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Archive for the ‘Executive Compensation’ Category

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.

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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

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For years, larger companies have routinely budgeted to increase base salaries of employees by a few percent based on what everybody else is doing. Then, the annual increase is usually spread among employees based on where they are paid in their job’s policy salary range and, hopefully, based on a merit performance score. There is a good deal of logic in such a process, but it is worth rethinking given the realities of today’s labor market.

payrollWhy does an annual increase in the guaranteed base salary make sense? The fact that it is routinely done at the same time each year gives employees a sense of security and if your strategy emphasizes low risk, steady growth with retention of a stable staff, then this approach to base salary management makes sense. On the other hand, if your organization’s strategy is for more risky growth where high levels of performance can make a big difference, perhaps a different approach to base pay would make better sense.

Maybe some of the base should be shifted over time to incentive pay. Perhaps base salary reviews should be done less often with bigger increase potentials when salary increases are eventually granted. How you mix pay between the guaranteed portion and the at-risk portion is a matter of strategy and to be effective, your pay strategy must support your business strategy. We hear HR professionals worrying about the annual 2% to 4% increase having become an entitlement. However, management of companies that have had depressed revenues during the recent economic recession have little patience for any entitlement attitude. HR professionals need to think about how their office can better support the organization’s strategy. Rethinking the annual base pay increase entitlement is a good place to start.

Of course, every organization is unique and there is no one-size-fits-all solution to managing base salaries and overall compensation. Having worked with hundreds of organizations, for-profit and not-for-profit, fast growing and declining, risk-averse and risk-tolerant, we understand the need for a custom solution. As the economy slowly improves, this is a good time to step back and question your organization’s compensation management. We would appreciate your thoughts. Please email, call or comment below.

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