitigation strategies. To comply, bank directors, and in particular the compensation committee, must be fully involved, well-informed and possess an in-depth understanding of not just executive incentive arrangements, but incentives for all employees.

To determine whether the bank’s current risk assessment process is adequate to comply with regulations, directors should ask a few key questions regarding their bank’s current programs and processes:

Do we have a process to identify and document covered employees?  Most banks already have identified a small number of executive and highly-paid employees, but that may no longer be enough.  Banks also are expected to develop processes to identify and define employees whose incentive arrangements might, if not properly structured, pose a threat to the institution’s fiscal safety and soundness.

Do we have defined processes to identify, assess and document the risks considered in the compensation programs?  Banks should have a systematic and documented approach to identify the full range of risks that could compromise the safety and soundness of the institution. 

Do incentive plans incorporate risk adjustment features?  While there is no “one-size-fits-all,” banks should consider for each role/function what type of risk adjustment features are most appropriate.  Some approaches include:

  • Using quantitative and/or qualitative risk information to adjust incentive pools and/or awards. For example, where a lending officers’ production was based on a higher risk portfolio, payouts may be adjusted.  If a bank felt earnings were a result of a higher risk profile, the overall incentive pool might be reduced. 
  • Including risk-based performance measures such as risk adjusted return on capital, capital and/or asset quality factors.  For example, lending officers may have a portion of their incentive paid (or deferred) based on the quality of the loan portfolio.
  • Deferring a portion of the incentive until long-term performance success (or failure) is known and reducing or eliminating the payout downward if performance is not sustained.
  • Using multi-year performance goals to reward performance to better align rewards with the time horizon of the risk.

Are risk-management and control personnel involved in the risk assessment process? To ensure effective risk assessment, these employees should be involved in the review as well as the design and monitoring of short and long-term incentives.  Additionally, their own incentive arrangements should ensure objectivity and not be tied directly to the business units they monitor. The chief credit officer shouldn’t get paid incentives tied to the volume of loans, for example.

Do we have proper documentation?  This is a key weakness of many banks where complete and clear documentation of all programs, policies, monitoring procedures and governance protocols is lacking.  Banks should seek to document all incentive plans as well as monitoring and control procedures.  Where discretion is applied, documentation of rationale should be included.  Committee minutes should reflect discussions and considerations of risk relative to plan designs and payouts.

Have internal communications with the board and/or compensation committee changed? While the risk review is important, risk-related information must be shared between board committees and management to ensure proper oversight during discussions of incentive plan designs, goal-setting and award payouts.

Conclusion

As bank risk assessment standards evolve, their effectiveness will depend heavily on the quality of the risk assessment process used, the actions taken to reduce risk in the compensation programs, and the commitment of directors to strong governance of the process. 

What Level is Your Risk Assessment Process?

Level 0 – No Assessment Process – Virtually all financial institutions are now required to conduct a risk review process and assess relative to the guidance provided in 2010 by all major bank regulators.   If you haven’t yet started to review and document your plans, it is critical to start now.

Level 1 – Conduct Basic Review of Incentive Plans – The bank has reviewed incentive plans relative to the June Agency guidance at a high level and feels there is limited need to adjust programs.  Documentation may be in process but not comprehensive.

Level 2 – Rigorous Process, Documentation and Oversight – The risk assessment process documents not only the programs, but also all covered employees, controls and risk mitigation techniques.  Formal risk accountabilities and a review process have been defined.  The board or its designated committee has oversight and some programs have been redesigned to mitigate/adjust for risk. 

Level 3 – Comprehensive and Holistic Risk Assessment Framework – The board or its designated committee is actively engaged in overseeing risk.  Risk assessment and mitigation is integrated into many compensation-related processes and risk management personnel play a vital role in ensuring compensation arrangements do not promote undue risk.  Compensation programs have been adjusted to account for risk.  

New Thinking on How to Handle Key Employees


Companies are trying to rethink executive pay packages in an environment of increased media, shareholder and regulatory scrutiny. New rules on pay are encouraging pay structures to reduce risk. But the problem of getting and keeping great employees is as pressing as it’s ever been. Meyer-Chatfield Compensation Advisors President Flynt Gallagher talks about ways to reward performance while reducing risk.

Is pay-for-performance the best approach to attracting and retaining key executives?

Pay-for-performance is not new, but it seems to get reinvented when the economy doesn’t cooperate.  The idea seems perfect.  In reality, however, the process of connecting pay to performance is far more difficult than it appears.

For the most part, a large percentage of an executive pay package is tied to the company’s stock.  As a result, the market may not be rewarding the executives for doing a good job. The stock market is not a rational indicator of a management team’s success year to year. If a company’s stock price is the gauge by which an executive’s success is measured, does that mean that when the dotcoms had a high price they were well managed? Certain industries, even in bad times, are on the rise. Does that have anything to do with the quality of their management teams?   There’s a mixed signal to executives asking them to take a long term view, yet they are measured quarter to quarter by stock market performance. 

Is there a better way to handle executive compensation?

The key to our economic recovery is to remove the handcuffs and the government’s position on pay. We need to get back to the free enterprise system, the fabric America was built on, and provide the incentives for the talent needed. No company wants to over-compensate or under-compensate, but the decision regarding the amounts paid to executives certainly can’t be left to Washington.

Maybe it’s time for a little creative thinking. Companies need to be able to attract and retain the talent that will make a difference during this recovery and consider approaches outside the box.

Nonqualified deferred compensation is a device that can work in concert with a company’s strategy and unquestionably aligns the interest of the executive with shareholders. These plans are friendly to shareholders, as there is no dilution in ownership, nor does the company have any significant cost of providing a plan.  The monies deferred are held as general assets by the company, subject to the claims of the company’s creditors. Executives are not taxed on those dollars until they are withdrawn, because they are at risk if the company fails.

What are the benefits of a performance-based Supplemental Executive Retirement Plan?

Traditional SERPs have been criticized by the media, shareholders, shareholder advocacy groups, boards and even the academic community. Their main criticism is that these plans have no performance element to them. Despite the negative sentiment regarding SERPs, there likely will be increased use of these plans, however, with a new design twist focusing the contributions on company performance. This concept is worth consideration for those companies looking for cost effective ways to attract, retain and reward key employees who can make a difference. A properly designed performance-based SERP can help companies reward executives for achievements that drive the company in the right direction, without the volatility of the stock price.

What words of encouragement can we provide to the industry?

The only way many companies can recover is to have the right people in key management roles; therefore, attracting and retaining people is critical.  It’s time to think a little more creatively.

The media and Washington would have us all believe that the senior executives in major companies and their rush to line their own pockets are at the core of the nation’s economic woes.  Executive compensation packages have been vilified and considered to be nothing more than corporate greed that is limiting our economic growth.  But if we are going to get this economy turned around, aren’t these executives the same people with the potential to restore investor confidence and market growth?

2011 Shareholder Voting Trends – Preparing for 2012 Say on Pay


vote.jpgStarting with the 2011 proxy season, public companies were required to conduct a non-binding shareholder advisory vote on executive compensation practices at least every three years. Of the more than 3,000 companies disclosing their say-on-pay votes in 2011, only 40 (including one bank) failed to receive majority shareholder support.  While the percentage of failures was not high, we expect that number to increase in 2012 as investors (and advisory firms) have more time and resources to assess pay programs, and in 2013 when smaller reporting companies are required to hold their shareholder vote.

While non-binding, a failed vote can result in negative media attention, pressure on board members and shareholder lawsuits.   Of the 40 companies failing in 2011, seven already face shareholder lawsuits against executives, directors and, in some cases, their consultants.   

2011 Vote Results

While many companies initially recommended votes every three years (triennial), shareholders and advisory firms made clear their preference was for annual votes.  By the end of the 2011 proxy season, shareholders at 76 percent, 1 percent and 22 percent of companies, respectively, voted in favor of annual, biennial and triennial votes.

Many companies’ compensation packages passed when put to a shareholder vote by an overwhelming majority (68 percent passed with more than 90 percent of the vote), while 8 percent of companies received less than 70 percent shareholder support. 

Role of Shareholder Advisory Firms

Shareholder advisory firms such as Institutional Shareholder Services and Glass Lewis & Co. are having a significant impact on proxy vote results.  While these firms have no sanctioned powers, their influence cannot be ignored by boards and companies.  ISS in particular had an impact on 2011 vote results, especially at companies with high institutional ownership.  Overall, companies with an ISS “against” recommendation received an average of 68 percent shareholder support, compared to 92 percent at companies that received ISS support.   Going forward, ISS has indicated they will give extra scrutiny to companies that received less than 70 percent shareholder support in their prior year say-on-pay vote. 

What Factors Influenced the Vote?

Based on our review of ISS and Glass Lewis vote recommendations, a common reason cited for receiving an “against” vote was a pay-for-performance disconnect.  For ISS, this outcome was triggered when a company’s 1- and 3-year Total Shareholder Return (TSR) fell below industry GICS (global industrial classification standard) codes, without a corresponding adjustment in CEO pay.  Poor pay practices such as the use of tax gross-ups and single-triggers on Change in Control benefits also influenced a number of “against” votes.  In some cases, poor disclosure and excessive compensation were cited as contributing factors.

Increasing the Likelihood of  Shareholder Support

Companies can do several things to increase their level of shareholder support for SOP votes in the 2012 proxy season. 

Enhance Proxy Disclosure

The Compensation Discussion and Analysis (CD&A) is the basis of shareholder votes and should be written clearly and presented in an easy-to-read format.  Using tables, graphs and bullets can focus the reader on key points.  While not required, an executive summary allows companies to tell their “story,” reinforce pay-performance alignment and highlight pay practices shareholders will view positively.  The CD&A should plainly discuss incentive plan metrics and payouts, as well as any data, analysis and information considered in the compensation committee’s decisions.  Peer groups will receive increased scrutiny next year, when ISS adds peer data to its vote methodology. 

Understand Shareholder Criticisms

How companies respond to concerns about executive pay programs will be an important factor in future votes.  It is critical to understand the voting policies of major shareholders and any issues raised as concerns, even if they didn’t result in an “against” recommendation.  Compensation committees should discuss these concerns and consider whether to make changes to pay programs.  Companies should provide enhanced disclosure to rationalize  pay programs and decisions in light of investor concerns.

Some changes made by companies include amending employment agreements to eliminate golden parachute tax gross-ups (Disney); adding performance conditions for equity grants (Umpqua, Lockheed Martin, GE); reducing compensation (Key Corp), and changing peer groups (Occidental).

Improve Shareholder Communications

One positive impact of say-on-pay is that it has increased communication between companies and their shareholders. A two-way dialogue with major shareholders throughout the year can increase the likelihood of support for say-on-pay. 

In Summary

Shareholder advisory votes on pay packages were mandated with little notice for the 2011 proxy season, leaving investors and advisory firms with limited resources and time to prepare. As say-on-pay moves into its second year, scrutiny of executive pay practices will continue.  ISS has already changed its methodology for their vote recommendations. Companies that received shareholder support last year are not guaranteed the same result in 2012. 

Overall, monitoring and aligning the pay-for-performance relationship should be an ongoing responsibility and focus of compensation committees.  It is not too late to make well informed decisions, engage shareholders and improve disclosure to increase the likelihood of receiving a positive say-on-pay result in 2012.

Balance the Challenge: Executive Compensation & Shareholder Value


Are your institution’s compensation plans structured to benefit or hurt your shareholders? In this five-minute video, William Flynt Gallagher, president of Meyer-Chatfield Compensation Advisors, offers insight and advice on strategies the compensation committee can use to maximize benefits and structure executive agreements to actually enhance shareholder value. 

Highlights includes:

  • Compensation challenges facing publicly traded banks today
  • Which compensation structures you should avoid
  • Ways to benefit both executives and shareholders

Click the arrow below to start the video.