Boot Camp: Executive Compensation 101 Bertha Masuda Susan Schroeder
Agenda Market Context Building Blocks of Compensation Primer on Equity Incentives Case Study
Market Context Current Compensation Environment
The current market environment is challenging The 1990s and Early 2000 Long-running bull market Tight labor market Stock options are free mentality The late-2000s Economic downturn with depressed/volatile stock prices Shareholder activism Tighter regulatory environment Media exposure
Many external and internal constituents impact executive compensation decisions Shareholders & Advisors Media / Public Perception Regulators Board of Directors & Compensation Committee Executive Compensation External Internal Management & Employees Consultants Human Resources & Finance
Building Blocks Components of Executive Compensation
For the company, executive compensation fulfills a number of objectives Competitiveness Alignment Connect with shareholders Attract qualified executives Executive Compensation Retain current executives Performance Focus decision-making Instill a long-term perspective Reward good performance
Executive compensation stems from company goals and business strategy The Company Goal The Company Strategy Performance Measurement and Goals Executive Compensation Philosophy Market definition Pay positioning Pay mix Risk/reward profile Executive Compensation Programs Salary administration Annual bonus Long-term incentives Benefits and perquisites Recruitment and retention Employment protections Components Policies
An executive s wealth can be accumulated during his/her employment At Hire Tenure Termination Compensation Components Sign-on bonuses Initial equity grant Wealth Accumulation Salary Annual bonus Equity grants Benefits Perquisites Change of Control Severance
New hire decisions and compensation can be significant Elements of Employment Agreements Duties Compensation components and process Sign-on bonus or equity grants Termination provisions Non-compete, non-solicit provisions Trends Sign-on bonus/grants increasingly performance-oriented Limitation on severance Bad boy clauses Negotiated renewals At-will employment
Annually, executives are eligible to participate in the following components Ongoing Components Salary Compensates executive for performing his/her day-to-day job responsibilities Annual Bonus 1 year Focuses and rewards executive for achieving shortterm results that create sustained future growth Long-Term Incentive 3 10 years Recognizes and rewards executive for long-term shareholder value creation Provides retention Benefits & Perquisites Employment / post-retirement Enhances overall compensation package Provides security Serves as a retention mechanism Risk Profile Low Moderate Moderate to High Low
Termination provisions are heavily scrutinized due to the payout potential Change of control elements Trigger (single/double) Multiple of Pay Equity Vesting Additional years credit and/or continuation of health benefits Tax gross-ups Trends Double trigger required/limitation of window Limits on COC pay No tax gross-ups
Primer on Equity Incentives Stock Options, Restricted Stock, Performance-based Equity Plans
Each long-term incentive vehicle has its advantages and disadvantages Equity Vehicle Description Pros/Cons Stock Options Restricted Stock Long-term Incentive Plans Right to buy stock in the future at a fixed price Grants of stock with some sort of restriction (e.g., vesting, possibly performance) Plans pay out cash/shares at the end of the performance period if criteria are met Delivers value only if stock appreciates Utilizes a significant number of shares, especially option plans with performance parameters Is less favored in the current environment Less leveraged, but still provides value if stock price decreases below grant price Conserves more shares compared to options Results in tax consequences upon vesting Offers dividends (for companies with dividends) Conserves shares compared to options Ties to Company financial or strategic measures May have unpredictable earnings charges
Performance shares incorporate performance measures and share appreciation 1 2 3 Target Award (# of Performance Units) % of Target Award Earned (as a % of Target) Actual Award (# of Performance Units) Relative TSR 50,000 x 125% = 62,500 Change in EPS 50,000 x 150% = 75,000 Converted to Total Performance Units 100,000 137,500 full shares of Stock Price $50 $75 stock Total Value $5,000,000 $10,312,500
Options are the more leveraged vehicle while shares provide value in down cycles $600,000 $500,000 Comparison of Stock Option, Performance Shares, Restricted Stock ($100,000 Grant Value at $25 per share) 13,333 Options $400,000 $300,000 $200,000 $100,000 Price on Grant Date Performance Shares 4,000 Restricted Stock $0 $16.40 $18.23 $20.25 $22.50 $25.00 $27.50 Assumes 30% Black-Scholes Value $30.25 $33.28 $36.60 $40.26 $44.29 $48.72 $53.59 $58.95 $64.84
Managing overhang and differentiated awards continue to be popular Stock options are still prevalent, but restricted stock and performance share plans are gaining favor Companies are using multiple vehicles Awards are differentiated by employee level Limiting dilution and equity overhang is still important Working with shareholder advisor services is de rigueur
Significant regulations govern executive compensation design Accounting Tax FASB 123(R) Share-Base Payment http://www.fasb.org/st/summary/stsum123r.shtml IRC 409(A) http://www.ustreas.gov/press/releases/reports/td9321.pdf Section 162(m) http://www.americanbenefitscouncil.org/documents/irs_rr2008-13.pdf http://www.irs.gov/pub/irs-regs/td8650.txt Section 280(G) http://www.unclefed.com/tax-bulls/2003/td9083.pdf SEC/Legal requirements Compensation Discussion & Analysis Sarbanes-Oxley Securities Law
Case Example Pfizer Inc.
Pfizer: Company Profile and Strategy Company Profile Company Strategy Global research-based biomedical and pharmaceutical company $48 Billion Revenue Maker of Lipitor, Viagra, and Zoloft Source: Company Website & Proxy Aggressive cost cuts New management team and organizational structure Emphasis on cancer-drug pipeline Focus on new product development Successful launches of new products
Compensation Philosophy Pay Positioning: Peer Group: Objectives:
CEO New Hire Package in 2006 Salary: $ New Hire Grant: Terms of Employment Agreement:
CEO 2007 Compensation Salary Annual Bonus Long-Term Incentive Benefits & Perquisites $ % of total pay $ % Target Opportunity: % of salary Upside: Performance Measures: $ % # of Stock Options # of Performance Shares (at Target) Upside: $ % Type of Benefits & Perquisites: Performance Measures:
Change of Control Scenario: List components and amounts:
Key Take-Aways Get smart by reading the proxy materials and understanding the array of programs offered by your company Eligibility, depth of participation, pay-for-performance leverage, total cost/opportunity, etc. Understand your company s strategy, objectives and culture and the environment its operating in Know who is involved in the decision-making and what s their perspectives Be aware of any sticking points or hot issues