In The Belly Of The Compensation Beast

A more demanding regulatory environment is pulling independent directors ever more deeply into the operations of their banks, and nowhere is that more evident than on the compensation committee.

Participants in an editorial roundtable discussion held last November at Bank Director’s Bank Executive and Board Compensation conference in Chicago generally agreed that both the responsibilities and time requirements of the compensation committee have greatly increased over the last few years. Most members of the group, which included six bank compensation committee members, attributed these rising expectations to increased regulatory and shareholder expectations, which in turn have led to a fundamental shift in the role of the director when it comes to compensation.

Bill Fike, director at CapitalSource Bank in Los Angeles, says that the CEO used to have a more guiding role in the compensation of the staff, but now the compensation committee is required to act more like inside management in really understanding competitive pressures, and risk and reward balances. “The challenge today is that in trying to identify and balance risk with reward, a [compensation] committee member and board member need to know much more about how the bank works and where the risks are,” said Fike.

Dallas Kayser, compensation committee chair at City Holding Co.in Charleston, West Virginia, made a similar observation. “I think there are things that we are now required to do that before management would have simply done and maybe given a report,” said Kayser. “Now we have a duty to really investigate. For example, [there is the] requirement that we approve every compensation plan in the company to make sure there’s not excess risk. Well, that’s something normally the CEO would bring to us, and he still does, but now we really have to dig in.”

Henry Oehmann, director of national executive compensation services at Grant Thornton LLP in Chicago, which sponsored the roundtable discussion, said that in his experience directors are grappling with how to handle compensation for their senior team when the performance of the bank might not be a true reflection of the team’s effectiveness-a result of both a tough economic environment and thinner margins caused by low interest rates.

The roundtable agreed that this tougher environment requires some subjective measurement in compensation plans, and the real challenge is not to encourage practices that will look good in the short term at the expense of long-term earnings.

Frank Farnesi, compensation chairman at Beneficial Mutual Bancorp Inc. in Philadelphia, said that he tries to make sure his bank doesn’t fall into the trap of doing what his competitors are doing if it’s not going to advance the strategic plan down the line, even if that means telling shareholders they are going to have to wait to see results.

“We know rates are going to go up,” said Farnesi. “We don’t know exactly when, but the bottom line is you do what’s right from a common sense point of view, and sometimes you just have to stand up to shareholders and say, ‘This is what we are doing [and] this is why we are doing it.’”

Craig Thompson, who chairs the compensation committee at Hudson Valley Holding Corp., in Yonkers, New York, said his board is also making sure that elements of the compensation plans are geared towards the long-term health of the bank instead of short-term production.

“We use incentive [compensation] to shape behavior, and this year, with us trying to clean up credit quality, we’ve said, ‘Time out. It’s not just production,’” said Thompson. “So we’ve given a component of [the bonus] toward credit quality.”

Even with the extra hours, operational responsibilities and liability currently faced by boards, the roundtable participants were somewhat mixed on whether their boards planned to increase director compensation in 2013.

Those not planning to increase compensation said it’s really not an issue of whether increased compensation is justified given their increased work load, because in their opinion it is. The real issue is how to present a raise to shareholders at a time when bank earnings aren’t what they used to be.