Succession planning could be the key solution boards can use to address their biggest compensation challenges.
Succession planning is one of the most critical tasks for a bank’s board of directors, right up there with attracting talented executives and compensating them. But many boards miss the opportunity of allowing succession planning to drive talent retention and compensation. Banks can address two major challenges with one well-crafted plan.
Ideally, succession planning is an ongoing discussion between executive management and board members. Proper planning encourages banks to assess their current talent base for various positions and identify opportunities or shortfalls.
It’s not a static one-and-done project either. Directors should be aware of the problems that succession planning attempts to solve: preparing future leaders, filling any talent voids, attracting and retaining key talent, strategically disbursing training funds and ultimately, improving shareholder value.
About a third of respondents in the Bank Director's 2019 Compensation Survey reported that “succession planning for the CEO and/or executives” was one of the biggest challenges facing their banks. More popular challenges included “tying compensation to performance,” “managing compensation and benefit costs,” and “recruiting commercial lenders.”
But in our experience, these priorities are out of order. Developing a strategic succession planning process can actually drive solutions to the other three compensation challenges.
There are several approaches boards can use to formulate a successful succession plan. But they should start by assessing the critical roles in the bank, the projected departure dates of those individuals, and information and guidance about the skills needed for each position.
Boards should be mindful that the current leaders’ skill sets may be less relevant or evolve in the future. Susan Rogers, organizational change expert and president of People Pinnacle, said succession planning should consider what skills the role may require in the future, based on a company’s strategic direction and trends in the industry and market.
“The skills and experiences that got you where you are today likely won’t get you where you need to go in the future. We need to prepare future leaders for what’s ahead rather than what’s behind,” she said.
Once a board has identified potential successors, it can now design compensation plans that align their roles and training plans with incentives to remain with the organization. Nonqualified benefit plans, such as deferred compensation programs, can be effective tools for attracting and retaining key bank performers.
According to the American Bankers Association 2018 Compensation and Benefits Survey, 64% of respondents offered a nonqualified deferred compensation plan for top management. Their design flexibility means they can focus on both longer-term deferrals to provide retirement income or shorter-term deferrals for interim financial needs.
Plans with provisions that link benefits to the long-term success of the bank can help increase performance and shareholder value. Bank contributions can be at the board’s discretion or follow defined performance goals, and can either be a specific dollar amount or a percentage of an executive’s salary. Succession and training goals can also be incorporated into the plan’s award parameters.
Such plans can be very attractive to key employees, particularly the young and high performing. For example, assume that the bank contributes 8% of a $125,000 salary for a 37-year-old employee annually until age 65. At age 65, the participant could have an account balance equal to $1,470,000 (assuming a crediting rate equal to the bank's return on equity (8%), with an annual payment of $130,000 per year for 15 years).
This same participant could also use a portion of the benefit to pay for college expenses for two children, paid for with in-service distributions from the nonqualified plan. Assume there are two children, ages three and seven, and the employee wants $25,000 a year to be distributed for each child for four years. These annual $25,000 distributions would be paid out when the employee was between ages 49 and 56. The remaining portion would be available for retirement and provide an annual benefit of $83,000 for 15 years, beginning at age 65.
Boards could use a plan like this in lieu of stock plans that have similar time horizons. This type of arrangement can be more enticing to younger leaders looking at shorter, more mid-term financial needs than a long-term incentive plan.
And many banks already have defined benefit-type supplemental retirement plans to recruit, retain, and reward key executives. These plans are very popular with executives who are 45 and older, because they provide specific monthly distributions at retirement age.
It is important that boards craft meaningful compensation plans that reward older and younger executives, especially when they are vital to the bank’s overall succession planning efforts and future success.