Equity compensation grant trends 20110812 print

Hot Trends inEquity Compensation

Grant and Award PracticesWhat companies are doing,what they should be doing,

and what they may want to stop doing

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DAN WALTER, CEPDan Walter CEP, is the President of Performensation (www.performensation.com). For more than 15 years, Dan has assisted companies with equity and performance-based compensation issues. Dan has extensive experience with both executive and broad-based programs. A unique focus is the design and management of performance share and units.

Dan provides end-to-end solutions for private and public companies based in both the United States and abroad. Dan is a popular speaker on topics involving equity compensation and success growth. His extensive work with both very small and very large companies provides his clients with a unique perspective. He creates effective, company-specific solutions paired with post-consultation support. Dan’s expertise includes diagnosis of issues, plan design, communication, administration and reporting solutions.

The Winds of Change

• ISS and Glass Lewis Policies

• Say on Pay (and SOP Frequency)

• Academic Research

• Media Scrutiny

• Activist Shareholders

• Political Capital

• Underwater options (exchanged or not)

• Lions and Bulls and Bears ...Oh My!

Changing Faster Than Some Can Handle

Corporate Governance

• Influence of ISS and Glass-Lewis influence has continued to grow

• Average CD&A has grown from about 20 pages to approximately 30

• Linking pay to performance consistently mentioned as a key goal for both proxy advisors and boards

• Executive compensation now synonymous with equity compensation

What Does ISS Want?

• Always recommends annual vote for Say on Pay Frequency

• Negative Say on Pay recommendation if:

• Perception that CEO compensation is not aligned with corporate performance

• Board has not been willing to discuss compensation with ISS

• History of Problematic Pay Practices

Shoot-out at the Triple P!• Any new or extended CEO contract

that includes:

• Excise tax gross-up for CIC payments

• Single or Modified trigger CIC payments

• CIC payments >3 times current base and bonus

• Excessive perqs or tax gross-ups

• Ability to reprice/exchange underwater options without shareholder approval The Good, the Bad and the Ugly

Beware of Problematic Pay Practices

ISS Writes a New Rulebook

• CIC definition is deemed too liberal

• The company has a history of the “Triple P” and the equity plan was in same way involved.

• There is a disconnect between company performance and CEO Pay and at least 50% of year-over-year increase in in equity compensation

• The total cost of equity plans is deemed unreasonable

• Three year burn rate, exceeds defined limitations. Currently:

• 2% of the mean plus 1 standard deviation of the company’s industry group

• But, no more than 2 percentage points (+/-) from the PY industry group cap

You’re Doing it Wrong If...

Say on Pay

• About 2% of companies had failed SOP votes

• Multiple lawsuits filed on behalf of shareholders

• Not a “check the box” process

• Several companies have modified equity programs prior to final vote

Courtesy Ed Hauder: www.say-on-pay.com

More than Many Planned for

Say on Pay

• Eliminated tax gross-ups

• Disney

• Added/modified performance for equity

• Alcoa

• GE

• Lockheed Martin

• Filed additional info, new communications

• Tyco International

• Conoco Phillips

• Pfizer / Johnson & Johnson

Concede, Correct or Fight?

Academic Research• Optimal Contracts or Managerial Power?

Evidence on the Impact of CEO Compensation on Bank Risk in Europe Andre Uhde and Payam Elahi University of Bochum and University of Bochum Date Posted: May 30, 2011

• Share Repurchases, Equity Issuances, and the Optimal Design of Executive Pay Texas Law Review, Vol. 89, No. 5, p. 1113, 2011Jesse M. Fried Harvard Law School University of California, Berkeley - School of Law Date Posted: May 20, 2011

• The Valuation Differences between Stock Option and Restricted Stock Grants for US Firms Journal of Business Finance & Accounting, Vol. 38, Nos. 3/4, pp. 395-412, 2011James H. Irving , Wayne R. Landsman and Bradley P. Lindsey College of William and Mary - Mason School of Business , University of North Carolina (UNC) at Chapel Hill - Accounting Area and College of William and Mary Date Posted: May 11, 2011

• Manipulation and Equity-Based Compensation American Economic Review, Vol. 98, No. 2, pp. 285-90, 2008Lin Peng and Ailsa Röell Zicklin School of Business, Baruch College / CUNY and Columbia University, School of International and Public Affairs Date Posted: April 24, 2011

• Seven Myths of Corporate Governance Rock Center for Corporate Governance at Stanford University Closer Look Series: Topics, Issues and Controversies in Corporate Governance No. CGRP-16David F. Larcker and Brian Tayan Stanford University - Graduate School of Business and Stanford University - Graduate School of Business Date Posted: June 2, 2011

• Optimal Contracts or Managerial Power? Evidence on the Impact of CEO Compensation on Bank Risk in Europe Andre Uhde and Payam Elahi University of Bochum and University of Bochum Date Posted: May 30, 2011

More Volume, Less Conclusions

Equity Compensation MixPercentage of Shares Awarded

• This and the preceding charts clearly show the miscommunication regarding the growth of full value equity usage

• All of the growth full value equity compensation can be attributed to the growing use of performance equity

0%10%20%30%40%50%60%70%80%90%100%

73% 69%65%

27% 31% 35%

20072008

2009

Stock Options Restricted / Performance

Equity Compensation MixValues

• CEO Stock Options

• 44% in 2008

• 34% on 2010

• CEO Restricted Equity

• 16% in 2008

• 17% in 2010

• CEO Performance Awards

• 40% in 2008

• 49% in 2010

0%10%20%30%40%50%60%70%80%90%100%

44% 41% 39% 39%34% 31%

16% 22%17% 20%

17% 20%

40% 37% 43% 41%49% 48%

2008 CEO 2008 CFO 2009 CEO 2009 CFO 2010 CEO 2010 CFO

Stock Options Restricted Performance

Any equity instrument can be blended with others

will it blend?WILL IT BLEND?

The Indomitable Stock Option

• Nearly all S&P 1500 companies still have stock options (approximately 98% have outstanding options)

• Lately they just use LESS of them

• Outstanding Options were about 35% lower in 2010 as compared to 2004

• Less companies are granting options and many grants are several year old. We will see a continued drop-off in outstanding options as a percentage of total outstanding equity awards.

Stock Options Are Here To Stay

Stock OptionsLess shares, more value

• The percentage of companies granting options dropped from 2004 to 2010

BUT

• The value being granted dropped from 2004-2007, then rose back to 2005 levels by 2009!

Stock OptionsIt’s good at the top

• In 2004 NEO’s received one out of every five stock option shares granted

• In 2010 NEO’s received one out of every THREE stock options shares granted

• 2009 median NEO stock option value was at its highest point since prior to 2004

Time-Based Full Value Awards

• In many industries a higher percentage of companies use restricted awards than stock options!

• Overall growth in the use of time-based restricted equity has leveled off

• Programs have generally remained linked to three-year vesting scheduled with annual vesting events

• Most plans are RSUs due to more simplicity their use globally

• We will probably see a small surge of Restricted Stock Shares as IPOs pickup, then a drop-off shortly after

Restricted Shares and Units

Performance Equity Awards

• Recent surveys claim 50%-80% of companies use performance awards

• Surveys are at least 8-12 months behind reality

• Most live polls show the percentage of companies who use equity and incorporate performance goals to be 75-85%

High Growth Instruments!


Common Performance Metrics

• Revenue

• EPS

• Operating Income

• ROIC

• Cash Flow

• Profit Margin


Common Market-based Metrics

• Total Shareholder Return (TSR)

• Relative-TSR - 88% of companies

• Absolute-TSR - 12% of companies

• Indexed Stock Price


• Performance-based Stock Options: Trend or Fad?

• Several companies have added performance criteria to outstanding options in response to ISS or Glass Lewis comments

• Example GE added performance to Jeffrey Immelt’s 2010 stock options (linked to cash flow and stock performance) after a negative recommendation during the recent proxy season.

• Opinion: FAD!

High-Level Issues

• Bow to the pressure and modify the obvious

• A struggle to balance poor predictability for defined metrics against growing cry against goals discretion

• Clean-up the last few options while there may still be time

• Performance, Performance, Performance

• In many cases executive values are now above pre-recession levels

• In nearly every case broad-based values still trail pre-recession levels

• Some increased interest in IRC 423 ESPP

Hottest Equity Trend for 2011

A balanced meal

ESPP broadbased

Stock Options Restricted Awards

Legacy Award Performance

Equity

Equity

Equity Trends for 2011

•Hot Trend 1•Leave “Market Data” for last

•Design the right plan and levels for your company, then check against survey data


•Hot Trend 2•Focus equity on management

•add cash and recognition for everyone else)


•Hot Trend 3•Structure Performance

Awards so that Maximum level pays out above 100%


•Hot Trend 4•Build Generic Grant Agreements •with addendum for:

•Individual Countries•Performance Metrics and Goals


•Hot Trend 5•Performance

Awards for 3 years with a series of one-year goals

DON’T DO THIS

• Equity Don’t 1

• Stop granting stock options without considering intrinsic, modeled and expected potential value

• as if each stock option share is a legitimate form of currency regardless of price and value

This

is worth...

Variable amounts

of this

DON”T DO THIS


• Don’t think that your company will avoid performance-based equity. 95%+ of publicly traded companies in the US will have performance equity, at least for executives, by Q1 2012.

DON’T DO THIS

•Equity Don’t 3

•Stop using compensation expense as an excuse for a poor (or no) IRC 423 ESPP.

•Broad-based grants are probably a long-way off.

•ESPP’s provide a tangible attraction and motivation device, while provide a perfect focal point for communications from management.

DON’T DO THIS


• Stop waiting for the big turn-around to reevaluate and improve your equity compensation plans. Start correcting your design, communications and administrative systems and providers while things are still calm enough to do it right.

DON’T DO THIS


• Stop hoping that someone else will ask that great question that’s in your head. Be bold and ask away!

EQUITY ISSUES REVIEW

•THE MORE THINGS CHANGE, THE MORE THEY CHANGE

•SAY ON PAY

•PROBLEMATIC PAY PRATICES

•ACADEMIC RESEARCH HAS GROWN-UP

•OPTIONS ARE HERE TO STAY

•PERFORMANCE IS THE ONLY INSTRUMENT GROWING

EQUITY TREND REVIEW

•BALANCED MEAL APPROACH TO EQUITY

•LEAVE MARKET DATA FOR LAST

•FOCUS EQUITY ON MANAGEMENT

•STRUCTURE PERFORMANCE TO PAY MORE THAN 100%

•GENERIC AGREEMENTS WITH LOCATION-SPECIFIC ADDENDUM

•3 YEAR PERFORMANCE WITH ONE YEAR GOALS

Questions?Dan Walter

President and CEO, PerformensationEmail: [email protected]: 415-625-3406mobile: +1-917-734-4649

T witter: @performensation Skype: performensationLinkedIn: www.linkedin.com/in/danwalterPresentation Library: www.slideshare.net/performensation

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WWW.PERFORMENSATION.COM!

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Other online places to learn (or find Dan Walter)

Equity Compensation ExpertsFREE Online Networking

www.equitycompensationexperts.groupsite.com

ShareComp 2011FREE Online Conference and Portal

(up to 16 houres of CEP credit)www.bit.ly/sharecomp2011

(use passcode “GEMS”)

Compensation CafeTop 10 HR/Compensation Blog 2010

www.compensationcafe.com

Equity compensation grant trends 20110812 print

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