How to Improve Compensation Committee Effectiveness

Finding the time and resources for board and committee development is an ongoing challenge.  But enhancing the effectiveness of your Compensation Committee can be done with a few key actions.  This blog and ones that follow will address:

  • Setting a workable Committee calendarCompensation Committee Calendar
  • Selecting membership
  • Continuing education on executive compensation

The beginning of the year is a great time to update or set up a calendar for your Compensation Committee.  Committee responsibilities and activities need to be spelled out in advance and scheduled throughout the year to:

  • Balance the Committee’s workload
  • Allow sufficient time for review before decisions are required
  • Ensure that decisions are well-timed for effectiveness as well as meeting any regulatory requirements

The first step in building the calendar is listing and grouping activities.  You may be surprised at how many issues need to be addressed when you write them all down.  Our basic categorized list includes:

  • Compensation Philosophy Statement
    • This roadmap for guiding Committee decisions should be reviewed at least annually.
    • If you don’t have one, you would be surprised how helpful having written principles can be.
    • Market and Peer Group Review
      • Update the peer group for relevancy.
      • Gather compensation data from surveys and proxies.
      • Monitor performance versus peers.
      • Performance and Salary Review
        • Board/Committee review of CEO performance; and CEO review and report on other senior officers.
        • Committee review of CEO salary and adjust based on market/peer pay levels and executive job performance.
        • Committee review of CEO recommendations for other senior officers.
        • Annual Incentive Plan
          • Update plan in terms of participation, payout ranges, objectives, weights, and performance ranges.
          • Review performance and potential payout levels at mid-year.
          • Complete end-of-year review and approve payouts.
          • Long Term Incentive Plan (if you use stock)
            • Review existing grants and remaining share reserve.
            • Determine any need for updating plan and/or share reserve.
            • Determine new grant (type of grant, total shares, terms, CEO allocation).
            • Review and approve CEO recommendation for grants to other officers.
  • Compensation Risk Assessment
    • Conduct at least annually – ideally just after the end of the year so the Committee can look back at the prior year and plan for the year just beginning.
    • Director Compensation
      • Determine frequency of review (we recommend an annual review; but at least every third year as a minimum).
      • Conduct review and recommend changes to Board.

Of course, companies participating in government programs like TARP or those who are required to report to the SEC have a number of other requirements and activities that we won’t try to cover here.  Suffice it to say that these requirements are a significant expansion of the previous list.

Filling out the calendar is best done using a grid with the major categories of work down the left side of the calendar, and the months across the top.  This approach allows you to schedule the items in each category in logical order as well as look at the volume of Committee work in each month.

Finally, this is a task best completed by the Committee Chair, CEO, and outside compensation consultant if you have one.  You may also want your CFO and Chief Human Resources Officer involved if they interact directly with the Committee.

Please add comments below, and if you want to know more about how we can help, call me at 919-644-6962 or ask us to contact you at http://matthewsyoung.com/contact.htm.

Five Traits Future Community Bank CEOs Must Possess

Succession Planning

Passing the Baton

When our Firm initiates a new CEO search or Succession Plan, we work with the owners and/or Board of Directors of the client company to build an “Ideal Candidate Profile.” This profile, while useful, is a target which can seem unrealistic when you start to see real live candidates.

I often simplify the Profile to a short list of Knowledge, Skills and Abilities (KSAs) that are critical. This becomes a “must have at a minimum” list. We recently produced a list of critical “musts” for a community bank CEO search. Listed below are the five traits that we all agreed were needed by any bank CEO of the future:

  1. Ability to see local community needs and think outside the “Banker Box” to envision how the Bank can satisfy the unmet needs.
  2. Ability to inspire all constituencies with a vision that creates value for customers, staff and shareholders.
  3. Keen risk management skills to manage risk under all economic scenarios.
  4. Ability to manage a wide diversity of products and service lines.
  5. In-depth understanding of how technology is changing the marketplace.

Given enough time, some of these critical KSAs can be developed with internal succession candidates, but there must also exist within such candidates a propensity to think broadly and deeply enough to be simultaneously analytical, creative and eloquent. Often, an outside candidate is able to strengthen an already strong internal team with these KSAs.

I would be happy to present this and other succession planning topics to your owners, Board and/or your Management Team as an introduction to our Succession Strategy, Executive Development and Executive Search services. Call me at 919-732-2716 or complete the request form below and I will reach out to you.

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How to Improve Executive Compensation Committee Effectiveness – Membership Selection and Committee Structure

In a previous blog entry, I talked about improving Executive Compensation Committee Effectiveness by setting up an annual Committee calendar to balance workload, set priorities, and ensure timely and effective decisions.

This follow-on blog highlights four important elements for effectiveness from the standpoint of Committee membership, structure, and decision-making authority:

  • Characteristics of effective committee members
  • Appropriate committee size and turnover
  • Balancing other committee assignments
  • Assigning sufficient authority

 

Characteristics of Effective Committee Members

Some Director backgrounds are more appropriate than others for the Compensation Committee.  Candidates with formal corporate management experience or service as professional directors tend to have a better perspective for dealing with complex compensation issues.  Directors with entrepreneurial or smaller company experience may not have faced these kinds of issues before.

 

Appropriate Committee Size and Turnover

Our experience shows that the Compensation Committee needs at least three independent members but typically not more than five.  Decision-making is streamlined with a smaller committee; but don’t get so small that you limit important interaction and having a range of perspectives that ultimately builds strong consensus.  Also, you should change no more than one-third of the committee’s members in a year.  Otherwise, you lose “institutional memory” and valuable experience and expertise that takes a while to develop.

 

Balancing Other Committee Assignments

Because of the importance placed on the governance of executive compensation, membership on the Compensation Committee should be a director’s primary committee assignment.  If at all possible, don’t place directors on both the Compensation and Audit Committees.  While you want your best directors on your most critical committees, you don’t want to stretch them too thin.

 

Assigning Sufficient Authority

And finally, all Boards of Directors should take the time to determine what level of authority the Compensation Committee will hold.  We believe that Compensation Committees are most effective when the Board assigns them specific decision-making authority.   Where full Board voting is desired or required, the Committee should always bring a specific recommendation that the Committee has developed and fully supports.

If you would like a sample Compensation Committee Membership Profile, we would be happy to send you one.  Complete the following request form:

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Performance-Based Long Term Incentives – Not Just a Best Practice

Executive compensation and performance-based pay continue to be a hot topics in board rooms and in the press. Corporate directors should be wary of compensation plans that can distort the pay for performance equation. Two pending SEC rule changes may impact how public companies implement executive compensation in the future: the Pay for Performance disclosure, and the CEO pay ratio. Where CEO pay and company performance are misaligned, proxy reporting will raise a red flag for shareholders and investor groups. Large pay packages that result in problematic CEO pay ratios (the ratio of CEO pay to employee median pay) have been key topics in the press as companies anticipate the implementation of the SEC’s new pay ratios rules.

Strategic PlanningAs the deadline nears for implementing these new pay disclosure rules, public boards and executives should focus on the effectiveness of all elements of executive pay. Since a large part of CEO compensation is long-term incentives, typically stock-based or plan-based compensation, these plans should be closely evaluated. While public companies will be concerned with the new pay rules, private companies will also be interested since pay for performance is a best practice. Consequently, long-term incentive pay will be a focus in the near term.

Historically, long-term incentives were granted to retain executive talent; executive retention is greatly enhanced when adding a vesting feature and a forfeiture clause for executives who leaves before vesting. Retention in the form of long-term incentives generally were implemented using stock grants, primarily in the form of restricted stock and RSUs with vesting after three or five year’s continuous service. Stock options could also be used to help with retention; however they often lose their effectiveness when the stock price drops and options fall underwater. While these types of grants are effective retention tools, they lack the focus that is generated with performance-based incentives.

We believe that a meaningful way to measure the effectiveness of long-term incentive compensation is to evaluate whether the incentives reward senior executives for meeting and sustaining the strategic goals of the company. While service vested stock grants have an element of performance, too often vesting of large stock grants occur during a time when the company’s performance is declining. This misalignment of pay and performance can send a bad message to shareholders and regulators. A better message to send occurs when a large block of stock vests when the company achieves a key success or during a period of excellent performance. For this reason, we believe that long-term incentive pay should be primarily tied to company performance that is linked to long-term, sustained improvement in shareholder value.

Naturally, these incentives should be linked to the executive team’s success against the main goals outlined in the company’s strategic plan. This can be a complicated task. Executive teams are leery of setting performance expectations too far into the future due to the uncertainty of the business environment. The need to set goals that are measurable and meaningful is a significant factor in a plan’s success. A few key goals can be far more meaningful than a long list of performance objectives that may be difficult to track and fraught with confusion about final outcomes. Ultimately long-term incentive plans should (1) be simple enough to communicate to multiple constituencies, (2) reflect the expectations of the board over a long time period and (3) align with sustained and improved total shareholder value.

However, long-term incentives tied to key performance objectives often compete against the desire to meet annual incentive plan goals. Focus on short-term earnings performance and near-term outcomes to satisfy investor groups can be a detriment to achieving a long-term strategy. For public companies, too much emphasis is placed on quarterly results at the expense of meeting longer term objectives. Private companies have less pressure, but the tension between short-term performance and longer term strategic objectives still exists. Successfully implementing performance-based long term incentive plans is one way to counter the pressure of shorter term thinking.

For example, most financial institutions are experiencing pressure to boost their earnings because of declining revenues due to low interest rates. Could this lead bank executives to seek higher interest rate loans with greater risks or higher market concentration in order to generate higher rates and more fees? Could this pressure to boost earnings cause executives to drift away from the long-term strategy of the bank? Of course it could; this is reasonable outcome when pressure on short-term earnings overshadows the long term strategy of a bank; this focus could be a problem for future success. Our suggestion to counter this short-term behavior is to establish long-term incentives linked to an emphasis on loan portfolios that are more consistent with the bank’s strategic direction.

So what are some of the key issues to address if you want to implement a performance-based long-term incentive plan? As a first step, do you have an up-to-date and effective strategic plan? If not, start here. Next, you need to decide whether stock or cash is the best way to provide executive incentives. Also, determining the best time frame for vesting is another important step. We think a minimum of three to five years makes sense. However, you may want to tie the vesting to a major business initiative or a future liquidity event; these events don’t always occur on a fixed schedule. Using multiple grants (annual or biennial) can add another favorable dimension to the plan design. Having rolling vesting dates can help sustain the plan’s long-term momentum. These plan design features and many other plan design decisions must be made when implementing a new plan or moving the emphasis away from service vesting toward performance vesting.

In summary, performance-based long-term incentive plans are a recognized best practice among industry experts and corporate governance groups like ISS and Glass Lewis. With the SEC implementing new rules that will spotlight pay for performance and CEO pay, this may be an excellent time to evaluate your current executive compensation plans to make sure that executive pay is closely aligned with company performance. Finally, directors and executives should examine both the annual bonus plan and the long-term incentive plan to validate that these plans are fulfilling the long-term strategic needs of the company.

Author J. Henry Oehmann can be reached at Henry.Oehmann@MatthewsYoung.com

Bankers and Regulators, “Incentive” Is Not A Four Letter Word

The Wells Fargo incentive pay problem is at least as old as Matthews, Young; and we’ve been advising the banking industry on performance-based incentive compensation for over 40 years.  Decades ago when we discussed design of incentive plans, we would half-joke about avoiding the creation of an employee mindset of “open an account and get a new toaster; open three new accounts and get three toasters”.

Our experience tells us that a cardinal rule of incentives is that you get what you pay for – in terms of employee behavior and results.  If your bank sets new account goals without incorporating a balancing measure like branch customer satisfaction, you are sending a problematic message:  account growth matters and gets rewarded and customer satisfaction does not.  If your incentives are driven by Net Income growth without corresponding Return on Assets / Equity measures, you are telling management that it’s okay to inflate the balance sheet for that extra dollar of profits.   If loan growth is the key to incentive earnings without corresponding credit quality requirements . . . well, we all know where that got us in the recent past!

Business news reports of the Wells Fargo problem indicate that another cardinal rule of incentives may have been violated:  employees must have a reasonable chance of achieving goals and not fear losing their jobs for failing to achieve what they perceive as unobtainable results.  Such a situation will cause some employees to quit trying and others to start their search for different employment.  Or in the Wells Fargo case, employees will find a way to achieve goals even when they know their behavior is inconsistent with customer interests and, ultimately, shareholder return.

We also believe that Wells Fargo’s decision to cancel incentive plans is an over-reaction.  Well-designed incentive plans are an effective management tool to:

  • focus attention and action plans on key results
  • motivate individual effort and teamwork
  • link company and employee success

The Wells Fargo story will fade in the press, but we believe it should be a wakeup call for banks to take a fresh look at incentive plans.  With the new year approaching, now is the time to ask the tough questions:  Are performance measures balanced with respect to growth, profitability, soundness, and customer satisfaction?  Are expectations reasonably obtainable and do employees have the proper tools and training to perform at their best?  Are payout levels competitive but reasonable compared to base pay (e.g., are high incentives necessary for cash compensation to be competitive)?  Are we supporting our incentives plans with effective employee communications that explain expectations for results and behavior?

Matthews, Young has been advising banks, thrifts, and credit unions for over four decades on the use of sound incentive compensation.  We are experienced in the design of new plans as well as the review of existing plans.  Contact us at: Info@MatthewsYoung.com.

Chair of Succession Committee

Our Succession Committee Board Members have been extremely pleased with the services provided by Tim and his staff.  He has been the perfect person to support our (BOD and staff) through this process.  We are most appreciative of his deep expertise, understanding of our culture and responsiveness to our particular needs.”

– Financial Institution Board Chair

Commercial Bank CEO

“They understand the changes that are taking place. They are able to look at the marketplace and evaluate banking needs. They are in a position to help us respond to the technology and lifestyle changes in the marketplace over the coming years. They are up-to-date on current regulation.”

– Commercial Bank CEO

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