Total Exposure in Executive Compensation

Slide 0Pearl Meyer & Partners
Southborough, MA 01772
Executive Compensation Tools
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Interested parties
Changing Landscape
Former Tyco CEO
How many of you recognize these any of these faces?
They are all been in the news quite a bit in the last couple of years for things that they have done in their corporate lives that have lead to changes in the executive compensation world.
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Greater institutional shareholder oversight
Manage equity grant practices
Independent compensation consultants
Tax gross-ups
Competitive analysis
Provides comparison of target compensation
Tally sheets (or some form of)
Tally up total direct compensation (TDC) typically at target
Provides payout information of various programs:
Retirement plans
©2007 Pearl Meyer & Partners
Challenges with Current Tools
Does not provide a complete picture of an executive compensation package
Provides “static”, point-in-time snapshot of the amount of compensation to be delivered typically at target
May encourage “competitive compensation” programs not necessarily performance-based compensation
Not focused on what an executive could earn
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EIA Approach
Illustrates the compensation opportunity for each component and in total over a period of time
Dynamic, not static assessment
Shows the relationship between pay and performance in terms of company financial and stock price performance
Simulates potential results of a compensation program
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Whether a program has the appropriate performance-orientation
If there is to much focus on company vs. stock price performance or vice-versa
If incentive opportunities are appropriately aligned (payouts vs. performance achievement)
If the current compensation mix is appropriate
If the program is to heavily weighted towards time-based awards
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Amounts paid to executives
Performance metrics and goal-setting
Key Discussion Points
1.) Is this to much compensation for a CEO performing between the 10th - 20th percentile for company and stock price performance?
2.) Is this an appropriate amount of compensation for a CEO performing at the 50th percentile for company and stock price performance?
3.) Is this an appropriate amount of compensation for a CEO performing between the 80th - 90th percentile for company and stock price performance?
4.) Is an incremental change in potential TDC of 9.7% (btw the 30th and 70th percentile for company performance only) enough incentive to drive executive behaviors on company performance?
5.) Is enough of the TDC package driven by company performance?
6.) Is an incremental change in potential TDC of 67% (btw the 30th and 70th percentile for stock price performance only) an appropriate amount of incentive to drive executive behaviors?
7.) Is an appropriate amount of the TDC package driven by stock price performance?
8.) Is the mix between company and stock price performance appropriate?
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Used to forecast potential performance outcomes for the compensation program (mean and standard deviations)
Are very important and can substantially impact outcomes
Typically analyze the following:
Look Around
Historical performance of a specific industry
Historical performance of an Index
Look Forward – Value Line’s forecasted performance
Expected Value –annualized expected return using the Black-Scholes model
Management Estimates
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Compares total potential total direct compensation (TDC) to the incremental market value created for shareholders
Reflects a reasonably aligned pay and performance orientation
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Helps Assess
The relationship of total potential payouts for executives as compared to the incremental market value delivered to shareholders
The orientation of the lines:
Rise and run
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Revenues ~$1B; Market cap ~$3B
Historical revenue growth 5-10%
Compensation
Annual Short-Term Incentive (STI)
Threshold: 0% of salary Target: 100% of salary Maximum: 250% of salary (2.5 times the target award) Metrics: Corp EPS, Corp Operating Income, Corporate Sales, Corp ROA
Annual Long-Term Incentives (LTI)
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Firm A only uses financial performance for its STI plan
Threshold and maximum performance range +/-10-15% of target for STI plan
Evaluated the following to determine appropriate growth assumptions:
Look back - One year historical TSR for 10 years
Average return - 12%, standard deviation – 20%
Look around - One year historical avg TSR over 20 years for Dow Jones and S&P
Average return – 10%, standard deviation – 15%
Assumptions:
Used the combined Index return (10%) and standard deviation (15%)
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Salary - $800,000
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Target STI – 100%
Max STI – 250%
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Vests in 3 years
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7 year term
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7 year term
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Key Discussion Points
3.) Is this an appropriate amount of compensation for a CEO performing between the 80th - 90th percentile for company and stock price performance?
1.) Is this to much compensation for a CEO performing between the 10th - 20th percentile for company and stock price performance?
2.) Is this an appropriate amount of compensation for a CEO performing at the 50th percentile for company and stock price performance?
4.) Is an incremental change in potential TDC of 9.7% (btw the 30th and 70th percentile for company performance only) enough incentive to drive executive behaviors on company performance?
5.) Is enough of the TDC package driven by company performance?
6.) Is an incremental change in potential TDC of 67% (btw the 30th and 70th percentile for stock price performance only) an appropriate amount of incentive to drive executive behaviors?
7.) Is an appropriate amount of the TDC package driven by stock price performance?
8.) Is the mix between company and stock price performance appropriate?
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Mix of Pay
Stock options are the primary vehicle with the largest potential value based on stock price performance
Stock options make up 4% of the total direct compensation (TDC) value assuming a 10th percentile stock price performance and 62% of the value assuming a 90th percentile stock price performance
Stock & 10th & 10th & 10th & 50th & 50th & 50th & 90th & 90th & 90th &
Company 10th 50th 90th 10th 50th 90th 10th 50th 90th
Performance
Incremental Pay & Performance Alignment Analysis
Total potential value of the CEO’s total direct compensation (TDC) and incremental wealth creation for shareholders
Over a 5 year period:
Firm A will pay the CEO between $19M to $104M
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Findings:
STI plan allows for threshold level payouts below last year’s performance achievement level
Results from using +/-10-15% to set thresholds and maximums
Minimum orientation of pay programs to company financial performance
Financial performance metrics used only in STI plan
Outcomes:
Adjusted STI plan so thresholds and maximums are set more appropriately each year specific to targets for the year
Eliminates potential for threshold payouts for performance below last year
Implemented new performance-based LTI plan
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Revenues ~$500M; Market cap ~$800M
Cyclical industry – 3 year cycles
2006 was an outstanding performance year
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Compensation
Annual Short-Term Incentive (STI)
Threshold: 0% of salary Target: 70% of salary Maximum: 210% of salary (3 times the target award) Metric: Corp EPS (100%)
Annual Mid-Term Incentive (MTI)
3 year performance-based restricted stock plan Earn more or less than target awards based on performance achievement Metric: Corp EPS (100%)
Annual Long-Term Incentive (LTI)
Stock Options – time-based vesting
Financial Performance Assumptions:
Used Firm B’s historical EPS mean (10%) and standard deviation (35%)
Simulated EPS results for 1 and 3 year periods for the STI and MTI
Achievement on Corp EPS assumed at the same level for both STI & MTI
Stock Price Performance Assumptions:
Firm B uses stock price performance for both the MTI and LTI
Evaluated the following to determine appropriate growth assumptions:
Alternatives
Salary - $400,000
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Target STI – 70%
Max STI – 210%
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Target MTI – 8,000
Max MTI – 15,000
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Options – 45,000
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Options – 45,000
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Key Discussion Points
3.) Is this an appropriate amount of compensation for a CEO performing between the 80th - 90th percentile for company and stock price performance?
1.) Is this to much compensation for a CEO performing between the 10th - 20th percentile for company and stock price performance?
2.) Is this an appropriate amount of compensation for a CEO performing at the 50th percentile for company and stock price performance?
4.) Is an incremental change in potential TDC of 9.7% (btw the 30th and 70th percentile for company performance only) enough incentive to drive executive behaviors on company performance?
5.) Is enough of the TDC package driven by company performance?
6.) Is an incremental change in potential TDC of 67% (btw the 30th and 70th percentile for stock price performance only) an appropriate amount of incentive to drive executive behaviors?
7.) Is an appropriate amount of the TDC package driven by stock price performance?
8.) Is the mix between company and stock price performance appropriate?
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Mix of Pay
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Incremental Pay & Performance Alignment Analysis
Total potential value of TDC and incremental wealth creation for shareholders
Over a 7 year period:
Firm B will pay the CEO between $3.3M to $43.6M
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Findings:
Executive compensation program aligns with how the program was designed and provides the intended results
In years when company is not performing – no payouts
In years when company is performing – target payouts
In years when company is outperforming – maximum payouts
Outcomes:
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Comprehensive assessment tools:
Competitive analysis
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Melissa L. Means
Pearl Meyer & Partners
Southborough, MA 01772
5%
20%
35%
50%
65%
80%
95%
5%
35%
65%
95%
$0
$1,000,000
$2,000,000
$3,000,000
$4,000,000
$5,000,000
$6,000,000
$7,000,000
$1,200,000-
$1,500,000
$900,000-
$1,200,000
$600,000-$900,000
$300,000-$600,000
$0-$300,000
5%
20%
35%
50%
65%
80%
95%
5%
20%
35%
50%
65%
80%
95%
$0
$200,000
$400,000
$600,000
$800,000
$1,000,000
$1,200,000
$6,000,000-$7,000,000
$5,000,000-$6,000,000
$4,000,000-$5,000,000
$3,000,000-$4,000,000
$2,000,000-$3,000,000
$1,000,000-$2,000,000
$0-$1,000,000
CEO Total Potential TDC vs. Incremental Market Value over 7 years
$17.9M
$38.4M
$3.2M
$0.8B
$1.5B
$0.2B
-$5,000,000
$0
$5,000,000
$10,000,000
$15,000,000
$20,000,000
$25,000,000
$30,000,000
$35,000,000
$40,000,000
$45,000,000
10th
P'tile
20th
P'tile
30th
P'tile
40th
P'tile
50th
P'tile
60th
P'tile
70th
P'tile
80th
P'tile
90th
P'tile
$2,500,000-
$3,000,000
$2,000,000-
$2,500,000
$1,500,000-
$2,000,000
$1,000,000-
$1,500,000
$500,000-
$1,000,000
$0-$500,000
5%
15%
25%
35%
45%
55%
65%
75%
85%
95%
5%
20%
35%
50%
65%
80%
95%
$0
$3,000,000
$6,000,000
$9,000,000
$12,000,000
$15,000,000
$0
$5,000,000
$10,000,000
$15,000,000
$20,000,000
$25,000,000
Options
Percentiles
CEO Total Potential TDC vs. Incremental Market Value over 5 years
$0
$20,000,000
$40,000,000
$60,000,000
$80,000,000
$100,000,000
10th
20th
30th
40th
50th
60th
70th
80th
90th
$1,200,000-$1,500,000
$900,000-$1,200,000
$600,000-$900,000
$300,000-$600,000
$0-$300,000
5%
20%
35%
50%
65%
80%
95%
5%
20%
35%
50%
65%
80%
95%
$0
$200,000
$400,000
$600,000
$800,000
$1,000,000
$1,200,000
$6,000,000-$7,000,000
$5,000,000-$6,000,000
$4,000,000-$5,000,000
$3,000,000-$4,000,000
$2,000,000-$3,000,000
$1,000,000-$2,000,000
$0-$1,000,000
CEO Total Potential TDC vs. Incremental Market Value over 7 years
$43,6M
$20.4M
$3.3M
$0.8B
$1.5B
$0.2B
-$5,000,000
$0
$5,000,000
$10,000,000
$15,000,000
$20,000,000
$25,000,000
$30,000,000
$35,000,000
$40,000,000
$45,000,000
10th
P'tile
20th
P'tile
30th
P'tile
40th
P'tile
50th
P'tile
60th
P'tile
70th
P'tile
80th
P'tile
90th
P'tile
15%
86%
7%
7%
Compensation
Options
MTI
STI
Base
5%
20%
35%
50%
65%
80%
95%
5%
20%
35%
50%
65%
80%
95%
$0
$1,000,000
$2,000,000
$3,000,000
$4,000,000
$5,000,000