"I think I've been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I've underestimated it. Never a year passes that I don't get some surprise that pushes my limit a little farther."
-- Charlie Munger
Bank of America (NYSE:BAC) announced earlier this month that it gave its CEO, Brian Moynihan, a $3 million pay raise last year. While the bank's performance improved in 2015, which I believe justified his raise, the structure of Moynihan's compensation leaves a lot to be desired.
The majority of Moynihan's compensation is tied to the bank's performance. Of his $16 million pay package, in fact, only $1.5 million consisted of a base salary. The remainder was split evenly between time- and performance-based restricted stock units.
The problem is that Bank of America's board set a low bar for Moynihan's performance-based award, which consists of $7.25 million worth of restricted stock. Two things must happen for him to clear the hurdle: Bank of America needs to earn a three-year average return on assets of 0.80%, and the bank's tangible book value must increase by a three-year annual average of 8.5%.
The latter isn't an issue; it's the return on assets benchmark that should raise shareholders' eyebrows. As a general rule, a well-run bank will earn 1% on its assets, and most high-performing banks consistently exceed that by a substantial margin.
Last year, Bank of America's closest competitors, Wells Fargo and JPMorgan Chase, generated ROAs of 1.32% and 0.99%, respectively. And they did so in an unprecedentedly low interest rate environment, which weighed heavily on bank earnings.
By comparison, Bank of America reported a mere 0.74% return on its average assets last year. That's extremely low, and particularly for one of only three banks in the country with a nationwide branch network. That gives Bank of America not only size, which should translate into economies of scale, but also access to an enormous source of cheap funds -- customer deposits.
The good news is that Bank of America's profitability will have to improve for Moynihan to earn the performance-based portion of his compensation. This follows from the simple fact that its ROA last year was below the 0.80% benchmark. It's worth noting, moreover, that 2015 was the bank's best year in nearly a decade.
But the bad news is that Bank of America's board must not think that the bank will return to the upper echelon of the industry anytime soon. Had they believed this was the case, I think it's fair to say that they would have set the profitability bar higher.
John Maxfield owns shares of Bank of America. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool has the following options: short March 2016 $52 puts on Wells Fargo. The Motley Fool recommends Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.