|Executive compensation post Dodd-Frank|
ANNUAL CONVENTION NOTES
Tackle the big stuff first
November 10, 2011
By Michele Gula, m.rae associates, as guest writer for ABA Banking Journal, from ABA Annual Convention
As some of the nation’s largest financial institutions continue to hold tight to much-questioned bonus and incentive plans, compliant executive compensation practices are wrought with more ambiguity and scrutiny than ever.
Speakers Susan O'Donnell of Pearl Myer & Partners and Arthur Warren of Warren & Associates, executive compensation firms, agree it is best to tackle the “big stuff” first. That translates to ensuring your bank’s plan is institution-wide and clear and that your governance controls are in place.
To better focus the fine details of the big picture, the two, speaking at ABA’s 2011 Annual Convention, examined compensation, benefits, supplemental executive retirement plans (SERPs), PERKs, and contracts in the post-Dodd Frank environment with guidance and best practices on compliance.
O’Donnell articulated the three core principles in incentive compensation practices (ICAs) as balancing risk and financial results; effective controls and risk management; and strong corporate governance. Five best practices were then identified to address these three areas and shed light on becoming ICA compliant.
Best Practice #1: Define your compensation philosophy
Your compensation philosophy should outline the objectives and components of the total program, competitive positioning, and the mix of total compensation.
Best Practice #2: Assess incentive plans for risk
Your assessment plan should be an articulated process based upon the principles of governance, policies/procedures/controls, and design features. This highlights the critical and expected need for oversight from the board as well as the management team.
Best Practice #3: Long-term perspective
This area ensures that the compensation actions at your bank reward long-term performance while mitigating the risk by aligning payouts more closely with the time horizon of that performance.
Best Practice #4: Pay-performance alignment
O’Donnell provided techniques to define what high performance is, what measures are appropriate, and how short-term and long-term performance are related at the same time to attracting and maintaining top talent.
Best Practice #5: Holistic Approach
Finally, insuring a holistic approach provides that comprehensive view on what the regulators are looking for. This viewpoint is meant to examine the possible outcomes and effectiveness of the compensation program as well as support the decision-making process.
It is not just the pay that is being scrutinized, but benefits as well. Pay and benefits criticism points to an ineffective board compensation governance, weak management, and excessive risk taking.
Warren noted that it isn’t the benefits process as a whole that is being scrutinized. Rather, it is the governance itself being placed under the microscope.
For example, the practice of pay based upon short-term gains was flagged by regulators because it was blind to the possible trajectory of the economy and its potential impact upon of the future of the institution. This type of laissez-faire governance invites inappropriate risk.
Warren asked the audience which bank’s CEO was compliant with the new regulatory oversight:
The answer is … both! Despite differences in pay, both banks utilized an independent board compensation committee to appropriately set the governance process.
While SERPs are popular for attracting, retaining and motivating executives, regulatory opinions are beginning to point at these plans as too rich, benefits are given for too long of a period and acceleration upon change-in-control is too low. To mitigate this, Warren examined Defined Contribution SERPs with performance-based contributions and shared various design concepts for this method.
PERKs were examined tongue in cheek with the remark, "no jets, no yachts, and no toga parties." However, the meat of protecting yourself in this area is to curtail and limit perquisites such as spousal benefits, club memberships, and post-retirement life insurance.
Employment contracts were another topic that was evaluated for regulatory scrutiny. The key point was to reserve these contracts for very senior executives only. A noncompete should be required, severance payments should be reduced and tax gross-ups should be removed. (For a detailed look at employment contracts, see Marian Exall’s latest “Human Element blog: “Employment Agreements: Golden handcuffs for key executives”)
Finally, practical issues were addressed. Board reluctance to negotiate, decrease, or eliminate executive contractual benefits, management’s reluctance to surrender these benefits and, as always, flight risks associated with these changes.
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