Executive Pay Trends in the Say-on-Pay Era

Executive Compensation in the Say-on-Pay Era
Winning the Shareholder Vote — Without Losing the Election

Presenters: Doug Friske, James Kroll, Steven Seelig, Olivia Wakefield
April 7, 2011

© 2011 Towers Watson. All rights reserved.

Today’s experts

Doug Friske is the global leader of Towers Watson's Executive Compensation business and
is based in Chicago. He has more than 20 years’ experience advising a wide range of
organizations on all aspects of executive compensation.

James Kroll is a senior consultant in Towers Watson’s Executive Compensation practice,
based in New York. He specializes in corporate governance and executive compensation
issues and assists clients with shareholder approval of equity plans, advisory votes on
executive pay and other compensation-related governance issues.

Steve Seelig is the executive compensation counsel for Towers Watson’s Research and
Information Center in Washington, D.C. His expertise includes the taxation, accounting and
legal implications (including SEC disclosure requirements) of all forms of executive
compensation and perquisite programs.

Olivia Wakefield is a senior consultant in Towers Watson’s Executive Compensation
practice, based in Boston. Specializing in executive compensation programs, she advises
clients on topics such as annual and long-term incentive performance metric calibration and
plan design, equity pool management and corporate governance.

towerswatson.com © 2011 Towers Watson. All rights reserved. Proprietary and Confidential. 2

Current context: Business performance has bounced
back to pre-recession levels
1,600 S&P 500 Composite
1,400

1,200

1,000

800

600

400

200

0
1/08 3/08 5/08 7/08 9/08 11/08 1/09 3/09 5/09 7/09 9/09 11/09 1/10 3/10 5/10 7/10 9/10 11/10

800 Cash Flow
Net Income and Cash Flow
Net Income
600

400

200

0

-200

-400
Q1Y08 Q2Y08 Q3Y08 Q4Y08 Q1Y09 Q2Y09 Q3Y09 Q4Y09 Q1Y10 Q2Y10 Q3Y10 Q4Y10
Source: Standard and Poor’s Compustat® database.

So, what are we seeing as the say-on-pay era unfolds?

Evidence that contemporary pay practices have largely worked….
Overwhelming support for pay plans for most companies in the current
say-on-pay cycle (at least so far)
Pay levels that have returned to mid-2000 levels
Incentive designs that are essentially unchanged in recent years
Continued correlation between pay and performance
…although companies are continuing to refine their approaches
Push back on “poor” pay practices
More complete and thoughtful disclosure
Ongoing debate regarding the rigor in goal setting and the role of explicit
performance conditions for long-term incentives

It appears that most companies are getting it right, but with shareholders and
other constituents paying close attention, the situation can change quickly
and there’s no room for complacence

Now we’ll take a look at where we’ve been — and where
we’re headed
Topic Presenter
Recent Trends in Pay Levels and Practices:
Olivia Wakefield
The Tale of the Proxies

What We Know About Say-on-Pay Votes, So Far James Kroll

What’s on the Regulatory Horizon? Steve Seelig

Wrap-up and Q&A Doug Friske


Recent Trends in Pay Levels and Practices
The Tale of the Proxies

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S:EGS2010ECR175418MKTProxy Webcast.ppt

The sample…

170 Fortune 1000 companies holding annual meetings on or after
January 21, 2011 (deadline for required say-on-pay votes under Dodd-
Frank) that filed proxies by late March

Annual Market
Revenue* Capitalization*
25th Percentile $3,000 $2,800
50th Percentile $6,500 $7,900
75th Percentile $13,500 $18,200

CEOs (principal executive officers) in the role for the past 36 months

*In millions of dollars.
Source: Standard and Poor’s Compustat® database.


2010 pay levels clearly reflect companies’ improving
performance
2009 Median 2010 Median
Pay Element Includes Change Change
Base salary Annual salary 0% 3%
Total cash Base + bonus (discretionary) 3% 17%
compensation + short-term non-equity
(TCC) incentive compensation
Total direct TCC + grant date value for -1% 9%
compensation stock options, restricted stock
(TDC) and performance plans

Source: Towers Watson Executive Compensation Resources.

The total pay mix really hasn’t changed that much

2008 2009 2010

41% 43% 42%
22%
19% Cash 20% 21% Cash 24%
19% Cash

15%
14% 22% 23%
22% 15%

23% 22% 19%
59% 57% 58%
LTI LTI LTI

Base
Bonus
Stock Options
Restricted Stock
Performance Plans


What has changed is the long-term incentive mix

2008 2009 2010

33%
37% 39% 36% 38%
41%

24% 26% 26%

Stock Options
Restricted Stock
Performance Plans

Companies may be reacting to the recent volatility in the market
and are less comfortable using as many options

Prevalence of performance measures in long-term
incentive plans remained fairly constant…
Prevalence of Long-Term Incentive Performance Measures

0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%

EPS/Net Income

TSR

Operating Income/Margin

ROC/ROIC

Revenue
2010
Other Non-Financial 2009
2008
ROE

Cash Flow


…as have annual plan measures for the most part…

Prevalence of Annual Incentive Plan Measures

0% 10% 20% 30% 40% 50% 60% 70%

EPS/Net Income

Individual Performance

Operating Income/Margin

Business Unit Performance

Revenue

Operating/Strategic 2010
2009
Cash Flow 2008

ROC/ROIC

ROE


…although a number of companies made adjustments in
2010
For annual plans
A quarter (25%) of companies changed the performance measures used for
2010 annual awards from those used in 2009
For LTI plans
Almost as many (24%) changed performance goals used for 2010 LTI
awards

Bottom line: Many companies continue to fine-tune
their programs to try to get it right


The distribution of CEO bonuses is back to pre-crisis
levels…
Percent of CEOs Receiving an Actual Bonus That is…

0% 5% 10% 15% 20% 25% 30% 35% 40%

>200% of target

>150% – 200% of target

>100% – 150% of target

>50% – 100% of target 2007
2008
2009
<50% of target
2010

0%


…and the alignment with performance continues to be
strong

2008 2009 2010

Total Direct Compensation


Above Market
Above Market

Above Market
15% 12% 18%

68% Below Market 76% 66%

Below Market
Below Market

17% 12% 16%
Below Industry Above Industry Below Industry Above Industry Below Industry Above Industry

Total Shareholder Returns Total Shareholder Returns Total Shareholder Returns


We also saw a close correlation between investor returns
and the value of LTI granted that the CEO realizes

Three-year TSR LTI Realized/
(2008 to 2010) LTI Granted*
Top-third TSR performance 33% 118%
Middle-third TSR performance -1% 89%
Bottom-third TSR performance -34% 49%

*Values include equity awarded to CEOs in fiscal years 2008, 2009 and 2010.
Source: Towers Watson Executive Compensation Resources; Standard and Poor’s Compustat® database.


Companies made more one-time grants in 2010

Almost a third (29%) of companies made one-time and/or retention
grants in 2010, compared to 16% in 2009
In both years, the great majority of these grants were time-based
Companies Making One-Time and/or Retention Grants
2009 2010

16%
29%

71%
84%

One-time or retention
grants made
No grants made


Finally, our review found many changes in CD&As

They are longer
Average length increased by 7%
Executive summaries are now the rage
Half (50%) of companies added an executive summary during 2011, so that a
majority (64%) of companies now include one
Disclosures of annual plan goals improved
Fully 85% of companies disclosed the specific performance goals for the
2010 plan year
More than three-quarters (78%) of companies showed actual performance
attained for 2010 to support the bonus paid


What We Know About Say-on-Pay Votes, So Far


Key observations to date

Overall, we’re seeing strong support for most companies’ proposals,
similar to last proxy season
Proxy advisors and some shareholders acknowledge that “outliers” will
come in for added scrutiny
The circumstances behind negative votes and company responses are
highly situational
No one approach will work for all companies


Early say-on-pay votes show most companies are
receiving strong shareholder support…
Distribution of Support for Say-on-Pay Proposals: 2011*
Percentage of
Companies in
Support Range
80% 74.7%

60%

40%

20% 13.7%
5.5%
2.7% 1.4% 2.0%
0%
Below 50% 50% – 59.9% 60% – 69.9% 70% – 79.9% 80% – 89.9% 90%+

Support for Say-on-Pay Proposal

*Source: Towers Watson Executive Compensation Resources analysis as of April 4, 2011.

…but a negative ISS vote recommendation has an impact
The 14% of companies receiving negative Institutional Shareholder
Services (ISS) vote recommendations have received above-average
opposition from shareholders
ISS Vote Number of Votes in
Recommendation Companies Favor
For 126 94%
Against 20 71%

Four companies have failed to get majority support for their say-on-pay
proposals
On average, only about 46% of shareholders at each of these companies
voted in favor of the say-on-pay proposal
ISS recommended votes against these proposals, citing such concerns as a
pay-for-performance “disconnect” or change-in-control provisions containing
tax gross-ups
Source: Towers Watson Executive Compensation Resources analysis as of April 4, 2011.

Subpar TSR performance doesn’t necessarily result in a
negative ISS vote recommendation
Almost a third (29%) of companies failed both the one- and three-year
TSR test
Yet ISS recommended votes in favor of say-on-pay at more than two-thirds
(68%) of these companies

ISS Say-on-Pay Vote Recommendations for
Companies With Below-Median TSR
Negative
recommendations
(32%) 9%
ISS support despite
18%
pay-for-performance concern
ISS support, other factors (e.g.,
23% pay decrease, new CEO)
ISS negative, pay-for-
performance concern
ISS negative, other concern
50%
Positive
recommendations
(68%)

Say when on pay: After an early push for triennial, annual
votes gain steam
Three quarters (76%) of companies have seen annual vote frequency
receive majority support
Only one-third (33%) of companies recommending triennial votes
received majority support
Implementation of Say-on-Pay Vote Frequency
Original Companies Frequency Implemented Frequency
Frequency Recommending Decision
Recommendation Frequency Annual Biennial Triennial Pending
Annual 49 20 None None 29
Biennial 9 3 1 None 5
Triennial 80 20 None 14 46
None 8 3 None None 5
Total 146 46 1 14 85


After say-on-pay, now what?
Some next steps to consider
Define the vote outcome you want to see
Review proxy advisor reports for accuracy
Determine what additional information will help you gain greater
shareholder support
Assess the influence of proxy advisor vote recommendations
Determine who will represent the company in the shareholder
engagement process and the timing of outreach efforts


What’s on the Regulatory Horizon?


One set of Dodd-Frank enabling regulations was released
in late March…
Exchange Listing Disclosure of
Requirements — “Independence” “Conflicts of Interest”
Who Compensation consultants, lawyers and other Compensation consultants
advisors to the compensation committee
What Factors in evaluating independence: Proxy disclosure expanded to address:
1. Other services provided by the advisor’s Whether the work of the compensation
firm consultant raised any conflict of interest
and, if so, the nature of the conflict and how
2. Fees as a percentage of firm revenue
it was addressed
3. Policies and procedures to prevent
conflicts of interest How the five factors influenced the
committee’s conclusion
4. Other business or personal
relationships with compensation
committee members
5. Company stock owned

A second set of proposed regulations addresses the
independence of compensation committee members


…while we await others later in 2011

1 Disclosure of pay for performance
How will pay be measured?
What is the time period required?
How will performance be measured — only TSR?
Will this be in place for the 2012 proxy?

2 Disclosure of CEO pay versus median employee pay
Repeal legislation has been introduced in the House
SEC officials have testified to Congress that there is little leeway because the statute requires
median rather than average compensation

3 Clawbacks of compensation paid based on misstated financial results
Can discretion be exercised in enforcing the clawback?
Would existing contracts be grandfathered?
How is incentive compensation defined?
Would the SEC regulate indemnity clauses?


Wrap-up and Q&A


Where do we go from here?

Get behind the say-on-pay vote totals
Even if your 2011 vote was highly favorable, things can change year to year
depending on performance and pay
Understand the input from shareholders and proxy advisors
Stay committed to your principles and practices — you don’t need to
conform to have a successful program or shareholder vote
Understand the value and implications of outstanding incentives
Significant value created the past few years, given market volatility
Influences expectations, with big vesting cliff likely on the horizon
Fine-tune your thinking in advance of the next round of SEC rule
making
Consider potential pay-for-performance rationalization and disclosure


Questions?

doug.friske@towerswatson.com
james.kroll@towerswatson.com
steven.seelig@towerswatson.com
olivia.wakefield.lee@towerswatson.com

Watch for our soon-to-be-launched blog,
Executive Pay Matters, for ongoing updates and information
on the latest trends and emerging issues in executive pay


Executive Pay Trends in the Say-on-Pay Era

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