Executive bonus plans for banks The Business Review reported that TrustCo Bank Corp of New York reinstated its executive bonus plan that had been suspended for three years during the Great Recession.29 The suspended plan had been based on return on equity and was a large proportion of total compensation.

The revised plan means that the three top executives could receive bonuses up to 25% of their base salaries, which is a much smaller at-risk proportion than the suspended plan. The plan was suspended in 2008 because the board of directors felt, at the time, that it was prudent to make executive compensation less sensitive to performance standards. While the incentive plan was suspended, the bank more than doubled executive base pay. The bank will probably keep their fixed salaries at the new, higher level.

The revised plan for 2011 is based on the bank’s benchmarked return on average assets, return on average equity, efficiency ratio, and the ratio of non-performing assets to total assets.

To earn the maximum bonus, the bank must perform 25% better than the average of peer banks of similar size, in the same region of the US, and that also were not ‘bailed out.’ A spokesperson stated that, ‘We think there should be an incentive program to motivate executives, but it should not be so big that it encourages risk taking and stops us from being what we are, which is sound and safe and conservative.’

Required:

1. Describe how the suspended incentive plan might have motivated TrustCo managers to take excessive risks.

2. Explain how the revised incentive plan moderates risk taking.

3. Discuss whether the new incentive plan should be pushed down into lower levels of management.