Executive compensation in the say on pay era winning the shareholder value

Specializing in executive compensation programs, she advises clients on topics such as annual and long-term incentive performance metric calibration and plan design, equity pool manageme

Executive Compensation in the Say-on-Pay Era

Winning the Shareholder Vote — Without Losing the Election

Presenters: Doug Friske, James Kroll, Steven Seelig, Olivia Wakefield

April 7, 2011

Today’s experts

Doug Friske is the global leader of Towers Watson's Executive Compensation business and

is based in Chicago He has more than 20 years’ experience advising a wide range of organizations on all aspects of executive compensation.

James Kroll is a senior consultant in Towers Watson’s Executive Compensation practice, based in New York He specializes in corporate governance and executive compensation issues and assists clients with shareholder approval of equity plans, advisory votes on executive pay and other compensation-related governance issues.

Steve Seelig is the executive compensation counsel for Towers Watson’s Research and Information Center in Washington, D.C His expertise includes the taxation, accounting and legal implications (including SEC disclosure requirements) of all forms of executive

compensation and perquisite programs

Olivia Wakefield is a senior consultant in Towers Watson’s Executive Compensation practice, based in Boston Specializing in executive compensation programs, she advises clients on topics such as annual and long-term incentive performance metric calibration and plan design, equity pool management and corporate governance

Current context: Business performance has bounced

back to pre-recession levels

Net Income and Cash Flow

Source: Standard and Poor’s Compustat® database.

So, what are we seeing as the say-on-pay era unfolds?

z Overwhelming support for pay plans for most companies in the current

say-on-pay cycle (at least so far)

z Pay levels that have returned to mid-2000 levels

z Incentive designs that are essentially unchanged in recent years

z Continued correlation between pay and performance

z Push back on “poor” pay practices

z More complete and thoughtful disclosure

z Ongoing debate regarding the rigor in goal setting and the role of explicit

performance conditions for long-term incentives

It appears that most companies are getting it right, but with shareholders and

other constituents paying close attention, the situation can change quickly

Now we’ll take a look at where we’ve been — and where we’re headed

Recent Trends in Pay Levels and Practices:

What We Know About Say-on-Pay Votes, So Far James Kroll

Recent Trends in Pay Levels and Practices

The Tale of the Proxies

The sample…

January 21, 2011 (deadline for required say-on-pay votes under Frank) that filed proxies by late March

Annual Revenue*

Market Capitalization*

*In millions of dollars.

Source: Standard and Poor’s Compustat® database.

2010 pay levels clearly reflect companies’ improving

performance

2009 Median Change

2010 Median Change

The total pay mix really hasn’t changed that much

Source: Towers Watson Executive Compensation Resources.

58%

LTI

What has changed is the long-term incentive mix

Companies may be reacting to the recent volatility in the market

and are less comfortable using as many options

Prevalence of performance measures in long-term

incentive plans remained fairly constant…

Prevalence of Long-Term Incentive Performance Measures

Source: Towers Watson Executive Compensation Resources.

Cash Flow ROE Other Non-Financial

Revenue ROC/ROIC Operating Income/Margin

TSR EPS/Net Income

2010 2009 2008

…as have annual plan measures for the most part…

Prevalence of Annual Incentive Plan Measures

ROE ROC/ROIC Cash Flow Operating/Strategic

Revenue Business Unit Performance

Operating Income/Margin

Individual Performance

EPS/Net Income

2010 2009 2008

…although a number of companies made adjustments in

2010

z A quarter (25%) of companies changed the performance measures used for

2010 annual awards from those used in 2009

z Almost as many (24%) changed performance goals used for 2010 LTI

awards

Source: Towers Watson Executive Compensation Resources.

Bottom line: Many companies continue to fine-tune

their programs to try to get it right

The distribution of CEO bonuses is back to pre-crisis

…and the alignment with performance continues to be strong

18%

16% 66%

2010

Source: Towers Watson Executive Compensation Resources.

We also saw a close correlation between investor returns and the value of LTI granted that the CEO realizes

Three-year TSR (2008 to 2010)

Companies made more one-time grants in 2010

grants in 2010, compared to 16% in 2009

z In both years, the great majority of these grants were time-based

Source: Towers Watson Executive Compensation Resources.

2009 Companies Making One-Time and/or Retention Grants

16%

84%

„ One-time or retention grants made

„ No grants made

2010

29%

71%

Finally, our review found many changes in CD&As

z They are longer

z Average length increased by 7%

z Executive summaries are now the rage

z Half (50%) of companies added an executive summary during 2011, so that a majority (64%) of companies now include one

z Disclosures of annual plan goals improved

z Fully 85% of companies disclosed the specific performance goals for the

2010 plan year

z More than three-quarters (78%) of companies showed actual performance attained for 2010 to support the bonus paid

What We Know About Say-on-Pay Votes, So Far

Key observations to date

similar to last proxy season

come in for added scrutiny

highly situational

Early say-on-pay votes show most companies are

receiving strong shareholder support…

*Source: Towers Watson Executive Compensation Resources analysis as of April 4, 2011.

Support for Say-on-Pay Proposal

…but a negative ISS vote recommendation has an impact

Services (ISS) vote recommendations have received above-average opposition from shareholders

proposals

z On average, only about 46% of shareholders at each of these companies

voted in favor of the say-on-pay proposal

z ISS recommended votes against these proposals, citing such concerns as a pay-for-performance “disconnect” or change-in-control provisions containing tax gross-ups

ISS Vote Recommendation

Number of Companies

Votes in Favor

Subpar TSR performance doesn’t necessarily result in a negative ISS vote recommendation

Negative recommendations

(32%)

Source: Towers Watson Executive Compensation Resources analysis as of April 4, 2011.

Say when on pay: After an early push for triennial, annual votes gain steam

receive majority support

received majority support

Original

Frequency

Recommendation

Companies Recommending Frequency

Frequency Implemented Frequency

Decision Pending Annual Biennial Triennial

After say-on-pay, now what?

Some next steps to consider

shareholder support

engagement process and the timing of outreach efforts

What’s on the Regulatory Horizon?

One set of Dodd-Frank enabling regulations was released

in late March…

Exchange Listing Requirements — “Independence”

Disclosure of

“Conflicts of Interest”

Who Compensation consultants, lawyers and other

advisors to the compensation committee

Compensation consultants

What Factors in evaluating independence:

1 Other services provided by the advisor’s

firm

2 Fees as a percentage of firm revenue

3 Policies and procedures to prevent

conflicts of interest

4 Other business or personal

relationships with compensation

committee members

5 Company stock owned

Proxy disclosure expanded to address:

z Whether the work of the compensation consultant raised any conflict of interest

and, if so, the nature of the conflict and how

…while we await others later in 2011

z How will pay be measured?

z What is the time period required?

z How will performance be measured — only TSR?

z Will this be in place for the 2012 proxy?

Disclosure of pay for performance

1

Disclosure of CEO pay versus median employee pay

2

z Repeal legislation has been introduced in the House

z SEC officials have testified to Congress that there is little leeway because the statute requires median rather than average compensation

Clawbacks of compensation paid based on misstated financial results

3

z Can discretion be exercised in enforcing the clawback?

z Would existing contracts be grandfathered?

z How is incentive compensation defined?

z Would the SEC regulate indemnity clauses?

Wrap-up and Q&A

Where do we go from here?

z Even if your 2011 vote was highly favorable, things can change year to year depending on performance and pay

z Understand the input from shareholders and proxy advisors

conform to have a successful program or shareholder vote

z Significant value created the past few years, given market volatility

z Influences expectations, with big vesting cliff likely on the horizon

making

z Consider potential pay-for-performance rationalization and disclosure

Watch for our soon-to-be-launched blog,

Executive Pay Matters , for ongoing updates and information

on the latest trends and emerging issues in executive pay