A Postcard From the Compensation Conference


BEBC13-Postcard-article.pngIt wasn’t that long ago that a bank’s CEO proposed his own pay and the board of directors for the bank approved it with few questions asked.

That practice continues at many small, privately owned banks. But increasingly, boards are the drivers of the bank’s executive compensation, including the CEO’s. They are asking difficult questions, getting pressure from proxy firms and regulators to adjust pay, and positioning themselves not only as the decision makers, but crafting the bank’s executive pay plan from day one.

Attending Bank Director’s Bank Executive and Board Compensation conference in Chicago this year, which was held Nov. 4-5, I was struck by how the job of the board in setting pay has changed.

The increasingly powerful proxy firms, such as Institutional Shareholder Services (ISS) and Glass Lewis, are making a difference in the pay practices not only of big, publicly traded banks, but smaller banks as well. One key emphasis of these firms is to tie executive pay with shareholder returns.

Although many banks don’t have much institutional ownership of their stock, and therefore don’t necessarily need to worry about ISS’ view of their pay plan, many of them do want to implement pay practices that will balance the need to recruit and retain great talent, as well meet the demands of shareholders and regulators. Banks increasingly give restricted stock to executives that vests when multiple performance measures for the bank and the individual are met.

In addition to the proxy firms, regulators are putting pressure on boards to assess the risk in all their incentive programs, including loan officer pay, in keeping with the 2010 joint regulatory guidance on incentive pay. Boards seem to be increasingly involved in the minutiae of pay structures for all levels of staff, a job that was previously left up to management. Boards are simplifying and cutting the number of pay plans at their banks, which sometimes run to 20 or 30 different bonus programs.

Another change noted in the conference was the increasing use of deferrals of executive bonuses over a three or five-year period, even for banks below $50 billion in assets, as a way to mitigate risk, an awfully interesting development since only those above $50 billion in assets will be required to defer pay under the 2010 Dodd-Frank Act.

The fact that regulators haven’t finalized many pay rules under Dodd-Frank, including the deferral rule, is making the job of the board harder. Attendees at the conference told me they want to design a program that will last three or five years down the road without having to be revamped every time a new rule comes out. Michele Meyer, legal counsel for the Office of the Comptroller of the Currency’s Central District, explained during a panel discussion that multiple regulatory agencies, each with a different mission statement, have to sign off on the new rules, which has delayed the process.

All these headaches combined might be a reason why directors are getting paid more for the work they do for the bank—director pay increases at public banks below $15 billion in assets varied from 8 percent to 15 percent in 2012, as reported in 2013 proxy statements and analyzed by compensation consulting firm McLagan. As an example, the average total director compensation in cash and stock was $43,946 in 2012 for publicly traded banks between $1 billion and $5 billion in assets, an 8 percent increase from the year before. Many banks had frozen pay during the financial crisis, and now directors want to get paid in line with increasing shareholder value, said McLagan principal Gayle Appelbaum, a presenter at the conference.

BEBC13-Postcard-article2.pngThe conference didn’t focus only on executive and director pay. Steve Steinour, the chairman, president and chief executive officer of $56-billion asset Huntington Bancshares in Columbus, Ohio, was the keynote speaker and didn’t talk about the frustrating issues of proxy advisor firms and regulatory guidance. Instead, he urged the audience to think about what kind of bank they wanted to run, and how to attract young people to work in banking. “There are fewer people seeking careers in banking than there were years ago,’’ he said, noting that the industry has been pilloried, sometimes deservedly. (Huntington Bank’s recruitment and training video features images taken of Occupy Wall Street demonstrations and pledges the bank will operate on the simple principle of doing the right thing.)

Steinour offered a different perspective on the issue of pay and retention: How do you make sure you have the staff you need so you can excel in the coming years? It was a question very much on the minds of some of the more than 250 attendees of the conference.

What to Do When Caught Between Investors and Regulators


hands-tied.jpgIt’s tough to please both regulators and shareholders these days, especially when they want contradictory things. Take the case of executive compensation.

Shareholder groups have been pushing for a greater tie between performance and executive pay. One of the most powerful of these, Institutional Shareholder Services, screens executive pay packages to see how they stack up against peers relative to performance and how the change in CEO pay mirrors change in total shareholder value over five years. ISS recommendations to shareholders on such matters can strongly influence a company’s say-on-pay shareholder advisory vote. Umpqua Holdings Corp. and other banks found this out, as described in a recent story in Bank Director magazine.

But looking at the stock price and shareholder value is exactly what regulators don’t like.

Jim Nelson, a senior vice president of supervision and regulator for the Federal Reserve Bank of Chicago overseeing large banks and savings institutions, is concerned with the use of stock price or return on equity as a measure of performance in making pay determinations. Return on equity doesn’t factor in the risk that executives might be taking to achieve such returns, he said at Bank Director’s Bank Executive & Board Compensation conference recently in Chicago.  There are many factors that can influence the stock price which are outside the realm of management’s control, he said.

“We think most of the people in the firm don’t have a direct impact on the value of the stock price,’’ he said. “We’re looking for a measurement tied to something that that person does control.”

Regulators also explained how they feel about shareholders in their 2010 Guidance on Sound Incentive Compensation Policies, which applies to all banks and thrifts.

The joint regulatory guidance says “shareholders of a banking organization in some cases may be willing to tolerate a degree of risk that is inconsistent with the organization’s safety and soundness.”

So there’s the rub. Do you please shareholders or do you please regulators? But there are ways to combine the concerns of both.

“It’s not the amount [of bonus or incentive pay],’’ Nelson said. “What we’re looking at is the arrangements. You should reward individuals who are producing an attractive risk-adjusted return for you. If they are making more money with low risk, they should be paid more than someone who is making money with high risk. I think that is aligned with what shareholders want and the board wants. There is a lot more free enterprise in this approach than people think.”

He said some big banks are adjusting their profits based on risk metrics before handing out bonuses.

Meanwhile, big banks also are taking into account the needs of shareholders and the recommendations of shareholder advisory groups. Tying short and long-term bonuses, at least in part, to shareholder return is one way to do that.

For example, Buffalo, New York-based First Niagara Financial Corp., one of the nation’s 25 largest bank holding companies with $35 billion in assets, paid out long term incentives to top executives in three ways: stock options, time-vested restricted stock and performance-based restricted stock that vests in three years based on total shareholder return relative to the SNL Mid-Cap Bank Index.

Barbara Jeremiah, a First Niagara director who chairs it compensation committee, said when the bank ran into troubles trying to raise capital for its acquisition last May of HSBC branches in New York and had to cut its dividend in half, the board recognized the hit shareholders took and wasn’t locked into paying short-term bonuses based on earnings per share. The board had made sure it had some level of discretion in determining the bonus, she said.

The board adjusted incentive compensation for CEO John Koelmel to reflect the decline in stock price and reduction of the dividend. Jeremiah encouraged compensation committee members and human resources directors at the Bank Director conference to read and stay abreast of how others viewed executive pay, making note of an article by Gretchen Morgenson of The New York Times entitled  “C.E.O.’s and the Pay-‘Em-or-Lose-‘Em Myth.”

 “We need to keep that outside view,’’ Jeremiah said. “How do our customers and others view us?”

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.

We’ve been through this before: Corporate governance ratings don’t work


Following the S&L crisis twenty years ago, a number of banking trade organizations, usually in association with a directors and officers liability (D&O) insurance company, trotted out the idea that directors should be accredited. Banks were told that if they sent their boards to special programs on corporate governance, the directors would be accredited and this would save the bank money on D&O policies. The organizations then offered the accreditation programs and made money on them. And if the D&O was placed with the preferred insurance company, the association made a finder’s fee.

However, D&O insurance is a hand written policy, so a discount on your policy is not transparent. It is like getting a discount on a house or a used car. In a negotiated process, how would you be able to tell what kind of discount you actually got?

D&O prices are determined by an underwriter who tries to anticipate how likely it is that you or your bank will be sued. If your bank recently merged, had its CAMELS rating take a beating or saw an ugly drop in the value of its shares, the underwriter either will not write it or charge a great deal of money to cover you. The board’s accreditation won’t affect the price.

The accreditation and corporate governance rating concept was recycled right after Sarbanes Oxley passed in 2002 when Institutional Shareholder Services (ISS, which is now part of MSCI) created a corporate governance rating for publicly traded companies.  ISS then asked the same companies to pay them a consulting fee through its RiskMetrics brand to figure out how to improve their corporate governance. Since ISS voted a great number of shares for institutional investors, companies paid more often than they would publicly admit.

MSCI is changing this business model because it failed to have predictive value in the latest crisis. In fact, as reported by the Huffington Post: “Exactly fourteen days before Lehman Brothers Holding[s], Inc. filed for bankruptcy in September 2008, ISS gave Lehman a corporate governance rating of 87.6 percent, meaning that Lehman’s corporate governance in ISS’ view was better than 87.6% of other diversified financial companies. ISS also doled out generous ratings to other ailing financial companies such as Washington Mutual, which was rated by ISS as being ‘better than 44.3% of S&P 500 companies and 95.6% of [b]ank companies’  just weeks before it’s [sic] undoing. And if that was not enough, a few days before AIG scurried to put together an emergency loan, ISS rated AIG as being ‘better than 97.9% of S&P 500 companies and 99.2% of [i]nsurance companies.’”

Our partner Bill Seidman used to say: “When the tide goes out you get to see who was swimming without their shorts on.” The tide went out and corporate governance ratings took a beating.

director-education.jpg

There is a big difference between accreditation and education. Educated boards are stronger boards.

Right now, if I were serving on a bank board I would be drilling into the issues that really affect the health of the bank. I would be asking about our strategic plan around the coming wave of M&A and if we had a firm idea of what the bank was worth. I’d want to hear what the regulators are saying about our bank and how the Dodd-Frank Act might affect our institution. I would focus on how we pay our people, especially the CEO and the top five key leaders, and how we are developing our bench. I would want to hear about pockets of opportunity for lending and how much we know about our customers. I would attend highly focused programs, talk to my director peers and talk to auditors, lawyers and consultants that work with banks regularly to identify the coming challenges and opportunities. And of course I would read Bank Director. (Yes, that is a plug for our magazine).

I think that a toolbox of information for a board is far better that a one-time, one-size-fits-all accreditation process that focuses on corporate governance in a traditional sense.