Will CIBC try to save its U.S. deal? There’s a clue in the fine print

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Like all of CIBC's 44,000 employees, chief executive officer Victor Dodig faces a year-end performance review that determines his take-home pay.

There may be a few more zeros in the CEO's paycheque – he made $8.1-million last year – but the boss has the same conversation as other staff about whether the bank achieved its targets. However, the criteria CIBC uses in setting his pay all but guarantees that Mr. Dodig will want to raise the bank's $3.8-billion (U.S.) bid for Chicago-based PrivateBancorp Inc.

PrivateBancorp, a commercial bank with 1,200 employees, postponed a planned shareholder vote on CIBC's takeover this week after it became clear that the $47-per-share offer made last June would be voted down. Blame U.S. president-elect Donald Trump for the setback: U.S. bank stocks have rallied furiously in the wake of the November election. A CIBC offer that appeared sweet in the summer now looks cheap.

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What's the next move? Some hedge funds are betting CIBC will up its offer to something in the $55 range and spent the week piling into PrivateBancorp stock, in part because they've read CIBC's regulatory filings and they know what drives the size of Mr. Dodig's paycheque.

In simple terms, the boss gets paid for growth. The same is true for CEOs at rival banks, and most other public companies. That approach to compensation drives strategy.

In each year's proxy circular, CIBC uses HR jargon and fancy formulas to describe how the CEO is rewarded. Stripped down to basics, the proxy circular reveals that 70 per cent of the CEO's compensation comes from deploying the bank's capital in a manner that increases profits and revenues.

Another 15 per cent of pay is based on "employee culture," which may be part of the reason why Mr. Dodig is tireless in visiting branches. The final 15 per cent is awarded if he doesn't blow up the bank – in bank-HR-speak, managing the "risk appetite." This approach means there's every reason for the CEO to roll the dice on deals.

Finding growth markets was the biggest challenge facing Mr. Dodig when he took the top job two years ago. Where the other Canadian banks had significant operations outside Canada, CIBC relies on domestic clients for more than 90 per cent of revenues. Canada's economy is growing at modest 2 per cent annual clip. As the smallest of the five big banks, CIBC faces serious headwinds trying to squeeze more profit from a slow-growth home market.

Before announcing the PrivateBancorp deal, Mr. Dodig consistently said CIBC planned to expand its U.S. operations through acquisitions. He had necessary cash: The bank has far more capital on its balance sheet than regulators require. And CIBC had a modest base to build from, as it acquired a small U.S. wealth management operation called Atlantic Trust in 2014.

Buying PrivateBancorp and adding its commercial banking operations to Atlantic Trust's services represents the first real step in Mr. Dodig's U.S. expansion strategy. But without this acquisition, CIBC doesn't have a U.S. expansion strategy.

There is no cheaper alternative deal to be done if this one fails. The same investor sentiment that lifted PrivateBancorp's stock has propelled the U.S. benchmark for regional bank stocks up by 44 per cent. Every potential target now commands a premium price.

It may be tempting to say this market is now frothy, and walk away from PrivateBancorp in the hope the Trump rally fizzles and bank valuations fall. But timing markets is a mug's game.

Toronto-Dominion Bank and Royal Bank of Canada did large U.S. retail bank acquisitions in recent years that were judged as expensive at the time – they look prescient now. Analyst Sumit Malhotra at the Bank of Nova Scotia said the economics of the PrivateBankCorp takeover made sense at $55 a share, and "walking away from the deal would put CIBC back in the familiar position of the Canadian pure play looking to deploy capital in the U.S."

After years of watching the bank retrench, CIBC's owners are frustrated: Only 43 per cent of shareholders approved of the bank's approach to compensation in a non-binding vote last year. Mr. Dodig has millions of reasons to complete a PrivateBancorp takeover that launches the bank's assault on the U.S. market. He doesn't get paid if CIBC doesn't grow.