A Middle Market Perspective

Executive Compensation

March 27, 2014

Agenda

• Today, we will:

- Take a look back

o Perspectives on 2013

o Results of the S&P Mid-Cap Index Study

- Take a look forward

o 2014 issues and emerging trends

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What did we see in 2013

Simply put…more of the same… “drifting with a purpose”

• Pay less while paying more

• “Play” for performance

• Decisions driven by disclosure

• “Optics” continue to be a major feature in plan design

• Continued pressure on “problematic” practices

• Continued oversight by outside advisors, e.g., ISS, Glass Lewis

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S&P 400 Midcap Index

• This study covers CEO’s in 321 non-financial companies within the S&P Midcap 400 Index

• This database is updated twice a year, in June and in December

• As a result, data can span fiscal years based on filing dates and when the database was last updated

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Industry Breakout

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This Index provides a good cross section of industries

Consumer

Discretionary

21%

Consumer Staples

4%

Energy

7%

Healthcare

12%Industrials

21%

Information

Technology

19%

Materials

8%

Telecommunication

Services

1%Utilites

7%

Industry Distribution

Revenue Breakout

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Also provides a good representation of “Middle Market”

Less $1B, 17%

$1B - $5B, 67%

$5B - $10B, 13%

"10B +, 3%

Revenue Breakout

Target Total Direct Compensation

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• Targeted TDC increased 12% from 2011/2012 to 2012/2013, slightly above the annual 9% movement we saw last year

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Target Total Direct Compensation = Base Salary + Target Cash Short-Term Incentive + Grant Date Value of Stock Options (as reported by Company) + Grant Date Value of Restricted Shares + Target Value of Performance Share Grants.

$2,642,565 $3,123,328

$3,460,775 $4,175,268

$4,547,221 $5,110,040

$5,654,551 $6,042,506

$7,069,947

2010/2011 2011/2012 2012/2013

Target Total Direct Compensation

25th %ile 50th %ile 75th %ile

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Target Total Direct Compensation

$6,568,500

$5,531,253

$4,787,403

$4,704,182

$4,614,921

$4,271,669

$3,508,264

$2,817,634

Construction

Wholesale/Retail

Services

Manufacturing

Communications

Mining

Transportation

Utilities

Last Fiscal Year Target Total Direct Compensation

By Industry

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Target Total Direct Compensation

-7%

12%

13%

10%

6%

13%

21%

14%

Year over Year Change in Target Total Direct Compensation

By Industry Median

Base Salary

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$634,729 $673,308 $700,000

$806,540 $835,000 $840,000

$969,755 $1,000,000 $1,000,000

2010/2011 2011/2012 2012/2013

CEO Base Salaries

25th %ile 50th %ile 75th %ile

CEO base salaries were relatively flat compared to last year, following a 3.5% increase over the prior year

Short-Term Incentive Plans (STIP)

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$660,000 $723,000 $678,330

$846,260 $903,455 $900,800

$1,125,000 $1,230,408 $1,209,500

2010/2011 2011/2012 2012/2013

Short-Term Incentive Plan Targets(Excludes Zeroes)

25th %ile 50th %ile 75th %ile

Target STIP values were also relatively flat compared to last year, following a 6.8% increase over the prior year

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Short-Term Incentive Plan Payouts

Over 90% of the companies with a formal STIP paid out above target in all three years with payouts relatively flat compared to last year, following a 31% increase over the prior year

$579,920 $690,000 $705,729

$837,500

$1,100,000 $1,020,044

$1,313,200

$1,605,294 $1,560,080

2010/2011 2011/2012 2012/2013

Short-Term Incentive Plan Payouts(Excludes Zeroes)

25th %ile 50th %ile 75th %ile

Paying for Performance – Short TermYear over Year Increase in Total Cash vs. Net Income Growth Alignment

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-43%

6%

43%

3% 4% 4%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

Bottom Third Middle Third Top Third

CEO YoY Total Cash Compensation Change

vs YoY Net Income Change

% Change in NI % Change in Total Cash

The top 1/3 of performers saw the same change in cash as the middle 1/3, which saw nominally more cash than the bottom 1/3

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About 20% utilized some cash payment in the form of a discretionary payment

21%

17%19%

2010/2011 2011/2012 2012/2013

Prevalence Discretionary Bonus Payments (% of Companies that Awarded a Discretionary Bonus to the CEO)

Discretionary Bonus Payments

Discretionary Bonus Payments

The value of discretionary increases declined by about 12%, following a 15% increase in the prior year

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$212,000 $150,000 $148,350

$430,000 $494,400

$432,800

$750,000

$921,281 $1,000,000

2010/2011 2011/2012 2012/2013

Discretionary Bonus Payments(Excludes Zeroes)

25th %ile 50th %ile 75th %ile

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Pay Mix: Short-Term vs. Long-Term

Long-term compensation continues to surpass that of short-term compensation in the CEOs pay mix

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41% 38% 44%

59% 62% 56%

0%

20%

40%

60%

80%

100%

120%

2010/2011 2011/2012 2012/2013

Pay Mix

Short Term Target Comp vs. Long Term Target Comp

PAY MIX Long-Term

PAY MIX Short-Term

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Long-Term Incentive Grant Values

Long-term incentives as a multiple of base salary have increased significantly in year-over-year comparisons

0.00

1.00

2.00

3.00

4.00

5.00

25th Median 75th

1.30

2.40

3.91

1.92

2.90

4.46

2.10

3.14

4.67

Long-Term Incentive Values

as Multiple of CEO Base Salary

2010/2011 2011/2012 2012/2013

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Average Equity Grant Makeup – Mix Value

Equity grants continue to shift away from stock options, with the heaviest weight now on performance-contingent shares

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42%37%

33%27%

32%

30%31%

33%

26%32% 37% 41%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2009/2010 2010/2011 2011/2012 2012/2013

Average Equity Grant Makeup

Performance-Based Restricted Stock

Time-Based Restricted Stock

Stock Options

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Equity Grant Vesting

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Equity Grant Vesting

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

Immediate

1

2

3

4

5+

1%

3%

4%

56%

25%

12%

Vesting for Service-Based Full Value Awards

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Cash-Based Performance Unit Vesting

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0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

LFY LFY-1 LFY-2

Performance Contingent Awards

Performance Period

25th Percentile 50th Percentile 75th Percentile

Performance Period for Performance Share Plans

The most common performance period is 3 years. Companies with shorter performance periods typically vest over 3 years

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Prevalence of LTI Vehicles

• Fewer companies granting stock options

• Performance-Based Restricted Stock remained steady while Time-Based Restricted Stock saw a slight gain

• Cash programs declined slightly

57%

51%

62%

14%

6%

60%56% 56%

14%

7%

60% 59%

50%

8% 9%

0%

10%

20%

30%

40%

50%

60%

70%

PBRS TBRS Stock Options Cash None

3-Year Long-Term Incentive

Vehicle Utilization

LFY-2 Prevalence

LFY-1 Prevalence

LFY Prevalence

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Value of Long-Term Incentive Plan Targets

Date of Grant values for Last Fiscal Year (LFY) LTIP remained relatively steady after an 11% increase in the prior year

$1,542,740

$1,921,173 $1,829,954

$2,660,272 $2,950,520 $2,876,446

$3,835,618

$4,218,631 $4,243,434

$-

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

$3,500,000

$4,000,000

$4,500,000

LFY-2 LFY-1 LFY

Long-Term Incentive Plan Grant Values(excludes zeroes)

25th Percentile 50th Percentile 75th Percentile

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Long-Term Incentive Realizable Values?

• Companies will continue to refine the “message” in their CD&A disclosure to help explain equity pay practices to shareholders

• We are seeing greater use of “realizable pay” disclosures as a clarifying alternative to grant date LTIP values

• Demonstrate that the real value of pay opportunities depends on future stock prices and/or achievement of performance goals which may not ultimately be delivered, not accounting/valuation models

• Investors believe that this should be a consideration in a pay-for-performance analysis

• ISS has generally considered amounts of "realized" equity and performance grants in the qualitative analysis phase of its pay-for-performance analysis

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Paying for Performance – Realized Value

Overall alignment between 3-Year TSR and 3-Year Average Realized LTI shows greater gap at high end than low end

26Realized LTI includes gains from exercisable options, value of vested shares, and Cash LTI payments made within each fiscal year (2010-2013) for a sample of 121 companies.

$3,954

$5,774

$13,342

$-

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

Bottom Third Middle Third Top Third

Pay and Performance

3-Year Avg Realized LTI vs. 3-Year Total Shareholder Retun

3-Year Avg Realized LTI ($000)

3-Yr TSR

29.4%

3-Yr TSR

12.7%3-Yr TSR

-6.4%

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Long-Term Incentive Vehicle Combinations - LFY

• A “portfolio” approach is still popular among companies, with no single combination a “benchmark”; TBRS & PBRS combination was the most common at 19% of companies

19%

17%

13%

13%

13%

10%

7%

3%

2%

1%

1%

1%

1%

0.3%

0% 5% 10% 15% 20% 25%

TBRS & PBRS

Options, TBRS, PBRS

PBRS Only

Options & TBRS

Options & PBRS

TBRS Only

Options Only

Cash, Options, TBRS

Cash, PBRS, TBRS

Cash & Options

Options, TBRS, PBRS, Cash

Cash & TBRS

Cash, Options, PBRS

Cash & PBRS

Percent of Companies with Combination

LFY Long-Term Incentive Vehicle Combinations

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Performance Metrics

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Groups like ISS and Glass Lewis prefer different metrics for short and long-term incentives to mitigate unintended risk

0% 20% 40% 60% 80%

MBO

Share Price

Not Disclosed

TSR

Relative TSR

EVA

Working Capital

Other Ratio

Division Performance

Cost/ Cost-Ratio

Other

Return

Cash Flow

Qualitative Metrics

EPS

Revenue

Profit/Income/Earnings

STI - Performance Share Metrics - FY-1

0% 5% 10% 15% 20%

MBO

Cost/ Cost-Ratio

Division Performance

Not Disclosed

Other

Qualitative Metrics

Other Ratio

Share Price

EVA

Cash Flow

Revenue

TSR

Return

Relative TSR

EPS

Profit/Income/Earnings

LTI - Performance Share Metrics - FY-1

• Now, a look forward…

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CEO Pay Ratio

• Section 953(b) of the Dodd-Frank Act directs the Commission to amend existing rules to require companies to disclose:

- The median of the annual total compensation of all employees of the company

- The ratio of that median to the annual total compensation of its CEO

• Since September announcement, almost 1,000 "unique" letters and 127,000 form letters have been sent to the SEC

• Compliance costs for some companies could be "substantial," even though smaller companies exempt and SEC does not spell out a specific methodology for companies to identify a median employee

• Consensus thinking: final rules will be adopted this year substantially as proposed, with the pay ratio disclosure required in 2016 proxies

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SEC and Advisory Firms

• SEC announced that it will soon review recommendations for possible regulatory action targeting proxy advisory firms

• At an earlier roundtable, concerns were raised about whether the firms properly disclose potential conflicts of interest and whether investment advisers too heavily rely on their advice when they vote on behalf of clients

• SEC became concerned after the SEC staff issued letters that permit advisers to rely on the advice without the fear of possible enforcement action

• SEC will issue recommendations in “near term”; likely to require more disclosures of conflicts, such as whether a proponent of a shareholder proposal or a competing director slate is a client

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Dodd-Frank: Rules not yet Proposed

• Disclosure of Pay vs. Performance- Complex disclosure on relationship between executive compensation

actually paid and the financial performance of the issuer

- Proposal scheduled end of October 2014

• Recovery of Erroneously Awarded Compensation- “Clawbacks”, likely with teeth

- Proposal scheduled end of October 2014

• Disclosure regarding Employee and Director Hedging- Disclose whether employees or directors are permitted to hedge equity of

the issuer (granted as compensation or otherwise held)

- Proposal scheduled end of October 2014

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Hedging and Pledging

• Corporate law does not prohibit a director or executive from pledging or hedging stock, but disclosure is required and no loans under SOX

• Section 955 of the Dodd-Frank Act requires that companies disclose whether directors or employees are permitted to hedge company securities. No proposed rules have been published by the SEC

• ISS 2013 policy updates identified “hedging of company stock and significant pledging of company stock” by directors and/or executives as examples of “failures of risk oversight.” “Significant” is not defined

• The ISS warned issuers that this type of failure, “under extraordinary circumstances,” may result in a vote against or a “withhold vote” declaration with respect to “directors individually, committee members, or entire board.”

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Hedging and Pledging

• ISS has opted for a substantive, facts-and-circumstances standard

• Will consider the following factors “in determining vote recommendations for election of directors of companies who currently have executives or directors with pledged company stock”:

- Presence in the company’s proxy statement of an anti-pledging policy that prohibits future pledging activity

- Magnitude of aggregate pledged shares in terms of total common shares outstanding or market value or trading volume

- Disclosure of progress or lack thereof in reducing the magnitude of aggregate pledged shares over time

- Disclosure in the proxy statement that shares subject to stock ownership and holding requirements do not include pledged company stock

- Any other relevant factors34

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ISS 2014 Policy Updates

• The final updates revise ISS proxy voting policies for U.S. listed companies relating to executive compensation and governance:

- Board Response to Majority-Supported Shareholder Proposals

o Now: case by case basis

- The Quantitative Pay-for-Performance Test Impacting ISS’s Evaluation of Say on Pay (“SOP”) Proposals

o TSR and CEO pay relative to ISS peer group solely over 3 year period

- The Qualitative Pay-for-Performance Assessment Impacting ISS’s Evaluation of SOP Proposals

o Quantitative assessment performed where qualitative analysis demonstrates “significant unsatisfactory long-term pay for performance alignment

o “Realizable pay” and granted pay compared to S&P 1500 companies35

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ISS 2014 Policy Updates

• Glass Lewis now uses a pay-for-performance model that benchmarks executive pay and company performance against four peer groups across seven metrics.

- Companies can receive a grade of A to F based on quantitative review

- Will vote against say on pay and withhold “For” votes for compensation committee members with pattern of failing

• Must disclose extent that short-term incentive have been achieved against relevant targets

- Must justify any non-disclosure

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ISS Longer Term Policy Changes

• Director tenure

• Director independence

• Shareholder proposals to require independent chair of board

• Evaluation of equity plans (US and Canada)

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What To Expect Going ForwardNo chance for R&R…

• Take a proactive approach to shareholder and advisory group concerns

– Look for low hanging fruit

• Many companies may considered:– Plan design changes

– Holding discussions with institutional investors

– Supplemental filings

• Enhance strategies to improve shareholder support– Assess pay programs from an advisory group perspective

– Re-orient your CD&A so that it serves as an advocate for your pay program and your successes as a company (like an MD&A)

• Reach out to major shareholders proactively to understand concerns38

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What To Expect Going Forward

• Also, you can expect executive compensation to continue to go up…

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Questions

Jim SilleryPrincipal952.806.6114312.315.2815James.sillery@buckconsultants.com