Saturday, February 07, 2015

Say on Pay for Financial Institutions

Researchers at Rice University performed a study on CEO compensation, including bank CEOs, relative to average employee compensation. The study was in reaction to the media's often cited pay disparity between the CEO's of the largest institutions and their rank and file employees.

As for banks, the Dodd-Frank Act mandates that all corporations administer a non-binding shareholder vote on the compensation of its executives. For publicly traded banking institutions, the study found the mean pay ratio was 16.6x, well within the 25x bounds identified by Peter Drucker in 1977.  

Not leaving well-enough alone, I did some digging into the matter on my own, knowing that when you move up the banking food chain (i.e. asset size), the disparity, or ratio, will get larger. But most community financial institutions don't live in that world, or so I thought. 

So I searched for publicly traded financial institutions with total assets between $1 billion and $3 billion that reported their CEO's total compensation (i.e. was not "NA"). The search yielded 148 financial institutions. I then took their annualized salary and benefits expense for their last reporting period and divided by their full-time equivalent employees ("FTEs") to come up with average salary and benefits per employee, and compared to the CEO's total compensation. 

The results are in the following table:

Although not the exact methodology of the Rice study, the table indicates that publicly traded community bank CEOs are not excessively compensated.

Since I went that far, I decided to see if there was a correlation between the CEO compensation multiple and financial performance, such as Return on Average Assets (ROAA). 

I took my search of $1 billion - $3 billion financial institutions and narrowed it down to $1 billion to $1.2 billion to keep a tight range, yet yield a decent sized sample. I eliminated companies with multiple bank subsidiaries, because the granular salary plus benefits and FTE data is typically at the bank-level. Plus I had to look and calculate manually. The search resulted in 36 financial institutions. 

I separated them into quartiles based on ROAA. The results are in the below table.

Each quartile had nine financial institutions. Interestingly, the bottom quartile performer had the greatest CEO to average employee pay disparity, the highest CEO total compensation, and the highest average employee salary. But I'm not certain the message here is to not pay employees well. Perhaps the bottom performers have too many employees AND pay them well, lacking the expense discipline to elevate financial performance.

The middle quartiles are similar in total CEO compensation and average employee compensation. In fact, the top through the third quartile are intuitive in their financial performance versus compensation versus the pay multiplier. 

In my experience, there are some financial institutions that pay executives well regardless of their relative financial performance. This was the main logic behind Dodd-Frank's Say on Pay.

The answer may not be in reducing executive compensation, although some Boards should consider it based on the facts. The answer, in my opinion, is to find ways to increase the compensation of rank and file employees. If we were socialists, we would mandate it and everyone would gravitate towards the lowest common denominator in employee productivity and financial performance would plummet.

But we're capitalists. And the way to increase real compensation is to improve productivity. That means instead of needing ten people in a department with average wages, we do it with seven people and pay above average wages. 

Time and again my firm reviews departmental processes that are outdated and unnecessary, technologies that are underutilized, and managers that protect "the way we've always done it".  If executives don't assume a leadership position in removing inefficiencies and elevating real wages while improving financial performance, perhaps their compensation should be evaluated.

As technology changes, it is difficult to keep up with process change. But the cost of doing business should decline as industries and the technologies that support them become more mature. When I performed my research, even though the asset size of the financial institutions was tight, the amount of FTEs per institution varied widely. One had 130 FTEs, another had 521. And average salary plus benefits varied, with the top payer averaging $135k, and the bottom payer averaging $45k. 

The top payer, by the way, was in the bottom quartile financial performer, and the lowest payer was the last bank in the second quartile. Somewhere in between lies the answer for your financial institution.

Any thoughts on pay philosophy?

~ Jeff

Note: The below SNL Financial article by Kiah Lau Haslett alerted me to the Rice study. It may require a subscription to view:

1 comment:

  1. Wow!! What an informative article you have shared my friend! My uncle Dr. Aloke Ghosh is also gathering the information on this topic. I will tell him about your article!