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Compensation Strategies. in a. "Bifurcated" Economy. Michael A. Thompson F REDERIC W. C OOK & C O. July 19, 2000. Topics Covered. Old economy companies losing to new economy companies May be changing, but not certain Retaining high performers harder than ever - PowerPoint PPT Presentation
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Michael A. ThompsonFREDERIC W. COOK & CO.
July 19, 2000
2
Topics CoveredTopics Covered
• Old economy companies losing to new Old economy companies losing to new economy companieseconomy companies– May be changing, but not certainMay be changing, but not certain
• Retaining high performers harder than Retaining high performers harder than everever
• Investors pushing back on dilutionInvestors pushing back on dilution• Rescuing underwater options is difficult, Rescuing underwater options is difficult,
not impossiblenot impossible• Innovations and trends to watchInnovations and trends to watch
3
Stock MarketStock Market
“Bifurcated” Economy
4
Volatile Stock MarketVolatile Stock Market
• Nasdaq was down 1/3 but recoveringNasdaq was down 1/3 but recovering– Up 40% over past 12 monthsUp 40% over past 12 months
• Dow down slightly over past 12 mos.Dow down slightly over past 12 mos.• Many companies have lost 50% or more Many companies have lost 50% or more
of their valueof their value– XeroxXerox MattelMattel– ArmstrongArmstrong Bank OneBank One– Sara LeeSara Lee R.R. DonnelleyR.R. Donnelley– SearsSears Toys R UsToys R Us– E-ToysE-Toys Red HatRed Hat
“Bifurcated” Economy
5
Corporate TransactionsCorporate Transactions
• MergersMergers
• AcquisitionsAcquisitions
• Divestitures/ SalesDivestitures/ Sales
• IPOsIPOs
• Spin-offsSpin-offs
• Tracking StockTracking Stock
“Bifurcated” Economy
6
Rise of Venture CapitalRise of Venture Capital
• Corporate Venture Capital and Corporate Venture Capital and Private Equity FundsPrivate Equity Funds
• Creates significant pressure on Creates significant pressure on executive compensationexecutive compensation– Internal venture managersInternal venture managers
• Raises issues regarding “friends and Raises issues regarding “friends and family” shares on IPOfamily” shares on IPO
“Bifurcated” Economy
7
Corp. Venture CapitalCorp. Venture Capital
“Bifurcated” Economy
Corporate VC Compensation Practices
Carried Interest
Incentives
Mandatory Co-Invest
Voluntary Ad Hoc
Co-Invest
Voluntary Side-by-Side
Fund
Current Prevalence Future Prevalence
32%
68%
7% 11%
21% 18%
0%
32%
0%
25%
50%
75%
100%
8
Internet ImpactInternet Impact
• Changing the gameChanging the game– Focus on carried interest, not Black-Scholes Focus on carried interest, not Black-Scholes
valuevalue– Equity interest in E-commerce unitsEquity interest in E-commerce units
• Raises the ante for retentionRaises the ante for retention• Significant salary increases in some Significant salary increases in some
sectors, e.g., law firmssectors, e.g., law firms• Push to client equity pools in others, e.g., Push to client equity pools in others, e.g.,
consulting firmsconsulting firms
Oldcos vs. Newcos
9
Competing Pay ModelsCompeting Pay Models
Oldcos vs. Newcos
Relative ComparisonRelative Comparison
OldcosOldcos NewcosNewcos
Annual CashAnnual Cash HighHigh LowLow
BenefitsBenefits HighHigh LowLow
Stock OptionsStock Options Low Low HighHigh
10
Expensive RecruitingExpensive Recruiting
• In the money option values:In the money option values:– 18 internet companies18 internet companies
$0
$50
$100
$150
$200
$250
1999 2000
(est.)
1999 2000
(est.)
1999 2000
(est.)
1999 2000
(est.)
Vested Unvested
Option Gains ($000,000)
CEO COO CFO Top Sales
Oldcos vs. Newcos
11
Different Pay PackagesDifferent Pay Packages
• Joseph Galli example:Joseph Galli example:From To
Company Black & Decker Amazon
Position Head of Power ToolBusiness
President & COO
Compensation (Latest year) $1.1Mannual cash + $460KLTI + 75K options +rich pension/SERP
$200K salary +3.9M options with$20M guarantee +$5M cash signingbonus
Oldcos vs. Newcos
12
Generic ComparisonsGeneric Comparisons
$0
$500
$1,000
$1,500
$2,000
$2,500
Salary Bonus Long-Term
CEO CFO Top Sales General Counsel
GI
GIGI
GI
Internet
Internet
Internet
Internet
($000)
Oldcos vs. Newcos
13
Pre- vs. Post-IPOPre- vs. Post-IPO
Pre-IPOPre-IPO Post-IPOPost-IPO
Median RevenuesMedian Revenues $3 MM$3 MM $6 MM$6 MM
Median Market Median Market ValuationValuation
$38 MM$38 MM $362 MM$362 MM
Median Number of Median Number of EmployeesEmployees
4040 158158
Source: SCA ePay Study, April 2000-- Over 30 pre-IPO companies and 50 post-IPO companies-- Traditional company assumed to be $400MM revenue and $275 Market Cap
Oldcos vs. Newcos
14
Company PracticesCompany Practices
$118$153
$175
$20
$30
$80
13%
13%22%
87%65%
$0
$50
$100
$150
$200
$250
$300
Pre-IPO Post-IPO Traditional Post-IPO Traditional
Dol
lars
(00
0)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
% o
f sh
ares
out
stan
ding
Investors
Founders
Employees
Source: SCA ePay Study, April 2000
Vice President Cash Compensation Median Company Ownership
Salary
Bonus
Oldcos vs. Newcos
15
Company PracticesCompany Practices
$145
$250
$140
8.0%
5.0%
0.9%
$0
$50
$100
$150
$200
$250
$300
CEO-Founder CEO-Nonfounder
Vice President CEO-Founder CEO-Nonfounder
Vice President
Dol
lars
(00
0)
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
% o
f sha
res
outs
tand
ing
Median Cash Compensation Median Equity Owned
Source: SCA ePay Study, April 2000
Oldcos vs. Newcos
16
Run Rate ComparisonsRun Rate Comparisons
1.1%
5.0% - 7.0%
2.1%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
Old Economy New Economy
1989 1999
An
nu
al G
ran
ts a
s a
% o
f O
uts
tan
din
g S
har
es
91% Growth
Oldcos vs. Newcos
17
Dilution ComparisonsDilution Comparisons
6.9%
13.7%
20.0% - 25.0%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
Old Economy New Economy
1989 1999
Pot
enti
al D
ilu
tion
as
a %
of
Ou
tsta
nd
ing
Sh
ares
99% Growth
Oldcos vs. Newcos
18
Candidates’ ResponseCandidates’ Response
• More risk averseMore risk averse• Want additional cashWant additional cash• Will trade-off options for Will trade-off options for
– restricted stock, restricted stock, – SERPs, SERPs, – deferred annuities, deferred annuities, – forgivable loans, forgivable loans, – etc.etc.
Oldcos vs. Newcos
19
Recent InitiativesRecent Initiatives
• Tracking stockTracking stock– Disney, DLJ, Quantum, Staples, ATTDisney, DLJ, Quantum, Staples, ATT
• Spinoffs/IPOsSpinoffs/IPOs– ATT, GM, HP, LucentATT, GM, HP, Lucent
• Subsidiary OptionsSubsidiary Options• Venture Capital IncentivesVenture Capital Incentives
– Merrill Lynch, ?Merrill Lynch, ?
Oldcos vs. Newcos
20
Reason for the ProblemReason for the Problem
• High demandHigh demand• High mobility and High mobility and
accessible infoaccessible info• Recruiting premiums Recruiting premiums
and buyout packagesand buyout packages• ““Star” systemStar” system
• Longest bull marketLongest bull market• Options and other Options and other
equity compequity comp• Stock price is major Stock price is major
determinant of comp determinant of comp valuevalue
Retention
Labor Market Stock Market
21
Carly Fiorina ExampleCarly Fiorina Example
Retention
FromFrom ToTo
CompanyCompany LucentLucent Hewlett-PackardHewlett-Packard
PositionPosition Group President, Group President, Global Service Global Service
Provider BusinessProvider Business
Chief Executive Chief Executive OfficerOfficer
CompensationCompensation $70MM of unvested $70MM of unvested options forfeited at options forfeited at
terminationtermination
$100MM signing $100MM signing packagepackage
22
Design ProvisionsDesign Provisions
Beyond the traditional . . .Beyond the traditional . . .• Option Clawbacks (Cigna, Delta, Goodyear, Option Clawbacks (Cigna, Delta, Goodyear,
IBM)IBM)• Tandem option guarantees (Amazon)Tandem option guarantees (Amazon)• Stock purchase loans (eBay, Excite@Home, Stock purchase loans (eBay, Excite@Home,
Kodak) Kodak) • Career Restricted Stock (Coca-Cola, GE, 3M)Career Restricted Stock (Coca-Cola, GE, 3M)• Forfeitable Deferral Premiums (Alcoa, Dell, Forfeitable Deferral Premiums (Alcoa, Dell,
GM)GM)
Retention
23
Design ProvisionsDesign Provisions
• Restricted stockRestricted stock– 3/5 year vesting or career3/5 year vesting or career
• VC investment fundsVC investment funds• Shared participation in e-commerce Shared participation in e-commerce
subsidiariessubsidiaries• Voluntary cash/stock deferrals, with Voluntary cash/stock deferrals, with
forfeitable sweetenerforfeitable sweetener• Supplemental retirement plans with “bad Supplemental retirement plans with “bad
boy” clausesboy” clauses
Retention
24
• Higher “burn rates” and “overhang”Higher “burn rates” and “overhang”
• More scrutiny from institutional investorsMore scrutiny from institutional investors
Upward TrendUpward Trend
% Outstanding SharesTop-200 (P. Meyer Survey)
1989 1999
Annual Grants 1.1% 2.1%
Potential Dilution 6.9% 13.7%
Dilution
25
2000 Voting--ISS2000 Voting--ISS
• Opposed majority of plans (55%)Opposed majority of plans (55%)– Limited impact, but still a concernLimited impact, but still a concern
• Continued flaws in modelContinued flaws in model– Overvalues grants at high performers and Overvalues grants at high performers and
vice-versavice-versa– Penalizes omnibus plans without limits on Penalizes omnibus plans without limits on
full-value grantsfull-value grants– Discourages breakout from low utilization Discourages breakout from low utilization
industries (defense, utilities)industries (defense, utilities)
Dilution
26
2000 Voting--Others2000 Voting--Others
• Focused mostly on dilution, not wealth Focused mostly on dilution, not wealth transfertransfer
• Fidelity opposed to RS without Fidelity opposed to RS without minimum 2-3 years restrictionsminimum 2-3 years restrictions
Dilution
Large Cap Small Cap
> 15% > 20%
10-15% 15-20%
<10% <15%
27
Changes in PracticesChanges in Practices
• Smaller more Smaller more frequent share frequent share authorizationsauthorizations
• Shares counted on Shares counted on net, as issued basis, net, as issued basis, not gross, as granted not gross, as granted basisbasis
• Add back shares re-Add back shares re-purchased with option purchased with option proceedsproceeds
• Board approved plans Board approved plans for non-officersfor non-officers
• Best voting outcome Best voting outcome because of dilution because of dilution teststests
• Add back shares to Add back shares to pool from stock-swap pool from stock-swap exercises, etc.exercises, etc.
• Particularly with Particularly with prevalent buy-back prevalent buy-back programsprograms
• Possible under stock Possible under stock exchange rulesexchange rules
Dilution
28
Looking AheadLooking Ahead
• NYSE may limit broad-based exemptionNYSE may limit broad-based exemption• Efforts needed to encourage improved Efforts needed to encourage improved
investor voting rulesinvestor voting rules– Especially ISSEspecially ISS
• % of salary grant guidelines no longer % of salary grant guidelines no longer usefuluseful– Start with competitive % share usage, using Start with competitive % share usage, using
surveys for surveys for allocationallocation
Dilution
29
Underwater Options
If shares availableIf shares available
• Front-load future option grantsFront-load future option grants• Next 2-3 yearsNext 2-3 years• Incentive for price recovery and Incentive for price recovery and
retentionretention• No additional “competitive” No additional “competitive”
compensation valuecompensation value
30
If shares not availableIf shares not available
New option grants could be made New option grants could be made after 6 months with no variable after 6 months with no variable accounting expenseaccounting expense
• Executives voluntarily cancelExecutives voluntarily cancel• Company buys back for restricted Company buys back for restricted
stock or cashstock or cash– At fair value (Black-Scholes)At fair value (Black-Scholes)– Discount from fair valueDiscount from fair value
Underwater Options
31
More Drastic HedgesMore Drastic Hedges
• Options with dividend equivalentsOptions with dividend equivalents• Replace u/w options with restricted Replace u/w options with restricted
stockstock• Price-recovery restricted stockPrice-recovery restricted stock• Cash-appreciation bonusesCash-appreciation bonuses• Subsidiary optionsSubsidiary options• Relative performance sharesRelative performance shares• Combination option/rs grantsCombination option/rs grants
Underwater Options
32
Innovations/Trends
Option-RelatedOption-Related
• Opportunistic grant timingOpportunistic grant timing• More frequent grants More frequent grants • Shorter option termsShorter option terms• Offset guaranteesOffset guarantees• ReloadsReloads• Auto-acceleration at terminationAuto-acceleration at termination
– Except cause or voluntary quitExcept cause or voluntary quit
• Price thresholds for exercisePrice thresholds for exercise
33
OtherOther
• Double-trigger change-in-control Double-trigger change-in-control stock vestingstock vesting– No vesting if stock awards replacedNo vesting if stock awards replaced
• Personal loansPersonal loans– Forgivable and non-forgivableForgivable and non-forgivable
• Flexible DeferralsFlexible Deferrals
Innovations/Trends
34
Likely ResponseLikely Response
• Increased share usage/dilutionIncreased share usage/dilution– Human capital value addedHuman capital value added
• Greater dispersion and selectivity of Greater dispersion and selectivity of rewards by individualsrewards by individuals– Four critical factorsFour critical factors
• Focus on line-of-sight incentivesFocus on line-of-sight incentives– Less focus on wholeLess focus on whole– More potential for inequitiesMore potential for inequities
Innovations/Trends
35
Frederic W. Cook & Co., Inc. provides management compensation consulting services to business clients.Formed in 1973, our firm has served over 1,000 corporations in a wide variety of industries from our offices in NewYork, Chicago, and Los Angeles. Our primary focus is on performance-based compensation programs which helpcompanies attract and retain key employees, motivate and reward them for improved performance, and align theirinterests with shareholders. Our range of consulting services encompasses the following areas:
Total Compensation Reviews Incentive Grant Guidelines Performance Measurement Strategic Incentives Executive Ownership Programs Globalization Specific Plan Reviews All-Employee Plans Privatization Restructuring Services Directors’ Compensation Compensation Committee Advisor Competitive Comparisons Equity Instruments Stock Option Enhancements
Our offices are located:
New York Chicago Los Angeles90 Park Avenue35th floor
19 South LaSalle StreetSuite 400
2029 Century Park EastSuite 1130
New York, New York 10016 Chicago, Illinois 60603 Los Angeles, California 90067212-986-6330 phone 312-332-0910 phone 310-277-5070 phone212-986-3836 fax 312-332-0647 fax 310-277-5068 fax
Web site address:www.fredericwcook.com