Mega-Acquirers: Compensation Practices That Make a Difference

April 18th, 2016

As football coach Lou Holtz famously stated, “In this world you're either growing or you're dying, so get in motion...” In the past two years, 545 banks have been acquired—the highest level of activity since 2006 to 2007. During this busy cycle, the regional public banks between $5 billion and $50 billion have enjoyed greater profitability than either their smaller or larger counterparts.

With improving financial markets, increasing regulatory requirements, and decreasing margins, some of these regional banks have been executing an acquisition growth strategy for several years. Pearl Meyer identified 22 “mega-acquirers,” banks in the top quartile of regional banks ranked by three-year asset growth. These mega-acquirers have averaged a three-year asset growth rate of over 30 percent, compared to just over 7 percent for other regionals. Not only do they outperform in asset growth, but also on a number of other key financial metrics.

Median Financial Performance of Mega-Acquirers Versus Other Regionals (as of 12/31/2015)

  3-yr Asset CAGR (%)Price/Tangible Book (%)TSR CAGR (%)Diluted EPS after Extraordinary Items CAGR (%)
1-Yr 3-Yr 5-Yr 1-Yr 3-Yr 5-Yr
Mega Acquirers (n=22) 31.58 171.48 21.63 21.56 16.55 25.56 20.12 9.82
Other Regionals (n=89) 7.30 158.87 7.62 15.19 9.97 3.39 6.85 5.29

CAGR: Compound Annual Growth Rate
TSR: Total shareholder return defined as stock price appreciation plus dividends Source: S&P Global Market Intelligence

Pay Differences
While there are many factors that can influence financial success, we looked specifically at whether or not mega-acquirers structure executive compensation differently. The answer is yes and no. The median pay of CEOs for the mega-acquirers and other regionals aren’t markedly different. The mix between base salary, annual incentives, and long-term incentives for CEOs also were generally consistent for all regionals. There were, however, three key differences.

  • Mega-acquirers manage to results. Fewer mega-acquirers have an annual incentive plan with a discretionary component (33 percent versus 46 percent for other regionals), potentially inferring that mega-acquirer executives are accountable for achieving financial goals regardless of the external environment.
  • Mega-acquirers focus on both revenues and cost. While all regionals use net income as a metric equally, mega-acquirers are more likely to include an efficiency ratio in their annual plans (27 percent versus 17 percent for other regionals).
  • Mega-acquirers tend to use more time-vested restricted stock and fewer performance shares. Curiously, mega-acquirers are getting good financial results without the use of performance-based equity. Eighty-two percent (82 percent) of mega-acquirers provide time-based equity awards to their CEOs versus 73 percent for other regionals. Prevalence of performance-based shares is 36 percent for mega-acquirers versus 51 percent for other regionals.

While we can only speculate why there is a greater preference for restricted stock rather than performance shares, there are a couple possibilities. First, performance shares often vest based on achieving operational metrics. The argument may be that future operational performance is a function of what is acquired and this can be hard to pin down even if it is measured on a relative basis. Second, while median stock ownership for mega-acquirer CEOs is similar to other regionals, it is more than twice that of regional CEOs at the 75th percentile. There may be a strong desire by some of the mega-acquirers to ensure that the CEO has meaningful share ownership and is willing to achieve this through time-based vesting. In our experience, actual share ownership is what drives behavioral shifts and creates shareholder alignment.

Considerations
These pay differences are subtle. However, when you combine strategy, financial results, and pay practices together, the implications provide for compelling discussion in the boardroom.

Has the use of discretion in incentive plans gone too far? Discretionary components are inappropriately used if they are a way of explaining away poor performance on the defined metrics. Discretion is best used when it is a qualitative assessment of non-financial results or where it is difficult to determine financial outcomes due to acquisition or other factors. Establishing what will be evaluated qualitatively at the beginning of the year, rather than at year-end also fosters discipline in using appropriate discretion.

If there aren’t meaningful differences in CEO compensation values, are you getting what you are paying for? Holding CEOs and their executive teams accountable for strategy deployment and financial results is a primary board responsibility. Open and honest feedback coupled with active oversight can ensure the bank is getting value from its compensation dollars.

Are you evaluating the CEO on the right things? Simply focusing the CEO’s evaluation on whether the bank made its numbers that year is insufficient. A more holistic view of the role using seven characteristics should be considered:

  1. Strategy and Vision
  2. Leadership
  3. Innovation/Technology
  4. Operating Metrics
  5. Risk Management
  6. People Management
  7. External Relationships

Conclusion
Compared to both smaller and larger banking organizations, regional banks have enjoyed relatively strong performance despite a challenging operating environment—and mega-acquirer performance has been even stronger. Has executive pay design played a role in the success of mega-acquirers? The differences in design are small, but potentially impactful—a tighter link to performance, a stronger focus on operational effectiveness, and for some, a higher level of long-term equity ownership.

laurahay

Laura Hay is a managing director in the banking practice of Pearl Meyer & Partners, an independent compensation consulting firm serving as an advisor to boards and their senior management in the areas of governance, strategy and compensation program design.