Publications & Resources

October/November 2007
Focus: Directors Issues

Executive and Director Compensation in Today’s Environment

By Gayle Appelbaum

The world of compensation has changed significantly in recent years. The environment has been impacted by all of the recent legislation, changing the way organizations do business and conduct themselves. In today’s corporate governance climate, there is growing pressure on executive and director compensation. We have seen the results of the first proxy filings that were subject to the new SEC disclosure rules. All of this has caused great changes and new best practices in executive and director compensation.

Some of the trends in today’s environment are to adopt a formal compensation philosophy, have performance-based incentive compensation that is tied to measurable goals, consider granting other types of equity in combination with or in place of stock options and consider the use of performance-based vesting for equity grants. In addition, there are trends impacting the compensation committee’s role and responsibilities. It is critical in today’s world of heightened shareholder scrutiny for the compensation committee to have a charter and operate independently of management; while management provides input to the committee, committee decisions should be made independently of management. The committee needs to rely on independent third parties and experts to provide guidance in all areas of compensation.

A formal compensation philosophy must be disclosed in the new proxy statements by public filers and is also a best practice for private institutions. Establishing a compensation philosophy provides guidelines and parameters as new talent is recruited and when establishing compensation for current employees. A compensation philosophy should establish the ranges of compensation for base salary, cash compensation (salary plus cash bonus), direct compensation (cash compensation plus long-term incentives) and total compensation. The philosophy should define the comparative market and ranges for target or on-plan performance as well as for superior results. It is also recommended that banks adopt a compensation philosophy for director compensation, being mindful of the levels of compensation established for executives when setting the same for directors.

There initially was some uncertainty as to how FAS 123R would affect the matter of equity grants. While it took awhile to get used to the financial impact of this legislation, many organizations began exploring the use of numerous types of equity. The trend today is to adopt an omnibus plan allowing for maximum flexibility and the use of all allowable types of equity. Many organizations are using full value shares (i.e. restricted stock) in combination with appreciation shares (i.e. stock options), and some are granting awards comprised solely of restricted stock. In 103 publicly traded banks in the Western US , 21% granted restricted stock in 2006, a 40% increase since 2004. Restricted stock is gaining in popularity with executives as it is exempt from AMT treatment and does not require funds to “exercise” an award. In 2006, restricted stock grants to directors increased following comments that restricted stock would promote independent decision making among directors. The value of an award is not reduced when restricted stock is granted; however, its use could potentially be less dilutive to shareholders. Furthermore, granting restricted stock (even in combination with options) could result in a plan’s authorized shares lasting longer as fewer shares are required to achieve a grant of equal value. Executive equity plans should be performance-based, thereby granting equity when performance goals are achieved. Vesting of grants, most frequently done over three to five years, has historically been based on putting in one’s time. Alternatively, performance-based vesting is becoming more commonplace, particularly in institutions with significant long-term objectives. Performance-based vested awards can be delivered through grants that vest based upon attainment of goals or through the use of performance shares.

Total compensation for directors increased 15% on average in 2006. This was driven primarily by increased responsibilities, time required and liability. It is expected that director compensation will continue to increase annually on average 10% to 15%. Executive compensation has continued to increase as well. The 2006 median CEO compensation in 103 Western public banks is shown below; also, the median annual increase from 2004 to 2006 in base salary, cash compensation, direct compensation and total compensation was 8%, 28%, 30% and 45%, respectively.

Assets

Median Assets

Base Salary

Cash Comp

Direct Comp

Total Comp

<$250M

179.8

161.0

181.0

188.1

209.0

$250 - $500M

351.3

229.8

318.6

327.6

368.0

$500M - $1B

722.0

240.0

360.0

423.4

534.2

$1 - $5B

1961.5

365.0

619.8

803.3

871.9

Continued change appears to be on the horizon so plan to stay informed, flexible and ready to adapt to new requirements.

Gayle J. Appelbaum is vice president of Clark Consulting’s Compensation Group in Minneapolis . She has more than 32 years of experience in compensation consulting, as well as in financial and investment planning. She can be reached at 952-893-6795 or gayle.appelbaum@clarkconsulting.com.

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