When it comes to executive compensation in banking, the importance of retaining great employees often gets short shrift to discussions of pay-for-performance and what the regulators want. However, retaining top performing executives can be critical to a bank’s success. Following are four important questions all compensation committees should be discussing.

Why is retention important?

Developing a strong, high-performing executive team takes time. High-performing executives drive the development of the bank’s strategy and its execution. The unexpected departure of a key executive can create disruption and potentially lead to the departure of customers and other employees. Replacing those executives can often be a time-consuming and expensive proposition.

Compensation committees should also focus on succession planning, and retaining high-performers plays an important role. The next generation of leadership can be a target of competitors looking to strengthen executive talent. It is important for banks to identify top performers with the potential for greater leadership roles in the future, and ensure their compensation is structured to encourage them to remain and develop their skills within the bank.

How do you assess the level of retention in your programs?

An assessment of the retention hooks within your executive compensation program should include the following:

Pay Opportunity: Do your high performing executives have market-competitive compensation opportunities and incentive programs that are viewed as challenging but reasonable? High performers want to be rewarded with an effective performance-based structure.

Value of Unvested Compensation: Do high performing executives have meaningful value in unvested compensation that would be forfeited if they left and difficult for another bank to replace? This can often be assessed by analyzing the following:

  • Value of unvested compensation (e.g. deferred cash incentives, equity awards): Committees should regularly evaluate the value of outstanding awards at the current stock price to see if it is meaningful enough to retain key executives. While there are no specific guidelines, executives often have outstanding awards greater than their annual salary, with top executives generally significantly higher.
  • Retirement benefits: While the use of enhanced retirement benefits such as SERPs (Supplemental Executive Retirement Plans) for executives has been declining, it remains important to understand the value provided through your retirement programs, vesting milestones and integration with other retention instruments (e.g. stock).

Development Opportunities: Do high-performers know they are viewed as critical to the organization’s future and are they given opportunities that allow them to further develop? Retention is about more than just compensation.

How can we enhance the retention value of our programs?

There are several design features that can enhance retention:

Choice of Long-Term Incentive Vehicle: While there has been a significant shift towards the use of performance-based vesting, an over-emphasis on this vehicle can potentially create retention concerns–particularly if there is uncertainty in the potential payout (e.g. goals are set too high, and payouts are not seen as being likely). An overemphasis on stock options can create similar concerns since executives have less direct influence on stock price. Time-based restricted stock, when used in moderation, can be useful in ensuring some value will remain outstanding for executives while continuing to have the amount vary based on shareholder value.

Vesting of Equity: Irregular vesting schedules can result in uneven retention value from year-to-year, while annual grants with overlapping vesting schedules help ensure that executives always have meaningful value outstanding. Cliff vesting of large retention awards can also create concerns if the value of outstanding awards declines significantly after they vest.

Retirement Provisions: It is also important to understand the retirement provisions of your awards, as full vesting at an early retirement age will diminish the retention value of your program once executives meet retirement eligibility.

Retention is most effective when incorporated into the overall program, rather than as special one-time “make up” grants, which banks may need to give to executives when the existing program fails to provide adequate retention value.

How does retention fit into the rest of our program’s objectives?

Balance is critical in executive compensation programs. Retention is just one of several important objectives of an effective total compensation program. In addition to ensuring that your programs encourage retention of high-performing executives, compensation committees also need to ensure compensation programs are aligned with the bank’s strategy, link pay outcomes with performance, align executives with shareholders and avoid encouraging excessive risk.

Originally published at Bank Director.