A study of proxy statements for 147 banking companies shows a strong correlation between bank performance and senior executive pay in 1993, and it suggests directors played key roles in enforcing this discipline.
The banking company findings emerged as part of an Ernst & Young examination of proxy statements detailing 1993 senior executive compensation at 661 companies in five industry groups. In addition to banking companies, the study looked at major companies in biotechnology, high technology, insurance, and manufacturing.
The bonus-to-base-pay ratio for bank chief executives in 1993 was 60% for high performers (those executives attaining a better than 15% return on equity), 31% for medium performers (delivering returns between 10% and 15%), and 23% for low performers (who delivered returns of less than 10%).
Companies in other industries, despite having lower performance targets, showed less sensitivity to performance when compensating chief executives.
For example, the insurance industry rewarded high performers, but coddled low performers. Conversely, high-tech punished its executive failures, but also withheld rewards from successful leaders. Biotech offered the worst of both worlds - stingy with its winners and generous with its losers. Only manufacturing rivaled banking in the pay-for- performance arena.
What explains banks' comparative success in gearing pay to performance? The study points to strong monitoring by independent, hard-working boards.
In every size category banks had superior ratios of outside directors to inside directors than companies in other industries.
In the large-bank category, the ratio was particularly remarkable. For every two inside directors who were employed by the company, there were 13 outside directors with no employment links. That compared with a 2-to-11 ratio of insiders to outsiders in insurance, a 2-to-9 ratio in manufacturing, a 2-to-8 ratio in biotech, and a 2-to-7 ratio in high tech.
In terms of committee structure, banks of all sizes showed considerable vitality.
Although only two of every three bank boards had compensation committees, this modest ratio did not tell the whole story. In roughly one out of three cases - a far higher frequency than in other industries - bank boards had stock option committees. Furthermore, 5% of the surveyed banks had strategic planning committees, compared with ratios of 3% or less in other industries.
Also, bank board committees tended to have more members than did committees in other sectors.
Compared with a typical range of three to seven committee members in banking, the size ranges were three to six committee members in manufacturing, two to six in high tech, three to five in insurance, and two to four in biotech.
The presence of one or two extra people on a committee may not seem like much. But in small groups this can mean additional information or insights that can improve decision-making.
Finally, bank directors committed more time for less money. Bank boards met an average of 10 times a year, compared with five meetings a year for insurance company directors and seven meetings a year for directors in the other three industries studied.
Yet banks paid their directors at average or below-average rates, a finding that indicates board independence.