How One Bank Transformed Its Board & Shareholder Base in 6 Years

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The McConnell family has had a controlling interest in Pinnacle Financial Corp., based in Elberton, Georgia, since the 1940s. But over the past few years, Jackson McConnell Jr., the bank’s CEO and chairman, has worked to dilute his ownership from roughly 60% to around a third. “It’s still effective control, but it’s not an absolute control,” he says.

McConnell, a third-generation banker, has seen a lot of family-owned banks struggle with generational change in ownership as well as management and board succession issues, and he’s seen some of it firsthand when Pinnacle acquires another bank. It’s a frequent problem in community bank M&A. In Bank Director’s 2023 Bank M&A Survey, 38% of potential sellers think succession is a contributing factor, and 28% think shareholder liquidity is. 

“One of the things that I’ve experienced in our effort to grow the bank [via M&A is] the banks that we’re buying … maybe the ownership is at a place where they would like to liquidate and get out, or the board [has] run its course, or the management team is aging out,” he says. “And they end up saying the best course of action would be to team up with Pinnacle Bank.” 

There’s not another generation of McConnells coming through the ranks at $2 billion Pinnacle, and he doesn’t want the same result for his bank. “I want to make sure that I’m doing everything that I can to put us in a position to continue to perpetuate the company and let it go on beyond my leadership,” he says. Putting the long-term interests of the bank and its stakeholders first, Pinnacle is reinventing itself. It’s transitioned over the past few years from a Subchapter S, largely family-owned enterprise with fewer than 100 owners to a private bank with an expanded ownership base of around 500 shareholders that’s grown through M&A and community capital raises. As this has transpired, Pinnacle’s also shaking up the composition of the board to better reflect its size and geographic reach, and to serve the interests of its growing shareholder base.

Pinnacle is a “very traditional community bank,” says McConnell. It’s located in Northeast Georgia, with 27 offices in a mix of rural and what he calls “micro metro” markets, primarily college towns. It has expanded through a mix of de novo branch construction and acquisitions; in 2021, it built three new branches and acquired Liberty First Bank in Monroe, Georgia — its third acquisition since 2016. 

The bank’s acquisitions, combined with three separate capital raises to customers, personal connections and community members in its growing geographic footprint, have greatly expanded the bank’s ownership. 

But McConnell says he’s sensitive to the liquidity challenges that affect the holders of a private stock, who can’t access the public markets to buy and sell their shares. “We’ve done several things to try to provide liquidity to our shareholders, to cultivate buyers that are willing to step up,” McConnell says. “You can’t call your broker and sell [the shares] in 10 minutes, but I can usually get you some cash in 10 days. If you’re willing to accept that approach, then I can generally overcome the liquidity issue.” Sometimes the bank’s holding company or employee stock ownership plan (ESOP) can be a buyer; McConnell has also cultivated shareholders with a standing interest in buying the stock. The bank uses a listing service to facilitate these connections.

“We have a good story to tell,” McConnell says. “We’ve been very profitable and grown and have, I think, built a good reputation.”

The board contributes to that good reputation, he says. During one of the bank’s capital raises, McConnell met with a potential buyer. He had shared the bank’s private placement memorandum with the investor ahead of time and started his pitch. But the buyer stopped him. “He said, ‘Jackson, it’s OK. I’ve seen who’s on your board. I’m in,’” McConnell recalls. “That really struck me, to have people [who] are visible, [who] are known to be honorable and the type of people you want to do business with … it does make an impact.”  

The current makeup of Pinnacle’s board is the result of a multi-year journey inspired by the bank’s growth. Several years ago, the board recognized that it needed to represent the bank’s new markets, not just its legacy ones. And as the bank continued to push toward $1 billion in assets — a threshold it passed in 2020 — the board became concerned that the expertise represented in its membership wasn’t appropriate for that size. 

“If we wanted to be a billion dollar bank, we needed a billion dollar board,” says McConnell. The board started this process by discussing what expertise it might need, geographic areas that would need representation, and other skills and backgrounds that could help the bank as it grew. 

The board also chose to change its standing mandatory retirement policy to retain a valuable member. While the policy still has an age component, exceptions are in place to allow the bank to retain members still active in their business or the community, and who actively contribute to board and committee meetings. 

But there was a catch, says McConnell. “We said, ‘OK, we’re going to do this new policy to accommodate this particular board member — but for us to do this here and make this exception, let’s all commit that we’re going to do a renewal process that involves bringing in some new board members, and some of you voluntarily retiring.’” The board was all-in, he says. “I had a couple of board members approach me to say, ‘I don’t want to retire, but I’m willing to, because I think this is the right way to go about it,’” he recalls.

Conversations with directors who still view themselves as contributing members can be a challenge for any bank, but McConnell believes the board’s transparency on this has helped over the years, along with the example set by those retiring legacy board members. Over roughly six years, Pinnacle has brought on nine new board members. That’s a sizable portion of the bank’s outside directors, which currently total 10.

McConnell leveraged his own connections to fill that first cohort of new directors in 2016. The second and third cohorts leveraged the networks of Pinnacle’s board members and bankers. McConnell has had getting-to-know-you conversations with candidates he’s never previously met, explaining the bank’s vision and objectives. But he’s also transparent that it may not be a fit in the end for the individual or the board. “We talked openly about what we were trying to do, and also openly about how I might end up recruiting you, only to say, ‘No,’ later,” he says.

Director refreshment is an ongoing process; Bill McDermott, one of the independent directors that McConnell first recruited in 2016, confirms that the board spends time during meetings nominating prospective candidates for board seats.  

Both McConnell and McDermott say the diversity of expertise and backgrounds gained during the refreshment process has been good for the bank. Expansion into new markets led to bringing on an accountant and an attorney, as well as two women: a business owner and the chief financial officer of a construction company, who now make up two of the three women on the board.  

New, diverse membership “adds a lot of energy to the room. It’s been very successful,” says McConnell.

To onboard new directors, there’s a transition period in which the new directors and outgoing board members remain on the board for the same period of time — anywhere from six to 12 months — so sometimes the size of the board will fluctuate to accommodate this. 

It can take new directors with no background in banking time to get used to the ins and outs of a highly regulated industry. That’s led to some interesting discussions, McConnell says. “There is some uneasiness and awkwardness to some of the questions that get asked, but it’s all in the right spirit.” 

External education, in person and online, helps fill those gaps as well. McDermott says the board seeks to attract “lifelong learners” to its membership.

One of the factors that attracted McDermott to Pinnacle was the bank’s culture, which in the boardroom comes through as one built on transparency and mutual respect. “I was just attracted by an environment where everybody checked their egos at the door. The relationships were genuine,” he says. “[T]hat kind of environment, it’s so unique.” And he says that McConnell sets that tone as CEO.

“There is lively discussion,” says McDermott. “Jackson encourages people to ask thoughtful questions, and sometimes those thoughtful questions do lead to debate. But in the end, we’ve been able to synthesize the best part of the discussions around the table and come up with something that we think is in the best interest of the bank.”

Additional Resources
Bank Director’s Online Training Series library includes several videos about board refreshment, including “Creating a Strategically Aligned Board” and “Filling Gaps on Your Board.” For more context on term limits, read “The Promise and the Peril of Director Term Limits.” To learn more about onboarding new directors, watch “A New Director’s First Year” and “An Onboarding Blueprint for New Directors.” For more information about the board’s interaction with shareholders, read “When Directors Should Talk to Investors.” 

Bank Director’s 2023 Bank M&A Survey, sponsored by Crowe LLP, surveyed 250 independent directors, CEOs, chief financial officers and other senior executives of U.S. banks below $100 billion in assets to examine current growth strategies, particularly mergers and acquisitions. Bank Services members have exclusive access to the complete results of the survey, which was conducted in September 2022. 

When Directors Should Talk to Investors

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Company boards have long spoken to investors in indirect ways, through their votes and organizational performance. But as powers shift to large investors and governance norms have changed, investor groups have demanded more one-on-one conversations with bank directors.

Allowing directors to speak to investors comes with risk, and not just due to the potential for legal missteps. The director becomes a public representative of the bank and anything he or she says will be scrutinized, resulting in possible backfire.

“You can’t really say you’re not speaking for the company,” says Peter Weinstock, a partner at the global law firm Hunton Andrews Kurth. “You’re speaking for the company.”

But in an age where activist shareholders have an increased presence and institutional investors such as Blackrock and State Street Corp. have greater power, organizations find that some investors expect this one-to-one interface with directors. When done right, it can ease tension among the investor base, allowing management to maneuver more freely. When done wrong, however, it can result in proxy fights and changes to the board and management.

The topics that investors care about impact the moves that directors and boards make. Board discussions on compensation, for example, are becoming more important. Last year saw the lowest level of shareholder support for executive pay — only 87.4% of S&P 500 companies received shareholder approval in advisory voting during proxy season, according to PwC. That indicates a higher bar for boards to get shareholder buy-in for executive compensation.

Companies also must deal with an increasing amount of activist shareholder proposals. PwC reports there was a 17% increase in shareholder proposals last year. Out of 288 proposals related to environmental, social and governance (ESG) matters, a popular topic last year, 41 proposals passed.

One way to provide context for the company’s efforts on those matters: director conversations.
Institutional investors and shareholder analysis groups have turned their focus to three big concerns – audit, governance and compensation – all of which reside at the board level. With questions surrounding those specific concerns coming from many different groups, banks have turned to so-called “roadshows.” In those organized conversations, directors speak to shareholders or investor services groups about specific governance or audit topics. During those roadshows, board members stick to a prewritten script.

“The advent of the one-way listening session allayed director fear,” says Lex Suvanto, global CEO at the public relations firm Edelman Smithfield. “There isn’t much risk in what they shouldn’t say.”

Certain concerns may require more direct conversations with a specific investment group. When entering those conversations, it’s important to remember what information the shareholders want to glean. “Understand who you are speaking to and what they are all about,” says Tom Germinario, senior managing director at the financial communication firm D.F. King & Co. “Is it a governance department or a portfolio manager, because there’s a difference?”

Each investor will come to the conversation with different goals, investment criteria and questions they want addressed. It’s on the company to prepare the director for what types of questions each investor may need answered.

During those different calls, banks should ask to receive the questions ahead of time. Many investors will provide this, since they understand that the director cannot run afoul of fair disclosure rules, a set of parameters that prevent insider trading. But not all investors will provide those insights upfront.

To head off such concerns, the bank’s communications or investor relations team should run a rehearsal or prepare the director with possible questions, based on the reason for the meeting.

The investors will look for anything that might give them insight. Directors that veer off script could run afoul of what they can legally disclose. Plus, the tenor of the answers must match what the CEO has said publicly about the company. Without practice, the conversation can unwittingly turn awry.

“If a director is on the phone with an investor and something is asked that the company hasn’t disclosed, the director can table that part of the discussion,” says Weinstock. “The company can then make a Regulation Fair Disclosure filing before following up with the investor on a subsequent call. That’s an option if the company wants to release the information.”

It’s important to remember the practice will also protect you, since you will have a significant amount riding on the conversation as well. “Directors may reveal that they’re not in touch with important investor priorities,” says Suvanto. “Directors need to understand and be fully prepared to represent the values and behaviors [of the company].”

Suvanto adds that many directors would have been better not to speak at all than to go into a room with a large institutional investor, unprepared. In a public bank, such a misstep can lead to a proxy battle, which may result in the director (or many directors) being replaced by members the investors view as more favorable or knowledgeable.

The conversation also works differently, depending on the size of the bank and whether it’s a private or public institution. Institutional investors likely will focus on larger banks. Small banks may not account for an oversized spot in the institutional investor’s portfolios. Instead, for smaller companies, it’s often about getting the CEO and chief financial officer in front of investors to encourage investment. Often, this does not need a director’s voice.

For private banks, however, there are certain moments where directors may be asked to step in. If, say, an organization has questions about its auditing practices. Or what if a competitor bank has major governance violations? To address questions from investors concerning those issues, it may be advisable to have the committee head for the specific concern speak to investors about the bank’s practices.

But even a private bank cannot ignore concerns about releasing information that’s meant to stay within the board room. “It’s important to realize that information does not belong to a director,” says Weinstock. “It’s also important to realize that private companies could have insider trading violations.”

What else could go wrong? A director could overpromise when the company isn’t ready to address the issue. This can happen in the environmental, social and governance (ESG) space with regards to addressing social concerns, for example. If a director commits to social commitments that the company cannot yet adopt, it can pit the director against the board or management. Either the company will decide to adopt the promised measures, or the director will have misled the investor.

“A director should never get on the phone alone,” says Germinario. “You never want an investor to misconstrue a promise.”

ESG Principles at Work in Diversifying Governance

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Before environmental, social, and governance (ESG) matters became commercially and culturally significant, the lack of diversity and inclusion within governance structures was noted by stakeholders but not scrutinized.

The shifting tides now means that organizations lacking diversity in their corporate leadership could be potentially subjected to shareholder lawsuits, increased regulation and directives by state laws, investment bank requirements, and potential industry edicts.

Board and management diversity is undoubtedly a high-priority issue in the banking and financial services sectors. Numerous reports establish minority groups have historically been denied access to capital, which is mirrored by the lack of minority representation on the boards of financial institutions.

Some progress has been made. For example, for the first time in its 107-year history, white men held fewer than half of the board seats at the Federal Reserve’s 12 regional outposts. This was part of an intentional effort, as Fed leaders believe a more representative body of leaders will better understand economic conditions and make better policy decisions. However, further analysis reflects such diversity predominantly among the two-thirds of directors who are not bankers, while the experienced banking directors are mainly white males.

Board Diversity Lawsuits
The current pending shareholder suits have been primarily filed by the same group of firms and targeted many companies listed by a recent Newsweek article as not having a Black director. None of these suits involve financial institutions, but it is not hard to foresee such cases coming in the future. The lawsuits generally assert that the defendants breached their fiduciary duties and made false or misleading public statements regarding a company’s commitment to diversity. The Courts have summarily dismissed at least two suits, but a legal victory may not even be the goal in some cases.

Recently, Google’s parent settled its #MeToo derivative litigation and agreed to create a $310 million diversity, equity, and inclusion fund to support global diversity and inclusion initiatives within Google over the next ten years. The fund will also support various ESG programs outside Google focused on the digital and technology industries.

Regulatory, Industry, and Shareholder Efforts
Federal and state regulatory efforts preceded these recent lawsuits. The U.S. Securities and Exchange Commission has issued compliance interpretations advising companies on the disclosure of diversity characteristics upon which they rely when nominating board members and is expected to push more disclosure in the future. Additionally, the U.S. House of Representatives considered a bill in November 2019 requiring issuers of securities to disclose the racial, ethnic, and gender composition of their boards of directors and executive officers and any plans to promote such diversity.

These efforts will likely filter into boardrooms and may spur additional board regulation at the state level. In 2019, California became the first state to require headquartered public companies to have a minimum number of female directors or face sanctions, increasing 2021. In June 2020, New York began requiring companies to report how many of their directors are women. As other states follow California’s lead regarding board composition, we can expect more claims to be filed across the country.

At the industry level, the Nasdaq stock exchange filed a proposal with the SEC to adopt regulations that would require most listed companies to elect at least one woman director and one director from an underrepresented minority or who identify as LGBTQ+. If adopted, the tiered requirements would force non-compliant companies to disclose such failures in the company’s annual meeting proxy statement or on its website.

In the private sector, institutional investors, such as BlackRock and Vanguard Group, have encouraged companies to pursue ESG goals and disclose their boards’ racial diversity, using proxy votes to advance such efforts. Separately, Institutional Shareholder Services and some non-profit organizations have either encouraged companies to disclose their diversity efforts or signed challenges and pledges to increase the diversity on their boards. Goldman Sachs Group has made clear it will only assist companies to go public if they have at least one diverse board member.

Concrete Plans Can Decrease Director Risk
Successful institutions know their diversity commitment cannot be rhetorical and is measured by the number of their diverse board and management leaders. As pending lawsuits and legislation leverage diversity statements to form the basis of liability or regulatory culpability, financial institutions should ensure that their actions fully support their diversity proclamations. Among other things, boards should:

  • Take the lead from public and private efforts and review and, if necessary, reform board composition to open or create seats for diverse directors.
  • When recruiting new board members, identify and prioritize salient diversity characteristics; if necessary, utilize a diversity-focused search consultant to ensure a diverse pool of candidates.
  • Develop a quantifiable plan for diversity issues by reviewing and augmenting governance guidelines, board committee efforts, and executive compensation criteria.
  • Create and promote diversity and inclusion goals and incorporate training at the board and management levels.
  • Require quarterly board reporting on diversity and inclusion programs to reveal trends and progress towards stated goals.

As companies express their commitment to the board and C-level diversity and other ESG efforts, they should create and follow concrete plans with defined goals and meticulously measure their progress.

3 Ways a Democratic Presidency Could Impact Executive Compensation

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Sen. Elizabeth Warren, D-Mass., recently wrote, “Almost ten years ago, Congress directed federal regulators to impose new rules to address the flawed executive compensation incentives at big financial firms. But regulators still haven’t finalized (let alone implemented) a number of those key rules, including one that would claw back bonuses from bankers if their bets went bad in the long run. As President, I will appoint regulators who will actually do their job and finish these rules.”

Warren is referring to the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was introduced in 2010 as a response to the 2008 financial crisis. The act contained over 2,300 pages of provisions, including a number that impact executive compensation, to be implemented over several years. A few provisions — like management say-on-pay, say-on-golden-parachutes, CEO pay ratio — have been implemented, while others like incentive-based compensation arrangements (§ 956), clawbacks (§ 954) and pay-versus-performance (§ 953(a)) remain in limbo.

In any Democratic presidency, incentive-based compensation (§ 956) may be the easiest provision to finalize. The 2016 proposal creates a general restriction for banks with more than $1 billion in assets on incentive compensation arrangements that encourage inappropriate risks caused by a covered person receiving excessive compensation that could lead to a material financial loss. As proposed, it is very prescriptive for banks with assets of $50 billion or more, requiring mandatory deferrals, a minimum clawback periods, ability for downward adjustments and forfeiture.

The final rules for § 956 were re-proposed in 2016, but regulators’ interest in the topic has been muted during President Donald Trump’s administration. There are other ways that executive compensation programs could be impacted by a Democratic president, of which Warren is one contender for the nomination. While not exhaustive, we see three potential changes — beyond § 956 — that could impact  executive compensation programs.

1. Increased Regulatory Oversight
In almost all scenarios, a Democratic presidency will be accompanied by an increase in regulation. The 2016 sales practices scandal at Wells Fargo & Co. brought incentives into the spotlight. The Federal Reserve Board has stressed the importance of firms having appropriate governance of incentive plan design and administration, and have audited the process and structure in place at banks. One key thing that firms can and should be doing, even if the party in power does not change, is implement a documented and thorough incentive compensation risk review process as part of a robust internal control structure. Having a process in place will be key in the event of regulatory scrutiny of your compensation programs.

2. Mandatory Deferrals
Warren re-introduced and expanded the concept of mandatory deferrals through her Accountable Capitalism Act of 2018. This proposed legislation restricts the sales of company shares by the directors and officers of U.S. corporations within five years of receiving them or within three years of a company stock buyback. Deferred compensation gives the bank the ability to adjust or eliminate compensation over time in the event of material financial restatements or fraudulent activity, and is sure to be a topic that will come up with a Democratic presidency.

While the concept is different from deferred compensation, many firms have introduced holding periods in their long-term incentive programs for executives. This strengthens the retentive qualities of the executive incentive program and provides some accounting benefits for the organization, making it something to consider adding to stock-based incentive plans.

3. Focus On More Than The Shareholder
The environmental, social and governance (ESG) framework has been a very hot topic in investment communities, with heavy-hitting institutional investors introducing policies relating to ESG topics. For example, BlackRock is removing companies generating more than 25% of revenues from thermal coal production from its discretionary active investment portfolios, and State Street Corp. announced that it will vote against board members for “consistently underperforming” in the firm’s ESG performance scoring system. Warren believes that companies should focus on “the long-term interests of all of their stakeholders — including workers — rather than on the short-term financial interests of Wall Street investors.” It remains to be seen exactly what future compensation plans for banking executives will look like, though the myopic focus on total shareholder return may become a thing of the past.

Many potential incentive compensation changes that are likely to occur under a Democratic presidency already exist in the marketplace, including holding periods for long-term incentive plans; incentive compensation risk review, including the internal control structure; mandatory deferrals and clawbacks; and aligning incentive plans with the long-term strategy of the organization. Directors should evaluate their bank’s current plans and processes and identify ways to tweak the programs to ensure their practices are sound, no matter who takes office in 2021.

Generational Shift Complicates Shareholder Succession

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A challenge facing many community banks this new decade has nothing to do with public policy, the yield curve, regulation or technology.

A growing number of banks face an aging shareholder base, concentrated ownership and limited liquidity. This can lead to shareholder succession impositions when large shareholders want to exit their ownership position or an estate settlement creates a liquidity need.

Community banks have always been owned by local centers of influence, passed down through generations and thought of as both a financial investment and philanthropic participation in the community. But the societal aspect of bank ownership is not the same as the current ownership cedes to the younger generation, many of whom have moved away from home and see banking as an increasingly more digital experience.

Banking and securities regulations do not make the situation easier. There are parameters around a bank’s ability to issue stock in the local community to attract new shareholders. Banks are cautious of giving unknown investors a seat at the table, particularly institutional or activist owners, as they may only hold the stock for a defined, shorter period before seeking liquidity themselves. The bank itself can sometimes be a source of liquidity to repurchase stock from shareholders, but regulatory capital ratios may limit that capacity. Some advice for banks struggling with these issues includes the following:

Treat shareholder succession as a business initiative: Identifying issues before they occur, or a capital need before it becomes urgent, increases a bank’s flexibility. Boards should discuss shareholder liquidity issues, as some large owners may be sitting around the board table.

Investor relations is not just for large and liquid banks: Local banks are often owned by members of the local community. The legacy of family ownership is emotional, and large owners often do not want to “upset the apple cart” and force the bank to sell. Many may not realize that how they treat their position could impact the bank’s future. Some may not be open to discussing the issue, but others might appreciate the opportunity.

Address long-term liquidity in strategic planning: Under what conditions would the bank consider listing on a more liquid exchange, commencing a traditional public offering, or raising subordinated debt as a way to address shareholder succession? The owners of many closely held banks are wary of incurring dilution to their ownership stake but want to remain independent, which limits their options. For smaller banks, even upgrading to a slightly more liquid trading medium such as OTC Market Group’s OTCQX Banks market, may open the doors to investors that understand smaller, less-liquid situations and have capital to put to work.

Plan for shareholder liquidity as you would for balance sheet liquidity: It is helpful that directors and executives understand the bank’s capacity to repurchase shares, as the bank itself is often the first line of defense for an immediate liquidity need. Small bank holding company regulation gives community banks flexibility to leverage their capital structure by issuing debt at the holding company, which can be injected into the bank subsidiary as common equity. Creating an employee stock ownership plan or dividend reinvestment plan may help to manage and retain capital and dividend policy can also be critical.

The right answer is usually a combination of all of the above: There is no silver bullet for addressing shareholder liquidity in a smaller, more closely held bank; all of the discussed initiatives will play a part. Many banks get caught flat-footed after the fact, either faced with an estate settlement or a family with a large position seeking liquidity. Dealing with an urgent liquidity need, often in tight timing, limits the bank’s flexibility and options.

If a merger or sale is the right alternative, control that dialog: Some shareholders looking to exit may find the premium in a sale attractive relative to the desire of others for independence. It’s a worthwhile exercise for boards and executives to understand the bank’s value in a sale, as well as likely partners, even if a sale is only a remote possibility. This allows your bank to identify preferred partners and ascertain their ability to pay a competitive valuation independent of any urging from shareholders. Highlight those strategic alternatives to the board on a regular basis. If an urgent shareholder need forces the bank to seek a partner, your bank has already begun addressing these issues and building those relationships.

Shareholder succession issues can drive change and create uncertainty, risk and opportunity at community banks. Careful analysis and planning can help lead to a desired outcome for all involved.

A Valuable Lesson from the Best Bank You’ve Never Heard of

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strategy-8-24-18.pngThere are a lot of places you would expect to find one of the highest performing banks in the country, but a place that wouldn’t make most lists is Springfield, Missouri—the third-largest city in the 18th-largest state.

Yet, that’s where you’ll find Great Southern Bancorp, a $4.6 billion regional bank that has produced the fifth best total all-time shareholder return among every publicly traded bank based in the United States.

Since going public in 1989, just two years before hundreds of Missouri banks and thrifts failed in the savings and loan crisis, Great Southern has generated a total shareholder return, the ultimate arbiter of corporate performance, of nearly 15,000 percent.

What has been the secret to Great Southern’s success?

There are a number of them, but one is that the Turner family, which has run Great Southern since 1974, owns a substantial portion of the bank’s outstanding common stock. Between CEO Joe Turner, his father and sister, the family controls more than a quarter of the bank’s shares, according to its latest proxy report, which places most of their net worth in the bank.

The importance of having “skin in the game” can’t be overstated when it comes to corporate performance. This is especially true in banking, where a combination of leverage and the frequent, unforgiving vicissitudes of the credit cycle renders the typical bank, as one of the seminal books on banking written over the past decade is titled, “fragile by design.”

The trick is to implement structural elements that combat this. And one of the most effective is skin in the game—equity ownership among executives—which more closely aligns the interests of executives with those of shareholders.

“Having a big investment in the company…gives you credibility with institutional investors,” says Turner. “When we tell them we’re thinking long-term, they believe us. We never meet with an investor that our family doesn’t own at least twice as much stock in the bank as they do.”

An interesting allegory that speaks to this is the way the Romans and English governed bridge builders many years ago, as Nassim Taleb wrote in his book Antifragile:

For the Romans, engineers needed to spend some time under the bridge they built—something that should be required of financial engineers today. The English went further and had the families of the engineers spend time with them under the bridge after it was built.

To me, every opinion maker needs to have ‘skin in the game’ in the event of harm caused by reliance on his information or opinion. Further, anyone producing a forecast or making an economic analysis needs to have something to lose from it, given that others rely on those forecasts.

The most important thing having skin in the game has done for the executives at Great Southern is the long-term approach to their family business. “Our dad turned a valuable asset [stock in the bank] over to me and my sister [a fellow director at the bank] and my goal, when I’m finished, is to turn that over to my kids and have it be worth a lot more,” says Turner.

This becomes especially evident when the economy is hitting on all cylinders. “When institutional investors and analysts…are rewarding explosive growth, you need to have a longer-term view,” says Turner. “For instance, the explosive growth you can get from acquisitions is great in terms of the short-term boost to your stock price, but over the longer term that type of thing can reduce your shareholder return.”

Having skin in the game also addresses the asymmetry in risk appetite that otherwise exists between management and shareholders, where the potential reward to management in short-term incentives from taking excessive risk outweighs the potential long-term threat to a bank’s solvency, a principal concern of shareholders.

A long-term mindset promoted by skin in the game also causes like-minded, long-term investors to flock to your stock. This is a point Warren Buffett has made in the past by noting that companies tend to “get the investors they deserve.”

“That point is probably right,” says Turner. “We have a much larger proportion of retail investors than a lot of other companies do. I understand where institutional, especially fund, investors are coming from. It’s great for them to say they’re long-term shareholders, but they have investors in their funds that open their statements every quarter and want to see gains. So it’s harder for big money managers to be truly long-term investors.… It’s a different story with retail investors, who, in my opinion, tend to be longer term by nature.”

This cuts to the heart of what Turner identifies as the biggest challenge to running a successful bank.

“The hardest thing is balancing different constituencies,” says Turner. “We have a mission statement that is to build winning relationships with our customers, associates, shareholders, and communities. What we’re talking about is building relationships that are balanced in a way that allow each of those constituencies to win.”

The moral of the story is that, much like bridge builders in ancient Roman and English times, one of the most effective ways to construct an antifragile bank is by putting skin in the game.

When the Gloves Come Off

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shareholder-12-1-17.pngShareholder lawsuits are relatively common for the banking industry, but the reverse—a bank suing one of its shareholders—is fairly unique. On October 31, 2017, Nashville, Tennessee-based CapStar Financial Holdings, with $1.3 billion in assets, sued its second-largest shareholder, Gaylon Lawrence Jr. The bank alleges that the investor and his holding company, The Lawrence Group, violated the Change in Bank Control Act, which requires written notice and approval from the Federal Reserve before owning more than 10 percent of a financial institution, as well as a related Tennessee law. CapStar also maintains that Lawrence violated the Securities Exchange Act of 1934 by failing to disclose plans to acquire additional CapStar stock.

Passing the 10 percent ownership mark without the proper approvals is more common than one might think, according to Jonathan Hightower, a partner at the law firm Bryan Cave LLP. And often the violators of these rules are directors who are simply enthusiastic about their bank’s stock and want more of it. “They’re interested in the bank. They may know of shares that are available in the community and buy them up without realizing they’ve crossed the threshold where they need regulatory approval,” says Hightower.

How the Fed interprets these regulations and the steps required of shareholders is a specialized area, adds Hightower. “Given that, the Fed’s approach, assuming there’s not an intentional violation, is more permissive than might be expected.” The Fed is unlikely to levy penalties against a shareholder acting in good faith.

Lawrence filed a motion to dismiss the lawsuit on November 13, 2017, and maintains that he has complied where necessary and that, as an individual investor, the Tennessee code requiring a bank holding company to acquire control of the bank isn’t relevant.

What’s unique in the CapStar case is that it’s the bank taking action against the investor, rather than the regulator. In a letter dated November 20, 2017, CapStar asked the Fed to reject Mr. Lawrence’s stake in the bank and require that Lawrence divest “all illegally acquired CapStar shares,” in addition to a request for a cease-and-desist order and the levying of civil money penalties against Lawrence.

Requiring Lawrence to divest will likely harm what is, in CapStar’s own words, a “thinly traded” stock, according to Stephen Scouten, a managing director at Sandler O’Neill + Partners. Without Lawrence’s acquisitions of large amounts of stock, “the stock would be appreciably lower than it is today,” says Scouten. The stock price rose 6.95 percent year-over-year as of November 27, 2017, and 17 percent in the three months in which Lawrence has been accumulating a sizeable number of shares.

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Filings by CapStar indicate that Lawrence attempted to acquire the bank in the summer of 2016. When that attempt was unsuccessful, CapStar alleges that Lawrence approached two of the bank’s largest stockholders to buy their combined 30 percent stake. That attempt also failed, and Lawrence began acquiring CapStar stock on the open market after the bank’s initial public offering last year. From August through October 2017, Lawrence rapidly increased his stake in CapStar from 6.2 to 10.2 percent, paying a total of $82.7 million for 4.6 million shares. CapStar alleges that Lawrence has “coveted control” of CapStar, and it’s easy to see how the bank arrived at that conclusion.

Lawrence is a long-term investor who appears to like what he sees in the Nashville market. He even recently purchased a home there. He’s certainly an experienced bank investor. He owns seven community banks, including two in the Nashville area: F&M Bank, with $1 billion in assets, and Tennessee Bank & Trust, formerly a division of $510 million asset Farmers Bank & Trust in Blytheville, Arkansas, which is also owned by Lawrence. “He’s got a lot of money to put to work, [and] he thinks banks are a good investment for his capital,” says Scouten. Right now, that looks to be as much as 15 percent of CapStar. Whether that turns into a full-fledged bid for the bank, as he sought in 2016, is anyone’s guess. Bank Director was unable to reach a representative of Gaylon Lawrence Jr., and CapStar CEO Claire Tucker declined to comment.

Bank boards frequently deal with active investors, and in most cases, Hightower recommends focusing on shareholder engagement and ensuring that large investors understand the broad strokes of the bank’s strategic plan. “More often than not, it’s people not understanding what they’ve invested in, and where it’s going,” he says.