Analyzing executive compensation trends

American Banker's Allissa Kline speaks with Shaun Bisman and Kelly Malafis of Compensation Advisory Partners about the latest trends in bank executive compensation, including the future of retention awards and what to expect for the rest of the year.

Transcription:

Allissa Kline (00:16):

Hi everybody. Welcome to this episode of Leaders where we will talk about the latest executive compensation trends among bank CEOs and other high-ranking senior executives in the banking industry. My name is Allissa Kline. I'm a reporter for American Banker. I cover large and national banks and commercial and retail banking trends. With me today are Kelly Malafis and Shaun Bisman from Compensation Advisory Partners, or CAP for short. CAP is a consulting firm that works with boards of directors and management teams to develop executive compensation programs. CAP was founded in 2009 and provides a range of services including compensation strategy development, competitive market comparisons and benchmarking, and annual and long-term incentive plan designs. Kelly is a founding partner of CAP with more than 20 years of experience as an executive compensation consultant. Her work includes a focus in compensation strategy development, evaluating the pay and performance relationship for senior executives, annual and long-term incentive plan design, compensation program governance, and board of director compensation.

(01:34)

Kelly has advised large and small publicly-traded companies across several industries, including financial services, insurance, pharmaceutical, manufacturing and retail. Sean is a principal at CAP with more than 15 years of experience working with management and compensation committees. Sean provides consulting services to both public and privately-held companies. He advises on corporate governance, peer group development, performance measurement, pay-for-performance validation, incentive plan design, and director compensation. Welcome to both of you. It's good to see you again. I think this is the third year, at least the third year in a row, that we've done a Leaders episode with CAP based on an analysis that your firm puts together every year. And that analysis is all about executive compensation trends, mostly among bank CEOs, but I know you also take a look at what's going on with some of the other senior members of the management team at some of the banks that you review. Your analysis tracks all sorts of … the three different components of executive compensation. So you're looking at salary, bonus and long-term incentives, and then every year you compare that to the previous year's data to see what's going on in terms of compensation. Let's start with an overview of that process. Kelly, can you tell us which category of banks you looked at this year and what types of data specifically you analyzed?

Kelly Malafis (03:11):

Sure. Thanks Allissa, and thanks for that introduction. That's right. This is the third year that we're doing this Leaders series and we share with the group here our annual pay-for-performance study in the banking industry. We track the banking industry because a lot of our clients are in financial services and are very interested in the pay outcomes each year. And so for this year's study, we looked at banks with at least $10 billion in assets that filed their proxy statement through the end of April and that resulted in a sample of 55 banks with median assets of about $40 billion. And we specifically look at total compensation — which is salary, annual incentive and long-term incentive for CEOs — and we compare that to the performance of each of these companies to see what the pay and performance relationship is. We also looked at Say on Pay outcomes for these banks, the use of retention awards and also any notable incentive plan design changes. The last couple of years we've seen a lot of incorporation of diversity, inclusion and equity measures in incentive plans, so that's something we've been tracking the last couple of years.

Allissa Kline (04:38):

Good. And I'm curious, before we get into the data, maybe talking a little bit about why it's interesting to look at this data, what you take away from this data, how you put this to work. Sean, maybe you can talk a little bit about the bigger picture in terms of your rationale for looking at this data.

Shaun Bisman (05:03):

So the banking industry is a very unique industry. It's highly regulated, impacted by several macroeconomic factors. Think about the recent bank failures, inflation, the interest rate environment. These are just a multitude of factors that really impact banks' financial performance. So, as Kelly mentioned, a lot of our clients are in this industry, so it's imperative for us to track compensation levels year over year and report back to our clients. And also we have many publications that we speak with, including American Banker, where we share a lot of these data and findings, and we also speak at a lot of various industry conferences where we share this data. What's unique about some of the data that we analyze, we look at 2023 long-term incentives, so this is not disclosed in proxy statements. We'll look at various SEC filings and then we'll also compare it to the 2022 annual incentive payouts, as well as base salary, to really get the full picture of total compensation. So if you look at a proxy statement, which discloses the named executive officer compensation, long-term incentives generally lag a year. So our information is the most current information available, which is important to our clients when they're benchmarking compensation levels.

Allissa Kline (06:26):

Right, that makes sense. So before we get into the most recent trends of executive compensation, let's talk about the findings for 2021, which was, you tell me, it seemed like an unusual year. Let's see. Total compensation for 2021 performance rose by double digits. I think it was 21.5%, which is a huge increase compared to the year before when it rose about 5%, if I'm remembering correctly. What are some of the factors that drove that 21.5% increase for 2021 performance?

Kelly Malafis (07:11):

Sure, you're absolutely right, Allissa, that the pay increases were much higher than we have seen in the recent past, and also what we're seeing this year, and really 2021 performance for the banking industry was very strong. Income levels were up, returns were up, stock price had increased and there were a combination of factors for that. One, the base year for comparing performance was 2020, which was the year of COVID-19, where there was extreme uncertainty, not just in the banking industry, but across industries. And so that was not a great year for many banks. And so in 2021, the companies benefited from a rising interest rate, a lot of M&A activity, so a lot of fee income for companies with advisory services. A lot of banks also had provision releases. And so this strong performance really supported having higher payouts and the higher payouts, when we look at the components of pay in 2021, really came from the annual incentive. We saw annual incentives up almost 50%, which again is very unusual to see that in a given year. But as Sean mentioned earlier, financial services is a unique industry and they tend, especially the bigger banks, when you're performing, they pay and when you're not, they will reduce it, so there's a little more volatility in pay than we see in some other industries.

Allissa Kline (08:53):

Yeah, yeah. It was interesting to look at the data from last year. It was just so much, such a huge increase compared to the year before. But as you both predicted a year ago, that uptick in median total compensation for 2022 performance, it did rise. I think we talked about this in last year's session. It did rise, but it wasn't quite as high. It didn't hit double digits this year. In fact, I think it was about 7% year over year, according to your analysis. Sean, do you want to talk a little bit about some of the high-level findings for the 2022 performance year data and maybe speak a little bit about why that's more of a "return to normal," I guess?

Shaun Bisman (09:47):

Sure. So as you can see on the chart on the screen, we'd like to look at the pay-for-performance relationship. And what that really means is how do companies perform financially as measured by earnings per share? So profitability or total shareholder return. So stock price plus the reinvestment of dividends over the year. So the charts on this page show 2020 versus 2021 and in 2021, versus 2022. So if you look at the red bars on the left side of the chart, you'll see that stock price performance and earnings were very strong in 2021, as Kelly had mentioned, and as a result, compensation was up. Compensation was up about 21.5%. Then if you look at the light blue bars, one year total shareholder return or TSR was down about 5.7%. Earnings was down about 5.4%. And that resulted in total direct compensation … So total direct compensation is the salary, the bonus payout and then the most recent long-term incentive awards, and the long-term incentive awards were up around 7%.

(11:00)

So then, if you wanted to get a little bit more granular and want to look to see what it was driving that year-over-year increase of 7% versus the 21.5% [from] 2020 to 2021, as Kelly mentioned, 2021 increases were driven really by the annual incentive payouts, and to some extent the long-term incentives. For 2022, the 7% was really driven by about a 6% increase in the annual incentive payouts and about a 6% in the long-term incentive payouts. And then just given that long-term incentives really are the bigger piece of total compensation, so over 50% of the compensation for chief executive officers, and most companies do not decrease long-term incentives year over year, since many banks derive that value based off of market data and not always financial performance, you don't really see LTI decrease year over year. So even though it went up 6%, that's really what drove the 7% increase year over year.

(12:07)

And we believe that this is a more normal year, or 2022 was a more normal year in terms of increases because if you think back to 2022, at the second half of the year, it was when the interest rates started increasing, which really dampened the outlook for borrowing and interest rates for banks. And there was also some start of discussion of layoffs across industries, mainly in technology, but there were discussions at banks as well, should we have layoffs in 2023? So there's really a lot of economic uncertainty that was lying ahead as compensation decisions were made in 2022 and then again in early 2023. And then lastly, if you look at the financial performance, I mean, as we mentioned, stock prices were down in 2022, so there wasn't a lot of strong justification to really increase pay levels. And then also as Kelly mentioned, that 21.5% increase from 2020 to 2021 was really just driven by compensation levels being around 5%, as Allissa mentioned in 2020, really just driven by the pandemic shutdowns in 2020 driven by COVID.

Allissa Kline (13:21):

Right, right. Okay. I'm curious. In the most recent data, did you notice any differences between,  differences in CEO pay trends between the larger banks and some of the smaller ones that you included in your analysis?

Kelly Malafis (13:42):

Yeah, this year when we looked at the banks by size and we bifurcated by those that are over $50 billion in assets and those that are under $50 billion, the change in total compensation for CEOs was not that different than the overall sample. So when we look at the companies that are greater than $50 billion in assets, total compensation was up 5%. So a little bit lower than the 7% overall sample. And when we look at it for the banks under $50 billion, it was up almost 8%, 7.6%. So a little bit higher than the overall sample, so not too different. But those slight tweaks, the 5% versus the almost 8%, really comes down to pay mix and how larger banks deliver their pay versus smaller banks. For smaller banks, we see a lot more of the total pay mix in salary and short-term incentive, whereas for the larger banks, salary is a very small component of the pay mix and long-term incentives, the equity component, is the bigger mix, is the bigger piece of the pie. 

And so when performance adjusts and you have more in the performance components of the pay mix, the bonus and the LTI, we see more variability in the compensation. Not a change in trends between the small and the large banks, but larger banks tend to have a combination of financial and non-financial measures or potentially even use some discretion in their plans , whereas smaller banks tend to have more measures, more formulaic measures, more goal attainment plans. And so sometimes we see the bigger banks take into account the external environment a little bit more than the smaller banks because of how they design their plans. So for example, some clients looked at the 2022 results and said, are we getting too much benefit from the rate environment? And so do we need to adjust for that? Whereas if you have a formulated plan that's just built right into it and you win when the rates are up and you lose when the rates are down.

Allissa Kline (16:15):

Kelly, do you see any changing? Do you see that maybe smaller banks might move toward more discretionary ways of looking at things or not? Or does it seem pretty set: the smaller you are, the more formulaic you are?

Kelly Malafis (16:37):

I think that all companies, including the smaller banks, are always looking at their metrics annually to say, do we have the right measures, or should we be 100% formulaic financial? Do we need discretion? Do we need non-financial measures? And what we're hearing across banks is, should we be looking more at non-financial measures? And while those are not discretionary, they're also harder to measure. And one specific area that we hear companies talking about are, should we have more regulatory measures in our plans given what's going on in 2023 with the bank failures and oversight and compliance? Should that be built into the plans? And so I think that following COVID when companies who had formulaic plans saw that it's hard to do that in an uncertain environment, following the beginning of this year with the bank failures and seeing that perhaps we need some more regulatory measures in our plans, I do think that more companies will consider it. But there's also a beauty to having a link to the financial measures that's very tied to the shareholder, right? So I think banks need to decide what's the right balance for them to have that alignment with the shareholders.

Allissa Kline (18:06):

Right. Okay. Okay. Let's see. One thing that stood out to me when I was looking at your data this year is that we've talked about this, the 7% median total compensation increase, but there were a few banks where executive compensation fell and I think the lowest was by 20% and it maybe went up to like 40% year over year. Can you talk a little bit about what explains why that CEO pay package fell so dramatic year over year?

Kelly Malafis (18:46):

Yeah, absolutely. So the companies that had the biggest decrease in total compensation were among the largest in our sample. And it goes back to aligning with performance and the mix of business that those companies have. So those larger financial institutions may have bigger advisory businesses. So as we talked about earlier, in 2021 the advisory businesses did really, really well and organizations were willing to pay for that, and they paid up a lot for that. But in 2022, those business areas did not do well at all. There was not a lot of deal activity. It was very slow. And so when that performance came down, so did the pay levels. So it really has to do with business mix and the alignment to the performance. When it was up, the pay was up and it was up significantly. And now that the performance wasn't there, it was down significantly.

Allissa Kline (19:49):

Yeah. Okay. Okay. Let's see. One other thing that stood out to me in looking at your data from this year is what happened with retention awards and special retention awards are exactly what they sound like. They are special, usually one-time awards granted as a way to keep top leaders, certain executives, in place, most likely, I guess, in a hot job market. And so for 2021 performance, it looks like nearly one-quarter of the banks that you reviewed that year granted special compensation to their CEOs and other high-ranking executives. But for 2022, that number fell pretty substantially. There were far fewer. I think there were just four in the most recent data that you put together. What's your take on why that number declined year over year?

Shaun Bisman (20:56):

Yeah, I think there's three reasons why we would say that there was a decline year over year in these retention awards or these special one-off awards. I think the primary reason number one, 2021 was a really hot job market. Companies really needed to attract and even really retain executives, either prevent them from retiring or prevent them from joining other companies or even part of the succession planning process. So I think that was the primary reason. And then number two, the economic uncertainty … in 2022 for 2023 was really unclear. Is there going to be a recession or not? And also, financial performance was not expected to be as strong in 2022. And as we showed on the slide before, you saw that earnings and stock price were down year over year. So there was really a lot less justification to make these awards. And as I think I said last year on this webinar, there was strong rationale in 2021 to make these awards and that was the time to do it.

(22:03)

So not really as much for 2022. And then lastly, if you think about some of the companies that granted some of these large retention awards, there was pushback from investors or pushback from the proxy advisory firms. One company had failed Say on Pay, which is a non-binding vote on executive compensation. So it's really embarrassing to receive less than 80% support. The company had failed it. So there's just a lot of pushback as well from investors that the companies probably were thinking about that if they were going to make awards in 2022, financial performance was weak, is this really the time to do it? And the answer was no.

Allissa Kline (22:43):

Do you think of those three factors, is there one that stands, I guess that's more, plays more of a role in making that decision? Or are they all pretty much on equal footing?

Shaun Bisman (22:57):

Yeah, I mean, I think the biggest one is financial performance. I mean, there's not strong justification to make a one-time retention award of anywhere between a few $100,000 to several million dollars when there's really no alignment with the shareholders during that time period. So if the stock price is down and earnings are also down, that's having a negative impact on the shareholder. So there's really no alignment with the pay-for-performance relationship. So that's probably the main reason why companies did not make these special awards in the latest proxy season.

Allissa Kline (23:32):

Right. Okay. I think we've alluded to it a few different times here, but it's clearly not the same environment. Today is not the same environment as we saw a year ago and for sure two years ago. Any sense of what the future holds when it comes to these special retention awards, specifically for 2023? For the 2023 performance year?

Shaun Bisman (23:59):

Yeah. Well, I would say that 2021 was probably an outlier in terms of the number of retention awards granted to executives. 2022 was probably a more normal year for all the reasons we had mentioned on the webcast in terms of year-over-year compensation and performance, year over year. But companies really need to continue to balance when they make these retention awards, like the performance conditions and just time-based conditions. You know, I'm a big fan of including performance conditions on these retention awards because they become really highly effective. It really aligns with shareholders. If you are contributing to the success of the company and the award is tied to these financial or individual performance factors, it's really a win-win for the executives and the shareholders. And then even less with retention awards, I mean, there's other ways to really enhance career development, not really focusing on compensation.

(25:05)

There's internal initiatives such as career development. There's also upskilling, re-skilling. So there's really other factors that companies could consider instead of these retention awards. And then lastly, it's really important to balance the total compensation package. Are we providing the appropriate salary, a bonus opportunity, long-term incentive, benefits? So it's really important to take a holistic review when you're going to be making these retention awards. And then also what we're seeing is a lot of companies now are targeting critical areas such as commercial lenders, IT, technology, and even cybersecurity as areas where they may be considering retention awards for 2023. But again, we don't expect it to be the same magnitude as we saw in 2021.

Allissa Kline (26:00):

Yeah, and a lot of those that you were just listing, a lot of those job categories, that's not going to show up on the proxy statement. So banks, I suppose, might be making a bunch of these awards, but maybe not at the highest levels of management.

Shaun Bisman (26:17):

Yeah, yeah, that's accurate. We focused on named executive officers, but as you mentioned, below the executive or even the officer level, companies are not required to disclose any type of retention awards deeper down in the organization.

Allissa Kline (26:34):

Right. Okay. Okay. Let's talk about what comes next. We're more than halfway through the year. It's been rather turbulent for banking this year, to say the least. We have the bank failures in March and April. We have bank stocks tanking in many cases. And just a sort of general unease about the industry as a whole. I guess let's talk about some of the ways that those factors could impact executive compensation trends for 2023. Any thoughts or ideas on what we should expect to see when we're having this conversation a year from now?

Kelly Malafis (27:26):

Sure. And you know, you said it well, Allissa. It's been a turbulent year and continues to be uncertain, and while we still have a couple of more months before it's all said and done, it's likely that companies will be down in terms of performance in 2023. And as we've seen in this year's studies and prior studies, that really does impact the pay outcomes. So we're expecting to see changes in pay that are in the single digits, nothing like the 2021 changes. And just to close the loop on the retention awards, these depressed stock prices, as you mentioned, and as Sean was talking about, really does put a lot of pressure in terms of holding value for executives and for other employees. But companies will need to balance who can I give that to or who do I need to give that to? And what we see our clients doing is really focusing on key talent because if the industry is in this situation, it's hard to go somewhere else and be in a better position.

(28:38)

Everyone's kind of down. So we think that companies will still continue to think about it, but likely very selectively in terms of retention. In terms of what may impact the financial performance, which directly impacts the bonuses, and also considerations around long-term, while interest rates are up and that's normally a good thing, the bank failures have forced banks to be aggressive in seeking deposits, and that puts pressure on interest margin. So banks really haven't been able to benefit from the rising rate environment this year. There's also more caution around lending and the balance sheet strength and exposure to commercial real estate. So fees from lending are down, there's less M&A activity, so fees from investment banking are down as well. So that in combination leads us to think that it's going to be a down year overall.

Allissa Kline (29:44):

Any bright spots when you think about compensation, executive compensation, for the next couple of years? Anything that would stand out that maybe despite the macro environment that we're in, that there's a lift somewhere within the executive compensation package?

Kelly Malafis (30:10):

Yeah, so I think we can't predict performance for every year. And we saw 2020 was not a great year. I don't think anyone could have imagined that 2021 would've been as strong as it was. So I think that we're all hopeful that performance will rebound, and because these incentive plans and executive compensation are so heavily tied to performance and there's a lot of leverage, there's always opportunity, right, to see that rebound through the performance. The other thing, when stock prices are down, a lot of companies give their long-term incentives on a value basis. So if someone gets $100 of long-term incentive, if your price is at $10, you get 10 shares. If it's at $5, you get 20 shares. And long-term incentives are just that. They're long term. So if you hold onto it and the stock price rebounds, there's a lot of opportunity to accumulate wealth through the long term.

Allissa Kline (31:17):

Okay, great. Thank you both so much. I appreciate your time and we had an interesting conversation here today, and look forward to your analysis next spring.

Kelly Malafis (31:26):

Great. Thank you. Thanks so much.

Shaun Bisman (31:29):

Thank you.