Cost Control to Play Bigger Role Determining Executive Pay

Less means more for leaders of a growing number of banks that link compensation to efficiency.

Zions Bancorp. recently disclosed that more than a dozen top executives could lose half of their total compensation if the Salt Lake City company fails to control costs and hit efficiency targets. Harris Simmons, Zions' chairman and chief executive, and Scott McLean, the company's president and chief operating officer, have pledged to turn down bonuses if efficiency goals aren't met.

About a fifth of all banks with $10 billion to $400 billion of assets consider the efficiency ratio as they craft annual incentive plans, particularly in the area of short-term compensation such as annual cash bonuses, based on data from Meridian Compensation Partners.

Efficiency, once an important component of determining compensation, took a backseat as financial institutions evolved and became more complicated, industry observers said. The metric, particularly the cost side of the calculation, is making a comeback as Zions and other institutions look to rein in costs in the face of persistent revenue pressure.

"There's a bit more focus on the efficiency ratio than in past years," said Susan O'Donnell, a partner at Meridian. "Interest rates are so low, and margins are down, so there's more pressure on revenue and expenses. You have a focus on the revenue side, but there are limitations there so you have to be aware of your expenses."

"Costs are just too high," said Alan Johnson, who runs the executive compensation firm Johnson Associates. "We can blame whoever we want — the economy, the regulators. I don't think enough attention has been paid to costs, because bankers were too optimistic about the economic recovery."

A renewed dedication to efficiency should play well to investors, many of whom have complained in recent years about bloated expenses.

It is also likely that more banks could emphasize pure cost-cutting, which is more straightforward than an efficiency ratio and can also be lowered by boosting revenue, said Todd Sirras, managing director at Semler Brossy, an executive compensation consulting firm.

Boards that are looking to tweak their banks' compensation plans should break down their goals into components that are measurable and controllable. "The art of compensation is deciding where you want to shine the light and how bright you want it to be," Sirras said.

Zions decided to stake a lot on an efficiency plan it unveiled last June because "compensation tends to drive performance," said James Abbott, the $59 billion-asset company's director of investor relations. Management is looking to lower Zions' efficiency ratio below 65% in 2017, in large part by keeping noninterest expenses in check.

In addition to top executives, hundreds of other employees who "drive the decisions at Zions" will have compensation "closely linked to the success of both the expense number and the efficiency ratio target," Abbott said.

Zions is "focused on streamlining and simplifying" after spending years improving in areas such as risk management, credit quality, regulatory compliance and capital, Abbott said. "With the outlook for rising rates being hazy at best, management and the board is determined to drive profitability and growth back to more competitive levels."

Zions, on at least one other occasion, has successfully leveraged compensation to achieve a particular goal. The company, which had previously struggled with regulatory stress testing, once tied all of Simmons' incentive compensation to passing the Comprehensive Capital Analysis and Review.

Zions' plan should please investors by showing that management is taking cost-cutting seriously, industry observers said. Tying up to half of pay to one goal "seems like quite a focus" and is "probably as high as you'll see for an expense-orientated measure," Sirras said.

"It's a tough environment," said Brian Klock, an analyst at Keefe, Bruyette & Woods. "Management decided they needed to change things and decided not to wait on higher rates. They decided to grow earnings and create better returns by executing on what they can."

Community banks could be less likely to use efficiency to help calculate compensation, said Paul Schaus, chief executive of the consulting firm CCG Catalyst. Though investors would like the accountability of tying pay to efficiency, smaller institutions tend to have simpler plans for determining executive pay.

"You need someone to administer these formulas," Schaus said. "If you make it too complex, you're spending the money you would otherwise save on managing that."