Agenda Item of the Month: Director & Executive Compensation

The objective of AABD's Agenda of the Month is to expand the discussion of the Board of Directors beyond the ordinary subjects to include issues that arise outside the individual bank, but which may have a material impact on the bank.

For this month, AABD suggests that the Board consider adding a general discussion of director and executive compensation, particularly the use and design of stock options.

Compensation of corporate directors and executive officers has moved to the forefront of a national debate on what went wrong with Enron, Worldcom, Global Crossing and other failed companies whose executive officers walked away with hundreds of millions of dollars while shareholders, employees, and pensioners lost everything. The Sarbanes-Oxley Act of 2002 addressed regulation of the public accounting firms, financial statement certification by chief executive and chief financial officers, enhanced financial disclosures, analyst conflicts of interests, and white-collar crime enhancements. The Congress considered but decided not to act on any rules regarding compensation of senior officers and directors, including the expensing of stock options at the time of grant and other stock option limitations.

We can expect the Congress, upon its return from the summer recess, and/or the Financial Accounting Standards Board, to address whether to require stock options to be expensed when granted, and whether corporate directors and executive officers should be limited as to when and how they exercise stock options and resell the stock subject to such options.

For those banks and bank holding companies that currently have stock option plans in place, it is advisable for the Compensation Committee or the Board to evaluate whether adjustments to the plan or the structure and terms of the options to be issued under the plan are appropriate given the corporate events of the past year and the need to align the interests of corporate directors and officers with the long-term interests of the company. They should also consider the potential impact on the company's balance sheet and income statement if the company is required to expense the options that have been granted or may be granted in the foreseeable future. For those banks and bank holding companies that do not currently have stock option plans, it is appropriate to consider future compensation programs not utilizing stock options, or adopting stock option plans and terms and conditions to the options themselves that will assure that the insider interests are properly aligned with the company's interests.

Some companies are considering dispensing with stock options entirely, and replacing them with stock grants, which clearly must be expensed in the year in which they are granted. They are also considering restrictions on resale so that insiders cannot benefit from short-term swings in the market.

Compensation issues entail more than just stock options and stock grants. The grossly excessive compensation paid to the senior officers of the Enrons and Worldcoms of the world is a wake up call for boards of directors of all companies to revisit the compensation packages for their senior officers and themselves to assure that the compensation is in line with the financial performance of the company and is designed in a manner to encourage the senior officers and board to act in the best long-term interests of the company. Banks are also subject to laws and guidelines that define an unsafe and unsound banking practice to include the payment of excessive compensation, which board members need to address.

If your bank or bank holding company does not currently have a Compensation Committee, you should consider establishing such a committee to study these compensation issues more closely, and then having the committee report to the Board its findings and recommendations no later than the November meeting so that the Board will have sufficient time in which to formulate a compensation plan that makes sense in the new environment in which companies now operate. The composition of the Compensation Committee is also important; the New York Stock Exchange has proposed a rule requiring companies that are listed on the New York Stock Exchange to establish and maintain Compensation Committees consisting solely of "independent" directors (those who have no material relationships with the company other than their role as a director).