The Current State of Bank Incentives: A Board-Level View

Jake: We're wrapping up this season's industry discussions with a look at incentive compensation in the banking sector. Mark and Aalap are joined by managing director David Seitz, who brings more than 30 years of executive compensation experience and has advised more than 100 banks and financial institutions, from community banks to regional and super-regional institutions.

Together, they discuss how bank incentive programs differ from those in other industries, including the role of balanced scorecards, discretion and judgment, bank wide incentive oversight, and long-term equity design. They also examine why risk management and regulatory expectations make incentive governance especially important for bank compensation committees and boards. Let's listen in.

Mark: David, this is awesome. It's great to have you here. I've been looking forward to this for a while because we've got so many banking clients, and it's really great to have you on and talk about some of the things that are going on.

David: Thanks, Mark. Good to be with you and Aalap today. Looking forward to our discussion.

Aalap: Yeah, David, really glad that you're joining us. And before we jump in and really talk about incentive design and goal setting, my understanding is that the community has been operating in a pretty volatile market as of late. What are the contributing factors to that?

David: Yeah, it's been an incredibly volatile period in banking we've come through. First, we had that pandemic in 2021, and then in 2022, we had seven Fed interest rate hikes, unprecedented in the history of banking, which impacted the yield curve. In 2023, we had a liquidity crisis. We had three major banks melt down, right? This created havoc with bank financials and incentive plans. In 2024, things began to stabilize. 2025 was a pretty strong year. And 2026, while nothing's guaranteed, is looking like a solid year in the industry. But it's been an incredibly turbulent period.

Mark: And can you predict what's going to happen to interest rates in 2027 as you start talking to your clients about targets?

David: If I could predict that, Mark, I wouldn't be here with you and Aalap.

Mark: Maybe you could talk a little bit about how you handle annual incentive goals when you have this incredible uncertainty, especially with a third party setting the interest rates, which have such a big impact on financial statements.

David: Yeah, I think the most important thing with banks and annual incentive scorecards is a balanced scorecard, right? And that's true in many industries, but that's really a priority of the compensation committee, making sure there's a balanced scorecard and then making sure that it's aligned with that bank's priorities. That's the jumping-off point. And there's no one-size-fits-all approach. So the fundamental scorecard, and we can talk about metrics, varies a lot by bank.

Aalap: And when you think about the scorecard, obviously, scorecard usage has been in place for many years. But as you take that context of the volatile operating environment, are there any new and interesting things that banks are doing with the scorecard?

David: I think Aalap, surprisingly, as in many industries, there were a number of banks that had more discretionary scorecards, they've tightened those up. And what you're going to see on most bank scorecards is a balance between growth in the business. Usually, that's measured by balance sheet growth, assets and deposits, more so than revenues. You're going to see profitability, whatever income metric is being used, or return metrics, ROA/ROE.

But of course, in the banking industry, quality is paramount. Credit quality, asset quality, is always on the balanced scorecard. So those four cornerstones are there. It's been a huge issue in the industry, the individual or strategic category. Some banks had that as we went through these turbulent times, and some did not. There's been a reassessment and a rebalancing of those scorecards.

Mark: And while you talk about balance, how much balance is there between a pure income or return metric versus some of these more qualitative metrics? Is it 50/50, 80/20?

David: I'd say, Mark, in banking, it's probably 80% measurable, with all the financial suspects and asset quality, maybe 20%, max 30%, on the strategic and individual. But literally, some banks had zero on that aspect of the scorecard. And some banks that were going through repositioning’s had that as high as 50%. But I think the middle of the road is 20% to 30% there.

Aalap: David, if we could pull on that a little bit, you said that some of these individual KPIs and strategic objectives were being adopted to hedge against some maybe not-so-great financial results. Now that you're saying that the operating environment may be turning a bit more normal, do you still have those in 2026 programs, and do you expect them to continue in 2027?

David: Great question, Aalap. I think what we saw there is that there were some banks that didn't have that category, which made it even more difficult for the committee to exercise discretion because the plan was ostensibly 100% financial. It is what it is. The board had to intervene with complete discretion. 

Just as we saw during the pandemic, banks that had at least some aspect of their scorecard on strategic or individual could recognize, hey, look, we had all these interest rate changes, we had to pay special fees to the Fed. They could more easily say, well, we're going to pay X percentage of the award based on efforts and controllables of management.

Aalap: And how are the regulators feeling about this in terms of having more discretion in the program?

David: Well, regulators like the balanced scorecard. One of the biggest red flags for regulators is discretionary incentive plans with no emphasis on quality, right? Credit quality in the scorecard. I think they're very skeptical of that. And that's true whether it's an executive incentive plan or a line-of-business incentive plan. So, they're very supportive. Now, like all industries, the spotlights on the compensation committee and how they exercise that discretion, right? What's their rationale? What are they doing, and why?

Aalap: Yeah, but what you're saying is they're buying into the logic of having some level of discretion as part of the scorecard.

David: Regulators hate formulaic plans. And that's true of any incentive plan in the bank.

Mark: Are there any other hot topics or metrics that you're seeing? Sounds like a lot of organizations have moved toward a measured approach to this discretion, or I like to use the term ”judgment,” around these incentive plans. But anything else you're seeing pop up as you start thinking about 2027 plans?

David: Yeah, well, a couple of thoughts on that, Mark. Like we've seen in a lot of industries, what are best practices for discretion? It starts with what's the materiality? What changed here? How much did this affect our incentives, right? And then being very transparent with the impact on the incentive plan with the committee and board so we can document it and, if we're public, disclose that. And then lastly, being consistent, right? Hey, we added this back this year, we subtracted it this year, okay, that's our MO going forward.

I think, as we've seen with a lot of industries, there are emerging best practices on how to exercise discretion, right? What's good governance by the committee? I think the point that a lot of committees grapple with is just, again, the basics. Is this aligned with our priorities in our markets?

So, for example, banking in a lot of these community and regional banks is all fundamentally grounded in local economics. You could be in a region where you're facing really strong headwinds in terms of growth opportunities, right? So that bank really needs to shift its priorities to things like the efficiency ratio, expense management, things that they can control, and less on growth, right? And that should be reflected in the incentive scorecard.

Conversely, there are other banks that are in stronger markets for growth and have more opportunities. Maybe they have more lines of business that are fee-based, less just lending, consumer and commercial. You would expect to see that reflected in the scorecards. And that's always been the case, but I think committees are paying more attention to that now. You can often look at a scorecard right away and say, hey, does this line up with the strategy and what we're hearing, or the priorities of the company?

Mark: Yeah, that's such a good point that we always have to go back, irrespective of the industry, and anchor this in the strategy and what you're trying to accomplish. It's an interesting other point is that we always hear about a plethora of incentive plans in banks. Can you talk a little bit about bank-wide incentives? Are they different, and why is that the case?

David: Yeah, so it's very interesting. Banks have a plethora, a mountain of incentive plans. A typical community bank, aside from the executive incentive plan that the committee focuses on, might have 10 other line-of-business incentive plans. A larger regional or super-regional bank could have 50 plans. And as it should be, the primary focus of the compensation committee, the board, is on the executive incentive plan, right? But they need to be aware. They need to monitor. They have a fiduciary obligation to monitor all these other plans, not design these other plans, but monitor them.

And a best practice in that regard is always having an inventory of the plans. You don't want any board member or compensation committee member to read in the paper, hey, Aalap got paid a $5 million incentive last year. Who's this guy? Why is he getting paid more than the CEO? You never want them caught off guard, right? So that's where banks want to be is monitoring those organization-wide incentive plans.

Aalap: David, moving into long-term incentive plans, and really appreciate all the insight on the annual incentive plans. What's the current state of play in terms of the equity programs at banks?

David: Equity state of play, Aalap, is like other industries. Banks fundamentally want to balance performance and retention. And what they've really gravitated toward, starting at the top of the house, is a blend of performance units or shares and time-vested restricted shares or units. So that's really where they've gravitated to.

One interesting thing about banking is you rarely see stock options in public banks. You see it in privately owned banks, rarely in public. Nothing says you can't do it. Banks have less, generally speaking, double-digit growth opportunity than other industries. And at times, the regulators have been very critical of stock options. When we had the Great Recession and Shearson melted down, every time the Fed writes a postmortem on an industry crisis, they're sure going to take a shot at incentive compensation and stock options.

So that's really discouraged banks from using a lot of stock options. But if you're in a strong market, you've got double-digit growth opportunities, could that be part of your balanced LTI portfolio? Sure, but it's the exception.

Aalap: Is the concept that stock options are riskier weigh on this as well, in terms of how boards think about the different levers they can pull?

David: Yes, that's certainly what the regulators always go after. Well, the reason Shearson failed was their stock options. They played a role in this. I don't even remember if Shearson was granting stock options, though the perception is, swing for the fences with the stock price. That's what the regulators would always say.

I just think, though, practically, stock options, as we all know, are incredibly powerful incentives when you've got double-digit growth opportunities for earnings and ultimately stock price, right? And banking's a more mature industry where investors historically, if you were expecting an 8% total shareholder return in a banking context, 5% would be through price appreciation, 3% through dividend yield, right?

In considering whether to use stock options, it's the basic question, wait a minute, does this make sense? Are we going to have good growth opportunities? And the regulators are not going to say shame on you. You're going to take the same heat that you do from ISS and the advisory groups.

Mark: What metrics are you seeing in long-term incentives? And one of the things I keep thinking about is we talked about asset quality and return metrics in the annual plan, but how do you balance the two of those?

David: Yeah, so it's interesting, Mark. And this hasn't changed a lot over the last 10 years, but the big three in an LTI and the performance would be relative TSR, like other industries, that's in there. And then we would see earnings growth as potentially an operating metric, however that's being defined. We can talk about how a lot of banks use core operating earnings instead of GAAP earnings. And then ROE, return on equity.

This is an interesting thing in banking, is generally any kind of financial analysis will show the strongest correlations in financial services between long-term shareholder value creation and performance indicators. ROE is the metric, right? And so larger institutions tend to use ROE more. Smaller banks tend to lean more on ROA because traditionally it was all about lending, right? And ROA, those loans go on the balance sheet as assets so there's definitely a difference in the market between smaller banks leaning on ROA versus ROE.

Now, you asked an interesting question there. What you don't see a lot today is that quality tends to be in the annual incentive plan as the check on growth, and not in the long-term incentive plan. You see it occasionally, right? And considering that credit has a longer tail, one might expect it would be the opposite, but that's not how you see it in the market.

Aalap: I would have thought that as well, right? Because if you think about quality, you want to have that long tail to it and ensure that it stays consistent over many, many years, so I'm surprised to hear that. Do you think that has something to do with how quality is assessed and maybe doesn't have as much quantitative rigor?

David: I think it may have more to do, Aalap, with industry convention and following the market, whether it's relative TSR or where to put this metric. It varies by bank, and whether we're talking about consumer loans or commercial loans, those can play out over a couple of years, the effectiveness of that. I think it's more about convention. Certainly, nonperforming assets, any kind of asset quality metric, could be measured on a longer horizon.

One of the things we definitely see in banking, a tough issue always with incentives, it starts with setting the targets, but then there's the incentive zone and range, right? The threshold, the maximum. What you tend to see with asset-quality-type metrics, nonperforming assets in the industry, there's a very wide range on incentive metrics. Expense-type metrics have the narrowest range, and earnings metrics are in that traditional sweet spot.

Mark: David, you're talking about doing inventories, but I know one of the things that you also do for your clients is a risk review. And while the purview of the committee tends to be just the executives as it relates to setting pay and incentive programs, isn't there a requirement to think through the risk associated with those other incentive plans?

David: Yes, absolutely, Mark. There's an obligation, again, of the board, which is usually delegated to the comp committee, to assess the riskiness of incentive plans. And that's bank-wide incentive plans, not just the executive plan. It actually includes long-term incentive plans and that's required, as you know, for public companies since Dodd-Frank, right? To make sure there's no material adverse risk.

What's interesting in banking, there's also something referred to as Sound Incentive Compensation Practices. This is something that the Fed promulgated back in 2009, which isn't law, but it's best practice for banks, where it's saying, again, the board needs to monitor these incentive plans. And then lastly, we've got these pending rules under Dodd-Frank related to incentive compensation at regulated financial institutions, Section 956.

But all this means is that every year, management has an obligation to review the incentive plans and determine that they're not creating excessive risk. They're to be sharing that with the compensation committee or the board. And that's an annual obligation, and oftentimes, as the consultant advisor to the committee, we help facilitate that assessment.

Aalap: David, lots more to unpack with long-term incentives, and so hopefully we can have you back again to talk more about that. But really appreciate the time today.

David: Great. Thanks Aalap, thanks, Mark.

Mark: Appreciate it. Thank you.

Jake: Our thanks to David for his insights into how bank incentive programs have to balance performance, risk, regulation, and strategy in a way that is more complex than many other industries. It was a fitting end to our industry series, at least for now.

I suspect we'll be back in your feed soon with more episodes on this and other topics. If you missed any of our episodes earlier this year, please go back and explore our offerings, as we have published episodes related to leadership, hot topics on the Comp Committee agenda, and our industry series examining Life Sciences, Oil and Gas, Technology, Tax-Exempt Organizations, and of course Banking.

You can find these and all of our Unscripted episodes on Spotify, Apple Podcasts, pearlmeyer.com, or wherever you get your podcasts. Thanks as always for listening, and we'll meet you back here soon.