CBA's satisfying return

Three years ago, Commonwealth Bank embarked on something of an experiment in executive remuneration, introducing a long-term incentive scheme linked to customer satisfaction. It's had mixed success but there are some promising signs.

The scheme was driven by the stubbornly low levels of staff engagement and customer satisfaction created by the radical and disruptive Which New Bank rebuilding of CBA's platform and processes by former chief executive David Murray. Ralph Norris had, in a previous highly successful role as CEO of ASB Bank in New Zealand, had outstanding results by prioritising customer satisfaction.

So, for its senior executive plan, CBA departed from the conventional approach to long-term incentives, which are generally driven by total shareholder return comparisons with peer groups.

The CBA board essentially decides the size of the pool of CBA shares that will be made available to the executives, which has been 2.2 per cent of the growth in net profit since the introduction of the scheme. The profit number is adjusted by applying a capital charge to reflect the levels of risk taken to achieve that growth.

Having determined the size of the pool, the board then splits it into two metrics. One is CBA's cash earnings growth relative to its peers over the period – it has to be better than the average for any of the shares to vest. The other – the level of customer satisfaction – interacts with the first. Shares can only vest if the group achieves its relative financial performance hurdles but the proportion that vests depends on the bank's customer satisfaction rankings relative to its peers.

Those rankings are derived primarily from surveys undertaken by external research groups and cover the various aspects of the group.

When the scheme was introduced, CBA was ranked fifth out of the five largest banks. Had it remained at that level, the executives would have received no long-term incentives, even if they met the TSR hurdle. If they improved to fourth in the surveys, 30 per cent of their rights would vest; at third 50 per cent; second 75 per cent and first 100 per cent.

CBA's financial performance has, despite the financial crisis, been very strong both in absolute terms and relative to its peers. While improving its customer satisfaction levels it was, however, ranked only third among its peer group, which means that only half the available pool of shares – $14.8 million of a potential $29.6 million – will vest.

What will encourage Norris and his senior team, and CBA shareholders, is that beneath the simple ranking there is momentum.

Before the scheme was introduced, CBA wasn't within sight of the sector leader – it was 12.3 percentage points behind it. By June this year the gap had narrowed to 5.1 percentage points. Over the same period its customer satisfaction score has jumped 9.9 percentage points and it says it now has more than four million satisfied customers.

There is plenty of academic literature, and real world experience, to be able to conclude that staff engagement leads customer satisfaction which leads business and financial performance.

The trends in CBA's non-financial performance indicators may not yet have been strong enough to deliver the senior team all that they and their board might have hoped for three years ago but the degree to which CBA has narrowed the gap between itself and the best in a market where all the banks are trying to improve customer satisfaction levels would encourage them to believe that, while the hurdle they chose was unconventional, it is proving effective.