Risk Level – LOW: Retention Level – HIGH
These types of benefits focus on the franchise value of the bank and on providing a very strong retention. Why? By definition, supplemental executive retirement plans, SERPs, (also known as Non-Elective Non-qualified Deferred Compensation Plans) are a liability (debt) of the bank to the executive and subject to the claims of creditors in the extreme case of the bank’s failure. Since the payment of the compensation is dependent on the long-term continuation of the bank, the executive’s incentive is to avoid risks that might threaten the bank’s franchise. With regards to retention, a significant deferred benefit payment provides a strong reason to remain in the employment of the bank until retirement.
Perhaps because of some abuses or just a misunderstanding of SERPs, these types of benefits fell out of favor in some banking circles. But with a new understanding of how these plans work, and because of their positive elements regarding risk and retention, SERPs have been attributed an important position in a compensation portfolio. A Harvard Business Review article advocated Banks paying executives with “DEBT”, as well as equity, to reduce risk. A Boston University School of Law empirical study indicated bank CEOs’ inside debt holdings prior to the financial crisis was “significantly positively associated with bank performance”. A properly developed and implemented NQDC plan is an important part of a balanced compensation package.
Why are SERPS a Practical Component of Compensation?
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Note that the following assumptions were made: Constant $18,000 401(k) contribution made + $6,000 catch-up contribution; a 4% annual salary increase, a 6% annual interest rate in all years, assumes no matching contributions and retirement at age 65.