Executive Pay Today: Perform or Else
May 6, 2013 9:52 AM
Shareholders and regulators are on the warpath against executive compensation they regard as excessive or poorly structured. Senior bankers and directors, like their colleagues elsewhere in the corporate world, are struggling to design pay plans that encourage managers to innovate while discouraging excessive risk-taking. Further complicating the task are the sometimes competing agendas of investors and rule-makers, as well as the uncertainty surrounding the many Dodd-Frank pay rules yet to be written. Following is a look at some of hot-button items shaping executive compensation during the current proxy season.
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Finding a Balance on Incentives
Regulators have expressed concern that too much incentive pay can encourage bad behavior and, as a result, some banks are tweaking compensation programs to put more emphasis on salary. But regulators also recognize that investors dislike fixed salaries because they can lead to complacency, and are urging banks to strike the right balance. Still, some are doing away with salary increases and transitioning to pay programs that put greater emphasis on annual and long-term incentives. A case in point is TrustCo Bank (TRST) in Glenville, N.Y., which hasn't given CEO Robert McCormick a raise since 2010, despite the bank's relatively strong performance in recent years. In 2010, base salary represented 70% of McCormick's total compensation. Last year, it accounted for just 43% of his compensation, the result of the board adding more incentive-based pay to his total package.
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Tougher Clawback Policies
The Securities and Exchange Commission is still drafting the regulations that will govern how and when banks can claw back an exec's compensation, but investor pressure is forcing many banks to take action now. Citigroup (NYSE:C), Capital One Financial (COF), Regions Financial (RF) and Hancock Holding (HBHC) are among the large and regional banking companies that have adopted clawback measures.
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Saying No to Stock Options
The Federal Reserve Board is strongly urging banks it regulates to eliminate stock options from the compensation mix. Fed officials believe options can encourage management to take undue risks, with the sole intention of driving up the share price. Many shareholders are opposed to eliminating stock options, but regulators appear to have gained the upper hand. Bank of America (BAC), Bank of New York Mellon (BK), Citigroup, Wells Fargo (WFC) and PNC Financial Services Group (PNC) are among the large banks that have eliminated stock options entirely; several others, including U.S. Bancorp (USB), Fifth Third Bancshares (FITB) and Northern Trust (NTRS), have sharply curtailed their use of stock options. Some banks are replacing options with performance shares, whose value is based on long-term performance and are regarded as less likely to encourage risky behavior.
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Peer Comparisons Lose Favor
The Fed is also discouraging banks from using peer comparisons when setting benchmarks for CEO pay. The central bank is concerned that peer comparisons "may reward companies for underperformance and could lead [them] to take on excessive risk to 'chase after' leading performers," according to a recent report by the consulting firm Compensation Advisory Partners. The Fed is urging bank directors to set absolute targets. Critics charge that such measures can result in rewarding executives for achieving overly low targets.
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A Veto for Vesting
Restricted, or time-vested, shares remain a staple of executive compensation plans, but they carry far less weight than they used to. Simply put, shareholders do not like rewarding executives for doing nothing more than holding down jobs for a certain number of years. Restricted shares "feel like a giveaway," says Pearl Meyer & Partners' Susan O'Donnell.
Performance Shares Gain Steam
Many bank boards are replacing stock options and restricted stock with so-called performance shares, which can only vest if the bank hits certain profitability or efficiency targets over a period of years. At Huntington Bancshares (HBAN), for example, performance shares now represent 50% of CEO Stephen Steinour's long-term incentive pay. The shares are not earned unless the bank hits performance targets for three years running and Steinour must hold half the shares earned until he retires or is terminated. The trick with this sort of pay is setting appropriate targets for performance that can be years down the road.
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Thumbs Down for 'Gross-Ups'
Companies commonly pay taxes on golden parachutes paid to terminated executives. The taxes can be substantial and the IRS does not allow banks to claim a deduction as a result. Shareholder advisory groups are on a crusade to ban these so-called 'gross-ups,' and few new employment contracts contain them.
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