innovative approaches to executive compensation This could be the year it all begins to change.

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1 Since the adoption of Say-on-Pay in 2011, companies have struggled to develop innovative approaches to executive compensation that still pass shareholder muster. This could be the year it all begins to change. Talent, Rewards & Performance Radford Perspectives 6

2 Executive Compensation A rising tide may lift all boats, but could more shareholder waves be on the horizon? With contributions from: Brett Harsen, Partner Edward J. Speidel, Partner Nora McCord, Associate Partner Ram Kumar, Associate Partner Rob Surdel, Partner Ted Buyniski, Partner Since the adoption of Say-on-Pay in 2011, companies have struggled to develop innovative approaches to executive compensation that still pass shareholder muster. Say-on-Pay voting has ushered in an era of increasingly homogenous plan design primarily focused on relative total shareholder return (TSR) metrics. What s more, boards, advisors, shareholders and the broader governance community were rightfully pre-occupied with Dodd-Frank compliance as new regulations rolled out at a fairly regular pace between 2011 and Plan design innovation simply wasn t on the agenda. However, this could be the year it all begins to change. Once game-changing regulations like Say-on-Pay are now mainstream and fully incorporated into the everyday life of boards. It also seems likely that many remaining Dodd-Frank rules waiting to be enacted could be reversed or amended in the near future (we go into more detail below). Additionally, business activity in the United States is expected to accelerate in Investors are clearly bullish, having already priced anticipated tax and regulatory relief into the stock market. A robust economy will affect executive compensation in several ways, including larger incentive payouts, growth in the value of long-term incentive awards and holdings, and loftier shareholder expectations for earnings growth. For context, at the end of February 2017, the trailing 12-month price-to-earnings ratio for the S&P 500 reached This far exceeds the historical average benchmark of 15.5x, according to research firm Birinyi Associates. We already see the effect of a rising tide and strong sector-wide performance in our data. Per Figure 1 below, from 2015 to 2016, the median value of annual long-term incentive awards for CEOs across our global technology and life sciences databases grew by more than 20%. A bullish economy and decisions in Washington could have a significant impact on the design of executive compensation plans in 2017 and beyond by opening doors for companies to bring more innovation back into plan design. On the pages that follow we outline several key issues worth watching as the year progresses. Figure 1 Median Value of Annual CEO Long-Term Incentive Awards (in Millions) Sector Percent Change 3-Year Returns for NDX and NBI Indices Technology $2.58 $ % 37% Life Sciences $2.63 $ % 17% Source: Global Long-Term Incentive Reports from the Radford Global Technology Survey and Radford Global Life Sciences Survey Note: Option award values calculated using Radford s standard Black-Scholes methodology. Note: The NDX index represents the Nasdaq 100 as measured from 12/31/2013 to 12/27/2016. The NBI index represents the Nasdaq Biotechnology Index as measured from 12/31/2013 to 12/27/2016. Talent, Rewards & Performance Radford Perspectives 7

3 The Future of Dodd-Frank The roll-out of Dodd-Frank has consumed the executive compensation community since it was passed into law in Now, the conversation around Dodd-Frank has suddenly pivoted to speculation over which elements of the law will survive the new political landscape in Washington D.C.. Figure 2 below highlights the compensation and corporate governance provisions in the Act that appear safe and those that could be on the chopping block. Figure 2 Status of Dodd-Frank Compensation and Governance Rules Statute Current Status Likely Future Status Say-on-Pay Implemented in 2011 Very likely to remain in place Say-on-Golden Parachute Implemented in 2011 Very likely to remain in place Compensation Committee advisor Independence Implemented in 2011 Very likely to remain in place Board leadership disclosure Implemented in 2011 Very likely to remain in place Compensation Committee Independence Implemented in 2011 Very likely to remain in place Hedging of company stock Rule proposed in 2015 Very likely to remain in place; already broadly implemented Clawbacks Rule proposed in 2015 May be modified to omit certain qualifications or removed altogether Pay-for-performance disclosure Rule proposed in 2015 May be modified to include additional metrics or removed altogether CEO pay ratio disclosure Final rule goes into effect Jan Of any Dodd-Frank compensation rule, this one is the most likely to be removed through Congressional action Talent, Rewards & Performance Radford Perspectives 8

4 In just the past year, the number of non-sayon-pay related compensation proposals dropped from 131 to 73. In general, it is our view that rules already fully integrated into corporate governance processes, most notably Say-on-Pay voting, are safe from change. More controversial provisions of Dodd-Frank, which have yet to be implemented, such as the CEO pay ratio disclosure rule, are on shakier ground. In these cases, boards find themselves in a precarious position: How much energy should they invest in policy decisions and disclosure requirements that may never come to fruition? At the moment, we encourage clients not to expend too much time and resources on pending Dodd-Frank items that look likely to be amended or thrown out, pending further notice from the new White House administration or the Securities and Exchange Commission (SEC). Meanwhile, since the passage of Say-on-Pay, we ve also observed a dramatic drop-off in the number of compensation-related shareholder proposals. In just the past year, the number of non-say-on-pay related compensation proposals dropped from 131 to 73. Meanwhile, the overall number of shareholder proposals filed increased from 820 in 2013 to 916 in 2016, according to Institutional Shareholder Services (ISS). Investors are clearly using Say-on-Pay as their primary method for voicing concerns with executive pay, and now, shareholder activists are filling the void left behind by severance, pay-for-performance and other compensation-related proposals with more proposals aimed at climate change, political contributions and other social advocacy issues. We expect this trend to continue. The topics of compensation and social good intersect in a major way when it comes to the gender pay equality movement, which is gathering significant momentum. Various forms of fair pay and gender pay laws are proliferating in places like California, Massachusetts and the United Kingdom, to name a few. At Radford, we are working with a number of clients across the globe on auditing their pay programs to determine if, and how, biases exist in talent and rewards programs, along with developing strategies to eliminate unconscious bias. Talent, Rewards & Performance Radford Perspectives 9

5 Incentive Design: New Metrics, Scrutiny over Discretion For years, companies have complained that Dodd-Frank, proxy advisors and institutional investors were attempting to take a one-size-fits-all approach to executive compensation. Regardless of industry, stage of development or corporate strategy, methodologies for assessing comparator groups, plan design and pay-for-performance were universally applied. The pendulum now appears to be swinging back in the other direction, pushed by investors and external advisors like ISS. This suggests greater diversity in plan design, especially when it comes to metrics, is on the horizon. ISS decision last year to expand the list of financial metrics it uses to quantitatively evaluate CEO pay-for-performance alignment is a step in the right direction. It is likely only a matter of time before ISS extends its new policy formally into its quantitative screening process. In addition to TSR, ISS will now look at return on invested capital (ROIC), return on equity (ROE), return on assets (ROA), revenue growth, earnings before interest, tax, depreciation and amortization (EBITDA) growth, and growth in cash flow from operations. While these metrics don t always apply to some of our earlystage clients, especially pre-commercial biopharmaceutical companies, we think a more open-minded approach from ISS and other institutional shareholders is a good thing. Companies need to continue pushing on this issue by making compelling cases for choosing incentive plan metrics that speak to their specific business needs and goals. For our clients in the technology and life sciences sectors, we expect to see continued use and proliferation of the metrics cited in Figure 3, which is by no means an exhaustive list. Of note, board discretion around incentive plan goals will continue to be heavily scrutinized by shareholders and proxy advisory firms. While there are often legitimate reasons for boards to use discretion, compensation committees should be very careful about how they communicate and disclose their reasons for adjusting goalposts. We see a potential battle brewing between shareholders and companies over how much discretion boards should have when adjusting performance goals and payouts, especially if a prominent case of abuse is publicized by the media. Talent, Rewards & Performance Radford Perspectives 10

6 Figure 3 Some Common Metrics Used to Quantitatively Evaluate CEO Pay-For-Performance Alignment Technology Sector Companies Margin growth Market share New product introduction / development Customer satisfaction Life Sciences Sector Companies Achieving significant product milestones New product introduction Quality and compliance Patient satisfaction Talent, Rewards & Performance Radford Perspectives 11

7 Pricing Volatility into Your Equity Program Most companies in the technology and life sciences sectors have experience dealing with the impact of stock price volatility on their compensation programs. In 2016, the tempestuous stock market began with one of its worst performances ever to start a new year before rebounding soundly in the second half of And although the stock market is off to a very strong start in 2017, we know from experience that past results don t guarantee future performance, especially in technology and life sciences. Whether your stock is going up or down at the moment, we all need to be taking volatility into account. Companies that aren t performing as well as their peers find themselves struggling with employee retention more than ever before as the gap between the haves and have-nots widens. This explains the notable uptick in stock option exchange programs in 2016, which occurred despite long-standing investor push-back against exchanges. While option exchange programs often exclude executives and directors, programs of this nature, along with selective retention grants, are something to consider if you still have a heavy mix of options in your equity incentive plan and find yourself out of step with the rest of the market for the foreseeable future. To avoid the challenges associated with underwater stock options, along with many other factors such as managing dilution, technology companies continue to move to restricted stock units (RSUs) and performance shares into their CEO equity mix. Figure 4 below illustrates the multiyear shift underway. Figure 4 Average CEO Equity Vehicle Mix: Technology Companies Options Restricted Stock Performance Shares % 25% 25% 15% 55% 60% Radford Global Technology Survey Long-Term Incentive Report, 2013 and 2016 Talent, Rewards & Performance Radford Perspectives 12

8 Life sciences companies on the other hand, continue to rely heavily on stock options, and actually added more options into their CEO equity mix from 2013 to In the high stakes world of drug approvals where long development cycles can result in scientific winners and losers, this approach will payoff for some, but the risk vs. reward dynamic inherent in options only grows more acute as volatility climbs. Figure 5 below illustrates life sciences equity practices. So what can companies do to insulate their equity grants from stock price volatility in an era where TSR-based performance plans are becoming increasingly standard? Along with exploring the use of more diverse equity portfolios and performance metrics, some of our clients in the highly-volatile life sciences industry are changing the way they size equity awards, focusing not only on value, but on grant levels as a percentage of outstanding shares. Furthermore, if your company wants to maintain a valuebased approach to setting equity award grant sizes, it may make sense to consider targeting higher or lower market percentiles within your peer group. Aiming for the 40th vs. 50th vs. 60th percentile of the market could have profound impacts on the affordability of your equity program and potentially send a strong pay-for-performance message. While knowledge of broader market trends as well as the views of institutional investors and their advisors is important, we continue to believe that boards should remain focused on designing pay programs that are tailored to the specific facts and circumstances of each organization and support their own short- and long-term strategic objective as opposed to simply adopting the prevailing practice of the day. Experience has taught us that this approach is always in the best interests of longterm, responsible shareholders. Furthermore, when this approach is combined with a clear and compelling story in the CD&A and a structured shareholder outreach program, investors are likely to demonstrate their support in the Sayon-Pay vote. Figure 5 Average CEO Equity Vehicle Mix: Life Sciences Companies Options Restricted Stock Performance Shares % 4% 18% 16% 74% 80% Radford Global Life Sciences Survey Long-Term Incentive Report, 2013 and 2016 Talent, Rewards & Performance Radford Perspectives 13