Executive Compensation for Banks: Responding to Regulatory Perspectives while Ensuring Pay for Performance

Transcription

1 April 2014 Executive Compensation for Banks: Responding to Regulatory Perspectives while Ensuring Pay for Performance Daniel Rodda Lead Consultant Meridian Compensation Partners, LLC Phone: (770)

2 How We Got Here: Recent Banking Compensation Regulations TARP Executive Compensation Regulations (American Recovery and Reinvestment Act of 2009) Requirements for banks who received TARP funds included: Set strict limits on incentive compensation Required mandatory clawbacks for materially inaccurate performance criteria Mandated risk assessment of all employee incentive plans Joint Regulatory Guidance on Incentive Compensation (2009) Established three principles for incentive compensation: Balance risk and reward Be compatible with effective controls and risk management Be supported by strong corporate governance Defined covered employees Initiated Horizontal Review of Large, Complex Banking Organizations Dodd-Frank Section 956: Interagency Rule on Incentive-Based Compensation Arrangements (2011) Prohibits incentives providing excessive compensation Prohibits incentives encouraging inappropriate risks that could lead to material financial loss Requires 50% deferral of executive incentives for banks >$50B assets Mandates establishment of policies and procedures governing incentives Requires report to regulators on incentives for covered employees PAGE 2

3 Key Regulatory Concerns How Incentives are Governed Identifying covered employees Role of the Board Role of risk management How Performance is Measured Use of formulaic incentive plans How discretion is applied Choice of performance measures Use of relative performance measures Difficulty of performance goals How Incentives are Paid Timing of incentive payouts Incentive plan leverage Use of stock options Ability to adjust deferred compensation for negative risk outcomes PAGE 3

4 How Banks are Responding Regulatory Concern Use of formulaic plans Use of relative performance Incorporating risk in performance measures Examples of Bank Responses Move to discretionary incentives Add discretionary elements Use of payout bands Move to absolute performance measures Increase weighting on absolute measures Add absolute performance hurdle Use risk scorecards to consider adjusting payouts Including measures of capital levels Use risk-adjusted measures PAGE 4

5 How Banks are Responding Regulatory Concern Timing of incentive payouts Incentive plan leverage Adjusting deferred payouts for negative risk outcomes Examples of Bank Responses Ensure existing LTI program provides adequate deferral Use of total compensation approach for granting incentives Defer portion of incentives earned above target Reduce upside in incentive plans Change in pay mix higher salaries Eliminate defined payout ranges Change from target incentives to maximums Reduce or eliminate stock options Reduce performance required for maximum payouts Add discretionary or automatic forfeiture provisions to long-term incentives Negative earnings for firm or LOB Risk-adjusted returns below minimum hurdle Insufficient capital levels Violations of risk policies or failure of risk management Strengthen clawback provisions PAGE 5

6 Pay Ranking Median Performance Evaluating Pay for Performance While banks must be responsive to regulatory concerns, it remains critical to ensure that programs create alignment between business performance and pay outcomes Comparison of CEO Pay and Performance Rankings Relative to Peers High Pay/ Low Performance Peer D High Pay/ High Performance Peer A Peer G Peer C Peer E Peer F XYZ Bank Median Pay Peer L Peer H Peer I Peer J Low Pay/ Low Performance Peer B Performance Ranking Peer K Low Pay/ High Performance PAGE 6

7 Pay for Performance: Evaluating from an Annual Perspective Defining Pay Compensation awarded for the performance year Base salary paid Annual incentives paid Long-term incentives granted Defining Performance Performance results for the year Financial results relative to internal expectations Financial results relative to peers Performance on key strategic objectives Changes to the bank s risk profile Potential Adjustments to Remedy Pay for Performance Disconnects Target pay levels Goal setting Performance measures Payout leverage Use of formula vs. discretion Incorporation of risk in incentive payout decisions PAGE 7

8 Pay for Performance: Evaluating from a Long-Term Perspective Defining Pay Current value of pay awarded during the time period Realizable Compensation Base salary paid Annual incentives paid Current value of restricted stock grants In-the-money value of stock options Payouts from long-term performance plans or expected value based on current performance Realized Compensation Base salary paid Annual incentives paid Vested value of full value shares Gain on exercised options Payouts from longterm cash plans Defining Performance Performance results during the time period Financial performance relative to peers Earnings growth Returns Total shareholder return relative to peers Absolute shareholder return Potential Adjustments to Remedy Pay for Performance Disconnects Target pay levels Amount of pay at risk Goal setting process Payout leverage in incentive plans Mix of pay tied to stock price Amount of deferred pay subject to adjustments for risk outcomes Use of absolute vs. relative measures PAGE 8

9 Ensuring Pay Programs Fit Your Organization In the midst of often competing external pressures on executive compensation, banks must ensure pay programs motivate executives and support the business strategy Strategic Plan What is your strategic vision? What are the critical success factors? How will you measure success? Compensation Philosophy What is your pay philosophy? What do you want your pay programs to accomplish? Bank Culture What motivates your executive team? What behaviors are you trying to encourage? What is an acceptable level of risk? Organizational Profile What is the ownership structure? In what stage is the business (growth vs. mature)? How experienced is the management team? Impacts Impacts Impacts Impacts Performance measures Performance goals Length of performance periods Pay components and mix Pay levels Amount of pay at risk Absolute vs. relative performance Mix of corporate, business line and individual performance goals Pay components and mix Leverage of incentives Pay components and mix Pay levels Performance goals Length of performance periods PAGE 9