Paying For Performance Around the World

Transcription

1 Paying For Performance Around the World SPEAKERS Terry Adamson, Partner, Radford (US) Mike Albert, Vice President, Fidelity Investments (US) Kevin McDonald, Director of Executive Compensation, Covidien, Plc. (IR) Kathy Winfield, Global Compensation Leader, SPX Corporation (US)

2 Statement of the Problem Associated Press Yahoo CEO Mayer s pay package worth more than $59M CNN Money New Yahoo CEO Marissa Mayer nabs $71 million pay package Reuters Mayer gets $70 million pay package to lead Yahoo New York Times (Deal Professor) Adding Up Marissa Mayer s Pay at Yahoo By my calculations, if Ms. Mayer, the newly appointed chief executive of Yahoo, sticks around for five years, her contract will be at least $117 million.

3 Statement of the Problem Yahoo filed their Proxy on 4/30/2013, and they state that the 2012 value of Marissa Mayer s pay package is $36.6M Wow! So for the same pay package, we are seeing a range from $36.6M to $117M. Is there a warden in this asylum?

4 Statement of the Problem Unlike cash compensation, LTI values are subject to a wide variety of conflicting methodologies for determining compensation Corporate compensation practitioners use LTI market data resulting from a wide variation of methods (HR Values or Survey Values) Accountants and the SEC have a unified approach to LTI valuation (Accounting Values) Corporate governance advocates assess LTI value as an element of their analyses (ISS Values, but we shouldn t forget Glass Lewis and other groups) However, none of these values are as important as Perceived Values, which can be dramatically different

5 HR Values or Survey Values Each compensation survey firm has their own methodology for valuing stock options, restricted shares, and performance shares The following slide summarizes 6 well known firms, and their equity valuation approaches Since many compensation committees are granting equity on a dollar value basis, this accentuates the importance of developing that dollar value appropriately

6 HR Values or Survey Values Method of Calculating Pay Value of Equity Compensation Survey Stock Restricted Performance Cash Firm Options Stock/Units Shares LTI Firm A Black Scholes value 100% of FMV Fair value Excluded Proprietary calculation Firm B Black Scholes value 100% of FMV 100% of FMV at target Excluded individual company value Firm C 1 Black scholes 100% of FMV 100% of FMV at target Excluded 2 Binomial 3 NPV *Growth = 10% *Discount rate = 4.5% *Period = 5 Firm D NPV=45% of FMV NPV=75% of FMV Target less a discount: Target less a discount: *Growth = 10% *Growth = 0% 2 year period = 85% 2 year period = 85% *Discount rate = 6% Discount rate = 6% 3 year period = 80% 3 year period = 80% *Period = 5 Period = 5 4 year period = 75% 4 year period = 75% 5 year period = 70% 5 year period = 70% Firm E Risk Adjusted PV 100% of FMV 1 Target value Included *Growth = 12% plus option value 2 Fair value *Discount rate = 12% *Period = 5 Firm F Risk Adjusted PV PV of RAPV 1 Target value 1 Target value *Growth = 12% plus option value *Discount rate = Rf *Growth = 12% *Period = 3 *Discount rate = Rf *Period = 3

7 Accounting Values (under ASC 718 and IFRS2) FASB and IFRS have prescribed strict rules on the approach for valuing employee equity Typically, that involves the use of the Black-Scholes model, a binomial model, or Monte Carlo simulation For accounting purposes, all of the terms and conditions need to be considered in the valuation (we will get into some of the terms and conditions that need to be considered) The accounting values will also be disclosed in the Proxy for all Named Executive Officers

8 Accounting Values Black-Scholes, Binomial, or Monte Carlo S 5,0 S 4,0 S 4,4 S 3,0 S 5,1 S 2,0 S 4,1 S 1,0 S 3,1 S 5,2 S 0,0 S 2,1 S 4,2 S 1,1 S 3,2 S 5,3 S 2,2 S 4,3 S 3,3 S 5,4 S 5, % % % % % 3.125%

9 ISS Values Each of the governance groups (ISS, Glass Lewis, and others) have their own proprietary methodologies for calculating equity value ISS applies a proprietary binomial value Use a 3-year historical volatility (no use of implied volatility) Use the full contractual term Other economic assumptions are generally comparable Glass Lewis uses a proprietary model (Black Box) The following slide illustrates that the ISS value can be quite divergent from the accounting value. This slide was actually disclosed in Adobe s proxy

10 ISS Values - Example Adobe Systems DEF14A 3/1/2012

11 Other en vogue ideas of value Intrinsic value Realized value What the award was worth when exercised (options), vested (RS and PS), or paid (cash LTI) Realizable value What the award would be worth (right now) if fully paid out o Captures intrinsic value o Eliminates bias of unexercised options

12 And Perceived Values can be quite different than HR Values, Accounting Values, or ISS Values We will now get into some examples that help illustrate how these can differ The first is from an actual recent grant from BlackRock, who filed the following Form 4 with the SEC on 1/23/2013

13

14 The BlackRock Example - More In summary, Laurence Fink (CEO) was granted 37,472 shares of BlackRock stock on 1/18/2013 when the stock price equaled $ At first glance, this appears like an $8.8M grant (37,472 x $233.93) But wait, the footnote says he only gets them if, Value of $4,750,000 converted to a number of Restricted Stock Units using a $ per unit value. The per unit value used for conversion represents a discount to the full value of a share of BlackRock due to the risk of not meeting the following vesting schedules. A) 33% vests if stock is $ for at least 20 consecutive trading days, B) 33% vests if stock is $ for at least 20 consecutive trading days, C) 34% vests if stock is $ for at least 20 consecutive trading days; Expires in 6 years if stock price targets are not hit

15 The BlackRock Example - More So, if the Compensation Committee wanted to grant an award value of $4,750,000, then it could be done in various ways. Let s think about 2 possible alternatives: Alternative 1: Grant 37,472 discounted performance shares with these restrictions ($ x 37,472 = $4.75M) Alternative 2: Grant 20,305 time-based shares without any restrictions ($ x 20,305 = $4.75M)

16 The BlackRock Example - More $ Millions $14.00 $12.00 $10.00 $8.00 $6.00 $4.00 $2.00 Time Based shares pay out optimally Crossover point $290 Performance Shares pay out optimally $0.00 $233 $243 $253 $263 $273 $283 $293 $303 $313 $323 $333 $343 Highest Future Price over Next 6 Years The Performance Awards are much more leveraged The awards make a big statement about the expectation of future stock price growth: a $4.75M gamble that the stock price is $291 or greater.need to achieve at some point 3.6% annual return over 6 years to reach crossover point Alternative 1: Performance Shares Alternative 2: Restricted Shares

17 The BlackRock Example - More More and more, Compensation Committees are approving a dollar value ($) generally based on accounting dollars under ASC to be granted in LTI to an executive This is largely because the accounting values under ASC 718 are required to be disclosed in the Proxy. Therefore, the executive team has every incentive to add provisions that optimize the accounting valuation by adding provisions that lower the valuation What are some levers that can optimize the equity value? In the BlackRock example, they used stock price hurdles in the future to discount the value by 46%. (i.e. $ goes to $126.76)

18 Additional Levers for Optimization Stock Options or Stock Appreciation Rights Truncate contractual term from 10 years to 5 or 7 years Capping the future payout at improbable levels Full Value Shares or Performance Shares Stock Price hurdles (like BlackRock did) Negative TSR thresholds Capping the Maximum future value at improbable levels Post-vesting holding restrictions Clawbacks (discount allowed under IFRS2, not under US GAAP)

19 Stock Options: Truncated Terms and Caps Shorter Contractual Terms of 7 Years or less became popular in 2006 Volatililty 10 Years 7 Years / Reduction 30% 33.0% -14.0% 40% 41.4% -13.1% 50% 49.2% -12.4% 60% 56.5% -11.7% 70% 63.2% -11.0% 80% 69.2% -10.2% Capping the future payout at improbable levels Discount Achieved at Various Cap Levels Volatility 500% 400% 300% 200% 30% 0.42% 0.45% 2.88% 11.32% 40% 2.01% 3.93% 7.44% 21.01% 50% 6.71% 7.36% 13.85% 30.36% 60% 10.41% 13.20% 21.36% 39.41% 70% 13.61% 19.05% 27.99% 47.01% 80% 20.34% 25.71% 35.51% 53.66%

20 Shares: Stock Price Hurdles and Negative TSR Thresholds Stock Price Hurdles Negative TSR thresholds If a share vests if you have positive Total Shareholder Return over 3 years. If you have a negative TSR over 3 years, it does not vest. Expect a 30%- 35% discount from face.

21 Shares: Payout Caps and Post-vest Holding Restrictions Payout Caps Post-Vest Holding Restrictions generally can be reduced by risk-free rate of return during the restrictive period. During periods of low RFR not as helpful, but if/when a steeper yield curve returns, the discounts can be more significant.

22 One More Example - Relative TSR Performance Awards Example 1a: Currently, company ABC trades at $10 per share. An individual is granted a target of 100 awards contingent on the TSR of company ABC s stock price against a basket of comparators. Valuation: $14.33 or 143% of face value (Both examples use a 50% volatility, a 1% RFR, and 0% dividend yield)

23 Relative TSR Performance Awards (continued) Example 1b: Currently, company ABC trades at $10 per share. An individual is granted a target of 100 awards contingent on the TSR of company ABC s stock price against a basket of comparators. The final value at payout cannot exceed $4,000 Valuation: $11.40 or 114% of face value QUESTION: What would you rather have? What is your perceived value of each of these awards? 100 Shares of Alternative 1a or; 120 Shares of Alternative 1b

24 Findings from a service provider s perspective SPEAKER Mike Albert, Vice President Fidelity Investments (US)

25 There is a real opportunity for communication of value to participants this is being addressed by some issuers, but missed by many others More cooperation is needed between the finance/accounting teams, plan design teams, and equity administration teams to coordinate the value message Stock Options 40% Adjusted for company culture and participant background Performance Shares 40% Studies have shown that more complicated plans are considered less valuable Review of details of design and value analysis Trend towards simplifying performance metrics Behavioral economics theories being applied to U.S. defined contribution programs not so much in equity compensation design

26 LTI Program at SPX SPEAKER Kathy Winfield, Director Global Compensation, SPX (US)

27 SPX is a global, Fortune 500 company with a more than 100-year heritage of innovation. We have operations in more than 35 countries and approximately 15,000 employees. We collaborate with our customers to solve complex problems and deliver real world solutions that help meet rising global demand for food and energy. Everywhere You Look

28 LTI Program Prior to 2013 Award Value Restricted Stock Units (RSU) Performance Stock Units (PSU) Based on a fixed share amount, award values shift annually based on share price. Time-based award introduced as portion of annual grant in Performance-based restricted stock unit awards vest ratably provided specified business performance criteria is met for each tranche. If performance criteria not met, then tranche expires without vesting. Goals: Provide multiple long term incentive vehicles Measure and reward relative performance Award shares based on value, not number of shares ELIGIBILITY: ~300 non-officer executives located primarily in US, UK, China & Germany Prior to 2012, Annual Awards Were 100% Performance Based

29 Our Perspective: Performance results 2005 through 2012 met the performance criteria 90% of the time Introduction of timebased RSUs in 2012 well received by participants Participant feedback to better understand & appreciate the reward Influence from ISS be more mainstream New LTI Program for 2013 Award Value Restricted Stock Units (RSU) Performance Stock Units (PSU) Awards denominated in dollar value, then converted to a number of units based on share price. A greater portion of the annual grant is time-based. Performance-based award vest provided specified business performance requirements are met after 3 years. Shares may be earned above or below the target award (25% to 125%). A More Mainstream Approach that Rewards Financial Results and Provides Strong Retention Incentive

30 Value-based LTI Awards Illustration Converting the value of the award to a number of units to be granted considers an appropriate fair market value Time-based RSUs at full share price Performance-based at fair value price based on Monte Carlo valuation model Lower share price, more units; higher share price, less units value of the award remains the same Grant Type 2012: Fixed Share Award (50/50 based on shares) 2013: Value based Award (75/25 based on dollars) Time 450 $62.64 $28, $70.47 $36,715 Perf 450 $45.90 $20, $54.26 $12, $48, $48, Earn 25% (56) to 125% (281) provided performance is achieved. Total shares possible for maximum performance Same Value with More Certainty of Earning for Our Executives

31 In summary Did not believe our program was broken, but desired a more mainstream approach including: Multiple vehicles with appropriate portion of time-based and performance grants based on job level Performance grants that vest based on relative performance Value-based awards replacing former fixed share approach Significant change in program required solid change management plan, including: Socialization with senior executives as well as our business unit leaders including their HR and Finance partners Award communications highlighting the changes and addressing anticipated FAQs upfront Participant webinars post-award to ensure understanding On-going communication strategy with participants New LTI Program Has Been Well Received

32 LTI SharePoint Site Frequently Asked Questions Interim Performance Indicators e-learning Fidelity Stock Plan Services Local HR Business Partner Ongoing Communications With Participants

33 LTI Program at Covidien SPEAKER Kevin McDonald, Director of Executive Compensation Covidien, Plc. (IR)

34 Spun from Tyco International in 2007 Is a global medical device and pharmaceutical manufacturing company with nearly $12 Billion in annual revenue 2012 Sales by Segment 2012 Sales by Geography Medical Supplies $1.8B Pharmaceuticals $2.0B Medical Devices $8.1B Other Americas $0.7B Asia-Pacific $1.9B Europe $2.7B United States $6.6B

35 Medical device products in the endomechancial, soft tissue repair, energy, airway & ventilation, oximetry & monitoring and vascular markets Generic and branded pharmaceuticals, active pharmaceutical ingredients, contrast agents and delivery systems, radiopharmaceuticals Medical supplies including wound care, incontinence, needles and syringes, enteral feeding, operating room kits and accessories

36 Covidien s first annual grant in Grant All Employees Used a mix of three equity vehicles All employees received performance share units Calculated and communicated on a value basis Stock Options 50% RSUs 25% Performance Shares 25%

37 How Covidien Converts and Communicates Grant Value to Shares The closing price on date of grant is used to determine the number of shares, including performance shares The accounting value of those shares is approximately 25%-30% greater than the grant price that we communicate $14,500 Grant to Employee 50% Stock Options $7,250 Value of Option $7,250 $42.94 x (Black-Scholes Ratio) 730 options granted 25% Restricted Stock Units $3,625 Value of RSU $3,625 $ RSUs 25% Performance Shares $3,625 Value of PSU $3,625 $ PSUs

38 In 2011, made changes to the performance share portion of our equity mix Altered equity mix in 2011 based on: Market data Experience of employee understanding Division of equity grants Cost vs. value 2008 Grant All Employees 2011 Grant Stock Options 50% RSUs 25% Performance Shares 25% Stock Options 40% RSUs 20% Performance Shares 40% Stock Options 50% RSUs 50%

39 Future considerations on communication and valuation Likely to continue using grant date prices to calculate and communicate value, though more sensitive to the cost of performance shares Stock Options 40% Changes were made to the payout curve (raised the threshold) which reduced expense Performance Shares 40% Have discussed negative TSR threshold, and other plan features for stock options Continue to discuss balance between employee communication and valuation

40 Thank you! Terry Adamson Mike Albert Kevin McDonald Kathy Winfield