How did Bank of Montreal do last year? It was a mixed bag. Its revenue and earnings growth were tops in the industry, but in a lot of important ways – profitability, cost control, share price performance – the bank lagged peers. Indeed, if you look at the proxy circular sent to shareholders in advance of Tuesday’s annual meeting, you’ll see the bank missed every single financial goal it set for its executives.
It may surprise you, then to learn that the bank’s leaders emerged from 2019 with nearly all their incentive pay intact. When the bank looked at its collection of missed marks, it totaled up the damage and docked the biggies a whopping 6 per cent of their annual variable pay. BMO’s top five executives received more than $18-million in cash, shares and options from the payout.
Then again, if you have a long memory, it might not surprise you. In 2010, I wrote about how BMO said it had “four key factors [that]form the foundation” for aligning pay to performance, missed goals on three of them, and still gave then CEO Bill Downe a raise. In the spring of 2015, I again noted that BMO missed on three of four goals, yet gave Mr. Downe more money, largely because of a 35-per-cent increase in his annual bonus.
Now, 2020. Mr. Downe has retired, but new CEO Daryl White is able to benefit from the continued skewed view of incentive pay at BMO.
Let’s look at the scorecard: BMO set a goal of 6.7-per-cent revenue growth, but logged 5.9 per cent. Its goal for return on equity was 14.4 per cent, but it finished at 13.9 per cent. It hoped to grow earnings per share by 7.5 per cent, but ended up at 6.7 per cent.
And BMO aimed for an efficiency ratio – a measure of cost control where lower is better – of 60.7 per cent. It came in at 61.4 per cent. BMO exceeded one non-financial goal – for customer loyalty, as measured by internal surveys.
(A side note: All these numbers are reported in the proxy to shareholders as “results for compensation purposes,” which means they’ve been fiddled with by the board and don’t match the financial statements. This is a whole other topic, for another day.)
Here we now puzzle over how these results yield nearly full bonuses. BMO uses these numbers to create a “business performance factor,” or BPF, that is used to adjust the executives’ target pay. Meeting all the goals results in a 100 per cent factor – receiving the full target. That makes sense.
Missing every goal, however, is not a business performance factor of zero. Instead, BMO takes the margin of the misses, creates a weighted average, and deducts it from 100 per cent. The average miss in 2019 was 6 per cent; hence, a BPF of 94.
BMO uses the formula to adjust not only annual cash bonuses for executives, but also the amount of stock options and share awards they receive. I calculate the “annual incentive” cash payout for the top five BMO executives that was tied directly to this BPF at about $4.5-million, with the rest of the $18-million or so paid in options and share awards.
“BMO has a history of setting challenging financial targets and aligning compensation to those targets,” spokesman Paul Gammal said in an e-mail. “BMO delivered leading peer group performance in 2019 on a number of key financial metrics including earnings per share, revenue growth and operating leverage.”
At first, this formula sounds reasonable. However, if BMO missed every goal by 25 per cent – an unmitigated disaster – executives would still get 75 per cent of their incentive pay.
The Canadian banks have a long history of setting low bars, then often paying our performance share awards even when they come in behind peers. The explanation offered seems to be at play here: If there were the potential for the awards to go to zero, the executives might take on too much risk to hit the targets. So there always needs to be a payout.
However, there’s at least one Canadian company that feels differently. Canadian National Railway Ltd. missed all five of its financial targets in 2019 and paid its top executives zero bonuses – both for corporate performance and individual performance. I ran CN’s numbers through BMO’s formula: Had the CN executives been lucky enough to lead BMO, they’d have got 91 per cent of their bonus, not zero.
Perhaps BMO should look a bit outside the banking industry, and its own history, for guidance on how to construct a pay-for-performance program.