Compensation and Governance Committees: Sharing the Hot Seat in 2016


hot-seat-11-19-15.pngThe compensation committee has been on the hot seat for several years. Outrage regarding executive pay and its perceived role in the financial crisis has put the spotlight on the board members who serve on this committee. Say-on-pay, the non-binding shareholder vote on executive compensation practices, was one of the first new Securities and Exchange Commission (SEC) requirements implemented as part of the Dodd–Frank Wall Street Reform and Consumer Protection Act in 2010. Since that time, public companies have responded to shareholder feedback and changed compensation programs and policies to garner support from shareholders and advisory firms such as Institutional Shareholder Services (ISS) and Glass Lewis & Co. In recent years, only 2 percent of public companies have “failed” their say-on-pay vote. The significant majority of public companies (approximately 75 percent of Russell 3000 companies) received shareholder support of 90 percent or greater during the 2015 proxy season. Today, companies with less than 90 percent should increase their shareholder outreach, as a dip below that level is often an indicator of emerging concerns.

Compensation committees can’t sit back and relax on these results. The SEC’s proposed rule for pay versus performance disclosure (published in April) and the final rule for the CEO pay ratio (published in August) will further intensify the focus on executive pay and require compensation committees to dedicate much more time and energy to evaluate and explain their pay decisions in light of these new disclosures. Fortunately, implementation of the CEO pay ratio is delayed until the 2018 proxy season while the SEC has not yet adopted final rules for the pay versus performance disclosure (as of September). It is hard to predict what influence these additional disclosures will have on shareholders’ say-on-pay votes. What is clear is that boards will need to monitor these and other pending Dodd-Frank Act rules (i.e. mandatory clawback, disclosure on hedging policies, incentive risk management) in the coming year.  

In the meantime, however, boards may face increased shareholder scrutiny in key governance areas.

Proxy access, the ability of significant shareholders to nominate board members on the company’s proxy ballot, achieved momentum in 2015 when New York City Comptroller Scott Singer submitted proxy access proposals at 75 public companies as part of his 2015 Boardroom Accountability Project. We expect proxy access proposals will remain a focus among activist shareholders during the 2016 proxy season. Dissatisfaction with executive compensation and board governance are often the reasons cited by shareholders seeking proxy access.

Institutional shareholders and governance groups have also started to focus on board independence, tenure and diversity. Institutional investors such as Vanguard and State Street Global Advisors consider director tenure as part of their voting process and ISS includes director tenure as part of their governance review process. This could lead to a push for term and/or age limits for directors in the near future. While many companies use retirement age policies as a means to force board refreshment, it is unclear if that will be enough. Boards would be wise to start reviewing their board composition and succession processes in light of their specific business strategies but also in consideration of these emerging governance and shareholder perspectives.

The intense scrutiny by investors and proxy advisors of public companies’ compensation and governance practices shows no signs of abating. Bank boards will need to develop their philosophies, programs and policies with an acknowledgement of emerging regulations and perspectives. Board composition and processes such as member education, evaluation, nomination and independence will gain focus. Executive pay levels and performance alignment will continue to be scrutinized based on new disclosures mandated by Dodd-Frank. The spotlight on pay and governance is not winding down, but rather widening and both the compensation and governance committees will need to spend more time addressing these issues in the years to come.

Playing Your Cards Right With Executive Compensation Disclosures


proxy-season-11-13-15.pngAs the 2015 calendar gets shorter, are you hedging bets that your next Compensation Discussion & Analysis (CD&A) will wow shareholders and ensure a strong say-on-pay vote next year? Or are you hoping to bluff your way through the next proxy season? Between regulatory changes and a high level of public scrutiny, it’s never too early to begin focusing on your executive compensation disclosures. 

Why Communication Strategy Matters More Than Ever
Effectively communicating your compensation plan and its link to the bank’s business and leadership strategies is a growing priority among boards and management teams. As we all know, executive compensation—and the regulation surrounding it—is increasingly complex. A well-planned and artfully delivered disclosure document can improve chances of a favorable say-on-pay outcome and potentially bolster your defenses against shareholder activism. At a minimum, it can help improve overall shareholder engagement and build communication between the board, management and other stakeholders.

The Ante: Emerging Compliance Requirements
Unfortunately, the Dodd-Frank Act’s many provisions are still looming and it’s only a question of time before the final proposals on matters such as the CEO pay ratio, pay-for-performance, and clawbacks are implemented. These fast-changing rules can make it difficult to keep up from a communication perspective. How might these new mandates complicate or conflict with your compensation strategy and how can a public bank ensure they’re fully compliant, while delivering the most effective story to shareholders and employees about the executive pay programs?

Remember—balance is the key. With so many requirements coming, it will be necessary to offset the potential complication of your message with clear details on your compensation design and its alignment with the bank’s business strategy. Within the regulatory context, there’s an opportunity to discuss:

  • How executive compensation supports your business strategy and leadership talent goals;
  • How compensation is defined;
  • How performance is viewed;
  • How sound governance and risk management is practiced; and
  • What you pay your executives and why.

It’s not just public banks that face these issues. While private entities aren’t required to disclose, many feel the resulting public pressure to communicate more and can benefit from the following guidelines.

The Winning Hand: Moving Beyond Compliance to Tell Your Story
Obviously, compliance is important, but companies need to continue shifting program design focus from compliance to a compensation philosophy that supports the long-term business strategy.

Results from Pearl Meyer’s 2015 OnPoint Survey: The New Normal of Annual Compensation Disclosure, offer several points to consider as you begin the CD&A development process. Perhaps most surprising is that ”reader-friendliness” of the CD&A is just as important to compensation committees as technical accuracy. In fact, making the content easier to read/understand ranked as the number one request compensation committees make to staff regarding the CD&A. Survey results also indicate those companies who rate their CD&A as “excellent” or “very good” experience a higher percentage of yes votes for say-on-pay from shareholders than companies who don’t rate their CD&A as high.

There are three ways to ensure you “win the hand” in regards to your pay communications to shareholders:

  1. Take advantage of emerging trends for content and design.  There have been big changes over the past five years in how information about pay is presented within the CD&A. Content needs to be accurate, complete and concise while keeping in mind that shareholders are the target audience. Incorporating elements such as executive summaries and visuals that illustrate year-over-year pay levels, mix of variable versus fixed pay, and realizable/realized pay help organize the story and pull the reader through the document. The survey results show a clear pattern: companies with favorable views of their communication use these methods far more than companies who believe their CD&A is only fair or needs improvement.
  2. Leverage the experts to develop and deploy your message. Using internal corporate communications practitioners, graphic designers, and external writers can be worth the expense. Survey results show that companies who have relied on communication experts to help develop content typically have excellent or very good communication effectiveness and almost 80 percent of these companies are using at least one professional resource.
  3. Adjust your timeframe. The quality of executive compensation disclosure is more important today than ever and the quantity of information required is growing. Therefore, it it’s never too early to get started! Our survey confirmed that those who began working on their disclosures before the close of the fiscal year reported excellent or very good communication effectiveness. It’s a safe bet to follow their lead.

Taking this disciplined approach to communicating the value of your programs should pay off in the long-term and can help your board successfully move ahead with strategy-based design.

The Current Status of Dodd-Frank Act Compensation Rules


dodd-frank-8-17-15.pngWe have waited for five years since the Dodd-Frank Act became law and we are now seeing consistent movement to finalize several compensation provisions of the law.  

Meetings started in October with President Barack Obama gathering the heads of U.S. financial regulators and urging them to finish the Dodd-Frank rules. To date, we have already adopted Securities and Exchange Commission (SEC) rules that include shareholder votes on executive compensation (Section 951 on say-on-pay and so-called golden parachutes), and on independence of compensation committees (Section 952). Remaining Dodd-Frank provisions, designed to regulate behavior encouraged by compensation structures, are Sections 953, 954, and 956. Already, many institutions have implemented more stringent variable pay plans since 2010, with more compensation tied to longer term performance. The current status of the rules is highlighted below.

Pay Versus Performance Disclosure, Section 953(a)
The proposal for section 953(a) is intended to provide compensation information to augment the say-on-pay vote for public companies. The proposal highlights a new form of realized pay versus reported pay as well as a comparison of the company and peer group total shareholder return (TSR) over several years. The proposed disclosure reflects the SEC’s attempt to help shareholders gain a better understanding of how executive pay compares to company performance by comparing named executive officers’ total compensation as described in the summary compensation table to what the SEC is now defining as compensation actually paid. As an example, the vested value of equity will be incorporated into the actually paid definition versus the value of equity at grant date. Also, the new rule uses total shareholder return (TSR) as the performance measure comparing performance to compensation “actually paid,” and using TSR of a company’s peer group to provide additional context for the company’s performance. In addition, companies will be required to provide a clear description of the relationship between the compensation actually paid and cumulative TSR for each of the last five completed fiscal years.

Current Status of Rulemaking: We expect either a final, or re-proposed rule, by fall, 2015.

Pay Ratio Disclosure, Section 953(b)
The SEC finalized this rule in August, 2015, with implementation deferred to fiscal years beginning on or after January 1, 2017. The rule requires that public companies disclose the ratio of the CEO’s total compensation to the total compensation of all other employees. For example, if the CEO’s compensation was 45 times the median of all other employees, it can be listed as a ratio (1 to 45) or as a narrative. Total compensation for all employees has to be calculated the same way the CEO’s is calculated for the proxy. All employees means all full-time, part-time, temporary and seasonal employees.

Current Status of Rulemaking: The SEC finalized the rule on August 5, 2015. The first disclosure is expected for 2017 fiscal year as shown in proxy statements filed in 2018.

Clawbacks, Section 954
Section 954 is often referred to as the “clawback” provision of Dodd-Frank and applies to all public companies. The proposal requires companies set policies to revoke incentive-based compensation from top executives with a restatement of earnings if the compensation was based on inaccurate financial statements. The company has to take back the amount of compensation above what the executive would have been paid based on the restated financial statements. This rule applies to public company Section 16 officers, generally any executive with policy making powers. Variable compensation that is based upon financial metrics as well as total shareholder return would need to be clawed back, and there is a three year look-back for current and former executives.

Current Status of Rulemaking: Expect final rules in fall, 2015; once final from SEC, stock exchanges will create the listing rule and an effective date (expected late 2016 or early 2017).

Enhanced Compensation Structure Reporting, Section 956
This rule was proposed in April, 2011—more than four years ago. This rule applies to financial institutions, specifically banks greater than $1 billion in assets. The rule is primarily a codification of the principles as found in joint regulatory Guidance on Sound Incentive Compensation Policies, which stated that compensation needs to be:

  • Balanced to both risk and reward over a long-term horizon
  • Compatible with effective controls and risk management, and
  • Supported by strong corporate governance.

In addition, there is an annual reporting requirement and for large banks (greater than $50 billion in assets), there is a mandatory deferral of incentive pay. Given that there have been four years since the original proposal, we are expecting a number of changes as the global regulatory structures have changed greatly since 2011.

Current Status of Rulemaking: Originally proposed in April 2011, changes are expected to be re-proposed in 2015.

Assessing Your Say-on-Pay Vote


As banks prepare for their annual shareholder meetings, most will have a say-on-pay vote where shareholders indicate whether they support the executive compensation program. This process has pressured companies to improve their compensation disclosures and clearly explain their pay practices and decisions. Today’s bank boards should engage with shareholders to understand their evolving perspectives on compensation and governance practices.

Meridian Compensation Partners’ Susan O’Donnell and Daniel Rodda discuss how to interpret your say-on-pay results and how to prepare for next year’s vote.

What do directors need to understand about the results of their 2015 say-on-pay vote?
Directors should know what percentage of their shareholders voted in favor of their executive compensation programs, and how that level of support compared to prior years. Receiving majority support isn’t enough. Over 70 percent of banks last proxy season received a favorable shareholder vote on their programs of 90 percent or more, so any result below that level suggests potential concerns. If your bank receives less than 70 percent support, shareholders and advisory firms such as Institutional Shareholder Services (ISS) will expect to hear specific details on how the company responded to feedback, and they will conduct a more rigorous assessment the following year. Strong shareholder support one year does not guarantee future success. We have seen the result change swiftly when not monitored.

How can directors understand what drove the results of their say-on-pay vote?
Directors should understand the makeup of their shareholder base, as there are differences in what drives the voting patterns of retail and institutional investors. Many institutional shareholders are influenced by ISS and another prominent shareholder advisory firm, Glass Lewis, so it is valuable to review their vote reports. Other institutional shareholders, like Blackrock and Vanguard, follow their own voting guidelines. While pay outcomes are more easily controlled, say-on-pay also reflects how shareholders view performance, primarily based on total shareholder return (both relative to peers and on an absolute basis). Directors need to take an objective look at how shareholders will view the relationship between executive pay and the bank’s performance.

How can banks improve the results of their say-on-pay vote?
Ensuring a significant portion of your total pay program is variable and that actual pay outcomes vary based on performance are the best ways to gain shareholder support. It is also important to maintain and disclose policies and practices that reinforce sound governance, such as stock ownership requirements, clawback policies, minimal perquisites and elimination of any tax gross-ups. The Compensation Discussion and Analysis (CD&A) section of your company’s annual proxy must effectively communicate the context and rationale for pay decisions, as well as how the programs ensure alignment between pay and performance. Investors want to understand the “how and why” of compensation decisions, including why performance measures were chosen, how pay decisions were made, and how the compensation program is aligned with shareholder value. If the say-on-pay vote receives less than 90 percent support, banks should consider reaching out to large shareholders to understand any concerns they may have. Additionally, banks that received negative recommendations from ISS and Glass Lewis should reach out to these advisory firms to discuss what led to their recommendation and what might address their concerns.

When should banks begin preparing for the following year’s say-on-pay vote?
Directors should already be thinking ahead to next year’s vote. The board has likely already made pay decisions in 2015 that will be evaluated as part of the 2016 say-on-pay vote. Typically, salary increases and equity awards are made in the first quarter of the year, but shareholders will be evaluating those decisions through the lens of performance through the end of the year. This can at times lead to an unfortunate disconnect. As a result, it is never too early to consider decisions in light of shareholder perspectives and the potential impact on the say-on-pay vote. In addition, ongoing shareholder outreach is viewed positively by investors and can proactively surface potential issues while there is still time to make changes. Being proactive and considering pay in the broader context of bank performance and shareholder perspectives should be an ongoing process.

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


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

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

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

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

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

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

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

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

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

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

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

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


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Getting Shareholders to Say “Yes” to Your Pay Plan


12-11-13-Naomi.jpgHonolulu-based Territorial Bancorp’s Vice Chairman Vernon Hirata has a piece of advice for other bank boards: communicate with shareholders about potentially sensitive compensation related matters. Or else.

Territorial received a 74 percent approval rating from shareholders in its annual “say on pay” advisory vote in 2012. Sure, it was a passing vote, but too close for comfort, said Todd Leone, a partner at McLagan, the bank’s compensation advisor.

“We called McLagan and said, ‘Houston, we have a problem,’’’ said Hirata, who spoke at Bank Director’s recent Bank Executive and Board Compensation Conference in Chicago.

As Hirata remembers it, the $1.6-billion asset company approved a new equity incentive plan for top management in 2010 after an initial public offering of bank stock in 2009. The company spent lots of time with investor groups explaining the compensation plan, and passed its first shareholder advisory vote with no sweat. But the next year, in 2012, there was almost no communication with shareholders about the incentive plan, aside from a written description in the proxy.

And that was unfortunate because the proxy statement’s summary compensation table that year had some high numbers in it. Most notably, chairman, president and chief executive officer Allan Kitagawa had been paid almost $6.8 million in 2010, more than double his pay in 2009 or 2011. Other executives saw similar jumps that year.

Hirata said the executives were paid stock awards that year that vested over a six-year period, but the company had to report the amounts as a one-time grant, per rules from the Securities and Exchange Commission. Apparently, shareholders were not pleased. “Soon after our proxy was distributed, we got a call from our proxy distributor and said a proxy firm was deciding to recommend a ‘no’ vote,’’ Hirata said.

It was a little late to do anything, as the shareholder meeting was right around the corner. But this year, the bank reached out to shareholders and explained the equity plan better, he said. The bank was rewarded with a 91 percent approval vote this time around.

Shareholder advisory firms, which recommend votes to the large institutional investors who are their clients, don’t like big equity payouts when they don’t seem to be linked to performance, said Chris Fischer, a partner at Aon Hewitt consulting, which owns McLagan. Institutional shareholders owned about 55 percent of Territorial Bancorp’s stock, which meant the bank had to pay attention to the advisory groups.

Other compensation practices that draw the ire of shareholder advisory groups include tax gross ups, where the company agrees to pay an executive’s taxes when a change-in-control would trigger a “golden parachute” and additional taxes under the Internal Revenue Code. Also, shareholder groups don’t like it when companies tell the market one set of goals for the institution’s financial performance, while benchmarking their executives to a lower standard for bonuses.

Another red flag for shareholder advisory groups is when companies compare their compensation to a peer group with other companies that are much larger. Instead, companies typically set up peer groups with similar-sized companies in the range of half to 2.5 times the bank’s asset size, Fischer said. Communication with shareholders is important to winning a say on pay vote, he said.

“It’s better on an annual basis to reach out to your institutional investors about what concerns them with your pay package,’’ he said.

Leone agreed.“You are generating some good will with them, and most important, in your next proxy, you get to say you went out and talked to your investors,’’ he said.

As for Hirata, he had his own lessons learned from the crisis at his bank.

“Do the hard work now,’’ he said. “You don’t want to have that call and scramble at the last minute. You need to do the work before your proxy gets out there.”

Shareholders Give Banks a Thumbs-Up on Pay


6-26-13_Semler.pngBank directors can take heart from the results of say-on-pay votes during the past three years. Since the 2010 Dodd Frank Act gave shareholders of public companies the right to an advisory vote on executive compensation practices, banks have, on average, slightly outperformed all other companies in affirmative votes.

Although say-on-pay voting is ostensibly about pay only, it is one of the few mechanisms shareholders can use to directly send a message about their overall satisfaction with the company. Since the 2008 recession, banks have been subjected to intense scrutiny and an avalanche of negative publicity for their perceived role in precipitating the financial crisis. Nevertheless, if bank shareholders are unhappy, it hasn’t shown up in their say-on-pay votes.

From Semler Brossy’s say-on-pay database, we looked at the 2013 voting results through May 27th for all banks in the Russell 3000 index and compared them to the results for all other companies in the Russell 3000. We found that banks averaged a positive say-on-pay approval vote of 92.9 percent. The average for all other Russell 3000 companies is 91.1 percent. Banks not only outperformed other companies on the average approval rate but also in terms of variance: 83 percent of banks passed with more than 90 percent approval for executive pay compared to 77 percent for companies overall. Interestingly, no banks have as yet failed say-on-pay this year, while 2.2 percent of other companies recorded less than 50 percent shareholder approval, basically a failure.

These results have held remarkably steady since say-on-pay was instituted in 2011. In 2011, banks averaged 92.6 percent approval versus other companies at 90.7 percent. In 2012, banks averaged 91.7 percent approval versus other companies at 89.7 percent. Also, banks have failed say-on-pay at a slightly lower rate than companies in general, with failure rates of 0.5 percent in 2011 and 1.6 percent in 2012, versus general industry numbers of 1.5 percent in 2011 and 2.7 percent in 2012.

What about the results for big banks versus small banks? After all, it was the big banks that bore the brunt of negative publicity about executive pay and government bailouts after 2008, while small and regional banks were largely unscathed. But when we looked at the 2013 results for the 30 largest banks by assets compared to all other banks, we found little difference. The large banks averaged 93.1 percent approval and the other banks averaged 92.5 percent, with similar results holding for 2012 and 2011.

These positive results may stem from a combination of factors. Shareholders are likely evaluating the compensation practices of their banks separately and distinctly from broad public or other concerns. Also, bank boards are likely taking the time to carefully design compensation programs and also clearly explaining this linkage of pay and performance in the proxy materials. In any case, no negative messages here. Move along.

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.

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.