More than ever banks are demanding that executives prove their worth before handing them big paychecks.
A growing number of banks — including SunTrust Banks, Pinnacle Financial Partners, People’s United Financial and, most recently, BB&T — have shifted pay packages toward incentive-based compensation and away from stock options. This year BB&T will stop giving top executives stock options and instead will grant performance-share units, known as PSUs, which vest only after predetermined performance goals are met.
PSUs have become more popular because shareholders believe they better reflect their interests since they reward future performance, said Susan O’Donnell, a partner at Meridian Compensation Partners, a Newton, Mass., pay consultant for a wide range of industries. Meanwhile, regulators have expressed concerns that stock options can encourage excessive risk-taking.
“Performance shares have bubbled to the top as a way to deliver long-term incentives that balance the needs of regulators and shareholders,” O’Donnell said.
Many banks have also decided to spread the risk associated with executive pay.
“People are realizing that there is value in diversification of long-term incentive types,” O’Donnell said. “Options only measure one thing — stock price. Other types of incentives have multiple performance goals.”
Stock options allow an employee to buy company stock at a specific price in the future; an option becomes valuable if the stock price rises above the specific price, or it can lose value if it drops below the strike price. A PSU, equal in value to one share of stock and payable in cash or stock, is tied to performance metrics such as return on common equity, return on assets, earnings per share or total shareholder returns.
Among 38 publicly traded banking companies with assets between $20 billion and $400 billion, the portion that used stock options fell to 42% in 2015 from 53% in 2013, according to Meridian. In the same period, the portion that used PSUs rose to 84% from 79%. (The totals do not add up to 100% because some banks use a combination of both payment types.)
Executives of the $214 billion-asset BB&T will be issued PSUs that are subject to “robust performance criteria,” according to a Feb. 21 regulatory filing. The value of PSUs will be heavily based on BB&T’s return on equity as compared with the bank’s peer group. BB&T executives will be forced to forfeit the PSUs before full vesting if the company reports an “aggregate operating loss” or if a “negative risk outcome” occurs.
BB&T’s board decided to make the changes after consulting over the past year with the company’s 50 largest shareholders, who represent about 44% of its outstanding shares, in an attempt to “better understand and address their concerns,” spokesman Brian Davis said.
Banks of all sizes have taken similar steps. SunTrust, Wells Fargo and numerous other big banks have stopped granting stock options in recent years. The $11 billion-asset Pinnacle Financial Partners, in Nashville, Tenn., has not granted stock options since 2008, Chief Financial Officer Harold Carpenter said in an email.
The $40 billion-asset People’s United Financial last year reduced stock options to 25% of each executive’s long-term incentives, down from 50%. People’s United made the change “to reinforce the link between executive pay and long-term company performance,” the Bridgeport, Conn., company said in its 2017 proxy statement.
Myriad other reasons have led banks to phase out stock options. Federal banking regulators issued joint guidance in June 2010 that instructed banks to adjust incentive compensation to better contain risk, although it did not specifically mention stock options. Since then, the Federal Reserve has provided feedback to banks that encourages them to limit stock options, O’Donnell said.
Other factors have led to the decline of stock options at banks. Changes in tax law in 2006 required companies to expense options, which became problematic when stock prices dipped below certain thresholds and the options lost value, O’Donnell said. Stock options also do not capture the value of dividends, and many banking companies pay dividends.
Of course, not every bank is dumping stock options. The $6 billion-asset ServisFirst Bancshares in Birmingham, Ala., has used stock options to lure bankers from rival institutions.
“A big part of our business model is to hire teams of bankers and extend stock options,” CEO Tom Broughton said during a July 2016 conference call.
Broughton declined to comment on ServisFirst’s current use of stock options. ServisFirst has not yet issued its 2017 proxy statement.
Many other banks also continue to use stock options.
“We believe that stock options are an appropriate long-term incentive to link executives’ performance with stock-price appreciation,” the $7 billion-asset First Financial Bankshares in Abilene, Texas, said in its 2017 proxy.
But the clear trend is toward performance-based compensation. In addition to appeasing nervous shareholders, PSUs help employers and the employees when it comes to managing risk, said David Wood, an audit partner at the accounting firm Porter Keadle Moore who advises banks.
“Folks still remember that, during the recession, their stock options gave them no value,” Wood said. During the crisis, “many banks recognized a lot of expense related to stock options, and the employees did not realize any value when the stock price decreased.”