A 2012 Step Program for Detoxifying your Executive Pay Plans

May 22, 2012

A 2012 Step Program for Detoxifying your

Executive Pay Plans

2© 2012 Hay Group. All rights reserved

Discussion areas

Introductions

Current Environment

2012 Step Program

Key Learnings at CEDC

Q&A

1

2

3

4

5

01Introductions


Introductions

Presenter

Dan Moynihan, Principal, Executive Compensation, Hay Group

[email protected] | 201.557.8423

mailto:[email protected]


About Hay Group

Global organizational and human resources consulting firm

Compensation and benefits consulting

Employee, organizational and customer research

Executive coaching/leadership development

Organizational effectiveness and management development

Work design/strategy alignment

Information business

Founded in 1943

Offices in 49 countries

Ten US offices


About Central European Distribution Corporation

CEDC is one of the world’s largest vodka producers - $2B annual revenues

It maintains leading positions in all of its key markets:

Poland, Russia and Hungary

Our brand portfolio includes valuable and recognized brands like BOLS, Żubrówka,

Absolwent and Soplica in Poland; Green Mark and Parliament in Russia; and

Royal Vodka in Hungary.

02Current Environment


Overview

What are the key issues?

Dodd-Frank provided a “perfect storm” of shareholder empowerment around

executive pay

The Act arms shareholders with more information, power, access and

ultimately responsibility than before, while making it harder for management

to accumulate votes

In response to increased pressure from shareholders and proxy advisory firms,

as well as recent Say on Pay legislation, companies continue to monitor their

executive compensation programs

Only 41 companies failed in 2011, and thus far we have had 4 fail in 2012…is

the hubbub worth it? (as of 4/20/2012)

Given today’s intense scrutiny of executive compensation, we are seeing

companies and compensation committees re-evaluate their programs annually

and to make changes to comply with stakeholder concerns


What's next?

The 2011 voting results have some compensation committees more relaxed

than they were before the results were known.

Too soon to tell for 2012

We believe that the single biggest factor influencing the say on pay voting

trends this proxy season has been strong company performance

The fact that pay programs have been “cleaner” has certainly had impact

But at the end of the day, shareholders will make 2012 all about company

performance

Don’t be fooled by the modest shareholder reaction of 2011 – if performance

declines while pay does not, you can be sure that shareholders will make

themselves heard in 2012!

Citibank is the most notable case to date

A false sense of security?


The situation at CEDC

In 2009, ISS withheld their votes on several directors for PFP issues and

excise tax gross-ups

The pay packages were not in line with the market

The Compensation Committee chair resigned from the Board

A new Committee was formed and a new Chair named

Clean-up began on

Employment Agreements

Ownership Guidelines and better shareholder alignment

Removal of gross-ups

Realignment of equity plans

More performance based pay


The situation at CEDC

In 2010, changes to the LTIP, and a clean bill of health from ISS – Low

concern

In 2011, redesign of AIP to better meet the needs of business

In 2012, stock performance and pay may be misaligned

The Company is working closely with Hay Group and ISS to rectify prior to

the proxy release

032012 Step Program


2012 Step Program

1. Admit we are powerless over scrutiny

2. There is a power greater than our

compensation plan

3. Turn our plans over to the path of

righteousness

4. Do an inventory of our plans and issues

5. Admit we have made mistakes with our

pay plans

6. Admit we are ready to fix our plans

7. Ask to fix the shortcomings

8. Make a list of the problems, and

share with your team

9. Fix the issue, and make amends with

stakeholders

10. Continually take an inventory of

where we are, and fix any on going

issues

11. Focus on carrying out the plan

12. Spread the message to others who

need help fixing their plans


1. Admit we are powerless over scrutiny

Evaluate the stakeholder base

Employees

Unions

Shareholders

Institutional shareholders

Media

Watchdogs

ISS, Glass Lewis, etc.

Begin pro active communication with affected groups

Stay true to yourself

Best practice vs. Best fit

Critical to understand where the

issues are with these groups, and

be proactive in approach to

working with them


2. There is a power greater than our compensation plan

ISS and their ilk

Once we accept that we must deal with these activists, we are better prepared

A force to be reckoned with

Their power is perceived, and not always real

Success with outreach

In order to get to a successful Say on Pay vote, shareholder outreach is advisable

Build the story of why, not just what you did

There is power to the story

ISS/Glass Lewis can be reasonable

Work with them towards a satisfactory outcome

Begin the conversation off cycle


2. There is a power greater than our compensation plan (cont.)

ISS – Losing Influence?

Shareholders seem to be less influenced by ISS on say on pay – at least this proxy season

Only small number of companies that ISS recommended AGAINST lost their votes in

2011

However, a number of companies changed programs after receiving the ISS

recommendation and before the shareholder meeting

Direct shareholder outreach may be able to overpower ISS recommendations

More pressure on shareholders to not “rubber stamp” their vote

Investment manager proxy voting will be a matter of public record

More institutions developing their own “books”

All that said, every compensation committee in America continues to be aware of the ISS

standards around executive pay


3. Turn our plans over to the path of righteousness

Live by the rule of business judgment

Develop a Compensation Philosophy that is fair and just, and works for the business

If you have 75th percentile performance, then you can justify 75th percentile pay

Strategy

Make sure that the HR and pay philosophies match with current business strategy

Too often we change the course of the business, but forget to adapt our pay

strategy to match

Develop a story line that connects the dots between business strategy and reward

strategy

Charter

Review the Compensation Committee Charter

Ensure that they are overseeing the right things

Best Practice

Does not always equal best fit

Just because others are doing it, does not make it right for your business!


4. Do an inventory of our plans and issues

Compensation program audit

Need to really understand all of your plans and practices

Great time for tally sheets for the Committee

Problematic Pay Practices

Gross-Ups

Higher than 75th percentile pay

Inexplicable peer group

Be honest with yourself

PFP Analysis

Be proactive with this, and understand when you will have an issue

If company performance and/or stock performance over time is declining, need to be

aware that issues with PFP will arise

Again, BE PROACTIVE


5. Admit you have made mistakes

Did your audit uncover any of these hot buttons?

“Hot Button” Description

1. Employment contracts Egregious employment contracts with multi-year pay guarantees, non-

performance based bonuses and/or equity compensation

2. New CEO with overly

generous package Excessive “make-whole” provisions without sufficient rationale

3. Large bonus payouts

without justifiable

performance linkage or

proper disclosure

Performance metrics that are changed, canceled or replaced during

the performance period without explanation of the action and link to

performance

4. Egregious

pension/SERP payouts

Inclusion of additional years of service not worked or inclusion of

performance-based equity awards in the calculation



Do you need to fess up to these?


5. Excessive perquisites

Perquisites for former executives, such as lifetime benefits, car

allowances, or personal use of corporate aircraft

Extraordinary relocation benefits (including home buyouts)

Other perquisites including personal use of corporate aircraft, home

security systems and car allowances

6. Excessive severance

and/or change in

control provisions

Change in control payments exceeding 3 times base salary and bonus

or without loss of job or substantial diminution of job duties

New or materially amended employment or severance agreements that

provide for modified single triggers, under which an executive may

voluntarily leave for any reason within 1 month period following the 12

month period and still receive the change-in-control severance package

or that provide for an excise tax gross-up

Payments upon an executive's termination in connection with

performance failure

Liberal change in control definition in individual contracts or equity

plans which could result in payments to executives without an actual

change in control occurring



Need to make amends for these?


7. Tax Reimbursements

Reimbursement of income taxes on certain executive perquisites or other

payments (e.g., personal use of corporate aircraft, etc; see also excise

tax gross-ups on previous page)

8. Repricing or replacing

of underwater stock

options

Without prior shareholder approval (including cash buyouts)

Voluntary surrender of underwater options by executive officers may be

viewed as an indirect option repricing/exchange program, especially if

those cancelled options are returned to the equity plan, as they can be

regranted to executive officers at a lower exercise price and/or the

executives can subsequently receive unscheduled grants in the future

9. Internal pay disparity Significant differential between CEO total pay and that of next highest-

paid named executive officer (NEO)


6. Admit we are ready to fix our plans7. Ask to fix the shortcomings

Ok, so you have made some mistakes

Disclose it

Amended proxy filings explaining why ISS/Glass Lewis “got it wrong”

Shareholder calls and meetings

8-Ks disclosing new programs

We will fix it

Commit to making it right

Most difficult areas are gross up’s and elimination of single trigger

Want to keep executives engaged and motivated

They see the removal of these as huge take-aways

New philosophy

Outline the changes, and how your philosophy on pay has shifted

Use CD&A for this

Step away from the bar…


8. Make a list of the problems, and share with stakeholders

Outreach is essential

Create the full list of issues

Prioritize and identify any unintended consequences of change

Create a timeline for reparations

May not be possible to make all changes in one year

Especially if making complex changes to LTI plans, which often include a

shareholder request for more shares

Communicate

Good to involve multiple parties, based on your unique situation

Board

Compensation Committee

Executive Management

Internal Compensation, Finance, and Legal Teams

External Consultants and Legal Team

ISS and/or Institutional Investors


9. Fix the issue, and make amends with stakeholders10. Continually take inventory, and fix on going issues

Fix it

Say mea culpa

Monitor the plans to ensure they don’t get away from you

Review the plans as things change

Clawback policies will be a big issue for the 2013 proxy season

Final rules should be available, and ISS will expect swift action to ensure that

companies are complying with the new regulations


11. Focus on carrying out the plan

Stay committed to the cause

Remember, that Compensation has four goals:

Helps to attract new talent

Helps with retention of talent

Acts as a motivational tool

Helps to focus the executive on what is important to the business

Solid compensation plans will fit the business, link to shareholder return, and will be a

tool for helping to run the business


12. Spread the message to others who need help

Once you have seen the light…

Share the vision with others

Become a compensation evangelist

04Key Learnings at CEDC


The CEDC Story

Withheld votes on 2 directors in 2009

PFP disconnect

Excise tax gross ups

Subsequently eliminated from new contracts

2010 – low concern

There is no disclosure regarding a holding period for stock option grants to

executives

Created holding period

2011 – median concern

Directors are subject to sub-standard stock ownership guidelines

Fixed in mid-2011, and disclosed in July

The company did not disclose a clawback provision for variable cash

compensation

Awaiting final Dodd Frank rules

2012 – PFP likely to be an issue again

From ISS Withhold to Positive Outcomes


What was learned

Audit revealed issues that were forgotten or missed due to piecemeal approach to

compensation

New committee re-evaluated the entire package

Reviewed tally sheets to understand the historical issues for their executives

Fixed problematic pay practices

Better outreach to shareholders on key issues

For 2012, in the process of a share request for a new LTI plan

Got ISS involved at the beginning


What to Expect in 2012 and 2013

Continued government interest and involvement, specifically through Dodd-Frank

Due to shareholder and proxy advisory firm influence, continued conservatism around the

optics of certain pay program features and design:

Double triggers on equity plans

Lower severance multiples

Elimination of excise tax gross-ups and less perquisites

Increased share ownership guidelines or holding requirements

However, due to current performance equity designs, more volatility of outcomes

More pay for performance alignment

Companies using stock options and PSUs have significant leverage in their LTI program

Increased use of TSR-based performance plans to ensure executives don’t win if

shareholders lose

More companies will defer a portion of bonuses into stock

Both a “risk in compensation” issue as well as a mechanism to enforce clawbacks

Don’t be fooled by the modest shareholder reaction of 2011 – if performance declines while

pay does not, you can be sure that shareholders will make themselves heard in 2012

Overview


TopicWhat Makes

Business Sense?

What Do

Shareholders Want?

Where’s The

Breaking Point?

Issue for

CEDC?

Pay

Philosophy

Pay positioning that maps to

competitive positioning

Pay positioning that

maps to competitive

positioning

Targeting P75

without P75

performance

Not an issue

Pay MixMapping pay mix to key time

horizons for the business>50% in LTI for CEOs >50% in STI Not an issue

Performance

Measures

A balance that rewards

something when returns are

low but the team outperforms

plans and the market

High absolute returns

AND relative

outperformance

Big payouts when

shareholders lose

Have paid $0

bonuses in

last 2 years

STI /

Bonuses

Allowing some discretion when

warranted; Balancing financial

and strategic measures

Formula-driven

financial performance

Overriding the

formula with big

discretionary

payouts

Limited

discretion

LTI

Performance vesting when

linked to the “right” measures

and key milestones

Less dilution

Performance vesting

Lack of a

performance-vested

vehicle

LTI plans

balance time

and

performance

What to Expect in 2012/2013

Companies need to be aware of the “breaking point” for each pay element


TopicWhat Makes

Business Sense?

What Do

Shareholders Want?

Where’s The

Breaking Point?

Issue for

CEDC?

PerquisitesSome of these, some of the

timeNone of them

Gross-ups,

excessive personal

use of plane

None

anymore

Change in

Control

Incentive for executives to be

aligned with the best interest

of shareholders

Double-triggers

2x payouts (from 3x)

Single triggers –

even on equity –

and gross-ups

, Double

Trigger for

other NEOs

Managing

Risk in Pay

Some balance – but not too

much

Pay profile that maps to the

risk profile

Balance, but with a

focus on shareholder

value

One measure that

drives most of the

pay

Not an issue.

Multiple

metrics to

balance risk

What to Expect in 2012/2013

Companies need to be aware of the “breaking point” for each pay element

Q&A


Presenter

Dan Moynihan, Principal, Executive Compensation, Hay Group

[email protected] | 201.557.8423

mailto:[email protected]