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©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

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Page 1: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

©2009 Pearl Meyer & Partners, LLC

113th Annual Convention

Executive Compensation: Best Practices for Today’s Environment and Beyond

Laura Hanf, Vice President

Page 2: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

2©2009 Pearl Meyer & Partners, LLC

The Challenging Environment

Banks are suffering… 37 banks have failed in 2009, including one North Carolina bank

• Current failure rate is higher than the past six years combined• At the end of 2008, the FDIC had a list of 252 troubled institutions

As of the end of May, 594 banks have received TARP capital infusions totaling approximately $199.2 billion• 27 institutions in North Carolina (4.6%)• $29.7 billion received by North Carolina banks, roughly 15% of

total ($3.7 billion excluding Bank of America)

…but the worst may be over… The economy is “clearly stabilizing” – Geithner, Newsweek 5/18/2009

Banks are starting to repay TARP funds • Approximately $1.7 billion repaid as of the end of May• Treasury approved repayment from 10 banks - $68 billion

Page 3: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

3©2009 Pearl Meyer & Partners, LLC

The Challenging Environment

Lawmakers are introducing additional legislation … Three noteworthy events last week

• New TARP oversight program and final interim rules• Treasury statement setting forth five compensation principles

1. Compensation should properly measure and reward performance

2. Compensation should be structured to account for the time horizon of risks

3. Compensation should be aligned with sound risk management

4. Reexamination is needed as to the necessity of golden parachutes and SERPs

5. Transparency and accountability should be promoted

º Say on Pay

º Independent compensation committee

Page 4: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

4©2009 Pearl Meyer & Partners, LLC

The Challenging Environment

Lawmakers are introducing additional legislation …

Three noteworthy events last week (continued)

• SEC proposed updated "proxy access" rules that would give large shareholders the ability to nominate as many as 25% of all directors

SEC also expects to publish proposed amendments to the existing compensation disclosure rules• Disclosure of compensation for non-NEOs revisited • Discussion regarding risk in compensation programs may be

required of all public companies

…but not all banks can be painted with a broad brush “Without community banks, the current financial crisis would be a lot

worse.” – “Are Small Banks the Future?,” New York Times Magazine, May 17, 2009

Page 5: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

5©2009 Pearl Meyer & Partners, LLC

The Challenging Environment

Intense scrutiny of executive compensation practices

Community banks painted with same brush as the “troubled” Wall Street Banks

Changing (radical) landscape of compensation best practices – impacting all banks (and all companies)

Continuing need to attract, motivate and retain top talent

Pending shortage of executive talent as boomers retire; most banks have limited executive “bench strength”

Generational view/differences – what motivates, attracts and retains new leaders?

Financial crisis

Global economic recession

Government intervention

FDIC assessment

Bank regulator concerns (consolidation, pressure)

Bank failures

Earnings pressures

Credit risk

Housing slump

Plunging stock prices

Mergers & Acquisitions

Amidst unprecedented financial, economic and

business turmoil …

…community banks need to address critical issues ...

Page 6: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

6©2009 Pearl Meyer & Partners, LLC

…Where do we go from here?

Page 7: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

7©2009 Pearl Meyer & Partners, LLC

From Here to There…

Consider the optics

Make the most out of disclosure

Support your compensation committee in moving from competence to excellence

Address “risky business” in your incentive plans

Think long-term

Pay for performance

Think holistically about compensation

Page 8: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

8©2009 Pearl Meyer & Partners, LLC

Consider the Optics

Compensation has become increasingly a populist issue• “Make no mistake about it: the taxpayer dollars are being used for

that golf…That is not what most people thought was going to happen with our money."– Michael Q. Sullivan, President of Texans for Fiscal

Responsibility

Increased scrutiny is coming from a number of constituencies • Public and media • Politicians and government• Shareholders• Shareholder advisory firms (e.g., RiskMetrics)

Say on Pay likely to become a reality for all public companies • Required for TARP participants; current administration pushing for

similar requirement for all public companies• Non binding shareholder vote on executive compensation • Currently no specific format but “evolving; RiskMetrics “Against”

votes will drive significantly lower shareholder support

Page 9: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

9©2009 Pearl Meyer & Partners, LLC

Consider the Optics

“Hotbeds” for scrutiny • Perquisites• Business and entertainment expenses• Gross-ups• Employment and severance agreements • Supplemental retirement programs • Supersized incentive awards (short- and long-term)

Page 10: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

10©2009 Pearl Meyer & Partners, LLC

Make the Most out of Disclosure

Proxy disclosure is required for public companies but a clear and concise rationale for compensation decisions should be an expectation for all institutions• Not just the “what” but also the “why” – documents philosophy,

decision making process and outcomes• It’s an opportunity to tell your story – good (or bad) disclosure could

have an effect on shareholder votes for stock plans, say on pay and directors

Make the right decision first then consider how to disclose

Strengthen areas dealing with “glossed over” requirements • Explain decision making process not just outcomes• Clarify roles of committee, management and consultant in decision

making process; identify consultant’s independence • Discuss internal pay relationships and differences in pay decisions• Disclose specific performance metrics and results (competitive harm

is a tough hurdle)• Consider format; supplemental information can be beneficial

Page 11: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

11©2009 Pearl Meyer & Partners, LLC

Compensation Committee – from Competence to Excellence

An excellent committee…

Is proactive, not reactive • Annual calendar and sample agendas• Materials provided in advance • Major and/or complex decisions spread over more than one

meeting

Looks beyond the market-data

Thinks about succession planning

Has developed techniques to assess performance goals and performance relationships• May seek input from audit committee or other sources to assess

difficulty of performance goals• Use dynamic modeling • Compare institution to peers

Page 12: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

12©2009 Pearl Meyer & Partners, LLC

Compensation Committee – from Competence to Excellence

An excellent committee…

Doesn’t negotiate in a piecemeal fashion• Tally sheets• Wealth analyses

Can disagree without damaging its relationship with management• Discussions happen along the way• Time with management outside of boardroom

Never surprises the Board

Continually strives to improve • Annual committee evaluations and planning

Page 13: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

13©2009 Pearl Meyer & Partners, LLC

Address “Risky Business”

Highly leveraged incentive plans are partially to blame for the financial crisis but not a common structure in community banks

TARP participants must conduct a risk assessment semi-annually; the assessment is for all compensation plans• Likely that all public and all financial institutions (private and

public) will be expected to perform assessment in the future Process

Use a team approach – risk officer, internal audit, human resources, legal, etc.

All plans have risk – make sure the focus is on “excessive” and/or “unnecessary” risk

Potentially risky measures could be counterbalanced by internal processes or other incentive plan measures

Business Risk

Assessment

Identify Practices that Drive “Risky”

Behaviors

Linkage to Compensation

Programs

Change Programs (as appropriate)

Page 14: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

14©2009 Pearl Meyer & Partners, LLC

Questions to ask:

Do incentive plan metrics reflect the company’s business strategy?

What incentive measures are tied to potentially “risky” behaviors?

Is there an appropriate balance and mix of performance metrics?

Is the leverage (upside and downside) appropriate?

Is there appropriate focus on long-term/sustained performance?

Are there protections/controls in place to avoid excessive payouts?

Do the payouts align with shareholder interests?

Does performance and resulting rewards align with market practice?

Address “Risky Business”

Page 15: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

15©2009 Pearl Meyer & Partners, LLC

Think Long-term

Along with highly leveraged incentives, the focus on short-term results are much to blame for the financial crisis

Compensation practices should be adjusted to:• Place more focus on sustainable performance • Ensure reward periods match the timeframe required to determine

whether a decision/action was successful• Hold back a portion of compensation which is at risk if

performance is not sustained in future years

Short-term incentive techniques • Implement a rolling incentive plan• Paying incentive awards above a certain level in restricted stock

or unvested deferred compensation

Long-term incentive techniques • Stock ownership and retention guidelines• Hold until or past retirement requirements

Page 16: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

16©2009 Pearl Meyer & Partners, LLC

Pay for Performance

For TARP participants, compensation restrictions limit pay for performance – base salary and restricted stock are guarantees

Balance is the key to effective pay for performance • Short-term and long-term• Absolute and relative• Bank, team and individual• Formula and discretionary

Performance measures should:• Link to business strategy and goals• Include complementary measures • Motivate the right behaviors/results• Focus on more than one but a small number of critical measures

Example “unacceptable” practice: do not use a single (or the same) measure(s) in both short and long-term plan.

Page 17: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

17©2009 Pearl Meyer & Partners, LLC

Pay for Performance

Target performance goals should raise the bar, but be realistic• Minimum – lowest level of acceptable performance – guideline 80%

of time• Target – reflects budget/expectations – guideline 60-70% of time• Stretch – stars are in alignment – guideline 60-70% of time

If the Bank’s ability to predict is limited, consider:• Relative measures• Widening the range of performance between minimum and stretch

while also lowering the incentive opportunity • Providing the Committee with some discretion but define

expectations upfront

Remember incentives are not guaranteed payments• Results aren’t there – don’t pay out• Committee should have negative discretion• Good things not captured by short-term incentive plan measures are

likely to make their way into long-term incentive plan payouts

Page 18: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

18©2009 Pearl Meyer & Partners, LLC

Pay for Performance

CEO total direct compensation relative to 3-Year TSRAn Illustration of banks between $1b - $15b Assets

CompensationRanking

PerformanceRanking

High performer &Low compensation

Low performer &Low compensation

High performer & High compensation

Low performer &High compensation

Page 19: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

19©2009 Pearl Meyer & Partners, LLC

Compensation – Thinking Holistically

Focus on the total package and mix• Different components focus on different needs

» Fixed vs. variable» Annual vs. long-term» Reward vs. benefit

• Take a holistic view of compensation » What is overall “message” of the compensation package? Is it the

right message? Tally it up

• What does it look like when all the components are added up together?

• How does total compensation vary under different termination scenarios?» Change in Control» Termination (voluntary and involuntary)» Retirement» Disability

Page 20: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

20©2009 Pearl Meyer & Partners, LLC

Compensation – Thinking Holistically

Conduct Scenarios• How does total compensation vary under different performance

scenarios? (dynamic pay modeling)» What is the total potential upside/downside rewards of all

elements of performance-based compensation?» What is the executive’s payouts (and the company's actual

total exposure) at the extremes of performance?

Page 21: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

21©2009 Pearl Meyer & Partners, LLC

In Summary

Executive compensation is under increased scrutiny

Expectations about executive pay are high

Issues are complex

The world as we know it IS changing

At minimum, all banks should:• Conduct a risk assessment• Ensure incentives support business goals and are structured for

sustainable performance• Balance short- and long-term incentives and use a portfolio of

performance measures• Ensure total compensation is clearly aligned with both company

performance and interests of shareholders

Public banks should:• Tell their story and make the most out of proxy/CD&A disclosure • Be prepared for changes as various constituencies develop a

greater voice in executive compensation

Page 22: ©2009 Pearl Meyer & Partners, LLC 113 th Annual Convention Executive Compensation: Best Practices for Today’s Environment and Beyond Laura Hanf, Vice President

22©2009 Pearl Meyer & Partners, LLC

Contact Information & Additional Resources

Contact Information Laura Hanf

[email protected]• (704) 844-0437

Additional Resources www.pearlmeyer.com/banking

• Trends and Issues• Client Alerts • Research Reports