Executive Compensation Alert Inside RiskMetrics Group 2010 Compensation Policy Updates Introduction Key Changes in Overall Evaluation Approach Executive Compensation Evaluation Policy Executive Compensation Policy Update Pay for Performance Five-Year TSR Evaluation Unchanged or Marginal Decreases Problematic Pay Practices Volatility and Stock Prices Assumptions for Equity Plan Proposals Burn Rate Table for Key Industry Sectors Alert 2009-11 RiskMetrics Group 2010 Compensation Policy Updates U.S. Corporate Governance Policy Introduction As part of its annual policy updates process, on November 19, 2009, RiskMetrics Group ( RMG ) released the 2010 Updates to its U.S. Corporate Governance Policy and related Frequently Asked Questions on U.S. Compensation. The new policy updates are effective for public companies holding annual shareholders meetings scheduled to occur on or after February 1, 2010. The updates relating to RMG s policies on executive pay evaluation and equity-based and other incentive plans are summarized below. Key Changes to RMG s Overall Evaluation Approach 2010 RMG Policy: Executive Compensation Evaluation Policy This new integrated, holistic policy incorporates guidelines from the following three former RMG policies related to executive compensation: Pay for Performance; Poor Pay Practices; and Management Say on Pay (MSOP). Instead of having three separate frameworks for evaluating a company s compensation practices relative to a particular ballot item, this new policy allows RMG to integrate its overlapping policies and simplify its vote recommendation process. The MSOP proposal will now be the primary communication avenue to initially address problematic pay practices, with additional or alternative negative recommendations on director elections in egregious or continuing situations and/or equity plan proposals. RMG s Updates to Its Executive Compensation Policy 2010 RMG Policy: Pay for Performance 2009 Policy Under the 2009 policy, RMG may issue an AGAINST/WITHHOLD vote recommendation on: (i) MSOP proposals; (ii) director (generally compensation committee members) elections; and (iii) equity plan proposals if a pay-for-performance disconnect exists between the company s total shareholder return ( TSR ) performance and the CEO s compensation. Copyright 2009 Aon Hewitt 1 December 4, 2009 / Alert
A pay-for-performance disconnect exists if a company s one- and three-year TSR falls in the bottom half of its four-digit GICS industry group, and the CEO s year-over-year total direct compensation ( TDC ) has increased. (Total direct compensation is defined as the sum of base salary, bonus, non-equity incentives, grant date fair value of stock awards and options, target value of performance shares/units, change in pension value and nonqualified deferred compensation earnings, and all other compensation.) If RMG identifies a pay-forperformance disconnect, it will further scrutinize the company s executive compensation proxy disclosure to determine whether any of the increase in the CEO s TDC is attributable to nonperformance-based equity compensation. (Note: RMG does not consider time-vested stock options and restricted stock to be performance-based compensation.) Key Changes for 2010 Five-Year TSR Evaluation: Under the new policy for 2010, RMG will consider the alignment of the CEO s TDC and the company s TSR over five years. (Note: The longer 5-year review is only applicable if a company s 1- and 3-year TSR are in the bottom half of its 4-digit GICS industry group.) Unchanged or Marginal Decreases: The new policy also states that RMG may identify a potential pay-for-performance disconnect not only when the CEO s TDC increases, but also in situations where the CEO s TDC remains unchanged or only marginally decreases within the relevant time frame. When conducting its five-year evaluation, the most recent year-over-year increase or decrease in CEO pay remains a key consideration, but there will also be additional emphasis placed on: (i) the long-term trend of total CEO compensation relative to shareholder return; (ii) the mix of performance-based compensation relative to total compensation; and (iii) the complete and transparent disclosure of a company s pay-forperformance linkage (i.e., disclosure of performance measures and goals including any adjustments for non-gaap financial metrics to allow shareholders to assess the rigor of the performance-based compensation). A misalignment between CEO pay and company TSR performance may result in a vote AGAINST MSOP proposals and/or the election of directors (generally compensation committee members). If a significant portion of the pay misalignment is attributed to equity awards, RMG may vote AGAINST an equity plan proposal, and may consider the following (but is not limited to) in its equity plan evaluation: The magnitude of pay increase/decrease in the last fiscal year; The source of the pay increase (cash or equity); and The proportion of equity awards granted in the last fiscal year concentrated at the NEO level. Copyright 2009 Aon Hewitt 2 December 4, 2009 / Alert
2010 RMG Policy: Problematic Pay Practices 2009 Policy Under the 2009 policy, on a case-by-case basis, RMG may issue an AGAINST/WITHHOLD vote recommendation on: (i) MSOP proposals; (ii) director (generally compensation committee members) elections; and (iii) equity plan proposals if the company has Poor Pay Practices. Key Changes for 2010 In addition to establishing the MSOP as the initial vehicle to address pay practices, RMG now identifies a nonexhaustive list of the most serious problematic practices (and adds a new focus on practices that may motivate inappropriate risk taking) that, absent any mitigating factors, may result in AGAINST vote recommendations on a stand-alone basis for: (i) MSOP proposals; (ii) director elections (generally compensation committee members); and (iii) equity plan proposals (if excessive nonperformance-based equity awards are the major contributor to a pay-for-performance misalignment) including: Egregious employment contracts. Contracts containing multiyear guarantees for salary increases, nonperformancebased bonuses, and equity compensation. New CEO with overly generous new hire package. Excessive make whole provisions without sufficient rationale. Any of the problematic pay practices listed in this policy. Abnormally large bonus payouts without justifiable performance linkage or proper disclosure. Includes performance metrics that are changed, canceled, or replaced during the performance period. Egregious pension/supplemental executive retirement plan (SERP) payouts. Inclusion of additional years of service not worked that result in significant benefits provided in new arrangements. Inclusion of performance-based equity awards in the pension calculation. Copyright 2009 Aon Hewitt 3 December 4, 2009 / Alert
Excessive perquisites. Perquisites for former and/or retired executives, such as lifetime benefits, car allowances, personal use of corporate aircraft, or other inappropriate arrangements. Extraordinary relocation benefits (including home buyouts). Excessive severance and/or change-in-control provisions. Change-in-control payments exceeding three times base salary and bonus. Change-in-control payments without loss of job or substantial diminution of job duties (single-triggered). New or materially amended employment or severance agreements that provide for modified single triggers, under which an executive may voluntarily leave for any reason and still receive the change-in-control severance package. New or materially amended employment or severance agreements that provide for an excise tax gross-up. Modified gross-ups would be treated in the same manner as full gross-ups. Tax reimbursements. Reimbursement of income taxes on certain executive perquisites or other payments (e.g., personal use of corporate aircraft, executive life insurance, bonus; see also excise tax gross-ups above). Dividends or dividend equivalents paid on unvested performance shares or units. Executives using company stock in hedging activities, such as cashless collars, forward sales, equity swaps, or other similar arrangements. Repricing or replacing of underwater stock options/stock appreciation rights without prior shareholder approval (including cash buyouts). RMG also identifies other problematic pay practices that may trigger AGAINST/WITHHOLD vote recommendations or cautionary language upon a case-by-case analysis including: Excessive severance and/or change-in-control provisions. Payments upon an executive s termination in connection with performance failure. Liberal change-in-control definition in individual contracts or equity plans which could result in payments to executives without an actual change in control occurring. Copyright 2009 Aon Hewitt 4 December 4, 2009 / Alert
Overly generous perquisites which may include, but are not limited to, the following: Personal use of corporate aircraft; Personal security systems maintenance and/or installation; Car allowances; and Executive life insurance. Internal pay disparity. Excessive differential between CEO total pay and that of the next highest-paid NEO. Voluntary surrender of underwater options by executive officers. May be viewed as an indirect option repricing/exchange program, especially if those canceled options are returned to the equity plan, as they can be regranted to executive officers at a lower exercise price, and/or the executives subsequently receive unscheduled grants in the future. Other pay practices deemed problematic but not covered in any of the above categories. RMG will also assess company policies and practices related to compensation that could incentivize excessive risk taking, including: Guaranteed bonuses; A single-performance metric used for short- and long-term plans; Lucrative severance packages; High pay opportunities relative to industry peers; Disproportionate supplemental pensions; or Mega annual equity grants that provide unlimited upside with no downside risk. Note: Factors that potentially mitigate the impact of risky incentives include rigorous clawback provisions and robust stock ownership/holding guidelines. 2010 RMG Policy: Volatility and Stock Price Assumptions in Equity Plan Proposals 2009 Policy For the December 1, 2008 and March 1, June 1, and September 1, 2009 quarterly data downloads, RMG used the 400-day volatility and 90-day average stock price for the Shareholder Value Transfer and Burn Rate Policies. Key Changes for 2010 As the stock market continues to stabilize from the unprecedented volatility levels and price decline experienced toward the end of 2008 and early 2009, RMG will now revert back to using the 200-day volatility and 200-day average stock price for the Shareholder Value Transfer and Burn Rate Policies for December 1, 2009 and future quarterly data downloads. Copyright 2009 Aon Hewitt 5 December 4, 2009 / Alert
The 2010 updated burn rates for Russell 3000 and Non-Russell 3000 companies are also listed in the following table. Burn Rate Table for Key Industry Sectors (2010) Russell 3000 Non-Russell 3000 Standard Mean+STD Standard Mean+STD GICS Description Mean Deviation DEV Mean Deviation DEV 1010 Energy 1.07% 1.08% 2.14% 2.04% 2.26% 4.30% 1510 Materials 0.94% 0.68% 1.63% 1.97% 2.57% 4.54% 2010 Capital Goods 1.10% 0.85% 1.95% 2.07% 2.62% 4.69% 2020 Commercial Services 1.67% 1.23% 2.89% 1.82% 1.71% 3.53% & Supplies 2030 Transportation 1.20% 0.93% 2.13% 1.36% 0.95% 2.31% 2510 Automobiles & 1.36% 1.63% 2.99% 1.36% 1.63% 2.99% Components 2520 Consumer Durables & 1.76% 1.21% 2.97% 1.56% 1.81% 3.37% Apparel 2530 Hotels Restaurants & 1.69% 1.11% 2.80% 1.52% 1.65% 3.17% Leisure 2540 Media 1.36% 0.93% 2.28% 2.14% 1.88% 4.03% 2550 Retailing 1.69% 1.41% 3.10% 2.19% 1.82% 4.01% 3010, 3020, 3030 Food & Staples Retailing 1.25% 1.67% 2.92% 1.52% 1.65% 3.17% 3510 Health Care 2.19% 1.46% 3.65% 3.77% 4.16% 7.92% Equipment & Services 3520 Pharmaceuticals & 3.19% 1.97% 5.16% 4.52% 4.05% 8.58% Biotechnology 4010 Banks 1.02% 1.04% 2.05% 0.81% 1.31% 2.12% 4020 Diversified Financials 2.21% 2.94% 5.15% 4.25% 4.05% 8.30% 4030 Insurance 1.07% 0.94% 2.02% 1.03% 1.28% 2.31% 4040 Real Estate 0.56% 0.49% 1.04% 0.99% 2.14% 3.13% 4510 Software & Services 3.15% 2.32% 5.47% 4.32% 3.26% 7.58% 4520 Technology Hardware 2.60% 2.18% 4.79% 3.32% 3.76% 7.08% & Equipment 4530 Semiconductors & 2.94% 1.88% 4.82% 4.33% 2.98% 7.31% Semiconductor Equipment 5010 Telecommunication 1.30% 1.20% 2.50% 2.63% 2.45% 5.08% Services 5510 Utilities 0.41% 0.39% 0.80% 0.76% 0.88% 1.64% Vote AGAINST equity plans for companies whose average three-year burn rates exceeds the greater of: (1) the mean plus one standard deviation of the company s GICS group segmented by Russell 3000 index and non-russell 3000 index (see table above); or (2) 2% of weighted common shares outstanding. Copyright 2009 Aon Hewitt 6 December 4, 2009 / Alert
For companies that grant both full-value awards and stock options to their participants, RMG applies a premium on full-value awards for the past three fiscal years. The guideline for applying the premium will be as follows: Stock Price Volatility Multiplier 54.6% and higher 1 full-value award will count as 1.5 option shares 36.1% or higher and less than 54.6% 1 full-value award will count as 2.0 option shares 24.9% or higher and less than 36.1% 1 full-value award will count as 2.5 option shares 16.5% or higher and less than 24.9% 1 full-value award will count as 3.0 option shares 7.9% or higher and less than 16.5% 1 full-value award will count as 3.5 option shares Less than 7.9% 1 full-value award will count as 4.0 option shares * * * * * The Executive Compensation Alert is prepared by Aon Hewitt s Executive Compensation Center of Technical Expertise led by Dave Sugar. Questions regarding executive compensation technical issues may be directed to Dave Sugar at 847-295-5000 or dave.sugar@aonhewitt.com. This report is a publication of Aon Hewitt, provides general information for reference purposes only, and should not be construed as legal or accounting advice or a legal or accounting opinion on any specific fact circumstances. The information provided here should be reviewed with appropriate advisors concerning your own situation and any specific questions you may have. http://www.aonhewitt.com Copyright 2009 Aon Hewitt 7 December 4, 2009 / Alert