Publications & Resources
November/December 2008
Focus: Directors Issues
Benefits Tied to Performance Receive Higher Approval Rating by Board Members
By Clark W. Struve, CLU
We all have felt the recent budget-squeeze at home, in the office and in our communities. A slumping housing market, rising gas prices and sub-prime mortgage foreclosures have dealt their blow to the economy as well. When budgets are squeezed, the last thing on anyone’s radar is executive compensation. But should that be the case? If it’s the board’s responsibility to make sure highly qualified executives are managing the bank, are there real solutions that can provide incentives to work through these times without breaking the bank?
Without a doubt, there couldn’t be a better time to consider performance as a key indicator not only for annual incentives, but long-term benefit programs. In the past, supplemental executive retirement programs (SERPs) incorporated vesting schedules, like 401(k) plans, to provide the incentive to remain at the bank. While a vesting schedule can encourage longevity, it falls short of providing incentive for performance.
Incorporating Performance Benchmarks into Executive Benefit Plans
Much of today’s focus on performance-based compensation stems from increased scrutiny of executive compensation by stakeholders as well as recent legislative/regulatory developments (e.g., Sarbanes-Oxley, FASB 123R and SEC Proxy disclosure changes). As a result, banks are using performance-based compensation as a real-time budgeting solution. For years, performance benchmarks have been integral to the design of annual incentive bonus plans for executives. Similar benchmarks, or objectives that complement the bank’s strategic goals, can easily be incorporated into executive retirement programs.
Under a performance-based executive benefit program, a bank can link all or a portion of the benefits to the attainment of measurable benchmarks, such as core deposit growth, loan growth, return on assets, return on equity and net income on earnings. Furthermore, the benefit under such a program can be tiered based upon, for example, an executive’s role within the organization and their ability to impact the applicable performance measures.
A SERP, as a defined benefit plan, often provides a set benefit amount at retirement, paid to the executive in a single lump sum or gradually over a designated period of years. But, by adding performance criteria to such a plan, banks can directly link all or a portion of the benefit amount to the attainment of individual or organizational performance measures. The degree to which the benefit is tied to performance can vary based upon the bank’s culture and/or circumstances. For example, take a bank that wishes to deliver a maximum SERP benefit of $105,000 to a key executive. Rather than designing a SERP that guarantees the executive will receive the entire $105,000 upon retirement, the bank could instead structure the SERP to provide a guaranteed minimum benefit of $75,000 and an additional performance-based benefit equal to $3,750 for each year (not to exceed 8) that the executive reaches specified performance goals. Under this arrangement, the $75,000 benefit could potentially be increased by up to an additional $30,000 (i.e., $3,750 x 8 years), but only if the applicable performance goals are achieved.
A deferral plan, as a defined contribution arrangement, typically allows a bank’s officers or executives to defer salary and/or cash incentives on a pre-tax basis and to accumulate tax-deferred interest on such amounts. These deferred amounts are often paid to the officer or executive (and includible in taxable income) following retirement or such other events provided in the plan agreement. Depending on a bank’s objectives, a deferral plan can also be designed to link the value of a participant’s deferral account to organizational or individual performance measures. Such an arrangement not only encourages long-term performance of participants, but can also serve as an invaluable tool for the bank to attract and retain top executive talent. For example, a deferral plan can be designed such that the amount of interest that may be credited to an executive’s account is directly tied to the achievement of specified performance goals.
Structuring a performance-based executive benefit plan can offer meaningful rewards to top performers with minor impact to the bank’s bottom line. With higher accountability to stakeholders and increased focus on governance, board members are far more likely to approve compensation that rewards the achievement of strategic performance benchmarks. We are all feeling the squeeze, but by applying performance criteria to executive compensation, top performers can go for the gold without breaking the bank.
Clark W. Struve is an independent consultant of Clark Consulting, Inc. and is located in Monterey, Calif. He can be reached at 831-373-4614 or clark.struve@clark-consulting.com.
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