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Justifiable Compensation For Your CEO

Not long ago the Omaha Herald published a series of articles on the executive compensation practices of the CEO of Goodwill Industries, a non-profit organization in Omaha, NE.  The articles did not present a favorable picture and Goodwill Industries had a major public relations problem to resolve.

If the media asked you about CEO compensation practices at your Credit Union, how would you respond and what kind of public relations issues would be created for the Credit Union?

Most likely you would respond that the CEO’s experience, the credit union’s performance under the CEO and the size of the Credit Union are the factors that determine the CEO’s compensation.  But is that really the case?

In an attempt to answer that question we did a little study on CEO earnings (salary and incentive) as it compares to 1) asset size and 2) three year average Credit Union performance.  The study reviewed 2014 W-2 earnings (salary and incentive as reported to the IRS on Form 990) for over 550 $100 million plus credit union CEOs throughout the United States.

One would expect that cash compensation would be heavily influenced by the size of the credit union.  As the chart below shows, there is a casual relationship between CEO earnings and assets, but not to the degree you might have thought.

Babe Ruth, when asked if it was appropriate that he be paid more than President Hoover responded “What the hell has Hoover got to do with it? Anyway, I had a better year than he did.”  As Mr. Ruth so succinctly put it, pay should be based on performance, but is it?

We read in salary surveys and credit union publications that credit union executives are rewarded for performance factors like ROA, loan growth, net charge-offs, member satisfaction, etc.  To test the relationship we ran an analysis of long-term (three years) results for each credit union in our study using a model that measures financial results, growth results, and asset quality.  Each credit union was evaluated against the model and ranked based on the results, from 1 to 550, with 1 being the best.  Our assumption was that there would be some relationship between compensation and performance.

To isolate the effects of size, we ran the regressions against asset categories.  As the chart shows, the relationship between CEO earnings and long-term results is positive, but very weak.  With notable exceptions, low performing credit union CEO’s earned about the same as high performing credit union CEO’s. We found the same relationship in all the asset categories.

So if performance does not seem to have a strong relationship to pay, what factors besides assets and experience (a factor we could not test with the available data) drive executive compensation in credit unions?

Probably the strongest factor is not generally identified.  It is the backgrounds of individual Board members.  Over the years we have worked with scores of credit union Boards and executives in establishing pay-for-performance plans.  At virtually every credit union we found the executive compensation practices were a reflection of the primary sponsor group’s compensation practice.  This was true even in credit unions that were community charter or had several SEG groups.  The legacy of the orgional sponsor group’s pay practices were still engrained in the credit union’s pay practices.

In addition to bringing the sponsor group’s pay practices to the credit union, Board members also tend to personalize the CEO’s pay.  As a Board member myself I can attest to thinking on more than one occasion that our CEO could not make as much as she was making with our Credit Union.  She grew up in the Credit Union.  She did not have a degree.  Where else could she go?  Then it hit me, she could go to any number of other credit unions that needed her skills and, if we were not paying her competitively within our market, it would be simple for those other credit unions to recruit her away.  Add to this the fact that in many cases the CEO is making more than most of the Board members and you get compensation practices that are a mix of each Board member’s opinion on compensation.

To avoid these traps we recommend the following with regard to executive compensation:

  1. Most important, develop an executive compensation philosophy and practice. While there are many advantages to having one, the primary benefit is it provides the Board and executives with a structure for making compensation decisions.  It is a critical first step in making justifiable and competitive compensation decisions.  A few questions or examples to consider when developing a compensation policy might be:
  • What is our general compensation philosophy regarding the market place.
    I. Pay at Market?         II. Pay below Market?        III. Pay above Market?
  • Where should the CEO’s pay be within the pay structure? What factors bear on the placement?
  • Should we adopt a “pay-for-performance” compensation philosophy? What will that look like?
  • When should the pay structure be adjusted? With market movement?  With asset movement?  With inflation?
  • What is the mix between base pay and incentive pay?
  1. Establish a pay-for-performance program that consists of an annual performance plan and review. The plan should include measurable objectives as well as subjective reviews from the Board.  This will be discussed in greater depth in future articles.
  1. Set up a merit increase and incentive bonus scale in the performance plan. This will take the subjectivity out of the merit increase and/or incentive bonus.  ALWAYS pay what is earned, not more and not less.  Greater detail will be provided in a forthcoming article.

If all credit unions would utilize a pay-for-performance plan the relationship between pay and performance would improve and it would be very easy to justify your executive compensation program. The specificity of this will be discussed in a future article.

While you cannot keep the press (or Administrators) away, you can help yourself with a good, solid executive compensation program.  It is also good practice for keeping and motivating your CEO.

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