Incentive Compensation: Back in Balance
By Henry Oehmann and Jim Pulsipher, Grant Thornton LLP
Author Ayn Rand once wrote, “Money is only a tool. It will take you wherever you wish, but it will not replace you as the driver.” Financial institutions have been using compensation as a motivational tool to boost employee performance and retention rates. However, after a challenging year and new executive compensation rules from the Treasury, financial institutions need to reconsider the way they drive incentive compensation.
sign that check…
Financial institutions participating in the Capital Purchase Program face stricter rules regarding executive compensation during the time the Treasury holds equity issued under the program. In addition to the prohibition of golden parachute payments and the deduction of payments in excess of $500,000 for tax purposes, other conditions for financial institutions include:
Institutions must now be especially attuned to earnings and asset quality, instead of only revenues, when deciding rewards. Compensation plans that balance performance measurements with qualitative measurements are best equipped to address the challenges of the current climate while still fulfilling their purpose. As you plan a shift from the income statement to the balance sheet, focus on the objectives of stronger earnings, risk adjustment appropriateness and capital adequacy.
quality, not just quantity
Now more than ever, long-term performance measures are vital components of new incentive compensation plans. However, they can not simply be viewed through a quantitative lens. Monitoring the frequency of non-performing assets is not as important as determining how to improve asset quality evaluation. All too often, as loans were provided in risky areas, the returns may not have been commensurate with that risk adjustment.
Loop in members of the board who are involved with asset quality to help create a solution. For instance, institutions could follow up on the application process and the rating and scoring process of the loan itself. Incentive compensation arrangements should also be enabled to retain any income gained from the revenue objectives of past years in the event of declining asset quality.
The loan approval committee and mortgage lender should share in the responsibility of the forfeiture – often, the mortgage lender suffers the brunt of the performance failure. A possible decline in loans, revenue and asset growth may be the trade-off for shoring up the balance sheet and bolstering asset quality and capital adequacy.
In today’s environment, financial institutions are charged with staying abreast of ever-changing developments. As regulators and stakeholders alike demand more transparency, incentive compensation plans move front and center. Assessing your compensation plan on an ongoing basis to ensure compliance pays off.