EXECUTIVE COMPENSATION Strategy Governance CMM May 18 Presentation PPT

TRENDSIN

EXECUTIVE COMPENSATION

WMACCAMay 18, 2010

Catherine M. Marriott, Williams Mullen

Christopher McGee, Mercer

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Trends in Executive Compensation

• Executive pay design is driven by a number of factors:– employer goals and priorities– legal and regulatory requirements– best practices, perception within the market,

institutional investors (RiskMetrics) • This presentation will examine the conceptual

framework for executive pay and incentives, recent regulation of these arrangements, and the latest trends in executive compensation.

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Compensation Strategy• Corporate philosophy is the starting point

– Attract, motivate, retain top talent• Salary (employment contracts)• Bonus and incentives• Golden parachutes• SERPs

– Align interest of executive with shareholders• Equity compensation• Share ownership guidelines/requirements

– Align interest of executive with stakeholders• New(er) concept• Who are the stakeholders?

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Compensation Strategy• Pay determination

– External Competition• Reference to pay for similar jobs at competing companies• SEC disclosure rules require comparison in stock price of peer

group companies• Benchmarking by consultants

– Internal Equity• Comparison among similar jobs in the same company• Internal pay relationships

– Pay for Performance• Achievement of pre-established goals• Corporate and/or individual • Are guarantees consistent with this concept?

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Compensation Strategy• Pay delivery - form and proportions of pay over time

– Base pay or salary– Variable pay (bonus or other cash incentive)– Equity compensation (stock options, SARS, restricted stock,

stock units)– Deferred compensation– Supplemental retirement plans (SERPs)– Severance (golden parachute/change in control payments)– Perquisites

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Regulatory Environment

• Executive pay has been in the spotlight for several years, driven largely by negative corporate/financial events.

• Fallout from the ENRON collapse followed by a depressed stock market in 2008, and government intervention has resulted in even more regulation.

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Regulatory Environment• Existing Tax Law: 162(m) and 280G• New Tax Law: 409A• Changes to Securities Disclosure in 2010• TARP: clawbacks, prohibition of golden parachutes, say-

on-pay• Federal Reserve guidance on incentive compensation:

risk mitigation• Pending legislation

– TARP concepts may be applied to all public companies– Focus remains on risk, corporate governance, disclosure,

excessive pay, deductions for stock options

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Regulatory Environment: Section 409A• 2004: Congress passes the American Jobs

Creation Act and includes a new section of the Internal Revenue Code: 409A– 409A is implemented post-Enron to deal with

perceived abuses in executive deferred compensation

– It addresses the form and timing of deferred compensation

– It does not address compensation generally, incentive compensation, severance, or golden parachutes

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Regulatory Environment: Section 409A

• Section 409A must be analyzed in most aspects of executive compensation– Can drive bonus and incentive award design– Can drive severance pay structure– Can drive reimbursement promises– Requires advance planning because it makes

timing of payout hard to change

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Pending LegislationDATE TITLE AUTHOR

June 17, 2009 White Paper: Financial Reform: A New Foundation

Obama Administration

July 10, 2009 Investor Protection Act of 2009 Treasury Department

July 31, 2009 (passed by House)

Corporate and Financial Institution Compensation Fairness Act of 2009

Frank (House)

May 7, 2009 Excessive Pay Shareholder Approval Act Durbin (Senate)

May 7, 2009 Excessive Pay Capped Deduction Act of 2009 Durbin (Senate)

May 19, 2009 Shareholder Bill of Rights Act of 2009 Schumer (Senate)

June 12, 2009 Shareholder Empowerment Act of 2009 Peters (Senate)

December 2, 2009 (passed by house)

Wall Street Reform and Consumer Protection Act

Frank (House)

April 15, 2010 Restoring American Financial Stability Act of 2010

Dodd (Senate)

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Pending Legislation• Senators Charles Schumer, D-NY, and Maria

Cantwell, D-WA, introduced the Shareholder Bill of Rights Act of 2009. If enacted, the bill would require:– Shareholder advisory votes on executive pay (say-on-pay)

and golden parachutes– Proxy access for shareholders to nominate directors– Independent board chairs– Annual director elections– Majority voting for directors– Establishment of a board committee of independent

directors responsible for evaluating the company’s risk management practices

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Pending Legislation• Corporate and Financial Institution Compensation

Fairness Act– Proposed by Barney Frank and passed in the House on

July 31, 2009; focus is corporate governance– Includes a non-binding shareholder vote on compensation for

NEOs (say-on-pay)– Requires disclosure on golden parachutes plus a separate

advisory vote– Requires independence of compensation committee (no

consulting or advisory fee; no affiliates)– Compensation committee may engage independent

compensation consultant, counsel, other advisors– Financial institutions would have to disclose incentive-based

compensation programs to regulators

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Pending Litigation

• Senate Banking Committee has approved the American Financial Stability Act of 2010 (Dodd). The bill includes provisions on say-on-pay, compensation committee and advisor independence, clawback requirements, and more proxy disclosure.

• There likely will be intense debate on the bill.

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Common Themes in Pending Legislation

• Say-on-Pay: Separate shareholder vote to approve compensation of NEOs. Nonbinding

• Golden Parachutes: disclosure and shareholder approval• CEO/Chairman: Separate the roles• Clawbacks: implementation of procedure• Independent Compensation Consultant: compensation committee

can retain consultant• Risk Assessments: SEC already requires this disclosure• Independent Compensation Committee: Most, if not all,

compensation committees of public companies meet these standards

• Disclosure of Employee Hedging: prohibit or disclose financial instruments used to hedge company stock awards

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Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

• SEC Final Rule adopted December 16, 2009, to enhance compensation and corporate governance disclosures

• SEC Final Rule will require significant additional compensation disclosures– Risk Management– Summary and Director Compensation Table

disclosure– Board disclosure re: qualifications– Accelerated reporting of voting results– Compensation consultant disclosure

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Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Risk Management• Companies must address compensation policies

and practices for all employees if they create risks that are reasonably likely to have a material adverse effect on the company– This should trigger very few disclosures since most

companies do not have plans that are reasonably likely to have a materially adverse effect

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Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Risk Management, cont.• Companies may consider policies and practices that

mitigate or balance incentives in deciding whether compensation-related risks are reasonably likely to have a material adverse effect

• Disclosure is part of the proxy statement section on Executive Compensation, but not part of the Compensation Discussion & Analysis– However, companies may want to disclose in the CD&A

their process for evaluating risk and their policies for mitigating risk such as clawbacks, stock holding requirements, etc.

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Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Risk Management, cont.• Company does not need to make an affirmative

statement that it has determined that risks are not reasonably likely to have material adverse effect

• Examples of risk may include a business unit that has a compensation structure significantly different than the rest of the company or a business unit that carries a significant portion of the company’s risk profile

• Given the narrow definition of risk, few companies outside of financial services will have any disclosure requirements

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Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Summary and Director Compensation Table Disclosure• Full grant date fair value of stock and option awards

included, not amount expensed for fiscal year– May result in different executives designated as most

highly paid (based on sum of all compensation elements except deferred compensation earnings and changes in pension values)

• For performance awards, grant date fair value based on probable outcome of performance conditions, not maximum performance

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Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Summary and Director Compensation Table Disclosure, cont.– Footnote disclosure required of maximum value assuming

highest level of performance• Transition: For fiscal years ending on or after

December 20, 2009, companies must recompute disclosure for preceding fiscal years presented in SCT: stock awards, option awards and total compensation columns should reflect full grant date fair values– Not required to include different NEOs for any preceding

fiscal year based on recomputing those years

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Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Board Disclosure• Disclosure required annually for each director and each

nominee, which includes:– Particular experience, qualifications, attributes, or skills

that led the board to conclude that the person should serve as a director

– Directorships at other public companies or registered investment funds held at any time during the past five years

– Legal proceedings involving directors, nominees, and executive officers extended from five to ten years

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Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Board Disclosure• Disclose board leadership structure and rationale:

– Whether and why the company combines or keeps separate the CEO and chairman positions

– Why the company believes that this structure is most appropriate

– Whether and why the company has a lead independent director and what specific role the position plays in the leadership of the company

– Description required pertaining to the board’s role in risk oversight and how it organizes risk management practices (in Corporate Governance section)

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Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Accelerated Reporting of Voting Results• The results of shareholder votes must be reported

on a Form 8-K within four business days after the meeting where the vote took place

• Rules include preliminary disclosure within four days even where final outcome is uncertain until definitive voting results are known and a second more accurate filing can be made, for example in contested director elections

• Disclosure required regarding whether and, if so, how nominating committee considers diversity

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Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Compensation Consultant Disclosure• Fees paid to board compensation consultants and

their affiliates (or to management compensation consultants if the board has none) providing executive compensation and additional services must be reported only if the aggregate fees for additional services exceed $120,000 for the fiscal year

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Regulatory Environment

• The Federal Reserve will work with the SEC to improve the disclosures provided by public banking organizations in ways that promote the safety and soundness of these organizations

– The Federal Reserve guidelines require disclosure even where no SEC disclosure is required because a company concludes that compensation arrangements are not reasonably likely to have a material adverse effect

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RiskMetrics: 2010 Focus

• Withhold votes for Directors may occur on a CASE-BY-CASE basis (their emphasis) in areas such as pay and performance, defined by:– One- and three-year TSR are in bottom half of peer

group and– CEO total compensation is not aligned with TSR,

considering• Five-year period• Mix of pay• Performance-based incentives (options do not count)

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RiskMetrics: 2010 Focus

• Withhold votes may also occur if a company’s programs contain any features on the “problematic pay practices” list, such as– Multi-year guarantees for salary increases, non-

performance based bonuses, and equity compensation – Change-in-control payments exceeding 3 times base salary

and target bonus – Tax reimbursements related to executive perquisites – Dividends or dividend equivalents paid on unvested

performance shares – Repricing of underwater stock options/stock appreciation

rights without prior shareholder approval

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RiskMetrics: GRId Methodology• RiskMetrics has announced a new tool to assess

governance-related risk called Governance Risk Indication (GRId)– Absolute basis compared to “best practices”– Best practices are aligned with RiskMetrics proxy voting policies– Governance risk is measured in 4 categories- audit, board,

shareholder rights, compensation– Each category is given a score with a concern level (low, medium, and

high)– Purpose of the scoring system is to encourage disclosure– RiskMetrics will not use the GRId ratings to determine proxy voting

recommendations• Will use corporate governance policies• Rating will not guarantee positive vote recommendation or cause a

negative vote recommendation

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Implications for 2010: Decision-making in a more stable environment

Improvement in the stock market

• S&P 500 has recovered over 150% since its March 2009 low – Many 2009 grants already have substantial paper

gains

Companies may get a pass for their 2009 decisions but not for 2010.

Shareholders will expect a return to fundamentals.

Companies may get a pass for their 2009 decisions but not for 2010.

Shareholders will expect a return to fundamentals.

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Implications for 2010: Decision-making in a more stable environment

Cautious signs of economic recovery

• Automakers move through bankruptcy in record time and some TARP recipients have paid back government funds

• Unemployment is still very high, as jobs and job growth tend to lag economic recovery

• Economic recovery may mean that some incentive plans ending in 2009 may pay out

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Implications for 2010: Alignment with performance is critical

Pay aligned with results

Pay mix

Risk management

Sustainable results

Pay practices

Shareholder engagement

Long-term incentives and general use of equity are top-of-mind in 2010Long-term incentives and general use of equity are top-of-mind in 2010

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Outlook for 2010: Base pay for executives

• Executive Salaries are slowly defrosting• A majority of organizations plan to increase

salaries for 2010 (65%) or at least to restore reductions made last year (11%). Still, about a quarter of companies won’t be increasing salaries and most of those didn’t provide increases last year either. Increases are expected to be modest (2.8% on average).

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Outlook for 2010: Base pay for executives

Action (N=123) Percent of participants

Reduced salaries in 2009 and will likely restore reductions 11

Reduced salaries in 2009 and have no plans to restore reductions 1

Froze salaries in 2009 and will likely increase 2010 salaries 36

Froze salaries in 2009 and have no plans to increase salaries for 2010 19

Increased salaries in 2009 and will likely increase salaries in 2010 29

Increased salaries in 2009 and will likely not increase in 2010 4

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Outlook for 2010: Short-term incentives

• Examining risk and alignment with results

• Incentive plan goals have been in the spotlight. Organizations want to set credible goals that will motivate employees, but in many cases the economic outlook remains uncertain. At the same time, shareholders and legislators are demanding that pay be aligned with performance.

• Target annual incentive levels are remaining constant, however, there are plan design changes underway. Nearly half reported that they have introduced or plan to introduce new performance measures to their annual incentive program.

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Outlook for 2010: Short-term incentives

Annual incentive program changes - made or considering for 2010

4%

6%

7%

6%

6%

15%

15%

17%

33%

8%

20%

0% 10% 20% 30% 40%

Provide for mandatory payout of all or portion of aw ard in stock

Decr. maximum payout opportunity

Incr. maximum payout opportunity

Decr. threshold payout opportunity

Incr. threshold payout opportunity

Allow for increased discretion related to payouts

Decr. range of performance for corresponding payout levels

Incr. range of performance for corresponding payout levels

Introduce new relative measures

Introduce new non-financial measure(s)

Introduce new financial measure(s)

Op

tion

s

Percent of organizations

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Outlook for 2010: Long-term incentives

• Back to fundamentals• Like annual incentive plans, LTI programs are also

being examined, although the pace of change has slowed since 2009. A majority of companies expect to deliver the same value of LTI in 2010 as was granted in 2009. A number of companies expect to deliver higher values because of the appreciation in stock prices throughout 2009 and early 2010– There is a noticeable trend in using performance to

differentiate grant size among individuals

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Outlook for 2010: Long-term incentives

– There is also an increase in the use of performance shares/units. Companies that use performance shares/units continue to examine the performance metrics

• 25% of companies are adjusting the current range of performance

• Some companies are considering the use of shorter measurement periods with a deferred payout

• Some are converting the more traditional 3-year performance period to a series of 1-year performance periods with payout at the end of a 3-year timeframe

– For non-executive participants, the top action under consideration is a decrease in program participation.

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Initial Perspectives for 2010

3

5

11

11

12

12

15

15

16

5

3

9

16

2

16

7

21

6

93

92

80

74

87

72

79

64

79

0% 20% 40% 60% 80% 100%

Implement holding periods for equity awards

Eliminate dividends on unvested performance shares

Reduce executive severance or change-in-control benefits

Supplement competitive pay benchmarking with other analyses

Separate CEO and Chairman of the Board

Implement a recoupment or clawback policy

Eliminate gross ups or commit to doing so in future contracts

Complete a risk assessment of compensation programs

Reduce perquisites

Implemented in 2009 Planning to implement in 2010 No changes planned or implemented

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Contact Information

Catherine (Kate) M. Marriott

Williams Mullen

(w) 804-783-6901

(f) 804-783-6507

[email protected]

Christopher McGee

Mercer

(w) 202-331-2545

(f) 202-296-0909

[email protected]