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Current Trends in Compensation

Dallas CPA Society
Continuing Education Day Conference

May 26, 2011

Todays Agenda

Update on Compensation Committee Governance Issues

Differences in Executive and Managerial Compensation Trends in Executive and Managerial Compensation

Current Equity Based Compensation Techniques

Current Board Compensation Issues

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Update on Compensation Committee Governance Issues

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Executive Compensation Climate 2011 Extended period of stormy weather

Regulatory developments and impact since the financial crisis
2009
Federal Reserve Board (FRB): Proposed Guidance on Sound Incentive Compensation Policies; Horizontal review of 28 LCBOs SEC: Revised disclosure rules focused on compensation and risk and compensation committee processes Global regulators: Principles for sound incentive compensation

2010
FRB: Final Guidance on Sound Incentive Compensation Policies (June) Congress: Dodd-Frank Act o Say on pay, say on pay frequency, say on parachutes o Compensation committee independence o CEO pay ratio disclosure o Pay for performance disclosure o Recovery of executive compensation (clawbacks) o Executive hedging o Enhanced disclosure of incentives for financial institutions Global regulators: Capital Requirements Directive III and related territory guidance

2011
SEC: Rulemaking on Dodd-Frank provisions: Say on pay provisions (January) Guidance to exchanges on compensation committee independence (March) FRB, FDIC, OCC, OTS, SEC, NCUA, FLHMA: Incentive-based Compensation Arrangements (April) Other rulemaking not scheduled before August 2011: o CEO pay ratio disclosure o Pay for performance disclosure o Clawback policies o Executive hedging

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Impact On Compensation Committees Increased time commitment and diligence

Among the trends in compensation committee processes, we have observed the following: - Two-step decision making (one meeting to review proposals, second meeting for approvals) - Requests for additional documentation of compensation processes

- Longer committee meeting agendas

- Greater interaction with other board committees and full board The push for increased shareholder interaction may affect committee chairs: - Accepted practice in the UK for RemCo chairs to present to shareholders

- Encouraged by selected US director associations

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Say On Pay Preparation Reflections on 2011 proxy season Companies have modified practices for say on pay right up until the vote
Disclosure

- CD&A executive summary focusing on pay for performance, risk alignment, peer groups, severance/change in control, executive benefits, and governance
- Pay for performance supplemental disclosures Program changes - Elimination of gross up provisions and other executive benefits - Establishment of performance conditions on long-term incentive grants Shareholder Engagement - Proxy advisor rebuttals - Institutional shareholder outreach

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Say On Pay Results Early returns Most companies Fortune 100 companies (15 as of 4/29): are receiving a - Yes votes (14): strong majority Median 93% in favor of say on pay 25th percentile 82% in favor votes in favor of - No votes (1): 48% in favor compensation
Broad sample (503 as of 4/29) - 98% received majority in favor - 2% (11 companies) received majority no votes

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Say On Pay Frequency Results Early returns Annual votes are preferred by shareholders and increasingly recommended by companies
Company Recommendations Annual Biennial Triennial Fortune 100 60% 1% 30% Broad Sample 51% 3% 43%

No recommendation*
Sample size

9%
75

3%
2,177

Companies recommending triennial vote, but receiving annual majority:

Fortune 100: 4 of 6 (75%)

Broad sample: 62 of 145 (43%)
* Includes those precluded from making a recommendation due to TARP restrictions
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Say On Pay Post Mortem Interpreting the results

Companies will reflect on say on pay results during 2011 SEC regulations require companies to report on the impact of say on pay votes in future year proxy statements - Covers most recent say on pay vote - Whether issuer considered say on pay in determining policies and decisions - How say on pay results affected policies and decisions Shareholder engagement - How will companies gain insights on reasons for no votes?

- What methods of engagement will companies use outside the annual proxy statement?

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Expected 2011 Rulemaking More to come, with questions to be answered

CEO pay ratio disclosure (ratio of CEO pay to median employee pay) - Potential repeal (H.R. 1062) - Questions on population and definitions Pay for performance disclosure - What are the relevant definitions of pay? - What performance metrics can be used (market, operating)? - What is the appropriate time horizon for measurement Recovery of executive compensation (clawbacks) - Excess incentive-based compensation, including stock options - Three-year look-back on any restatement (not subject to misconduct) - All executive officers - Questions on affected metrics, board discretion, and treatment of equity

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Differences in Executive and Managerial Compensation

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Executive vs. Managerial Pay Structures

Pay Component Salary Annual Incentives Executive
Smaller % of overall pay Larger % of overall pay Generally available to all execs and tied to overall company performance

Manager
Larger % of overall pay Smaller % of overall pay Generally available to all senior management and most managers but may be tied to performance of company overall, business unit, and/or individual metrics.

Long-term Incentives

Larger % of overall pay Generally available to all execs May be in multiple forms (e.g., stock, options, cash, etc.)

Smaller % of overall pay Availability depends on company but most managers and higher eligible Limited in forms

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Executive vs. Managerial Pay Structures

Pay Component Health & Welfare Benefits Retirement Benefits Executive
Eligible for company-wide plans May also receive premium benefits (e.g., reimbursement)* Eligible for company-wide plans May also be eligible for NQDC, SERP, and/or Restoration Plan* Generally available to execs* Generally limited to officers*

Manager
Eligible for company-wide plans

Eligible for company-wide plans May also be eligible for NQDC Less prevalent Not prevalent

Perquisites Severance/CIC

* Many benefits which have been historically executive-only are on the decline with many companies completely eliminating them.

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Trends in Executive and Managerial Compensation

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Overall Trends
Overall, compensation trends have been focused on:

Performance measurement
Compensation risk Elements of remuneration - Elimination of executive benefits (e.g., SERPs, perquisites)

- Focus on severance periods, single trigger change in control benefits, tax gross-ups

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Trends In Program Design Assessing the impact of the regulatory climate

Trends have been developing since the financial crisis

Re-evaluating performance metrics:

- Risk adjustment and sustainability - Less emphasis on formulaic plans Lengthening time horizons:

- Greater proportion of compensation deferred

- Performance conditions applied to deferrals - Pressure on dilutive impact of equity plans Reducing executive protection:

- Elimination of executive benefits (e.g., SERPs, perquisites)

- Focus on severance periods, single trigger change in control benefits, tax gross-ups New requirements for financial institutions to disclose compensation to regulatory agencies (SEC, Federal Reserve, FDIC, OCC, OTS, NCUA, FHFA)
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Refining The Pay-For-Performance Model

Highlights: New compensation guidance is equal parts business opportunity and compliance. Compensation policies will need to focus more on long-term value creation and corporate stability. Companies must now consider the interaction of risk and performance across their entire organization, not just within the C-suite. Businesses may have to disclose more about their risk-and-reward models, as well as rethink the roles of key control.

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Todays Perspectives
Pay-for-performance models are under increasing scrutiny from US policymakers and their global counterparts. Collective goal is to ensure that compensation does not put the long term health of businesses and the overall economy at undue risk. - Not just banks and financial services institutions US lawmakers and regulators want to lessen companies emphasis on shortterm performance. - Want greater disclosure about how public companies' compensation policies might precipitate events that businesses don't have the financial wherewithal to withstand.

New guidance will force companies to take a much broader view of both performance and risk.
- If viewed as an opportunity, rather than just a compliance exercise, companies may derive long-term benefits from the pay-for performance model's evolution.
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What Does It Mean For Companies?

Spotlight on the Risk-Compensation relationship What it means for companies: Companies will need to demonstrate that compensation models are layering in risk considerations. Boards will have to assess the compensation policies for any employee who could put the business at heightened risk.

Putting compensation "at risk" for longer periods so that the timing of incentive pay and performance are not misaligned.
- May pose challenges for companies in light of recent tax rule changes. Greater disclosure on risk and reward may inform shareholder views/votes on compensation decisions.

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Redefining Performance
In their effort to address the various complex causes of the financial crisis, policymakers have been contemplating the role corporate pay packages played. - The result is compensation guidance from multiple agencies. Collectively, the guidance aims to ensure that compensation policies do not promote behavior that could put companiesand, by extension, marketsin jeopardy. To this end, policymakers want corporate compensation plans to take risk and long-term performance into greater account.

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Redefining Performance
Regulator/shareholder tension Some shareholders have traditionally focused on short-term returns, paying less attention to long-term value creation and risk. - This was particularly evident in the run-up to the financial crisis. Various companies that have fared relatively well in the wake of the crisis were criticized by shareholders (one to two years earlier) for not playing more aggressively in the subprime loan market. Many policymakers argue that the interests of such shareholders are not necessarily aligned with the interests of the general public and the goal of market stability. The new guidance attempts to bring those interests into balance.

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Redefining Performance
Pressure on boards Shareholders are beginning to bring about some of that balance themselves, post-crisis, giving greater consideration to the long-term corporate health of the companies they invest in. As a result, shareholders' usual pressure on boards to show a demonstrable and explicit link between pay and performance may start to shift in emphasisso that the long-term view of performance is stressed as much as the short-term view. Indeed, certain institutional investors (e.g., pension funds) have long made this their policy. Such pressure will be easier to apply if Congress requires public companies to grant shareholders a nonbinding advisory vote on executive pay ("say on pay").

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Redefining Performance
Pressure on boards (Contd) Boards also continue to confront public pressure, with negative sentiment about executive pay potentially diminishing corporate reputation and value. And, there may be pressure from within the board itself: - Although much of the new compensation guidance is directed at banks and other financial institutions, its core elements are likely to migrate to other sectors through cross-directorships and broader director education.

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Viewing Risk Through a Wider Lens

Looking past the habitual sightlines As the SEC and Fed see it, the risk compensation relationship isn't necessarily confined to the C-suite. Rather, any employee and business unit may, depending on their role, function, and how they are paid, put a company at heightened riskand, in turn, pose an indirect risk to the financial system and broader economy. Those two agencies, therefore, expect companies to assess the compensation policies for non-officer employees whose individual or collective decisions create such risks. The SEC also wants companies to disclose those policies in their proxy statements if they could result in potentially harmful consequences for the companies.

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Is Workforce Talent a New Measure?

Talent may be biggest challenge during economic recovery Many companies that downsized aggressively could soon face a shortage of skills suited to the new global economy Increased workloads, job reductions, and overall economic and employment uncertainty have strained employee morale

Companies focusing more on finding and motivating the right talent to support the companys business strategy
May be driven outside of HR if not a strategic partner

Understand how management is reshaping the skills and size of the companys workforce in light of its strategy and todays economic conditions
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Current Equity-based Compensation Techniques

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Equity-based Compensation Plans

Past practice Historically, stock options were the most common form of equity-based compensation. Often leveraged down to all employees in the organization. May be tax qualified or nonqualified. Companies also historically offered ESPPs but many companies discontinued or modified their plans following 123R. Companies which used restricted stock generally awarded them with serviceonly requirements.

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Equity-based Compensation Plans

Current landscape and techniques Shift away from pure stock options Limited employee population eligible for awards - May be limited to employees directly responsible for driving company growth - Cash may be used for other employees instead of equity Organizations, such as ISS, and shareholders recommend the use of performance measures to earn awards (both stock and options) Internal measures such as EPS and Cash Flows have been used more often

Prevalence towards metrics highly visible to shareholders

- External measures have been used more recently such as tied to solely to stock price appreciation or based on relative performance to competitors or indices.
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Current Board Compensation Issues

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Role of the Compensation Committee Maintain and Review

Review philosophy and Compensation Committee Charter periodically

Review compensation process periodically Review proxy disclosures / CD&A annually Conduct competitive compensation analyses annually Review peer set annually for any changes in size or operations through acquisition / divestiture Develop incentive metrics and performance targets annually Review aggregate share use annually

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Role of the Compensation Committee (Contd) Maintain and Review

Review CEO (and other key executive pay) annually Review incentive plan targets annually Review Board of Director pay periodically Periodic review of retirement and benefits plans (cost review annually)

Key executive shareholdings (annually) and stock transactions (quarterly)

Review of external relationships and fees annually Review of succession planning annually Review of policies and procedures as needed

Engagement with key executive hires and employment agreements

Education / training / update of trends

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Compensating the Board Board Trends

Majority of Boards have 10 members (8 outside Directors)

6 Board meetings per year

Members spend on average 10 to 15 hours a month on Board matters - Trend for 2011 indicates a continued increase Sub-committee meetings range from 3 to 5 meetings per year

Position of Chairperson and CEO is divided

Compensation levels has stayed flat for 2010 compared to 2009

* Source: Compensation Resources: 2010 BOD Compensation Survey

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Compensating the Board Components of Board Compensation

Annual Cash Retainers

- Typically cash payments, some companies provide in form of equity

Equity Grants - Stock options still prevalent, with Restricted Stock a strong second - Equity size determined on value versus number of shares

- Stock ownership guidelines

Board Meeting Fees - Still prevalent, but trend is reducing and to include in retainer Benefits and Perquisites

- Majority of companies do not provide

- Life, medical, dental - Matching gift programs

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Compensating the Board Components of Board Compensation

Committee Chair Retainers - Audit and Compensation Committee Chairs highest paid Committee Meeting Fees - Still prevalent, but trend is to pay only committee retainer Chairman Of the Board Retainers - Generally only to independent chairman or lead independent director

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2011 PwC. All rights reserved. In this document, "PwC" refers to PricewaterhouseCoopers LLP, a Delaware limited liability partnership, which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity. This document is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.