George B. Paulin

President & CEO

Frederic W. Cook & Co., Inc.

March 18, 2004

What the Top Compensation Consultants are NOW Telling Compensation Committees

NASPP Webcast

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Overview

1. Move beyond the recent focus on regulatory compliance

2. Prepare for change in equity compensation structure

3. Abandon traditional methods for determining equity compensation grant amounts

4. Be persistent on executive ownership

5. Address all of the important related areas other than direct compensation

Major points of “real-time” advice . . .

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Compliance Focus

Efforts in 2002-03 to improve process were largely effective

Independent membership

Compensation Committee Charters

Control of consultants and pay studies

Executive session meetings without management

Greater clarity in disclosure

Time, now, to concentrate on pay strategy

How should programs be designed for competitive advantage?

Process has temporarily overtaken substance . . .

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Equity Compensation Structure

Employees and outside directors eligible

All possible grant types

Administrative provisions in grant agreements, not in the plan

As-issued share count

Anticipate fewer shares more often, and no evergreen authorizations

“Fungible” pool for trading-off options and full-value grants

Potential for 3rd-party option transfers

Provide maximum flexibility in the shareholder-approved stock plan . . .

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Equity Compensation Structure (cont’d)

Restricted stock is not pay for performance

Performance stock is preferable but requires multi-year goal setting

Very difficult for younger, growth companies

Option pricing models overstate option value

So discounting is necessary for a fair trade-off (e.g., 3-or-4 option shares to 1 full-value share)

Shift from options to full-value grants should be carefully thought through . . .

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Equity Compensation Structure (cont’d)

Expect FAS 123 to impact future option design . . .

Winners Losers

Stock SARs Cash SARs

Attached dividend rights ISOs

Discount price Premium price

Indexed price Reloads

Performance vesting

3rd-party transferability

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Equity Grant Amounts

“Run rates” are coming down

Executive grant values are coming down

About 20% lower year-to-year for proxy officers

75th percentile is moving back closer to median

About 25% lower year-to-year for proxy officers

After spread above median roughly doubled in the last 10 years

Lower-level grants are coming down

What the current data shows . . .

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Equity Grant Amounts (cont’d)

Run rates (and dilution overhang) are no longer meaningful as grant value shifts from options

Most of the grant-value reduction is from 2 sources

Lower stock prices in early 2003 versus early 2002

Discounting in conversion from options to full-value grants

Reduction in lower-level grants is only partially complete

Driven by stock-exchange rules (not accounting), and many board-approved plans still had shares available in 2003

Look beyond the numbers . . .

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Equity Grant Amounts (cont’d)

New method for determining grant size is necessary but controversial . . .

Old Method New Method

Determine competitive individual grant values

Convert to company shares (or cash)

Aggregate individual grants to determine total grants

Start with competitive aggregate grant value as a percent of company market cap

Allocate to individuals based on competitive proportionate percentages of total grant value

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Equity Grant Amounts (cont’d)

Most agree with the logic

Equalizes different grant types (i.e., options vs. full-value)

Provides comparative basis for budgeting FAS 123 costs

Eliminates stock price impact on shares granted

Parallels ISS “SVT” methodology

However, implementation is slow

Higher grant value if market cap is relatively high and vice versa

No survey data on competitive lower-level allocations

Transition to new method is difficult, especially for larger and more mature companies . . .

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Executive Ownership

A major theme of investor groups and best-practice initiatives, but more work to be done . . .

“Best Practice” Reality

Ownership

Guidelines

Real ownership of specified salary multiple or number of shares; usually after 5 years

About half of mid-to-large caps; almost never in small caps and techs or West of the Mississippi

Retention

Guidelines

Hold net shares from compensation program for at least 1 year (i.e., no run-up and flipping)

GE, Citicorp, Lilly and a few other early adopters; few have followed

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Related Areas

Setting goals for annual bonuses to better balance pay for performance and pay for results

Possibly the most significant implication of ISS’s new voting guidelines

Understanding the value of supplemental executive retirement plans (SERPs), above-market interest on deferred compensation, and severance arrangements

Aligning outside directors’ compensation with their current responsibilities and risks

And compensation committees again taking charge of directors’ compensation, where it has moved to nominating/governance committees that may be less knowledgeable of compensation techniques

Committees need to spend more time on . . .