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.


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.

Federal Banking Agencies Offer Proposal to Reform Financial Institution Incentive Pay

Acting on a Dodd-Frank mandate, federal bank regulators have released proposed guidance establishing general requirements for the incentive compensation arrangements of a variety of covered financial institutions. The proposal implements Section 956 of Dodd-Frank, which requires the agencies to prohibit incentive pay arrangements that encourage inappropriate risks by providing excessive compensation or that could lead to a material loss. The application of Section 956 is limited to financial institutions with a $1 billion or more in assets, defining “financial institution” broadly to include all depository institutions, credit unions, broker-dealers, investment advisors, GSEs like Fannie Mae and Freddie Mac and the Federal Home Loan Banks. The rules cover all programs that offer “variable compensation that serves as an incentive for performance” and extends to all officers, employees, directors or 10 percent shareholders that participate in such programs. The proposal will be open for a 45-day comment period after publication in the Federal Register with a final rule expected to be in place by 2012.

Enhanced Reporting of Incentive Pay

The proposed regulation mandates enhanced reporting of incentive compensation arrangements to provide the agencies with a basis for determining whether an institution’s pay practices violate the prohibitions on excessive compensation or encourage inappropriate risk that could lead to a material loss. All covered financial institutions would be required to submit an annual report describing the structure of their incentive pay arrangements in a clear narrative format along with a discussion of the institution’s policies and procedures relating to the governance of incentive pay programs. However, for institutions with less than $50 billion in assets, the regulation does not require reporting of an individual executive’s actual compensation. Institutions with assets of $50 billion or more (large covered institutions) would be required to provide additional specific information on policies and procedures applicable to the determination of incentive compensation for executive officers (see below) and certain other employees identified by the board of directors as having the ability to expose the institution to losses that are substantial in relation to the institution’s size, capital or overall risk tolerance. Large covered institutions would also be required to report on material changes in their incentive pay program since the prior year’s report and to detail the specific reasons why the institution’s incentive pay practices do not provide excessive compensation or encourage inappropriate risk that could lead to a material loss.  

Prohibited Practices

The proposed rules identify two classes of prohibited incentive pay practices: (i) programs that encourage unnecessary risk by providing excessive compensation and (ii) programs that encourage inappropriate risks leading to material financial loss.

Excessive Compensation . The agencies define “excessive compensation” as amounts paid to a covered individual that are unreasonable or disproportionate to the services performed, taking into account a variety of factors, including (i) the individual’s total compensation (both cash and non-cash), (ii) the individual’s compensation history, (iii) the institution’s financial condition, (iv) peer group practices, and (iv) the individual’s connection to any fraudulent act or omission.

Material Financial Loss . The proposed rules ban incentive pay arrangements that encourage either covered individuals or groups of covered individuals to take inappropriate risks that could lead to a material financial loss. The guidance does not identify specific arrangements that fit within this category but makes reference to the three principles identified in the agencies’ prior Guidance on Sound Incentive Compensation Policies released in June 2010: (i) balance of risk and financial reward through the use of deferrals, risk adjusted awards and reduced sensitivity to short-term performance, (ii) compatibility with effective controls and risk management and (iii) support by strong corporate governance, particularly at the board or board committee level.

Deferral Requirements for Large Covered Institutions

For large covered institutions, the proposal requires that at least 50 percent of annual incentive compensation for “executive officers” be deferred for at least three years. The proposal defines “executive officer” fairly narrowly to include only persons holding the title (or function) of the president, chief executive officer, executive chairman, chief operation officer, chief financial officer, chief risk officer or the head of a major business unit. Deferred amounts are also subject to adjustment for actual losses or by reference to other aspects of performance that are realized or become known over the deferral period. The rules allow the deferred amounts to cliff vest, i.e., no vesting or payment prior to three years, or on a graded schedule, i.e., one-third vesting and paid each year of the deferral period.

High Risk Employees

The agencies are also requiring the board or a board committee at large covered institutions to identify persons other than executive officers who have the ability to expose the institution to losses that are substantial in relation to the institution’s size. For such persons, any incentive arrangement is subject to documented approval by the board or a board committee and the board or committee must make a specific determination that the arrangement (i) effectively balances the financial rewards to the employee and the range and time horizon of the risks associated with the employee’s activities, (ii) includes appropriate methods for ensuring risk sensitivity such as deferral, (iii) provides for risk adjustment of awards and (iv) is structured to reduce sensitivity to short-term performance.

New Governance Requirements for Incentive Pay

The proposal also mandates specific governance requirements for the implementation and operation of incentive pay arrangements. All covered institutions are required to adopt board-approved policies and procedures that are designed to ensure continuing oversight of compliance efforts. Specifically, the rules require (i) the inclusion of the institution’s risk management personnel in the incentive pay design process, (ii) ongoing monitoring of incentive pay awards and required risk-based adjustments, and (iii) the regular flow to the Board of critical data and analysis from management and other sources to allow the Board to assess the consistency of incentive pay programs with regulatory requirements.

For covered institutions, regardless of size, we recommend an immediate assessment of how the proposed rules will impact your existing incentive arrangements and a review of related corporate governance practices. The early identification of covered officers and an analysis of the viability of current incentive pay programs under the new rules will help ease the transition to a compliant structure.


Five Questions the Compensation Committees Should Consider when Evaluating the CEO

When it comes to determining what your CEO is worth, the compensation committee must balance the need to attract, reward and retain top executive talent with the shareholders concern that performance is in alignment with pay.

The latest round of regulations will start to mandate that bank boards understand the pay-performance relationships, whether they exist and whether they motivate risk taking. As banking regulators begin to demand further risk analysis or modeling to better meet these needs, Susan O’Donnell, managing partner for Pearl Meyers & Partners suggests compensation committees consider conducting five types of additional scenario analysis or modeling.

  1. Do you know the full range of potential compensation that might result from your programs in aggregate and under different performance scenarios? For example:
    • What is potential upside/downside if both short and long-term incentive plans paid out at threshold and max performance?
    • What is total realized value of compensation received including stock value under different stock price assumptions over the next several years?
    • The totals should be understood by the compensation committee and the recipients. It is different than what is disclosed in the proxy which only shows grant value (which may be worthless in the long run if performance of stock/goals is not achieved).
  2. Do you know how compensation might change under different risk scenarios? (e.g. impact of interest rates, economy, customer retention, etc.)
  3. Can you show a link between pay and performance? Relative to the annual decisions you make, but more importantly the long-term accumulation/rewards and alignment.
  4. Do you know what retention hooks you have on your high performing executives? How much unvested, in the money value they would leave on the table if they left? 
  5. Do you know how much equity/ownership your executives have? Is it sufficient to ensure their alignment with shareholders? Do they hold and retain stock over the long-term?

Compensation committees will need to be ready to answer these questions in the coming months. It’s how you can communicate a CEO’s worth, ensure a proper relationship between pay-performance, increase the likelihood of retaining your top performers and mitigate risk in your compensation programs.

Wilmington Trust blunders on CEO Pay

pencil.jpgIt’s been a bad few weeks for Wilmington Trust Corp. Make that a bad year.

The $10.4-billion-asset Wilmington, Delaware-based bank, which specializes in advisory services for wealthy clients and personal trust accounts, reported a $370 million loss in the third quarter of 2010 after it beefed up its loan loss provision. The bank, which has been around since 1903 but recently stumbled on bad commercial real estate loans, will be acquired this year by Buffalo, New York-based M&T Bank Corp. The deal was announced Nov. 1 at a value of $351 million or $3.84 per Wilmington Trust share, a 46 percent discount to the prior trading day’s closing price. No doubt Wilmington Trust shareholders are still unhappy because the bank was trading at about $4.41 per share Tuesday morning on the New York Stock Exchange.

It gets worse.

The bank subsequently announced in December that it was yanking back most of the CEO’s 2010 compensation, more than $1.75 million, because his pay package violated the rules for banks that participated in the federal government’s Troubled Asset Relief Program. (Wilmington Trust received $330 million in TARP funds in December 2008.) Oops! Bloomberg News picked up the story last week from one of the bank’s regulatory filings.

The TARP rules can be fairly complicated. But they aren’t complicated on this point:No retention or signing bonuses are allowed for banks that took TARP money according to multiple compensation experts, including Paul Hodgson, senior research associate at GovernanceMetrics International, formerly known as The Corporate Library, and Susan O’Donnell, managing director at compensation consulting firm Pearl Meyer & Partners.

Back in June, when Wilmington Trust board member Donald Foley was hired by the board to replace Ted T. Cecala as CEO, Foley was given a $1.75 million signing bonus that was clearly disclosed to shareholders. A full $1.3 million of that was to be paid in restricted stock vesting immediately and the rest of the $450,000 was in cash.

Then in December, the bank said it was taking back the full $1.75 million signing bonus and an additional 16,000 shares in restricted stock. And it also rescinded a part of the pay agreement that awarded Foley 14 years credit on the company’s executive retirement plan. Ouch!

The board did agree to increase Foley’s base pay from $1.2 million to $1.5 million, which is allowed under TARP, but the move doesn’t nearly make up for what was taken away.

Contrary to news reports, this doesn’t look like a claw-back, where a company is forced to take back executive pay based on a restatement of earnings or fraud.

“It’s a unique situation,” says Tim Bartl, senior vice president and general counsel for the Washington, DC-based Center on Executive Compensation, which was started by the human resources industry group, the HR Policy Association. “(This was) a do-over, more than it was a claw-back.

So who screwed up? Did the compensation committee fail to look at the TARP rules when granting the incentive package? Or did a consultant paid to do this job fail to understand the TARP restrictions? Foley did not return a phone call this week on the matter and a company spokesman, Bill Benintende, issued a statement saying the board took the action to comply with TARP rules and:  ” . . . the Board wishes to express its recognition and appreciation of the fact that since he became CEO in June, Mr. Foley has worked tirelessly and effectively to address both the challenges and opportunities facing Wilmington Trust.”

O’Donnell and Hodgson had never heard of a TARP bank having to take back a signing bonus, and TARP rules have been in place for more than a year.
But what about Wilmington Trust? How long will Foley’s tenure last at this point, especially since M&T is buying the company? (He has been invited to join the board of the newly merged bank). What kind of fruitful relationship can the board possibly have with Foley after reaching into his pocket and taking back nearly $2 million?

“That has to be a difficult conversation,” Hodgson says, in what may be the understatement of the year.

Stanley Baum, an attorney who consults with companies on compensation issues for Lerner Law Firm & Associates in Westbury, New York, was less circumspect.

“My impression is, ‘what the heck is going on over there?”’ he says. “It’s so blatant, you wonder what sort of procedures are in place here and at other companies.”

The upside is there probably won’t be too many more of these banks that have this problem, say Bartl and O’Donnell – not after Wilmington Trust embarrassed itself publicly.

For a full primer on the pay rules regarding TARP banks, check this out:

Next Steps for Compensation Committees

As our annual Bank Executive and Board Compensation event came to a close, I had a chance to catch up with Todd Leone, president & founder of Amalfi Consulting, to get his perspective on what directors should do once they leave the conference. With so much advice and recommendations communicated over the two-day event, I couldn’t help but wonder where do compensation committee members go from here. 

Here is what Todd had to offer:

Compensation Down the Ranks

It’s no real secret that the key to a successful organization is a strong and talented team of people. However, in today’s competitive and changing market, recruiting, rewarding and retaining top employees is a challenge. On the last day of our annual Bank Executive and Board Compensation event held at the InterContinental hotel in Chicago, this session focused on the role the compensation committee should take when planning competitive yet acceptable compensation plans for employees past the CEO.

Moderated by Jack Milligan, editor for Bank Director magazine, our panelists included Gayle Applebaum, managing director and founder of Amalfi Consulting, Kimberly Ellwanger, compensation committee chair at Heritage Financial Corp. in Olympia, WA and Donald Norman, partner at law firm, Barack Ferrazzano.


Oversee Not Micro-Manage

To begin the session, panelists addressed the less than obvious question of the compensation committee’s role when it comes to employees below the senior management team. With the liability now resting on the compensation committee, their responsibility for managing performance incentive plans now requires a more holistic approach. As Applebaum points out, the responsibility of the board is not to micromanage each plan, but rather to be aware of how they are designed. Compensation committees should actively review and evaluate the structure of all plans from the executive team down to the teller staff.

Don’t Have to Go it Alone

Sounds overwhelming? It can be, although the panelists agreed that the burden should not rest on the compensation committee alone, and that committee members should work in conjunction with the management team. While the board is ultimately responsible for oversight, they will most surely need input from the CEO and other senior team members.

The concern of some audience members was how to determine who was objective and well-versed enough in the requirements to help the board evaluate these plans thoroughly. Ellwanger openly shared that Heritage Financial Corp. had taken on a Chief Risk Officer whose responsibilities included sharing the list of all compensation plans semi-annually with the board for review. For those banks with limited resources, the following personnel should be able to help committee members analyze the plans on a regular basis:

  • Chief Risk Officer
  • Human Resources Officer
  • CEO/Executive Team
  • Inside Legal Counsel
  • Outside Compensation Advisor

Global Metrics Less Risky

Of course, assembling a qualified team of people to review and oversee all significant compensation plans at an institution is only part of the equation. Designing plans that are attractive to top talent is a critical piece of the puzzle. The panel encouraged smaller banks to not be hasty by cutting out bonuses and raising salaries as this would certainly result in the loss of key employees. Instead, banks should consider varying the levels of performance in their incentive plans by employee rank and then base those on individual and/or company-wide goals. Ellwanger provided the following example:

  • Top Level Team (Executives) = Metrics are driven by corporate performance
  • Next Level Team = Metrics are driven by bank and individual performance

As it turns out, regulators tend to lean more towards global metrics used in compensation plans as these are deemed less risky than behavioral based incentive plans.

Document, Document and then Document

Norman suggested that boards conduct at least a semi-annual risk analysis to evaluate the risks, goals and metrics developed. Throughout those sessions, it’s important to document thoroughly including meeting minutes, review changes and anything that speaks to the thought process behind the plans. A constant theme heard throughout the two-day conference was again reiterated in this session — be prepared to tell your story.

Different Voices; One Sound Board

As was I waiting for the next session to get started in the grand ballroom of the InterContinenal Hotel, I had this thought: If I was an outside director of a local community bank, would I rather spend one of my afternoons golfing, getting a root canal or telling the CEO of my board’s bank that he or she wasn’t doing the job as expected? Personally, I’d choose none of the above, but I’m positive that the majority of the 270-plus attendees would not have chosen the latter.

Which brings us to the last general session of day one where TK Kerstetter, of Corporate Board Member, artfully moderated the somewhat uncomfortable topic on handling situations most compensation committees want to avoid. The panel of compensation experts included Susan O’Donnell of Pearl Meyers & Partners, Henry Oehmann of Grant Thornton, and Alice Cho from Promontory Financial Group, who all naturally suggested what any expert would when you’re faced with a conflict — confront it.


Despite the somewhat obvious advice, the session focused specifically on guidelines for proactively managing the board and CEO relationship, effectively overseeing the CEO’s compensation and consistently conducting board evaluations. Susan O’Donnell started the discussions by outlining the following scenarios that many board members all too often find themselves struggling with:

  1. The compensation committee has designed the entire plan with no input from the management team and thus are experiencing an unexpected backlash that is costing the company time and money.

  2. The bank is being led by a dominate, yet high-performing, CEO who is driving most of compensation planning process, and therefore board members essentially have become lame ducks who rely too much on CEO.

  3. The CEO is best buddies with a few directors and as a result the board has lost all sense of objectivity.

If the above scenarios feel all too familiar to you, then the question became, how should the board deal with these scenarios, or at the very least work towards avoiding them in the future? The panelists all agreed that the following approaches will go a long way in setting the board up for success:

  • Set expectations with the CEO early on in the relationship.
  • Use outside advisers to help evaluate compensation plans, especially the CEOs.
  • Rely on the chair, lead director or compensation advisor to help have the tough discussions.
  • Don’t be afraid to think independently as healthy debates are important.
  • Know the compensation plans even for audit and risk team members.
  • Use board evaluations to hold each other accountable.

Clearly, the goal is to avoid dissension between the management team and the board while keeping the bank’s CEO happy and cooperative. Building these positive relationships starts by setting expectations, staying objective despite having differing opinions, and regularly evaluating your peers and the situation. Luckily, the National Association of Corporate Directors has a diagnostic book on doing peer reviews with directors available on its website at