Relative TSR Plans: The Next Generation of Equity

Transcription

1 Relative TSR Plans: The Next Generation of Equity October 21, 2009 Jon Burg and Matt Ward

2 Agenda > The Case for Relative TSR Plans > The Current Equity Landscape > Plan Design and Trends > Question and Answer 2

3 The Case for Relative TSR Plans 3

4 The Old Paradigm? > Is our current way of thinking outdated? Company Issue We expect significant growth and price appreciation over the next few years Our stock has been flat, employee options are significantly underwater, and we do not expect much growth and price appreciation over the next few years Our share pool is extremely constrained and we likely can not successfully go back to shareholders for more stock We want to balance growth but help employees manage some of the market risk (and are willing to forgo some upside to do so) The Compensation Committee and Finance want to manage to a 2% burn rate to manage the expense, EPS and burn rate impact Vehicle of Choice Stock Options Restricted Stock Cash/Restricted Stock Combination of Options/ Restricted Stock Restricted Stock 4

5 Has the Time for Relative TSR Plans Arrived? > Corporate governance opinions on long-term incentive (LTI) vehicles for executives are continually evolving. - Originally, groups like ISS (now known as RiskMetrics Group ( RMG )) were very anti-restricted Stock/Units ( RSUs ) because the only performance required for earn-out was continued employment. - After options fell out of favor following the back-dating scandal, the same groups began to expect RSUs to be part of the top five pay package as an offset to 100% option policies. - Now, as experience with RSUs accumulates, RMG and the like are beginning to insist upon performance-based earn-outs of full-value grants. > Relative TSR (as a Performance Share metric) - Eliminates the difficulty in determining multi-year internal performance targets - Is already reported to shareholders in the required 10-K TSR performance graph > Custom peer groups can also be created based on correlations as well as industry classification codes - Minimizes unproductive dilution - Requires fewer shares than option awards - Potentially increases participant morale and/or retention - Has fixed accounting expense - Is readily measurable/trackable at any time - Is relatively easy to administer - Is already used as a long-term performance metric in 90% of companies in international markets 5

6 Relative TSR Plan > The basic operation of the plan is presented in the following table: Target Share Aw ard X Relative TSR Peer Group Performance Multiplier From Schedule = Actual Shares Earne d > An example of a payout schedule: Sample Relative TSR Award Payout Schedule Awards Earned Upon Vesting MAXIMUM: Comparator Group (CG) + 25% 150% For every 1% in excess of Comparator Group, vesting payouts increase by 2%. Comparator Group TSR + 1% 102% TARGET: Comparator Group TSR 100% Comparator Group TSR - 1% 98% For every 1% less than Comparator Group, vesting payouts decrease by 2%. MINIMUM: Comparator Group TSR - 25% 50% 6

7 Relative TSR Plan Potential Payout $60,000 Employee Value Delivered 1 $50,000 $40,000 Payout $30,000 Zone 1 Zone 2 Zone 3 $20,000 $10,000 $0 3,000 Stock Options 1,000 RSUs 1,000 Relative TSR Units $0 $2 $4 $6 $8 $10 $12 $14 $16 $18 $20 $22 $24 $26 $28 $30 Future Stock Price Zone 1 Downside > Performance-based retention value when options would be underwater > Avoids RSUs straight-lined giveaway often criticized by shareholders Zone 2 Within Normal Distributions > Greater upside leverage than RSUs > Similar to or greater upside than options Zone 3 Outlying Upside > Much greater leverage than RSUs > Similar opportunity to options, but tempers potential windfall gains 1 Assumes 10% comparator group total shareholder return (TSR) in this example. 7

8 The Current Equity Landscape 8

9 The Equity Landscape: Market Decline Stock Price History 50% 40% NASDAQ S&P % 20% 10% 0% -10% -20% -30% -40% -50% 1/2/2002 1/2/2003 1/2/2004 1/2/2005 1/2/2006 1/2/2007 1/2/2008 1/2/2009 > NASDAQ low: October 9, 2002 of 1,114 > NASDAQ high after dot-com bust: October 31, 2007 of 2,859 9

10 The Equity Landscape: How things have changed Today I m not really sure what options are, but I know I want a lot of them and I am willing to give up salary to get them! Recent graduate from Top MBA program I m not really sure what options are, but I know my friend s options are worthless, so I want a high base salary and lot of options Typical new-hire employee I am not looking to put myself at risk by sacrificing cash for equity. I need a competitive base salary and a cash bonus. By the way, do you give out restricted stock? Seasoned employee with a few years experience I feel thankful to have a job. If I get equity this year it is just an added bonus. 80% of employees 10

11 The Equity Landscape: Perfect Storm DILUTION SHAREHOLDERS CASH Managing costs given decreased revenues Limited ROI to tolerate increased dilution Unproductive overhang from years if issuing options and recent market decline EMPLOYEE Limited ROI or retention value Wealth creation opportunities appear limited as the market has softened MANAGEMENT Time for many difficult decisions 11

12 Underwater Options > What do these companies all have in common? > Radford has tracked approximately 70 companies that have launched a tender offer thus far in

13 Prevalence of Relative TSR Plans > While underwater options captured the headlines, another trend in equity has been quietly gaining traction Breakdown of Plan Announcements Per Year 100 Number of Plans Announced Prior to n=256 Recent Relative TSR Adopters Intel Macy s Yahoo Owens Corning Motorola Red Hat BNY Mellon Mattel Logitech Copyright 2009 Radford Citrix Systems Gilead Sciences Agilent Source: 13

14 Plan Design and Trends 14

15 Plan Design Considerations Design Feature Considerations Plan Type Performance Period and Vesting Participation Peer Group Payout Schedule Dividend Treatment Post-employment Provisions Change-in-Control Provisions > Payout in cash or shares? > How long is the performance period? > Cliff vesting or graded? > Will the program be limited to senior management? > Could this plan replace broad-based stock options and restricted stock? > Broad index of peer companies ( already part of annual 10-K or other) > Customized peer group of comparators aligned with CD&A pay peers or other > What level should you use to define the target payout? > How high do you set the maximum? > Do you include a minimum floor payout? (operates as a restricted stock feature) > How do you treat dividends during the payment period? > Do you pro-rate on service following retirement, death, or involuntary termination? > What is the basis for the payout? Target? Future Final Payout Multiplier? > What do you do upon a change in control? 15

16 Types of Payout Vehicles > Radford has also seen that the vast majority of companies favor shares as the final payout vehicle, although the sample size may not allow for any statistical significance 100% Breakdown of Payout Vehicle 75% 50% 77% 25% 0% 12% 12% Cash Shares Combination n=138 Copyright 2009 Radford 16

17 Performance Period and Vesting > Vesting can be structured in a variety of ways, but most companies are employing 3 year overlapping performance periods Three-Year Cliff (Overlapping) Yr. 1 Yr. 2 Yr. 3 Yr. 4 Yr. 5 Yr. 6 Yr. 7 Yr. 8 Yr. 9 Yr. 10 Cycle 1 Years 1-3 Cycle 2 Years 2-4 Cycle 3 Years 3-5 Three-Year Cliff (End-to-End) Yr. 1 Yr. 2 Yr. 3 Yr. 4 Yr. 5 Yr. 6 Yr. 7 Yr. 8 Yr. 9 Yr. 10 Cycle 1 Years 1-3 Cycle 2 Years 4-6 Cycle 3 Years 7-9 Cycle 1 Cycle 2 Cycle 3 Three-Year Graded Yr. 1 Yr. 2 Yr. 3 Yr. 4 Yr. 5 Yr. 6 Yr. 7 Yr. 8 Yr. 9 Yr. 10 Year 1 Years 1-2 Years 1-3 Year 4 Years 4-5 Years 4-6 Year 7 Years 7-8 Years

18 Peer Group Types > Radford has seen that the bulk of companies tend use a custom peer group, but when using an index, the S&P 500 is the most popular and aligns with current required 10-K disclosure Breakdown of Peer Group Selection Custom 3% 2% 10% Any Bloomberg Index Any NASDAQ Index Any Dow Jones Index 9% Any FTSE Index Any REIT Index 3% 3% 2% 3% 3% 61% Any Russell Index Any S&P 400 Index Any S&P Industry Index Edison Electric Index Other 1% S&P 500 1% n=235 Copyright 2009 Radford 18

19 Payouts at Different Percentile Ranks > According to our research, companies using an actual index as a comparator group tend to have a higher percentage payouts Average Max Payout and Median Payout by Peer Group Type Payout Percentage of Target 200% 160% 120% 80% 40% 0% 168% 176% 165% Performance at Max - Payout 82% 88% 75% Performance at Median - Payout n=171 Custom Peer Group - n = 95 Actual Index - n = 70 Undisclosed - n = 6 Copyright 2009 Radford 19

20 Dividend Equivalents > We have also seen a trend in that most companies prefer to pay dividends based on the final payout amount Breakdown of Methods of Paying Out Dividend Equivalents Percentage Using Method 60% 40% 20% 0% 39% Payout at Future Multiplier 29% 17% Payout at Target Does Not Issue Dividend 15% No Payout n=119 Copyright 2009 Radford 20

21 Post-Employment Provisions > The majority of companies payout based on the actual target achieved regardless of whether it is also pro-rated on service Breakdown of Termination/Retirement Provisions Percentage Using Provision 60% 50% 40% 30% 20% 10% 0% 13% 50% Pro-rated with Service 13% 25% Not Pro-rated with Service n=118 Payout at Target Payout at Future Multiplier Copyright 2009 Radford 21

22 Change in Control Provisions > Most companies do not pro-rate the payout on service, but are split on whether the payout is based on target or the actual result achieved Breakdown of Change in Control Provisions Percentage Using Provision 40% 30% 20% 10% 0% 19% 11% 0% 1% Pro-rated with Service 32% 29% 4% 3% Not Pro-rated with Service n=93 Payout at Target Payout at Future Multiplier Payout at Max Payout at Greater Copyright 2009 Radford 22

23 Relative TSR Design Tips > Be cautious of some gotchas with plan design > Pay attention to payout bend-points - Valuation results can differ significantly from expectations > Disconnects between the Grant Date and the Performance Period - Example: Company issued award in March based on a January 1 performance period - Analogous to a headstart or starting from behind in a head-to-head race - Can create very volatile and unpredictable valuation results > Long Averaging Periods - Can create a disconnect between Grant Date from the TSR performance during the averaging period > Treatment of Dividend Equivalents during vesting period - Examples: none, guaranteed at target, or paid out at future payout multiplier - Can create a separate instrument and special valuation 23

24 Conclusion: Have we made a case for Relative TSR? > Recent stock market volatility and a plague of underwater options demonstrate that traditional broad-based equity vehicles can have extreme downsides for the foreseeable future. > Relative Total Shareholder Return (TSR) plans are gaining popularity for executive officer awards. - Vest based on stock performance vs. peers - Directly link payout to shareholder value creation already disclosed in the 10-K > Relative TSR design concepts can be applied to broad-based equity programs to mimic strengths and minimize flaws of traditional options and restricted stock. - Maintain upside potential - Minimize dilution - Provide downside retention - Improve Topic 718 cost efficiencies - Maintain historic payout/vesting schedules (e.g., can be designed to vest 25% annually over four years) > From a shareholder's perspective, Relative TSR programs have a high pay-forperformance linkage for broad-based equity incentive programs 24

25 Thank You! Questions? Contact Information: Jon Burg, Vice President Phone: Matt Ward, Senior Vice President Phone: