©2008 Pearl Meyer & Partners NECC Executive Compensation Forum Trends in Long-Term Incentives March 6, 2008 Melissa Means Vice President Pearl Meyer &

©2008 Pearl Meyer & Partners

NECC Executive Compensation ForumTrends in Long-Term Incentives

March 6, 2008

Melissa MeansVice President

Pearl Meyer & Partners(508) 630-1487

[email protected]

2©2008 Pearl Meyer & Partners

Agenda

Trends in Long-Term Incentives:

• Changing Landscape

• Long-Term Incentive (LTI) Usage

» Total Overhang

» Burn Rates

» New Share Requests

• Mix and Instruments Usage

» Mix

» Stock Options

» Stock

» Performance-Based Awards

• Other

» Exchange Ratios

» Ownership Guidelines

» RiskMetrics Group (formerly ISS)


The Changing Landscape

External influences significantly changing the use of LTI

• Perceived abuses

» Option backdating and other scandals

• SEC disclosure rules (CD&A)

» Increased transparency

» Mandated quantification

• Tax and accounting rules

» SFAS 123R

» 162(m)

• Unprecedented investor scrutiny

» Greater visibility and power

» More stringent requirements

» RiskMetrics (formerly ISS)

As a result:

• LTI remains in the forefront of public interest for the coming years

• Companies continue to re-evaluate the efficacy of their existing LTI programs


Usage – Total Overhang

Headline – Another consecutive year of reduced overhang levels

• Reality of expensing and shareholder pressures continue to drive companies to reduce total equity usage

The following outlines current total overhang levels for companies in the high technology industry (by industry and revenue):

Total Overhang

0%

5%

10%

15%

20%

25%

30%

Compu

ter

Semi/S

emi E

quip

Softw

are

Comm

/Net

HW

Telec

omm

Svc

sOth

er

Under

$1B

$1B to

$3B

$3B to

$10

B

Over $

10B

Total Equity Overhang

By Industry By Revenue


Usage – Burn Rates

Headline – Another consecutive year of reduced burn rate levels • To reduce total equity usage on an annual basis companies are:

» Reducing participation levels

» Reducing grant values

» Changing use of LTI instruments to deliver more value using fewer shares

The following outlines current total burn rate levels for companies in the high technology industry (by industry and revenue):

Burn Rates

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

Compu

ter

Semi/S

emi E

quip

Softw

are

Comm

/Net

HW

Telec

omm

Svc

sOth

er

Under

$1B

$1B to

$3B

$3B to

$10

B

Over $

10B

FY-3FY-2FY-1 (Most Recent Year)



Usage – New Share Requests

Headline – companies seeking more frequent authorization of smaller pools of available shares

The following outlines the percent of companies in the high technology industry seeking share approval in the past 3 years (by industry and revenue):

New Share Requests

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

Compu

ter

Semi/S

emi E

quip

Softw

are

Comm

/Net

HW

Telec

omm

Svc

sOth

er

Under

$1B

$1B to

$3B

$3B to

$10

B

Over $

10B




Mix & LTI Instrument – Mix

Headline - Companies continuing to evaluate and rebalance the mix of LTI instruments

Companies are also using multiple instruments to deliver LTI awards

CEO LTI Mix

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Options 79% 96% 69% 59% 49%

Restricted Stock 8% 4% 29% 39% 48%

Cash 13% 0% 2% 2% 3%

2003 2004 2005 2006 2007

Number of LTI Instruments Used

13%

4%

57%

26%

Options Only

RS Only

Other LTI Only

Use Multiple Instruments


Mix & LTI Instrument – Stock Options

Headline - Stock options are on the decline for another straight year• Companies are continuing to use other LTI instruments in lieu of options to

address:» Mandatory accounting issues (SFAS 123R)

» Constraints on dilution and burn rates (vs. competitors who shifted to restricted stock)

» Incentivize the proper behaviors

The following outlines option usage levels in the high technology industry (by industry and revenue) over the past 3 years:

Stock Options Granted

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%




Headline - Use of restricted stock (RS) continues to increase ~20%• Restricted stock can deliver the same value as options using fewer shares

Continued investor pressure when using restricted stock• Time-based awards minimum vesting over 3 years• Performance-based awards must have at least 1 year of vesting

The following outlines restricted stock usage levels in the high technology industry (by industry and revenue) over the past 3 years:

Mix & LTI Instrument - Restricted Stock

Restricted Stock Granted

0.0%

0.1%

0.2%

0.3%

0.4%

0.5%

0.6%

0.7%




Headline - Many companies are implementing or investigating the use of performance metrics in an LTI plan

• Stronger link between pay and performance

• More in line with shareholder and institutional expectations

44% of the Fortune 1000 and 62% of the S&P 500 have implemented a performance-based LTI plan

• Typically a 3 year plan that pays out in stock

However, performance-based plans can be challenging to design and administer. The following outlines key deign considerations for a performance-based plan:

• Single vs. multiple measures

• Shorter vs. longer time periods

• Absolute vs. relative measures

• Cumulative vs. point-in-time measures

• Performance/payout leverage and scaling

• Consecutive vs. overlapping cycles

Mix & LTI Instrument – Performance-Based LTI


The key to performance-based plans:

• Keep them as simple as possible

• Limit the plan initially to the top executives, consider expansion once plan is successful

• Consider shorter measurement periods for companies of high growth or acquisitive industries

• Selection of an appropriate performance metric

• Develop an appropriate performance/payout scale

• Discuss how to address unexpected financial circumstances

• Start slowly – consider consecutive cycles

Mix & LTI Instrument – Performance-Based LTI


Headline - 3 ways to think about LTI exchange ratios:

• Cost Neutral Ratio

» Assume SFAS 123R option cost is 33% of FMV and RS cost is 100% FMV

» Cost neutral ratio is 3 options : 1 restricted share

» 1 RS more valuable than 3 options until FMV increases 50%

• Premium Ratio

» Whatever cost neutral ratio is “+1”

• Risk Adjusted – looking forward

Mix & LTI Instrument –Exchange Ratios


Stock Ownership Guidelines

Headline – Continued movement towards stock ownership guidelines

• Ownership guidelines – mandate number of shares to be owned at all times

» Best for firms using full value instruments (e.g., restricted stock)

» Often serves as quid pro quo for implementing time-based restricted stock

• Disposition guidelines – mandate number of shares to be retained on post-exercise basis

» Best for firms using appreciation only instruments (e.g., options)

Programs are encouraged and well received by institutional shareholders

Actual guidelines and compliance periods vary by position


RiskMetrics Group (formerly ISS)

Average Burn Rates continue to trend downwards

Shareholder Value Transfer (SVT) increased in many segments due to changes in methodology in 2007

• Full value awards valued at full 200-day average share price

• Option cancellations/forfeitures and warrants/convertible debt not considered

SVT and Burn Rate allowable caps remain about the same as in 2007

Poor Pay Practices

• Could result in a “Withhold” vote for a Director up for re-election

Pay for Performance Policy in 2008

• ~1/3 of the Russell 3000 had negative 1 and 3-year TSR as of 12/31/07


Looking Forward

More long-term plans driven by non-market measures

Continuing shift from options to restricted stock

• Desire to link executives with financial performance

» Recent trend of higher option concentration at top executive level

• Time-based restricted stock for mid-to-lower level employees

Continuing evolution of linking pay and performance


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©2008 Pearl Meyer & Partners NECC Executive Compensation Forum Trends in Long-Term Incentives March 6, 2008 Melissa Means Vice President Pearl Meyer &