Bank Director Annual Compensation Review

Using 2005 review, boards can weigh fellow directors’ candid opinions on compensation along with results from our annual report on retainers, fees, and benefits to benchmark their own pay packages and training programs.
Establishing the right director compensation structure can be a challenging task for any bank. In doing so, board members must consider the interests of shareholders alongside their own; establish fair, objective policies within their ranks; and eliminate any hint of self-interest.
Moreover, in the wake of governance reform, more accountability has been placed on the board to be the gatekeeper for sound compensation policies and decisions. To fulfill their obligations, board and compensation committee members require a great deal of information and training to make prudent decisions.
Though compensation is rarely the sole reason for accepting a director’s seat, it is an important means of rewarding individuals for the time and inherent risk of the position. Therefore, as industry and regulatory challenges have become more complex, it’s reasonable to periodically evaluate director pay to ensure it keeps pace with responsibilities, hours, and the risk of liability. To aid in this process, Bank Director annually surveys bank board members to obtain the latest information on retainers, fees, benefit levels, and compensation review practices. In addition, we ask directors to share their opinions on their perceptions of liability, director education, and the challenging environment in which they work. The results of the 10th annual Director Compensation Survey are presented here to help boards become better equipped to structure a competitive and equitable director compensation package.
Drawing up a blueprint
The approach taken by boards in designing pay and benefit plans is unique to each institution’s culture, but in general, boards use a common array of tools. The survey found 64% of institutions use peer review to assess compensation; larger institutions also rely on consultants’ benchmarking reports.
The parties involved in evaluating and structuring pay programs often differ according to institution size. Community bank boards are more apt to review their own compensation levels, whereas institutions greater than $1 billion in assets more often have a compensation committee oversee the process. Across the board, 50% of respondents believe the full board should be the primary decision maker in this regard, 35% believe it should be the compensation committee, and 7% believe it should be the CEO. In reality, 38% reported that the full board currently has this primary responsibility, 36% reported that the compensation committe does so, and 15% reported that their CEOs are primarily responsible for setting director compensation.
In large part, directors’ comments reflect a system that is working satisfactorily. “For a community banking organization, I believe peer studies of director compensation, as well as a common sense approach, works well,” says Charles Funk, president and CEO of $535 million Iowa State Bank & Trust Co. in Iowa City, Iowa. He adds, “I have had the sense that our directors are not on our board for the compensation they receive.” He admits that demands placed on his outside directors have increased during the last three years, but explains that Iowa State Bank has proactively raised director compensation during that period to balance those extra demands. Director Dennis C. Hovis, from $525 million Eagle Bank & Trust of Missouri in Festus, Missouri, estimates his director workload has increased about 25% over the last three years and believes director pay “should be evaluated every couple of years.”
Given the wide variety of methods and tools available, how does a compensation committee or community bank board—or in some cases, the CEO—ensure an independent and objective evaluation of director compensation? What means of measurement should a board consider?
One thing to remember is that regular board compensation review shouldn’t necessarily translate into regular increases. Todd Leone, managing director for the compensation group of Clark Consulting, a cosponsor of the Bank Director survey, says board pay has been in a state of flux since the passage of Sarbanes-Oxley and may take more time to settle. “We do not recommend changing or increasing board pay every year,” Leone says. Rather, Clark Consulting encourages most boards to review pay levels and practices every two to three years. According to the Bank Director survey, about two-thirds of responding board members reported their director compensation had been reviewed within the last 12 months.
When the time is right to undergo a review, however, banks may need guidance on how to go about it objectively. While there are many methodologies available, in the end, processes used to review compensation are unique to each institution. Leone suggests banks look at proxies as a means of peer review or create their own local peer group survey through original research. Whenever possible, he advises banks to ensure that a number of factors be taken into consideration when developing the peer group—asset size, type of bank, performance, geographic influences, etc.
Nuts and bolts
After conducting research and reviewing its process, an institution should focus on both the pay package components as well as the overall pay on a per-director basis. To assist with this, the Director Compensation Survey breaks out the primary elements that comprise director compensation—cash retainer, board meeting fees, committee meeting and chair fees, and other compensation such as equity. The data from survey respondents is then tabulated and these results are presented in the charts and analysis that follow.
This year, we offer results both at the holding company and lead bank levels (Figure 1). For holding company boards, 2004 cash retainers averaged $10,489 (median $9,000); for lead bank boards, cash retainers averaged $8,704 (median $6,500). Board meeting fees averaged $769 (median $600) at holding companies; at lead banks, board meeting fees averaged $662 (median $500). Total 2004 cash compensation for directors on holding company boards averaged $13,724 (median 9,000); total cash compensation for those at lead banks averaged $13,347 (median $10,900).
As in the past, we note a positive correlation between asset size and total cash compensation as well as by the individual cash components (Figures 2 and 3). Total cash compensation for banks $1.1 billion to $5 billion in assets, for instance, is more than three times as high as for banks with less than $100 million in assets.
Interestingly, while the average number of hours spent on board activities increases slightly with asset size, the annual retainer at banks $1.1 billion to $5 billion is nearly triple that of directors at smaller institutions. One reason for this may be that at least 80% of reporting institutions in the larger-bank category are publicly traded, which brings more complex business models and layers of regulatory concerns. (Only 33% of those in the under $100 million group were publicly traded.)
Leone explains this phenomenon as it relates to pay level comparisons for larger and smaller institutions. “When a bank becomes a certain size, or of a certain complexity, which often happens when a bank moves into the $1 billion to $5 billion range, the board must attract members who are directors and professionals serving at other large, often publicly traded organizations. These individuals have more sophisticated backgrounds and experiences that they bring to the bank. Therefore, it’s not the hours you serve, per se, it’s the type of people you must have on your board that dictates higher compensation for those at larger banks.”
Committee work
Beyond full-board meetings, a great deal of directors’ work occurs in committees that oversee and monitor specific governance functions. To take a closer look at committee compensation, we isolated meeting fees by major committee types for both holding companies and lead banks (see Figure 4).
The table affirms a growing trend of differentiating pay levels among committee types. Publicly traded audit committees, for instance, must supervise external auditors, ensure compliance with internal control guidelines, and oversee certification of quarterly financial reports, which has led many directors and managers to the conclusion that audit committee members deserve additional remuneration. Pay for other committees and roles is following suit, according to Leone.
“By 2003, every board member realized he or she was spending more time on the job—but now the pay differentiation is directed mainly toward specific positions, for example, the audit committee chair.” Among those also being singled out, he says, are lead directors or nonexecutive chairs, and, to a lesser extent, compensation and governance committee chairs, and in some instances, members of the audit committee.
Directors commenting on the fairness of this sliding scale provide fodder for both sides of the issue. In general, says Charles J. Volpe, director at the $553 million Greater Community Bancorp in Totowa, New Jersey, all members of the board should be paid equally, with a few exceptions. “I do believe certain committees (i.e., Audit) should receive higher compensation than other committees,” he says. But Harry Truitt, chairman of $75 million Prime Pacific Bank in Lynnwood, Washington, points out that simply carrying the mantle of the audit committee shouldn’t be a slam dunk for higher pay. “Board members contribute different amounts of time and should be compensated for the time they spend, not the committee they serve on,” he says.
Whether or not it translates to additional pay, across the board, directors acknowledge that the workload for certain committees—and the training and expertise necessary to fulfill those responsibilities—has increased. “It is incumbent upon companies to encourage members of the audit committee to invest time outside the framework of the board and committee meetings to perform research and to educate themselves,” says Eli Kramer, director of $3.2 billion Sun National Bancorp in Vineland, New Jersey. “This is also true for board members involved in other areas such as technology, compensation, and the like.”
Equity
Outside of cash compensation, equity benefits—such as stock options and restricted stock—are still far more prevalent at larger asset-size institutions, according to survey results. Clark Consulting’s proxy study from 2004 provides a snapshot of equity values reported among various asset sizes (see Figure 5). When asked how they would prefer to be paid, the most common answer among community bank respondents was a 100/0 cash/stock split; only those at banks greater than $5 billion chose a 50/50 cash/stock split.
The merits of equity compensation are debated by some, extolled by others. “I believe [equity compensation] drives bank performance, but I am not convinced it will motivate a nonperforming director—nor do I believe it will drive a motivated director to do anything he is not already doing,” says Greater Community Bancorp’s Volpe.
But Prime Pacific chairman Harry Truitt disagrees. “If directors are serious about growing their shareholders’ investment in the bank, then increasing a director’s equity would be most beneficial. Tying equity compensation for directors to bank performance would be a good way to increase bank performance.” Sun National’s Kramer also believes it’s a positive influence, saying, “Equity compensation reminds the directors we are not just being paid to be the government’s policeman—but the shareholders’ champion.”
Leone says equity will continue to play a key role in motivating and rewarding directors and management. “Equity today is alive and well for directors. It is something that, arguably, perfectly aligns directors’ interests with that of shareholders—which is a good thing.” He adds there is an increasing use of full-value shares today, that is, restricted stock. These are being given in lieu of options, which, Leone explains, are sometimes viewed as clouding directors’ independent judgment by inviting them to focus on short-term stock price goals.