Executive Compensation at Credit Unions

By Daniel Koslovsky
The Developing Economist
2016, Vol. 3 No. 1 | pg. 1/2 |


This study is the first to examine credit union executive pay using compensation information from IRS Form 990. Using OLS, logistic, and tobit regression analysis to identify the determinants of base and bonus compensation of chief executive officers (CEOs), this paper finds evidence of misaligned incentives between CEOs and the institutions' member-owners{ although caution is needed when trying to reach firm conclusions because of the limits of the study. Higher fees and lower dividend payments are costly to the credit union members, and yet are correlated with higher compensation for executives. On the other hand, improving the efficiency of the credit union through lower operating expenses has little to no impact on compensation at credit unions. Instead, financial performance indicators such as asset growth and net worth are positively related to higher pay. Other factors such as smaller boards or using a compensation consultant impact the bonus an executive receives.

I. Introduction

The purpose of this study is to examine the CEO compensation practices of credit unions. Specifically, I examine the factors that determine the base compensation for a credit union CEO, study what determines whether a credit union CEO will receive a bonus, and analyze the incentives credit unions provide for CEOs through bonus compensation. Extensive research has been done on executive compensation in for-profit firms. The banking sector in particular came under close scrutiny in the last decade for the role executive compensation structures may have played in the financial crisis. In comparison, nonprofit executive compensation has been studied much less. While there is a growing literature examining how nonprofits incentivize their executives, the topic of executive compensation for credit unions has yet to be properly analyzed.

Credit unions play an important role in the US financial system and conduct business in a unique environment. At the beginning of 2015, there were over 6,300 credit unions in the United States, with total assets amounting to about $1.173 trillion. While the total assets in credit unions are over ten times smaller than the banking sector, they still constitute a significant portion of the US financial system. Moreover, credit unions provide a unique setting to examine executive compensation that has so far gone unexplored. Credit unions operate at the intersection of the nonprofit sector and the banking sector. As a nonprofit, credit unions are subject to the same advantages and constraints as all nonprofits|they are tax exempt, they have a social mission that is principal over making profit, and their compensation is subject to the nondistribution constraint, meaning income cannot be distributed to managers. Unlike most nonprofits, credit unions receive all of their revenue from commercial activities and are in direct competition with for-profit organizations, banks. Determining the incentives used by credit union directors will provide us with insight to what credit unions set as their objectives and how that compares to their expected mission. Additionally, the results for credit unions have broader implications as they could be used to make generalizations about all commercial nonprofits.

I use 2013 compensation data from Schedule J of IRS Form 990, combined with annual 5300 Call Report data collected by the National Credit Union Administration, to regress base and bonus compensation of credit union CEOs and presidents (from here on just referred to as CEOs) against credit union characteristics. I find that the base compensation received by credit union CEOs is significantly determined by financial performance. Further, CEOs are more likely to receive a bonus if their credit union employs a compensation consultant. Finally, evidence suggests that credit unions disincentivize better member services.

The rest of the paper proceeds as follows. Section II provides background and a literature review of previous studies of executive compensation. Section III details the data that is used in this study and the econometric models for base and bonus compensation are introduced. Section IV provides descriptive statistics of the data. Section V presents the results of the equations and offers analysis. Section VI concludes.

II. Background and Literature Review

For-Profit Executive Compensation

Executive compensation has been given extensive attention in the for-profit literature. It is typically studied under the paradigm of the principle-agent model, in which a company's board is the principle and the executives are the agents. The incentives of the board and the executive rarely match; the board seeks profit maximization for the firm, while the executive possesses rent-seeking incentives. This incentives mismatch incurs agency costs onto the board, which typically manifest in the compensation given to the executive, but also can take the form of welfare loss (Jensen & Meckling, 1976). To incentivize the executive to take actions that are in the best interest of the firm, the board's most effective tool is the way in which they compensate him/her, typically through bonuses that promote firm profit and discourage rent-seeking.

Following the most recent financial crisis, possible incentive misalignment in financial firms resulting from executive compensation structure was studied to see what role it may have played in precipitating the crisis. Prior to the recession, risky investments, most notably mortgage-backed securities, were increasingly made in order to maximize short-term profits. The failure of these investments catalyzed the recession. Once the market crashed, many economists began to investigate how compensation structures affected risk-taking in financial firms. One school of thought believes that executives were not overly incentivized towards risk-taking because the losses they assumed following the crash wiped out any short-term gains from extra risk (Fahlenbrach & Stulz, 2011). Bebchuk, Cohen & Spamann (2010) counter this argument by showing that, although executives at Bear Stearns and Lehman Brothers lost all or almost all of the value on the bonus stock options at the height of the crisis, they still cashed out enough of their bonus options in the years prior to have made a lucrative amount of money overall. Thus, it is possible to conclude that the compensation structures in place before the crisis incentivized executives to make overly risky investments because it was in their best personal interest.

Looking at long-term trends, executive compensation among for-profit firms has risen sharply in the last few decades. As Frydman and Saks (2008) point out, the real value of executive compensation was strikingly at from the end of WWII into the mid-1970s regardless of aggregate firm growth, firm performance, or overall economic performance. They use longterm data on executive compensation to challenge the theories that the rise in pay is directly tied to performance or growth in firm size. Instead, they posit that the increase in executive compensation is a result of either increased board diligence or changes in social norms that made higher relative incomes more acceptable.

Nonprofit Executive Compensation

Nonprofits offer a notable contrast in executive compensation structures. Just like in for-profit firms, agency problems with executives must be addressed by the board. Distinct from forpro fit firms, nonprofits have a limit to how much they can incentivize their executives because they are subject to the non-distribution constraint, which prohibits nonprofits from distributing net earnings to anyone who oversees the organization. Additionally, nonprofits must balance maintaining the financial soundness of the organization with a social mission that is often difficult to quantify.

Agency theory plays an important role in the nonprofit sector as well, but the theoretical work is much less developed. Within the existing work, there are two views. One side of the arguments suggests that that principle-agent relations in nonpro fits are more problematic than in for-profits because of the difficulty in defining organizational objectives and ownership issues arising from the absence of shareholders. These issues make it more difficult for nonprofit boards to effectively control executives. In contrast, others believe that large, independent donors can effectively monitor and control management, thus reducing agency costs (Caers et al. 2004). But, both sides of the argument acknowledge that executive compensation plays major a role in controlling for agency problems.

The nonprofit executive compensation literature has identi fied a few key factors in determining a CEO's pay. Frumkin and Keating (2001) find a weak link between the amount of executive compensation paid out and the performance measures of improved fundraising results or better administrative efficiency. However, they attribute the weakness of the link to the non-distribution constraint as organizations with freer cash ows pay their CEOs significantly higher wages. Baber et al. (2002) and Hallock (2002) suggest that for charitable nonprofits changes in compensation are linked to charitable output. The former provides evidence that pay is significantly and positively associated with the level changes in spending on the organization's objectives. While the latter finds that a higher proportion of expenses going towards the nonprofit's mission leads to higher compensation. Evidence in support of nonprofit CEO compensation being related to financial performance is found by Sedatole et al. (2014), who find that increases in revenue and change in net assets are associated with higher pay. Finally, Balsam & Harris (2015) use IRS Form 990 data to examine nonprofit executive compensation's relationship to performance and found that bonus pay is positively associated with profitability, available cash, and the use of compensation consultants, and negatively associated with donations and charitable nature. In sum, it appears that nonpro fit executive compensation is usually linked to the achievement of the organization's social mission and the financial sustainability of the nonprofit.

In addition to social output and performance, board oversight appears to play an important role in determining executive compensation. The logic behind the relationship between board oversight and executive compensation is that more oversight means closer monitoring of CEOs by the board, which reduces the amount the board must pay to combat agency problems. Moreover, board size matters as well|a bigger board is believed to broaden the focus of an organization, making the incentives provided in the form of compensation less concentrated and therefore smaller. Balsam & Harris (2015), Hallock (2002), and Aggarwal et al. (2011) all examine the relationship between the makeup of nonprofit boards and executive pay. Balsam & Harris (2015) provide evidence that board approval reduces bonus pay, but that the size of the board has no effect. Hallock (2002) finds mixed results for board size and executive pay; he shows that the number of paid directors is significantly and negatively related to compensation, while the number of unpaid directors is positive, but not robust. Lastly, Aggarwal et al. (2011) discover strong evidence that nonprofit board size is negatively associated with managerial incentives, particularly for commercial nonprofits. While the literature is mixed on whether board oversight definitively plays a role in compensation, it is clear that if a relationship exists it is a negative one.

Credit Union Executive Compensation

Credit unions provide an interesting environment to study executive compensation because they exist at the intersection of banks and nonprofits. Banks want to maximize profit, so they incentivize CEOs using performance and risk measures. Nonprofits exist to maximize social output, so they incentivize executives to spend more on their social mission, reduce administrative expenses, and ensure the financial viability of the organization. Credit unions are nonprofit organizations; their raison d'etre is to serve the financial needs of their members (Cargill et al. 1980). But, they also face stiff competition for business from for-profit banks and rely solely on the commercial revenue they generate from that business for income. This seemingly creates a paradox for credit unions, they must balance incentivizing member services with financial performance.

While there has not been any previous academic work examining executive compensation in credit unions, some attention has been paid to nonprofits who derive almost all of their income from commercial revenue. Aggarwal et al. (2011) find that such organizations, termed commercial nonprofits, are larger than traditional nonprofits and pay their executives more. Moreover, commercial nonprofits typically have a smaller organizational focus, smaller board size, and stronger managerial incentives. Change in revenue is found to be signi ficantly positively related to compensation, but not more so than traditional nonprofits. Aggarwal et al.'s findings suggest that credit union compensation will be similar to nonprofit compensation, but the scope of their analysis between commercial nonprofits and traditional nonprofits is fairly limited. Thus, extensions of this the commercial nonprofit and credit union literature are necessary to expand our understanding of these sectors.

III. Data and Model Specifications


To examine executive compensation for credit union CEOs I pulled compensation data on all state chartered credit unions with over $500 million in assets at the end of 2013 from IRS Form 990 Schedule J. IRS 990 forms were found at the National Center for Charitable Statistics (NCCS) and using Foundation Center's 990 finder. The sample was limited to state chartered credit unions because federally chartered credit unions are not required to file annual IRS 990 forms. Data is used from the end of 2013 because it is the most recently available. There were 223 state chartered credit unions with over $500 million in assets at the end of 2013. Of the 223 credit unions, a 990 form could not be found for five of them1, no Schedule J was provided for four of them2, compensation data was only available upon request for two of them3, and no CEO was listed for three4. This left me with a sample of 209 credit unions and 210 CEOs. Navy Army Community Credit Union changed CEO's in the middle of 2013, so they had two CEO's listed on their call report. Since it appears that both CEO's were employed by the credit union before and after the change, I assume that the compensation data in the 990 form re ects a full year and leave both executives in the dataset.

The compensation data were then merged with the quarter four 2013 Call Report data from the National Credit Union Administration. Average credit union wage data for the county in which a credit union is headquartered uses data from the Bureau of Labor Statistics.

Empirical Model

I use OLS regression analysis to estimate the effects of different credit union characteristics on base compensation. A logistic regression model is used to identify what determines whether a CEO receives bonus compensation. Lastly, to estimate the amount of bonus compensation I use a tobit model. Robust standard errors are used in each equation in order to control for heteroscedasticity.

Equations (1)-(3) estimate the natural log of base compensation, the probability of a CEO receiving bonus compensation, and the natural log of bonus compensation received:

Each equation contains matrices Pj,Mj, and Xj.

Matrix Pj is composed of the credit union financial performance variables net income growth, loan growth, asset growth, net worth, non-interest expenditures as a share of total assets, and return on assets. The growth rates measure the change in the variable from the fourth quarter of 2012 to the fourth quarter of 2013. Each financial performance variable provides a way of measuring distinct indicators of a credit union's financial health. The connections between the empirical variable and the conceptual measures are fairly straightforward; net income growth measures the growth in profitability, loan growth measures the growth of new business for a credit union, asset growth measures a credit union's growth in size, net worth measures the level of size, non-interest expenditures as a share of total assets is a measurement of the operating costs of a credit union, and return on assets tells us how well a credit union's assets are performing. Based on the existing non-profit executive compensation literature, we should expect to see net income growth, loan growth, asset growth, net worth, and return on assets to be generally positive. Reverse causality is a concern for net worth because a credit union with a higher net worth will likely have more money to provide its CEO as compensation. In contrast to the other financial performance variables, non-interest expenditures as a share of total assets is expected to be negative. This variable measures the operating costs of a credit union. From what we know from the non-profit literature executives who can reduce the operating costs of their organization will be rewarded. Between the five financial performance variables, the ones we should expect to be largest in magnitude based on previous executive compensation studies are non-interest expenditures as a share of total assets and loan growth.

Mj contains the variables that measure the member services provided by a credit union: member growth, share of income from fees, and dividend yields. We should expect member growth and dividend yields to have positive coefficients. Credit unions have incentives to grow their membership because more members typically means more business, both in deposits and loans. Additionally, if a credit union's membership is growing, then that could be a proxy for good services attracting more members. As for dividend yields, the conceptual link is quite straightforward: members are going to prefer credit unions with higher dividend yields because that means they are getting a higher return for their deposits. Finally, the share of income from fees is expected to be negative|ceteris paribus, the more a credit union charges in fees, the worse for its members. Out of the three member service variables, dividend yields is expected to have the greatest magnitude because it is the most direct way of measuring credit union member benefits.

Finally, Xj is made up of a number of miscellaneous variables that may have an effect on executive compensation, including whether a credit union uses a compensation consultant, how many board members a credit union has, the gender of the CEO, and, in order to control for differences in cost of living across the country, the average salary of the credit union employee in the county in which a credit union is headquartered. The literature tells us to expect credit unions that use a compensation consultant to provide a higher bonus and for a credit union with more board members to give lower bonus compensation. There is no literature I surveyed that examined gender in non-profit executive compensation pay, but based on wage trends in the US the expected sign is positive, meaning higher compensation for males.

In equations (1) and (2), the CEO for East Texas Professional Credit Union was left out because the 990 form listed his base compensation was over $2.8 million and there are no other CEOs who receive even $1 million. Therefore, this observation is either an error or a major outlier. Similarly, the three CEOs whose ratio of bonus compensation received to credit union assets in millions exceeded 790 were also excluded. The cutoff was set at 790 because the ratio of the three CEOs who are greater than 790 are over twice as large as the next closest CEOs ratio, making it a clear break in the data that are either outliers or mistakes in the 990 form.

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