Regulatory, Investor Expectations Elevate Compensation Committee Role

By Debra Cope

A decade of rising expectations has expanded the role of the bank compensation committee. Banks, like all corporations, operate under a regulatory imperative to demonstrate a link between executive pay and corporate performance. And in the aftermath of sales missteps, a bright spotlight has fallen on incentive pay programs for rank-and-file employees.

“The compensation committee used to be much more focused on the question, ‘What we are paying the CEO and top executives?’ Gradually, it has taken on broader responsibility,” says Tim Reimink, a director in the performance consulting group of Crowe LLP, whose governance, compliance and risk management services are endorsed by the American Bankers Association. “Today’s compensation committee grapples with questions like, ‘How are we administering salaries across the bank as a whole? How is incentive compensation designed?’ The role of the committee has expanded to having more oversight into the general practices of compensation and incentives.”

For many publicly traded banks, investor interest is forcing compensation committee chairs to expand their expertise, said T.K. Kerstetter, CEO and founder of Boardroom Resources and a former bank director. “There is no area of the bank where it is more important for the chairman to be knowledgeable than the compensation committee,” Kerstetter says. “If an institutional investor wants to talk about pay, they are going right to the chair of the compensation committee or the board chair. No investor wants the CEO to come in and talk about their own pay.”

As a result, Kerstetter says, “The days of randomly rotating people onto the compensation committee and not having a chairman who truly understands compensation are past.” This is especially true for large and regional banks, but no one is immune, he adds.

Experts offer some tips and questions for board members:

Scrutinize the pay system. Rewarding employees for sales is only one part of a performance-based incentive system, Reimink says. Both individual and team factors should be part of the design. For example, did the branch pass its audit? Were customer service expectations met? Does a lender maintain delinquencies and exceptions at low levels? Is the quality of loan packages submitted appropriate? “Employees should be doing their job well to qualify for their entire incentive comp,” Reimink says.

By the same token, Reimink adds, it’s important not to lose sight of what motivates workers. “Taking an incentive plan that was paying for based on clear metrics for sales and other factors and replacing it with a discretionary bonus plan is a less effective way to motivate performance on the part of employees,” Reimink says. “It’s more difficult for employees to know what they need to do to get a bonus at the end of the year.”

One indication of whether a pay-for-performance system is working is whether employees feel the impact of a bad year, Kerstetter says. “When performance is at the low end of the peer group and all indicators including stock price are down, investors expect bonuses and pay increases to be lower than during a good year,” he said.

Consider an audit. In response to regulatory, investor and media attention on incentive compensation, more banks are conducting audits, either on their own or with a consultant, Reimink says. “Compensation committees are also pressing management to show them all the incentive plans and evaluate whether they make sense and to make sure everything is properly documented,” he says, adding that it’s not unusual for banks to have a number of “special plans” carried over from acquisitions.

Choose consultants wisely. The selection of a compensation consultant is a significant decision for any comp committee. Susan O’Donnell, a partner with Meridian Compensation Partners, says one of the most important qualities to look for is independence. “It’s not just about satisfying the regulatory requirements,” O’Donnell says. “Do they have the mindset of being objective, and are they willing to challenge the status quo?” In addition, compensation committees need to be satisfied that a consultant will be able to work across the organization—with management as well as the compensation committee—and maintain a consistent tone. “You want to know that they won’t be having different conversations with different parties. There should be no surprises at the compensation committee meeting,” O’Donnell says.

Privately held banks aren’t immune. Even privately held banks need to take pains to make sure their compensation plan works by delivering the appropriate rewards and penalties, Kerstetter says. “It’s my theory that there are many times that you should be thankful you are not a public company,” he explains. “But you should operate like you are one. Regulators don’t let banks have the leeway that a private company in another industry would have.”