Over the course of the last year, many factors have emerged that impact the banking industry, including the new administration, rising interest rates, and continued industry consolidation. The changing landscape for western banks indicates that it might be the right time to revisit the peer groups used by your bank to evaluate compensation program design and relative performance.
Compensation Peer Groups
Bank boards have typically used peer groups as the basis for a relative comparison of compensation levels, compensation plan design, and incentive plan goal calibration, as well as relative financial or stock price performance.
For compensation plan assessment, the priorities for shareholders and their advisors are: a) “similar” companies should have similar compensation opportunities, b) higher relative levels of pay should correlate with better-performing companies, and 3) the criteria for selecting peers should be objective. To facilitate this alignment, incentive plans should incorporate a measure of the bank’s relative performance to peers.
Since studies show that target levels of executive compensation are correlated with a company’s size, shareholder advisors identify “similar” companies primarily based on size (measured by assets and market capitalization) and industry. For community banks, advisors further narrow the selection by location.
These priorities are important, but may not fully encompass the issues. Ultimately, the priority for committee members is the attraction and retention of key executives, as well as motivating management to execute the long-term business strategy. This implies that a more expansive perspective, which takes into account the plan designs of those companies and where talent is sourced, may weigh more heavily than simply size and location.
The Challenge for Western Banks
In a world not limited by the availability of data or the influence of external optics, the perfect peer group would encompass direct market share competitors with similar characteristics envisioned by your institution’s strategic plan, such as desired scope of offerings, lending portfolios, regional footprint for loans and deposits, historical and future growth rates, as well as the desired size. There are challenges in developing the perfect compensation peer group for banks located in the western United States, the most significant being the limited number of banks. There are fewer than 90 western banks disclosing compensation data, with total assets ranging from $130 million to nearly $2 trillion. This narrow field is further complicated by the substantial regional differences in cost of wages and business development prospects.
For western U.S. banks, a more expansive source of compensation data can alleviate some of the issues. Data from published compensation surveys can be a source of competitive pay information for those peers who do not publicly disclose compensation data. In addition, banks should not be reticent to select peers from outside their region, giving preference to those banks similar in size and lending portfolio.
There is also an opportunity to broaden the market perspective for positions that are not specific to the banking industry but are becoming increasingly critical for community bank success—for example IT professionals.
Financial Performance Peer Groups
Institutional investors and advisers prefer that “compensation peers” are the same as the peers used to evaluate financial performance in relative incentive plans, thereby supporting an alignment of compensation with performance. If compensation is targeted at the median of peers and incentives are delivered, in part, based on financial or stock price performance, the resulting earned compensation will generally fall within a similar range of relative performance.
However, “compensation peers” may not include all of the direct competitors of an institution. Some competitors are too large or too small for compensation comparisons, or compensation data is not available. Banks have an advantage in identifying the perfect peer for financial comparisons—bank financial data available through regulatory filings. Therefore, banks can select financial performance peers which are most like themselves in terms of breadth of operations and are a better basis for assessing the bank’s relative performance. There are also numerous operation metrics which can be used to select financial performance peers, such as lines of lending, types of deposits, non-interest income, and efficiency, as well as regions of operations.
As executive compensation programs continue to evolve, the use of awards where payout is determined based on relative performance will continue to gain prevalence, which increases the importance of peer group selection for financial performance comparisons. For western banks, the most effective peer groups are likely to differ from traditional approaches. Selection of peers for compensation comparisons may need to include banks operating outside the western region, and potentially in different industries. A separate peer group for financial performance comparison may be required, providing a stronger benchmark for banks to evaluate relative performance. Approaching peer group development with added emphasis can help your bank achieve a competitive advantage with compensation programs in retaining talent and driving performance.
