As banks continue to eat or be eaten in today's active mergers and acquisitions environment, shareholders are turning up the heat on banks' top executives and their directors to improve the bank's performance. Shareholders are also insisting that banks recruit only the best independent board members-and compensate them with incentives for performance, not just increased fees. In response, banks must explore new, more efficient avenues of director compensation.
While not explicitly accountable for a bank's daily operations, directors must scrutinize management's activities to maintain independent from the bank's top executives. As directors are being watched closely by shareholders, they must strive to keep this distance from management; today's environment does not allow for rubber-stamping of a management's activities.
So to attract top-quality directors, banks need to develop innovative compensation packages while ensuring that any such packages also have shareholders' approval. Stock, stock options and stock purchase rights, all of which provide directors with incentives for taking an ownership in the banks they lead, head the list of successful payment vehicles. Deferred compensation, new pension plans, non-qualified pension plans and life insurance can also be used to pay directors. These options please directors and historically have been lauded by shareholders.
Some observers now say that all director compensation should be stock-related. They argue that large ownership by directors is essential if they are to think like owners. Unfortunately, this view is shortsighted.
Directors need to think like owners, true, and stock plans will make this happen. But directors have other responsibilities, like proper corporate governing, maintaining ethical standards and planning for the company's long-term well-being. Sometimes the balancing of these overall responsibilities is more important for shareholders than the share value on a given day. Thus, there is a need for a balanced compensation package that includes both stock and fee payments.
To make fee payments more palatable to stockholders, directors should be offered a standard deferred compensation plan, allowing them to defer income until retirement. This allows directors to concentrate on guiding the company for the long-term, and not on how much they will be paid; second, it provides directors with valuable retirement benefits. In accordance with the Employee Retirement Income Security Act (ERISA), outside directors cannot be legally included in the bank's qualified pension plan; however, a bank can set up a separate pension plan for directors, and many have done so.
Taking this one step further, non-qualified pension plans encourage directors to truly zero in on the tasks at hand by erasing compensation concerns. These plans are also specifically excluded from ERISA guidelines. Just like the deferred compensation plan, the pension plans, whether qualified or non-qualified, shield directors from income taxes until they actually receive benefits-when they may be in a lower tax bracket.
Providing additional compensation in the form of insurance can also be attractive to directors. Almost all banks provide some form of travel and accident insurance while directors are traveling on bank business. As an extension of this coverage, banks are beginning to offer directors group term-life coverage while they are on the board. Some plans are contributory, in that directors purchase the coverage through the bank at group rates. In addition, a few companies have adopted death benefit plans, which provide a fee continuation payment to the director's family if death occurs during board service.
While today's trend leans toward stock compensation for directors, it is important to achieve a balance. Basing the majority of their compensation on stock may unwittingly encourage directors to make short-term decisions designed to inflate the stock's price, rather than focusing on the company's long-term good. Assembling tax-effective benefit plans provide alternate forms of paying directors, yet assure shareholders that directors are minding the store.
W. Tom Wamberg is a principal with Clark/Bardes Inc., a consulting firm specializing in executive benefit and retirement plans.