What can bank boards do to make sure they hold on to their best executives, including the CEO?

Average payouts from incentive plans for 2009 and 2010 in the community banking industry were extremely low, including bonuses and stock incentives. Because a lot of stock options that were granted two or three years ago are now underwater, we’re looking at a significant potential drop in executive compensation for 2010 after a similar drop in 2009. It was down some last year and I’ve projected it’s going to be down even further this year on average. There are some notable exceptions, but on average you might say the at-risk forms of pay are very much at risk this year.

It’s a good time to pay attention to the base salary component and make sure that it is competitive enough to provide for bread, butter and mortgage money. In recent years most banks have been trying to keep base salaries low in favor of heavy use of incentives. As an overall strategy that makes a lot of sense, but when incentive comp is down due to things beyond the control of your CEO there’s also some risk that you could lose them if the base salary component is not competitive. So it’s a good time to look at that and make sure it is competitive.

What I would not do is throw out the incentive plan and replace it with a new plan that will pay out under the current conditions because shareholders will react negatively to that, as anyone would. What’s the purpose of having the incentive if we’re going to throw it out the first time it doesn’t pay? We are seeing a trend toward increased use of restricted stock awards where the full value of the shares are awarded. In other words, it’s not a right to purchase like an option but is actually a gift to the executive, with the restriction that if the executive leaves before a certain period of time has passed the stock is forfeited back to the bank. It’s a velvet handcuff if you will.

It’s also possible to tie the lapsing or forfeiture component to some modest level of performance so that not only does the executive have to stay but the bank must perform at some modest level, whether in a comparison with a group of peer banks or just in absolute terms. That’s a good way to provide some incentive in a down market because the shares have value regardless of where the stock price goes and if it goes up then there’s an incentive there to see that happen.

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