In addition, the SEC has provided an updated timeline for implementation of other key aspects of the Dodd-Frank legislation related to executive compensation, likely providing companies with additional time to comply with some of the potentially challenging aspects of the legislation.

Highlights of the Final Rules on Say on Pay and Say on Golden Parachutes

Under the Final Rules, the Effective Date for compliance with Say on Pay and the Say on Pay Frequency vote is listed as 60 days following publication in the Federal Register; however, companies that have not yet filed their 2011 proxy statements should comply with the Final Rules.

Advisory Vote on Say on Pay

As in the proposed rules, the final rules require companies to have a Say on Pay Vote in any proxy for an annual meeting after January 21, 2011 and to have additional votes at least once every three years. A key change in the final rules is that smaller issuers (i.e., public companies with less than $75 million in public equity float) have been provided with a two-year exemption from the Say on Pay and Say on Pay frequency votes. Consistent with the Proposed Rules, companies operating under TARP do not need to conduct the Say on Pay frequency vote until they have repaid TARP funds.

The Proposed Rules indicated that in future CD&A disclosure, companies would need to discuss how their compensation policies and decisions have been influenced by past Say on Pay votes. In the Final Rules, this has been clarified to specify that the mandatory disclosure is only for the most recent Say on Pay vote and that disclosure on earlier Say on Pay votes is only necessary to the extent material.

Aside from the above changes, most of the other changes from the Proposed Rules to the Final Rules are technical clarifications (e.g., clarify that the requirement is to have a vote once every three calendar years vs. by the third anniversary of the most recent Say on Pay vote). In addition, the SEC confirmed in the Final Rules that the Say on Pay Proposal and the Say on Pay Frequency Proposal do not trigger a preliminary proxy filing.

Vote on Frequency of Say on Pay Votes

The Final rules on the frequency of Say on Pay votes confirm that shareholders will have to be provided with four choices on frequency:

• Every year
• Every two years
• Every three years
• Abstain

Under the Proposed Rules, companies were required to disclose the frequency with which the company expects to conduct future Say on Pay votes and how it relates to the results of the shareholder vote in the 10-Q or 10-K covering the period in which the shareholder advisory vote occurred. The Final Rules have made a modification to provide companies with more time. Instead of disclosure in a 10-Q or 10-K, they will be required to disclose the frequency of future Say on Pay votes in a new required 8-K disclosure (as an amendment to the prior 8-K filings disclosing the preliminary and final results of the shareholder votes on frequency). The new 8-K will be due no later than 150 calendar days after the date of the vote and no later than 60 days before its next annual proxy meeting filing is due.

In the Proposed Rules, separate shareholder proposals on Say on Pay or Say on Pay frequency could be excluded from the proxy statement provided that the company’s policy was consistent with plurality of votes cast in the most recent vote. The Final Rules strengthened the standard to allow separate Say on Pay or Say on Pay Frequency proposals to be excluded only if the company adopts a Say on Pay frequency consistent with the majority of shareholders. As a result, in cases where no majority emerges in the Say on Pay Frequency vote, separate proposals on Say on Pay and Say on Pay Frequency will not be able to be excluded.

Finally, consistent with the Proposed Rules, companies participating in TARP (which are required to conduct a Say on Pay vote annually) will not be required to conduct a vote on the frequency of the Say on Pay vote until the shareholder meeting immediately following the repayment of TARP funds.

Highlights of the Guidance on Say on Parachutes

The SEC’s Final Rules for new enhanced disclosure of golden parachute payments and an advisory vote on parachute payments closely comply with the Proposed Rules. One key change in the Final Rules is that the effective date is established for merger filings on or after April 25, 2011. It should also be noted that there is no small company exception for the disclosure of golden parachute payments and advisory vote on parachute payments.

Disclosure of Golden Parachute Payments

Consistent with the Proposed Rules, the Final Rules will require tabular disclosure of the following elements related to Golden Parachute payments for each Named Executive Officer:

• Cash severance payments
• Dollar value of accelerated stock awards, in-the-money value of options accelerated, and payments to cancel stock or options
• Pension and deferred compensation enhancements
• Perks and benefits
• Tax reimbursement and gross-up payments
• Other
• Total

A change from the Proposed Rules is that in the Final Rules, for elements that are based on the transaction stock price, the value will be based on the consideration per share in the transaction (where applicable) or the average closing day price for the 5 days immediately following the announcement of the transaction.

Say on Golden Parachute Payments

Consistent with the Proposed Rules, the Final Rules require a separate non-binding shareholder advisory vote on golden parachute compensation, to the extent not previously subject to a prior general Say on Pay vote. In order to ensure that parachute payments are subject to the general Say on Pay vote, companies will have to disclose golden parachute compensation in their proxy statements with the new tabular disclosure and enhanced narrative disclosure of golden parachute payments. In addition, if any changes are made to the golden parachute payments following the most recent vote, the company will have to hold a subsequent vote on golden parachutes. It should be noted that in the Final Rules, the SEC has specified that an additional vote will not be required if the changes to golden parachute payments decrease the value of the parachute payments.

SEC Timing Updates

In order to fully implement Dodd-Frank, the SEC needs to develop rules governing several aspects of the legislation impacting executive compensation. Based on a recent status update from the SEC, the anticipated timing of when rules will be issued has been pushed back in many cases. The table below provides a summary of the current status.

	Proposed Rules	Adopt Final Rules
Compensation Committee and Advisor Independence	January-March, 2011	April – July, 2011
Disclosure of pay-for-performance, pay ratios, and hedging by employees and directors	August – December, 2011	TBD
Clawbacks	August – December, 2011	TBD

Based on the updated schedule, it is not clear that many of these items will be implemented in time for the 2012 proxy statements for calendar fiscal year end companies.

Conclusion

The Final Rules are largely consistent with the Proposed Rules. Most companies are already well on their way in the process of putting together their Say on Pay proposals and Say on Pay frequency recommendations and the Final Rules should not have much of an impact on their decision making.

The Final Rules covering increased disclosure of Golden Parachute Payments and Say on Golden Parachutes are largely consistent with the Proposed Rules. We expect that most companies will not adopt the enhanced disclosure of Golden Parachute Payments, as they are likely to have to conduct an additional shareholder vote on Golden Parachute Payments at the time of a transaction that triggers payments in any case.

The delay in the SEC’s schedule will likely be welcomed by companies, so long as it results in a delay for implementation beyond the 2012 proxy season for the new pay-for-performance and pay ratio disclosure. Given the potential challenges in implementing the these aspects of Dodd-Frank, we expect that it would be very difficult for calendar year companies to comply in their 2012 proxy statements, unless final rules were provided before the end of 2011.

Please contact us at (212) 921-9350 if you have any questions about the issues discussed above or would like to discuss your own executive compensation issues. You can access our website at www.capartners.com for more information on executive compensation.

Annual Incentive Plan Metrics

In our June 25, 2010 CAPflash, we noted that the most frequently reported modification in 2010 CD&As was changing performance metrics used to fund annual incentive awards (reported by 15 companies, or 44% of the 34 companies making annual incentive plan changes).

The chart below shows that for all industry groups, the two most common metrics used in annual incentive plan funding are Revenue/Revenue Growth and various measures of earnings, such as Operating Income, EBIT or EPS. In four of the six industry groups, the most prevalent metric used is Revenue/ Revenue Growth. Among Insurance and Healthcare companies, Operating Income and EPS, respectively, are the most prevalent metrics. Strategic goals are used by 67% of the Pharmaceutical companies. Return metrics are rarely used as key funding criteria. ROIC is one of the top metrics in the Healthcare industry, but other industry groups do not commonly use return measures. Excluding financial services companies, 60 companies (82% of 73 companies) use more than one metric to fund annual incentives.

The chart summarizes the three most prevalent metrics used in each industry group:

Industry	No. of Cos.	Annual Incentive Funding – Most Prevalent Metrics Used
		#1	#2	#3
Consumer Goods		Rev. / Rev. Growth	EPS	Operating Income
# of Cos.	13	9	8	7
% of Cos.		69%	62%	54%
Healthcare		EPS	Operating Income	ROIC
# of Cos.	11	4	4	2
% of Cos.		36%	36%	18%
Insurance		Operating Income	Operating Income EPS	Operating Income ROE
# of Cos.	12	9	6	6
% of Cos.		75%	50%	50%
Pharmaceuticals		Rev. / Rev. Growth	EPS	Strategic Goals
# of Cos.	12	10	10	8
% of Cos.		83%	83%	67%
Retail		Rev. / Rev. Growth	EBIT/ EBITDA	Operating Income
# of Cos.	10	3	3	2
% of Cos.		30%	30%	20%
Technology		Rev. / Rev. Growth	Operating Income	Cash Flow
# of Cos.	15	10	5	4
% of Cos.		67%	33%	27%
All Industry Groups		Rev. / Rev. Growth	Operating Income	EPS
# of Cos.	85	39	28	23
% of Cos.		46%	33%	27%

Note: Excludes financial services companies due to limited disclosure related to TARP participation/ restrictions. Four companies use a non-GAAP EPS metric.

As financial services companies increasingly come out of TARP, we expect their bonus pool funding to be linked to company profitability and performance expressed in bottom-line metrics as well as risk and capital adequacy metrics. In addition to financial services, many companies are making efforts in their plan design to offset any potential inappropriate risk taking by focusing on metrics used, time horizons, deferrals and performance sensitivities.

Long-Term Incentive Vehicles

In our June CAPflash, we found that the biggest change reported by companies with regard to long-term incentive practices was the mix of award vehicles.

Stock options are the most prevalent LTI vehicle used among the 85 companies studied, used by 62 companies (or 73%). Both Time Based Restricted Stock (“TBRS”) and Long-term Performance Plans (“LTIPs”) are also frequently seen, used by 53 and 51 companies, respectively (62% and 60%).

Here is the breakdown of overall LTI vehicle prevalence:

Long-Term Incentive Vehicle Prevalence	No. of Cos.	% of Cos. (n=85)
Stock Options	62	73%
Time-Based Restricted Stock (TBRS)	53	62%
LTIP	51	60%
Performance-Based Restricted Stock (PBRS)	31	36%
Performance-Based Stock Options (PBSO)	5	6%

Note: Percentages do not add up to 100% due to multiple responses.

As companies continue to make changes to LTI programs they are balancing time-based equity with performance-based equity. Of the 85 companies, 48 use two LTI vehicles in their executive program (56%), 20 use three vehicles (24%), 17 use one vehicle (20%). The two most prevalent vehicle combinations used are:

• 2 vehicles: stock options and LTIP/or PBRS, used by 24 companies (28% of 85 companies), and
• 3 vehicles: stock options, TBRS and LTIP/or PBRS, used by 20 companies (24% of 85 companies)

Below is the breakdown of the combination of LTI vehicles awarded:

Combination of LTI Vehicles Used
# of LTI Vehicles Granted	No. of Cos.	% of Cos. (n=85)
2 Vehicles (Options, LTIP/PBRS)	24	28%
2 Vehicles (Options, RS)	13	15%
2 Vehicles (TBRS, LTIP/PBRS)	11	13%
3 Vehicles (Options, RS, LTIP/PBRS)	20	24%
1 Vehicle (LTIP/ PBRS)	8	9%
1 Vehicle (TBRS)	5	6%
1 Vehicle (Options)	4	5%

We expect the use of performance-based LTI to continue to increase, modestly, in 2011 and beyond. Stock options will continue to be a part of the LTI mix, but with less emphasis. As the economy stabilizes and recovers, we also expect to see less time-based restricted stock granted at senior executive levels.

Performance-Based Long-Term Incentive Metrics

Of the 65 companies that use an LTIP or Performance Based Restricted Stock or Options, 27 companies use EPS (42%) and 23 companies use Relative TSR (35%) as metrics. We have seen a slight uptick in the use of Relative TSR, given its simplicity and clarity of measurement in a volatile market. Due to the difficultly in goal setting, companies continue to recalibrate performance metrics.

The breakdown of the most prevalent performance based LTI metrics used is as follows:

LTIP / PBRS / PBSO Metric	No. of Cos.	% of Cos. (n=65)
EPS	27	42%
Relative TSR	23	35%
Revenue / Revenue Growth	14	22%
ROC / ROE	13	20%
Cash Flow	7	11%
Operating Income	6	9%

Note: Percentages do not add up to 100% due to multiple responses.

Further, of those companies using EPS and Relative TSR, they are most common in certain industries:

• EPS is common in healthcare, consumer goods, pharmaceutical companies
• Relative TSR is common in technology, consumer goods, pharmaceutical companies

Of the companies that use an LTIP or PBRS, 52 companies (83%) pay out in stock.

LTIP / PBRS Payout	No. of Cos.	% of Cos. (n=63)
Stock	52	83%
Cash	25	40%
Both (Stock and Cash)	5	8%

Note: Percentages do not add up to 100% due to multiple responses.

Other Long-Term Incentive Provisions

Consistent with broad market norms we also found that a three year time frame for performance measurement and or vesting is common:

• Among the companies that use an LTIP/PBRS, the most common performance period is 3 years (86% of those providing)
• 37% of companies granting stock options use 3 year installment vesting
• 36% of companies granting time based RS use a 3 year vesting period, with cliff vesting somewhat more prevalent than installment vesting

Conclusions

Companies are continuing to evaluate and modify executive annual incentive and long-term incentive plans. We expect to see continued modest shifts in LTI programs, as companies continue to evaluate the appropriateness of specific LTI vehicles in light of the recovering market, accounting cost vs. employees’ perceived value, and overall pay strategy. The increased emphasis on performance-based compensation will prevail through 2011 as shareholders continue to demand clear alignment between pay and performance.

Please contact us at (212) 921-9350 if you have any questions about the issues discussed above or would like to discuss your own executive compensation issues. You can access our website at www.capartners.com for more information on executive compensation.

• A review of current director pay practices among the largest public U.S. corporations, generally considered trend setting organizations
• Observations regarding trends and outlook
• The Report’s Best in Class Director Compensation Process / Practices, listed below, provide a strong foundation for non-employee director compensation programs at organizations of any size/industry
• This report was authored by Dan Laddin and Matt Vnuk, with research assistance from Shaun Bisman, Meredith St. Lawrence, Deep Patel, Harsha Raghunath, and Devika Ray. Questions and comments should be directed to Dan Laddin or Matt Vnuk at [email protected] or (212) 921-9359, [email protected] or (212) 921-9364

Additional information on Compensation Advisory Partners can be found in the Company Profile section of the Appendix

Table of Contents

Executive Summary

• Best in Class Director Compensation Process / Practices
• Notable Findings / Outlook
• Elements Studied

Pay Levels

• Board Member Total Compensation
• Board Cash Retainers
• Board Meeting Fees
• Committee Member Compensation
• Total Board Cash Compensation
• Value of Equity Awards
• Committee Chair Compensation
• Non-Executive Board Leadership (additional compensation)

Pay Practices

• Mix
• Equity Vehicle Type
• Denomination of Equity Awards (fixed value vs. fixed shares)
• Vesting of Equity Awards
• Non-Executive Board Leadership (additional compensation)

Other Program Design Considerations

• Total Company Cost (of Board oversight)
• Board Membership and Meetings
• Committee Membership and Meetings
• Stock Ownership Guidelines (requirements)
• Benefits and Perquisites

Appendix

• Board Member Total Compensation (industry medians)
• Methodology
• Public Fortune 100 Companies
• Company Profile (Compensation Advisory Partners)

Executive Summary

• Best in Class Director Compensation Process / Practices
• Notable Findings / Outlook
• Elements Studied

Executive Summary | Best in Class Director Compensation Process / Practices

Process – Independent Directors Should:

• Establish a process to determine director pay levels and structure in an informed, deliberate and objective way, with consideration given to market data, trends and outlook
• Define target market positioning for total pay
  • Target should typically align with executive compensation philosophy
  • “Market” should reflect the peer group used for executive compensation benchmarking and/or size-appropriate general industry data; at times, other reference points may also be appropriate
• Use compensation as a tool to align the interests of non-employee directors and long-term shareholders

Practices – Compensation / Governance Committees Should:

• Align pay levels with an organization’s size and complexity; in turn, provide appropriate pay for time and responsibilities
• Review director pay programs focusing on aggregate pay (Total Board Compensation), with consideration given to:
  • The ratio of cash compensation to equity compensation
  • Additional pay for Board leadership roles
• Structure pay so that equity represents at least half of the total; however, the pay program should:
  • Not be highly leveraged
  • Be viewed as a “management fee”
• Establish meaningful equity ownership requirements that must be achieved within, at most, 5 years
• Eliminate benefit / perquisite programs unless there is a strong business case for maintaining them
• Provide detailed disclosure of the director compensation philosophy and rationale for the program

Executive Summary | Notable Findings / Outlook

Looking Back – While workload increased over the past couple of years, dramatic economic changes and poor performance increased scrutiny and debate in regard to director pay programs. Therefore, it is not surprising that this year’s study found:

• Conservative increases in pay levels; from 2008 to 2009 Total Board Compensation increased 4 percent, at median
• Year-over-year, no change in median pay mix
• Reduction in the prevalence of meeting fees, which were already minority practice
• Increase in the prevalence of full-value equity awards, with a corresponding decrease in the prevalence of stock options
• Increase in the prevalence of equity awards based on a fixed value, with a corresponding decrease in equity awards based on fixed number of shares
• At least one full-value equity award will not be transferred until retirement at approximately 50% of companies studied

Looking Ahead – Over the next few years, changes in director compensation will take place in terms of both pay levels and program design; specifically:

• Low-to-mid single digit annual increases in Total Board Compensation
• More companies moving to a fixed cash pay structure, with related:
  • Decreases in the prevalence of meeting fees, especially Board meeting fees
  • Slow / gradual decrease in the prevalence of committee member compensation
• Continued growth in prevalence of full-value equity awards, with corresponding decreases in the prevalence of stock option awards
• Increases in equity awards based on a fixed value, with corresponding reductions in equity awards based on fixed number of shares
• Increased use of, and modifications to, stock ownership guidelines / requirements
• Continued growth in the prevalence of hold until / transfer at retirement equity award provisions

Note: there will be a follow-up CAPFlash made available in early 2011 discussing the top 5 director compensation considerations for the next year.

Executive Summary | Elements Studied

CAP’s consulting staff reviewed current director compensation programs for each of the public Fortune 100 companies.

• The Fortune 100 reflects the largest U.S. corporations based on annual revenue (93 are public companies); see Appendix for a list of the 93 companies in this year’s survey
• “CAP Observations,” included throughout this report, provide commentary on trends and outlook

Elements Studied:

• Annual Cash Retainer
• Total Board Meeting Fees; per meeting fee times the number of meetings
• Committee Member Compensation; all meeting fees and retainers
• Total Board Cash Compensation; sum of cash retainer, total Board meeting fees and average committee member compensation
• Equity Awards (stock retainer); full-value shares/equivalents and stock options
• Total Board Compensation; sum of Total Board Cash Compensation and Equity Awards
• Total Company Cost (of Board oversight); Total Board compensation times number of non-employee directors plus additional/premium pay for committee leadership (Chair) roles and additional/premium pay for independent Board leadership roles (presiding / lead director or non-executive chair)

2010 Study Also Provides Data / Analysis On:

• Equity grant practices, compensation for leadership positions, stock ownership guidelines, perquisites/benefits, and industry pay practices

Note: Total Board Cash Compensation includes committee member compensation (excludes additional/premium meeting fees or retainers paid for chairing a committee) as the trend is towards companies building fees for basic committee service into annual Board fees/retainers. Further, committee member compensation is typically cash-based.

Executive Summary | Elements Studied (Continued)

While this analysis of Fortune 100 data focuses on the group of companies as a whole, industry specific practices were also reviewed (click here to see the list).

* Industry groups were determined by GICS code.

** Due to limited number of companies, revenue listed reflects industry average, not median.

Pay Levels

• Board Member Total Compensation
• Board Cash Retainers
• Board Meeting Fees
• Committee Member Compensation
• Total Board Cash Compensation
• Value of Equity Awards
• Committee Chair Compensation
• Non-Executive Board Leadership (additional compensation)

Pay Levels | Board Member Total Compensation

Between 2008 and 2009, basic compensation for service as a Board member (Total Board Compensation) increased approximately 4 percent, from $225,000 to $235,000 (at median).

• Reflects all cash and equity compensation, excluding compensation for additional leadership roles such as committee Chairman, Lead/Presiding director or non-executive Chairman of the Board
• CAP’s director compensation best practices (p.5) state that director compensation should be reviewed focusing on aggregate pay

CAP Observation:

• Director compensation levels increased substantially several years ago following the new demands of Sarbanes-Oxley, but pay has recently leveled off
• As a result of increased director workloads, during each of the next few years, we expect to see low-to-mid single-digit increases in Total Board Compensation
• We also expect to see more companies adopt a fixed cash pay structure

Pay Levels | Board Cash Retainers

The value of annual Board cash retainers remained constant over the past 2 years, at median.

• 98 percent of companies studied provide an annual cash retainer

CAP Observation:

• Once 2010 director pay levels are available, in part due to more companies moving to a fixed cash pay structure, we expect to see a small to moderate increase in the median value of annual cash retainers, as compared to 2009

Pay Levels | Board Meeting Fees

Board meeting fees are a minority practice, provided by only 23 percent of companies studied in 2009. Therefore, the median Board meeting fee in 2009 was zero.

• Of the companies studied that provide Board meeting fees, some only do so for special meetings or for meetings in excess of a minimum number
  • Only 19 percent of companies studied provided Board meeting / attendance fees for all regular Board meetings
  • This is down from 21 percent in 2008
• Among those companies paying meeting fees for all regular Board meetings, the median fee in 2009 was unchanged from 2008

CAP Observation:

• The practice of using Board meeting fees continues to decline in prevalence, partly in reaction to difficulties in defining what constitutes a “meeting” (e.g., ad hoc teleconferences)
• Companies that eliminate meeting fees typically provide an increased Board cash or equity retainer
• We expect to see more companies simplify their director compensation programs and eliminate meeting fees, moving towards a more fixed cash pay structure / “management fee”

Pay Levels | Committee Member Compensation

From 2008 to 2009, committee member compensation increased slightly, about 5 percent at median; reflects average compensation received by a director for all committee member service (includes 0s).

• Over 35% of companies studied pay no committee-specific fees to members of any of the 3 major committees
  • The median committee meeting fee for each of the Audit, Compensation and Nominating / Governance committees is $0
  • The median committee member retainer at the Audit Committee is $10,000, but is $0 at the Compensation and Nominating / Governance committees
  • Most often, the Audit Committee involves the largest workload; however, over recent years workload has been becoming less differentiated between the 3 major Board committees

CAP Observation:

• Many companies are shifting, or have shifted, committee member fees to the annual Board cash or equity retainer, viewing all Board members as active participants in Board matters / committee-level work
• In 2010, we may see moderate decreases in committee member compensation, primarily due to additional companies shifting committee-specific (member) fees to the annual Board cash or equity retainer

Pay Levels | Total Board Cash Compensation

From 2008 to 2009, Board cash compensation[1] increased approximately 5 percent.[2]

• 98 percent of companies studied provide annual cash compensation to non-employee directors

CAP Observation:

• In 2010, we expect to continue to see moderate increases in Board cash compensation

Pay Levels | Value of Equity Awards

Despite rebounding equity markets, from 2008 to 2009 the median value of equity awards increased only 3 percent, due largely to the majority practice of granting equity awards based on a fixed value.

• Granting equity awards is as near universal practice, with about 95 percent prevalence among companies studied
  • Initial at-election equity awards, meant to “ramp up” director equity ownership and alignment with shareholders, as well a recruitment tool, are a minority practice (under 20 percent of companies studied)
  • From 2008 to 2009, there was a small decrease in the prevalence of initial at-election equity awards
• During 2009 a small number of companies (ex: Apple and Caterpillar) intentionally reduced or eliminated equity awards
  • Apple switched from granting a fixed number of stock options annually to a fixed value award of restricted stock units
  • Caterpillar discontinued annual equity awards, but instituted a stock ownership requirement

CAP Observation:

• From 2009 to 2010, we expect to see a:
  • Moderate increase in annual equity award values
  • Continued decrease in the prevalence of initial at-election equity awards

Pay Levels | Committee Chair Compensation

From 2008 to 2009, the median value of additional retainers for committee Chairs (retainer value in-addition to that provided to committee members) remained constant.

• The total value of Chair retainers was also reviewed, and also remained constant from 2008 to 2009
• Chart below excludes zeros

CAP Observation:

• If workload between the major Board committees continues to become less differentiated, there may be less differentiation in additional / premium retainers for the Chairs of the major Board committees
• In 2009, approximately 20 percent of Fortune 100 companies did not differentiate additional / premium pay for the Chairs of the 3 major Board committees, and about another 10 percent of Fortune 100 companies did not differentiate additional / premium pay between the Chairs of the Audit and Compensation committees

Pay Levels | Non-Executive Board Leadership (additional compensation)

At median, the premium / additional retainer paid to non-executive Chairmen is 10 times that paid to Lead / Presiding directors.

• The median additional retainer for Lead / Presiding directors was consistent from 2008 to 2009 (excludes zeros)
• The median additional retainer paid to non-executive Chairman increased from 2008 to 2009 (excludes zeros); year-over-year, there were also more non-exec. COBs receiving additional pay
• While it is common to pay an additional retainer to independent Board leaders, not all receive an additional retainer
  • It is most common to provide additional pay to a non-executive Chairman, and less common to do so for Presiding directors
  • Prevalence of additional pay for Board leadership roles increased year-over-year
• Under 5 percent of companies providing additional pay do so for both a Lead / Presiding director and a non-executive Chairman

CAP Observation:

• When determining compensation for a Board leadership position, it is important to consider:
  • Does the role merit a premium based on scope of responsibilities, workload, visibility, influence, etc.?
  • How do the role / responsibilities relate to that of committee Chairs?
• While not all non-executive Board leaders receive additional pay for the role, prevalence is expected to continue increasing
• The differential in pay between Lead / Presiding directors and a non-executive Chair is in-line with the typically different responsibilities of each position

Pay Practices

• Mix
• Equity Vehicle Type
• Denomination of Equity Awards
  (fixed value vs. fixed shares)
• Vesting of Equity Awards
• Non-Executive Board Leadership
  (additional compensation)

Pay Practices | Mix

Over the past 2 years, cash versus equity pay mix has remained constant, with equity representing a majority of pay.[3]

• Reflects all cash and equity compensation, excluding compensation for additional leadership roles such as committee Chairman or independent Board leader (Lead / Presiding Director or non-executive Chairman of the Board)
• CAP’s Best in Class Director Compensation Process / Practices (p.5) state that independent directors should structure pay so that equity represents the majority of compensation

Both on average and at median, the weighting of the various elements of Total Board Compensation was nearly consistent between 2008 and 2009.

• Includes cash retainer, Board meeting fees, stock options, full-value equity awards, and committee member compensation

CAP Observation:

• Once 2010 director pay levels are available, we expect to see the portion of pay delivered in equity-based compensation to be similar to 2008 and 2009, with a slight increase possible
• Equity-based compensation aligns director pay with wealth created or lost for shareholders, especially when the equity-based pay is required to be held for an extended period of time
• Additionally, during 2010 we expect that the overall pay mix will remain relatively constant; however, over the next few years, we expect the weighting of stock options and committee member compensation to decrease even further, with a corresponding increase in full-value equity awards and cash retainer

Pay Practices | Equity Vehicle Type

From 2008 to 2009, the prevalence of stock option awards declined (less companies granted both full-value equity awards and stock options), with a corresponding increase in the prevalence of full-value equity awards.

• As compared to full-value awards, stock options are both more leveraged and more likely to be granted based on fixed number of shares (rather than based on a fixed value)
• Stock option values and equity awards based on a fixed number of shares are strongly affected by swings in stock price
• Two companies granted performance-based equity awards to directors in 2009, Intel and Coca-Cola

[4]

CAP Observation:

• As companies move more towards viewing director compensation as somewhat of a “management fee,” combined with a strong focus on risk management, we expect to see a continued move toward increased use of full-value equity awards
  • However, practices vary by industry and we do not expect the use of stock options to stop completely; i.e., in some industries the prevalence of stock option awards is greater than others and/or that seen in general industry data
• While two companies studied granted performance-based equity awards to directors during 2009, we do not expect this to become a trend

Pay Practices | Denomination of Equity Awards (fixed value vs. fixed shares)

Director equity awards are based on either a fixed value or a fixed number of shares. From 2008 to 2009, the prevalence of fixed value equity awards increased 5 percent, accounting for nearly three quarters of all equity awards.

• When equity awards are based on a fixed value, the number of shares / options granted changes each year, but the grant date value remains constant; however, when equity awards are based on a fixed number of shares, the value of the award changes each year mostly due to changes in stock price, but the number of shares granted remains constant from one year to the next
• Therefore, director compensation is more predictable from one year to the next when equity awards are based on a fixed value

[5]

CAP Observation:

• Part of the year-over-year shift is due to the declining prevalence of stock option awards
  • Stock options are more likely than full-value equity awards to be based on a fixed number of shares
• Over the past few years, volatile stock prices have helped drive a trend towards fixed value equity awards
• Fixed value equity awards can be viewed as prudent risk management, a predictable way to reach expectations related to director stock ownership, linking long-term director interests with those of shareholders

Pay Practices | Vesting of Equity Awards

A majority of both stock option and full-value equity awards cliff vest.

• Year-over-year, the percent of stock options with cliff vesting increased, while the percent of full-value equity awards with cliff vesting remained constant
• Both stock options awards and full-value equity awards typically vest after 1 year, at median
• At least one full-value equity award at approximately 50 percent of companies studied will not be transferred to directors until retirement
  • Since 2008, the prevalence of this practice has increased

CAP Observation:

• For a number of years, there has been a trend towards declassification of Boards; i.e., one year terms
• Short vesting periods line up with the term of declassified Boards
• Short vesting periods and hold until / transfer at retirement provisions, for director equity awards, are often viewed as best practices
• We expect short vesting periods to remain majority practice, and the prevalence of hold until / transfer at retirement provisions to increase in 2010 and beyond
  • Already, the high prevalence of hold until / transfer at retirement provisions is notable

Pay Practices | Non-Executive Board Leadership (additional compensation)

Additional / premium retainers for independent Board leadership roles are most often delivered through additional cash compensation.

CAP Observation:

• We expect cash to continue to be the dominant vehicle for delivering additional compensation for serving in an independent Board leadership role, with the possibility for an increase in equity-based compensation in coming years

Other Program Design Considerations

• Total Company Cost (of Board oversight)
• Board Membership and Meetings
• Committee Membership and Meetings
• Stock Ownership Guidelines (requirements)
• Benefits and Perquisites

Other Program Design Considerations | Total Company Cost (of Board oversight)

Total Company Cost can be a useful secondary reference point when reviewing non-employee director compensation.

• Includes the sum of cash retainers, equity awards, committee fees, and Board leadership fees received by each non-employee director

CAP Observation:

• Generally, the cost of Board oversight drops as the size of an organization increases, measured as a percent of revenue

Other Program Design Considerations | Board Membership and Meetings

Between 2008 and 2009, at median, the size of Boards remained constant; however, Board activity marginally increased based on median number of meetings.

CAP Observation:

• Over the past decade, the typical size of a Board shrunk, in part based on new proxy disclosure requirements; i.e., increased discussion of qualifications, required discussion of any director attending less than 75 percent of meetings, etc.
• As the year-over-year data shows, the size of Boards seems to have stabilized
  • Currently, the size of Boards is manageable
  • Work loads have generally been increasing
  • It is typical for all directors to be take part in Board work / activities / decision making

Other Program Design Considerations | Committee Membership and Meetings

Across the 3 major committees, membership / size is consistent; however, activity based on median number of meetings is not consistent, with the Audit Committee being the most active.

CAP Observation:

• An increasing amount of work is being done outside of official committee meetings, and not all meetings are created equal (in terms of time spent, topics covered, etc.)
• Therefore, we find that number of meetings is only one component of judging total committee activity / time commitment / workload

Other Program Design Considerations | Stock Ownership Guidelines (requirements)

Nearly 90 percent of companies studied have stock ownership guidelines, and nearly 80 percent of companies studied have formal stock ownership guidelines.

• Formal stock ownership guidelines reflect requirements stated as either: (i) a multiple of the annual Board cash retainer, the annual Board equity retainer, or both; (ii) a fixed value; or (iii) a fixed number of shares
  • Most often, formal stock ownership guidelines are defined as a multiple of the annual cash retainer
  • Most companies with formal stock ownership guidelines require non-employee directors to meet the ownership hurdle within 5 years of joining the Board; the next most common period is 3 years
• Non-formal stock ownership guidelines reflect retention ratios and equity awards that are held/deferred until retirement
  • The number of companies with retention ratios and/or deferring equity awards until retirement, in addition to formal stock ownership guidelines, has been increasing

[6]

CAP Observation:

• Due to volatility, some companies that use either a fixed value-based or fixed share-based formal stock ownership guideline have been implementing an either or approach; either a certain dollar value or a certain number of shares must be owned within a certain number of years
• Other design features that can alleviate the volatility issue are the idea of ownership value vs. investment value and measuring stock price over an extended period of time, rather than at fiscal year-end
• ISS (formerly RiskMetrics Group), regarding non-omnibus director-specific equity plans, expects a minimum ownership multiple of 3 times the annual retainer to be achieved within 5 years of joining a Board

Other Program Design Considerations | Benefits and Perquisites

While there was a small decrease in the prevalence of certain director benefit / perquisites (below) over the past year, during both 2009 and 2008 about two thirds of companies studied provided directors with some form of benefit /perquisite.

CAP Observation:

• Many companies have reduced or eliminated perquisites and benefit programs for outside directors, similar to their executives
• We expect that both the prevalence and value of benefits and perquisites will continue to decline; however, where a business case exits, some perquisites / benefits will be maintained

Appendix

• Board Member Total Compensation (industry medians)
• Methodology
• Public Fortune 100 Companies
• Company Profile

Appendix | Board Member Total Compensation (industry medians)

Pay levels and practices were also reviewed, and differ somewhat, by industry.

[7]

Appendix | Methodology

• It was assumed that every director served on the Board for the entire year and attended all meetings
• Meeting fees were calculated based on the actual number of meetings held
• Annual equity awards were assumed to have occurred on the annual meeting date; stock options were valued based on the FASB Topic 718 (FAS 123R) Black-Scholes value
• Initial at-election equity awards were annualized over 5 years
• Committee compensation includes all Board committees, reflecting actual committee assignments
• If the proxy statement disclosed forward-looking information regarding changes to the compensation structure, the most recent data was used

Appendix | Public Fortune 100 Companies

Company Names & Industry

Appendix | Company Profile

Compensation Advisory Partners LLC (CAP) is an independent consulting firm specializing in executive and director compensation, and related corporate governance matters, with a unique combination of deep expertise and intense client focus. Comprised of senior industry veterans from Mercer and KPMG, CAP’s consultants have served as independent advisor to Boards and senior management at many of the world’s largest and leading companies in the areas of compensation governance, strategy and program design.

• Formed in 2009, CAP’s founding principle is that compensation should be a management tool to help support business strategy. Our consulting experience enables our team to assist companies in creating and implementing defensible, performance-oriented executive compensation programs that meet high governance standards in a changing regulatory environment
  • The staff has strong industry sector knowledge and a broad client base, ranging from the largest Fortune 100 multi-nationals to start-up companies across all major industries
  • The firm’s breadth of experience and clientele keep it at the forefront of trends and practices in all areas of executive and director compensation
  • Compensation Advisory Partners provides Boards of Directors and Compensation Committees best-in-class advice, while also meeting the increasing need to demonstrate the independence and objectivity of that advice from a truly independent platform
• Please contact us at 212-921-9350 if you would like to discuss your own executive or director compensation issues. You can also access our website at www.capartners.com for more information

• Modified burn rate policy
• Recommendation for annual Say on Pay vote frequency
• Modified definition of “egregious” pay practices
• No longer accepting future commitments to revise practices as a means to prevent or reverse a negative vote recommendation
• A policy for vote recommendations on Say on Golden Parachutes

Changes in Equity Compensation Plan Burn Rate Policy

As a means of limiting the impact of market volatility on its equity burn rate analysis, ISS decided to limit “year-to-year changes possible in allowable [burn rate] caps” (important as ISS uses its burn rate cap to assess a company’s use of equity relative to industry peers) to no more than two percentage points.

Later this month, ISS plans to publish the related (updated) industry-specific burn rate table that will be used to determine its equity plan approval (or additional share request) vote recommendations.

Say on Pay Vote Frequency

Under the recent Dodd-Frank legislation, companies are required to provide shareholders with a non-binding choice on the frequency of a non-binding Say on Pay vote, with the options being every 1, 2, or 3 years. ISS is strongly advocating annual Say on Pay votes; ISS believes that annual Say on Pay votes provide for the “most consistent and clear communication channel for shareholder concerns about companies’ executive pay programs.”

Therefore, if a company plans to recommend / support a non-annual vote frequency, we recommend that the company’s management (possibly with the assistance of their outside advisors) reach out to major shareholders as their proxy filing is prepared. This is important to do ahead of time as ISS has a policy to recommend Withhold or Against votes for the entire Board of Directors if the Board fails to act on a shareholder proposal that received approval by a majority of the shares outstanding. That said, it is remains to be seen how this policy will apply to companies that do not comply with the voting preferences of the plurality of shareholders for Say on Pay frequency. This is an issue that will likely receive attention from ISS in the future.

Individual Problematic Pay Practices / Negative Say on Pay Recommendations

ISS highlighted specific problematic pay practices that it views as particularly egregious and may independently, “by themselves, [be] sufficiently problematic to warrant Withhold or Against votes in most circumstances.” These “egregious” pay practices include:

• Repricing or replacing underwater stock options / SARs without shareholder approval (including cash buyouts and voluntary surrender of underwater options)
• Excessive perquisites or tax gross-ups, including any gross-up related to a secular trust or restricted stock vesting
• New or extended agreements that provide for:
  • CIC (Change in Control) payments exceeding 3x base salary and average/target/most recent bonus
  • CIC severance payments without involuntary job loss or substantial diminution of duties (“single” or “modified single” triggers)
  • CIC payments with excise tax gross-ups (including “modified” gross-up)

Companies with these “egregious” practices can generally expect:

• Against vote recommendations for Say on Pay
• Against / Withhold recommendations on Compensation Committee members:
  • In egregious situations (ISS does not define what this is)
  • When no Say on Pay vote is on the ballot (potentially an argument for annual Say on Pay votes)
  • When Board has failed to respond to concerns from prior Say on Pay votes
• Against equity incentive plan proposal if excessive non-performance-based equity awards are major contributors for pay-for-performance misalignment.

ISS also states that agreements with evergreen provisions will receive “particular scrutiny,” possibly because they provide an avenue for grandfathering “egregious” pay practices indefinitely. What is somewhat unclear is that despite the above mentioned policy update, ISS continues to state that it will continue to evaluate programs on a case-by-case basis in the context of a company’s overall pay program and historic pay actions, including other problematic pay practices cited in the past.

In all likelihood, a result of this policy update will be more companies receiving negative vote recommendations from ISS. Therefore, if companies plan to maintain or add any of these compensation program features, it is especially important that they proactively initiate dialogue with their largest shareholders to provide the rationale for why these pay practices are in shareholders’ interests.

Future Commitments / Negative Recommendations

ISS says that it will no longer accept “future commitments on problematic pay practices as a way of preventing or reversing a negative vote recommendation,” with the associated rationale that its policies are widely available and have been well known for some time. ISS also goes a step further in critiquing the corporate governance process, by stating that companies need to spend more time considering a “cure” for such practices.

There are, however, some exceptions to this policy. ISS states that exceptions now include:

• Pay-for-performance and burn rate commitments
• Plan language related to certain equity grant practices (e.g., liberal CIC definition)

Criteria for Recommendations on Say on Golden Parachutes

ISS’ policy is to take a case-by-case approach regarding recommendations for the vote on golden parachute compensation. The vote recommendation will be consistent with ISS’ pre-existing policies on problematic pay practices related to severance packages. Specific features identified as potentially leading to an Against vote include:

• Recently adopted or materially amended agreements that include excise tax gross-up provisions (since prior annual meeting)
• Recently adopted or materially amended agreements that include modified single triggers (since prior annual meeting)
• Single trigger payments that will happen immediately upon a change in control, including cash payment and such items as the acceleration of performance-based equity despite the failure to achieve performance measures
• Single trigger vesting of equity based on a definition of change in control that requires only shareholder approval of the transaction (rather than consummation)
• Potentially excessive severance payments
• Recent amendments or other changes that may make packages so attractive as to influence merger agreements that may not be in the best interests of shareholders
• In the case of a substantial gross-up from pre-existing/grandfathered contract: the element that triggered the gross-up (i.e., option mega-grants at low point in stock price, unusual or outsized payments in cash or equity made or negotiated prior to the merger)
• The company’s assertion that a proposed transaction is conditioned on shareholder approval of the golden parachute advisory vote. ISS would view this as problematic from a corporate governance perspective

ISS indicated that in cases where the golden parachute vote is incorporated into the overall Say on Pay vote for the company, ISS may place a heavier weight on golden parachute compensation in determining its vote recommendations for Say on Pay. In our view, the new guideline is largely consistent with ISS’ existing policies on severance compensation and should not present problems for companies that have moved to address their change-in-control severance practices.

Conclusions

Due to ISS’ level of influence, it is important for companies / Committee members to be aware of its policies. If ISS voting recommendations strongly influence a company’s shareholder base, those companies should regularly review their programs against ISS policies and educate their directors on the impact of the policies, so as to not be surprised by an ISS voting recommendation.

Further, Say on Pay will receive a lot of attention during the upcoming proxy season, and ISS has expressed a clear preference for annual votes. If companies do not provide for an annual Say on Pay vote, ISS will likely use Against or Withhold vote recommendations on director elections as its means to express dissatisfaction with compensation programs.

***

Please contact us at (212) 921-9350 if you have any questions about the issues discussed above or would like to discuss your own executive compensation issues. You can access our website at www.capartners.com for more information on executive compensation.

The timing of the final rules may create challenges for companies with shareholder meetings the first quarter of 2011, as Say on Pay is required for all proxy statements filed for annual meetings after January 21, 2011. For companies with annual meetings after January 21, 2011, but before the final rules are issued, the proposed rules will have to serve as the final guidance for developing their Say on Pay proposals.

Highlights of the Guidance on Say on Pay

The proposed rules contain some good news for companies, as the SEC confirmed that the new advisory votes on Say on Pay and Say on Pay frequency will not trigger the filing of a preliminary proxy statement. The SEC also directed that broker discretionary voting of uninstructed shares is not permitted for Say on Pay or Say on Pay frequency votes. Below are highlights of the proposed rules for the Say on Pay and Say on Pay Frequency votes.

Advisory Vote on Say on Pay

The SEC guidance does not specify a form for the language of the Say on Pay vote resolution. However, the proposed rules state that the resolution should indicate that the vote is advisory only and that the vote will cover all aspects of executive compensation for the Named Executive Officers of the company as disclosed in the CD&A, compensation tables and accompanying narrative. Compensation of directors and the risk assessment of the compensation programs for all employees are not intended to be included in the Say on Pay vote. In future CD&A disclosure, companies will need to discuss how their compensation policies and decisions have been influenced by past Say on Pay votes.

Vote on Frequency of Say on Pay Votes

The SEC guidance on the frequency of Say on Pay votes confirms that shareholders will have to be provided with four choices on frequency:

• Every year
• Every two years
• Every three years
• Abstain

While companies are required to provide shareholders with all four of the above choices, the proposed rules do not preclude the company from stating its preference among the alternatives. In the proposed rules, the SEC also confirmed that the vote on the frequency of the Say on Pay vote is advisory in nature and not binding on the company. That is, if a company’s stated frequency preference does not win the plurality of votes, the company can still go ahead and conduct the Say on Pay vote with its preferred frequency.

However, as proposed, the rules will require companies to disclose in the 10-Q or 10-K immediately following the Say on Pay vote whether the company expects to conduct future Say on Pay votes with the frequency selected by the plurality of shareholder votes. Separate shareholder proposals on Say on Pay or Say on Pay frequency may be excluded from the proxy statement provided that the company’s policy is consistent with plurality of votes cast in the most recent vote. Given the above, companies may have a strong incentive to structure the frequency of their Say on Pay votes in accordance with shareholder preferences.

The SEC recognizes that a vote with four choices will raise implementation challenges for companies, as shareholder voting typically follows a yes/no voting format. However, based on the way the Dodd-Frank rules were written, there was little room to interpret the rules as providing for anything other than four choices.

Finally, companies participating in TARP (which are required to conduct a Say on Pay vote annually) will not be required to conduct a vote on the frequency of the Say on Pay vote until the shareholder meeting immediately following the repayment of TARP funds.

Highlights of the Guidance on Say on Parachutes

The SEC’s proposed rules for new enhanced disclosure of golden parachute payments and an advisory vote on parachute payments state that the rules will be effective for proxy or consent solicitations to approve mergers or other transactions after the effective date of SEC amendment to disclosure rules (expected in the first quarter of 2011). This timing is later than expected and is helpful to companies as the new disclosure rules may be challenging to implement.

Disclosure of Golden Parachute Payments

In response to Dodd-Frank’s requirement of disclosure of golden parachute compensation in a “clear and simple form”, the proposed rules will require a new compensation table covering golden parachute compensation to NEOs, including the following elements for each named executive officer:

• Cash severance payments
• Dollar value of accelerated stock awards, in-the-money value of options accelerated, and payments to cancel stock or options
• Pension and deferred compensation enhancements
• Perks and benefits
• Tax reimbursement and gross-up payments
• Other
• Total

Footnotes to the table will require disclosure of what payments are single trigger (triggered by change in control only) and double trigger (triggered by a change in control and termination of employment). In the tabular disclosure, equity will need to be valued based on the stock price as of the last practicable date before the proxy filing. The table will be accompanied by narrative disclosure of the timing of the payments and any conditions that would apply to payments, including covenants (e.g., non-compete, non-solicitation).

Say on Golden Parachute Payments

The new rules require a separate non-binding shareholder advisory vote on golden parachute compensation, to the extent not previously subject to a prior general Say on Pay vote. In order to ensure that parachute payments are subject to the general Say on Pay vote, companies will have to disclose golden parachute compensation in their proxy statements with the new tabular disclosure and enhanced narrative disclosure of golden parachute payments.

It is not clear whether companies will decide to adopt the new disclosure in their proxy statements to ensure that they are subject to the general Say on Pay vote. While there will be some additional disclosure burden involved in providing the new tabular disclosure, many companies are already providing tabular disclosure of termination payments in their annual proxy statements. For these companies, it may be a simple extension of their current disclosure to comply with the new requirements. In any case, disclosure in compliance with the new rules will be required in the merger proxy statement.

Conclusion

The proposed rules have provided adequate clarity for companies to begin developing their Say on Pay and Say on Pay frequency resolutions. While the SEC is seeking comment on a number of aspects of the proposed rules, we expect the final rules to be largely consistent with the proposed rules. In developing the Say on Pay frequency resolution, we expect that most companies will state a preference for the frequency of the vote. Immediately following the passage of Dodd-Frank, our sense was that most companies would prefer biennial or triennial Say on Pay vote frequency; however, based on our discussions with clients we are seeing a trend toward a preference for an annual vote frequency.

The proposed rules for the Say on Golden Parachutes increase the disclosure requirements for companies, but will likely improve the quality of the disclosure from a shareholder’s perspective. It will be interesting to see whether companies choose to voluntarily adopt the new disclosure requirements for golden parachute compensation in annual proxy statements to ensure that golden parachute compensation is subject to the general Say on Pay vote.

Seventy companies were invited to participate in the survey and nineteen completed the full survey. Several companies that did not participate expressed interest, but said that they were too early in the decision-making process to respond.

We asked seven questions in the survey. Here is what we found:

1) Dodd-Frank mandates that companies must solicit a non-binding advisory Say-on-Pay vote from shareholders at least once every three years. Do you anticipate your Board recommending that shareholders approve a specific (preferred) frequency for Say-on-Pay or will you allow shareholders to decide by voting?

The new legislation requires companies to hold a non-binding advisory vote on their executive compensation at least once every three years and to give shareholders the opportunity to vote on the frequency of the Say-on-Pay vote at least every six years. The legislation does not specify the method for the frequency vote (e.g., give shareholders the full range of choices without a recommendation, recommend a preferred frequency but let shareholders pick from the full list, or give the shareholders a yes/no vote on a frequency recommended by management and Board).

The survey results indicate that companies are fairly evenly split between recommending a preferred approach but allowing shareholders to vote on the range of choices (37%) and asking shareholders to vote yes/no on a specific frequency (26%). The remainder of the sample (37%) is undecided or waiting for guidance.

Recommending a Say-on-Pay Vote Frequency to Shareholders

2) If you are going to recommend a preferred frequency to shareholders for Say-on-Pay voting, what do you expect to recommend?

Most companies (63%) say it is too early to tell which frequency they will recommend. Of those that did specify a time period, two years was the most common (21%). But keep in mind that this represents four companies. Given discussions we are having with clients, we would not be surprised if one or three years becomes the more common approach when companies finally implement Say-on Pay.

Choosing a Say-on-Pay Vote Frequency

3) Does your company currently engage in active dialogue with your 10 largest shareholders at least once a year on your Company’s executive compensation practices?

Even absent Say-on-Pay, we believe engaging in open and meaningful dialogue with large shareholders is a best practice and can provide insights and avoid surprises. 42% of companies say they currently engage in active dialogue with their shareholders and 26% do so for specific issues (e.g., approval of a new equity plan).

Dialogue with Largest Shareholders

4) Do you anticipate increasing dialogue with your largest shareholders, relative to your executive compensation practices, as a result of the legislation?

We believe companies will increasingly engage their shareholders in dialogue to gain greater insight from them on their views on executive compensation, since this is more informative than a yes/no vote on the full executive compensation program. This is supported by the survey which finds that 70% of respondents expect to increase dialogue with shareholders to at least some degree.

Increasing Dialogue with Largest Shareholders

5) Do you anticipate making meaningful changes to any of your executive compensation practices/programs as a result of the Say-on-Pay requirements?

The most commonly anticipated change to executive compensation programs is clawbacks, which is a requirement of the new legislation (63%). Just under one-third of companies anticipate changing their stock ownership and holding requirements. While ownership requirements have been very common, holding requirements (where an executive must hold all or a portion of net shares realized from option exercise (net of taxes and exercise price) and vested equity (net of taxes)) for a specified period time has been an emerging trend. Many more companies may begin to adopt this practice as they try to provide for greater alignment between executives and shareholders.

Anticipated Changes to Executive Compensation Programs*

6) Do you anticipate changing or implementing a clawback policy?

Many companies implemented or enhanced their clawback policies in the recent past; however, the new legislation specifies that the period covered span 3 years. Many companies (58%) must adjust their policy to comply with the new requirements.

Clawback Policy

7) Do you anticipate changing or implementing hedging policies?

Unlike the clawback requirement, the new legislation does not require a company to implement a hedging policy; however, a company must disclose if it does not have such a policy. 33% of companies currently have a hedging policy and will leave it unchanged. 56% of companies will either implement a policy or anticipate reviewing or changing their current policy. Only 11% state they do not have a hedging policy and do not anticipate implementing one. These companies will have to disclose that they do not have a hedging policy and this may be a negative for shareholders.

Hedging Policy

We hope you find these early findings helpful. Since the SEC will be providing guidance and there is a lot of uncertainty, where companies land on these issues is something of a moving target. Some of the key steps we believe companies should take in the interim include:

• Discussing the implications of the legislation with their Compensation Committee
• Forming a working team to develop a response, including: Human Resources/Compensation, Legal, Investor Relations, outside consultant and legal counsel
• Engaging in dialogues with large institutional shareholders

If you would like to participate in our CAPFlash survey topics going forward, please feel free to sign up at https://www.capartners.com/signup-surveys

* Responses add to more than 100% due to multiple responses by company

***

Please contact us at (212) 921-9350 if you have any questions about the issues discussed above or would like to discuss your own executive compensation issues. You can access our website at www.capartners.com for more information on executive compensation.

What We Found

In response to continued focus on executive compensation and recently enacted legislation, many companies are strengthening governance and other pay practices. The most significant change is the assessment and identification of any material risks arising from compensation programs, required by the SEC for all public companies for the first time in 2010. We also see widespread use of clawbacks, continuing focus on reducing perquisites, executive benefits and eliminating tax gross-ups on perks. Companies are reducing supplemental retirement benefits and continue to emphasize stock ownership guidelines and stock retention requirements.

Compensation Risk Disclosure

The review of material risk arising from compensation programs is an important process, initially required for TARP companies and now required for all public companies by the SEC. Of the 85 companies in our study, 75 companies or 88% make some type of affirmative disclosure related to their assessment of risk in the compensation program. While some companies disclose changes that were made to the compensation programs to discourage risk, none of the companies in our study indicate that their programs can create material adverse risks. The large number of companies including affirmative disclosure in proxy statements is striking, since the disclosure is not required under current rules. Of the 10 companies that did not address compensation risk in their proxy statements, 5 or 50% filed their proxy statements prior to the publication of the SEC’s final disclosure rules in December 2009.

Most of the companies make their risk-related disclosures in the CD&A, with the next most common disclosure being in Section 407, the corporate governance section of the proxy statement. The table below summarizes where risk disclosures were made:

Section of the Proxy Statement with Compensation Risk Disclosure	No. of Cos.	% of Cos. (n = 75)
CD&A	39	52%
Section 407	19	25%
CD&A and Section 407	7	9%
Comp Committee Report or Comp Committee Report and CD&A	2	3%
Separate Stand Alone Section	8	11%

The type of disclosure varies significantly, ranging from an in-depth description of the process and key safeguards to just one sentence indicating that the company’s programs do not encourage excessive risk-taking. 71% of the companies that make risk-related disclosures indicate that a formal risk review was conducted and comment on their assessment. Among these companies, the most common approach to the risk review is collaboration between the Compensation Committee, management and the Committee’s independent consultant (20%). The table below summarizes the different approaches used:

Approach to Compensation Risk Reviews	No. of Cos.	% of Cos. (n = 75)
Compensation Committee, Committee’s Consultant and Management	15	20%
Compensation Committee and Management	10	13%
Compensation Committee and Committee’s Consultant	9	12%
Compensation Committee	7	9%
Management	7	9%
Management and Management’s Consultant	1	1%
Not Disclosed	26	35%

29% of the companies do not describe the risk assessment process and only comment on the results of their assessment of the compensation program. A majority of the companies (84%) describe safeguards that are in place to reduce risk-taking. Such safeguards often include:

• Balanced mix of short and long-term pay
• Use of multiple performance metrics
• Vesting requirements for equity vehicles
• Incentive plan caps
• Clawback policies
• Stock ownership requirements
• Committee discretion and oversight

Clawbacks

The use of clawbacks has increased dramatically in the past few years as a result of SOX and TARP regulations. The policies help alleviate shareholder concerns over managing risk and are viewed as stronger corporate governance. Clawbacks are currently mandated by the SEC for all public company CEOs and CFOs under SOX, for the top 25 executives for participants under TARP, and going forward for executive officers at all public companies as part of the Wall Street Reform and Consumer Protection Act of 2010.

Reflecting broad market trends, a significant majority of our research companies—68 of 85 companies or 80%—maintain some form of clawback provision. For 2009 and 2010, 5 of the 68 companies put a new policy in place and 16 modified existing policies, by expanding the type of compensation that can be recouped, the events that trigger a clawback, or the executives covered.

A financial restatement is required in nearly all cases. Further, 48 companies (71% of those with a clawback) disclose that fraud or misconduct are triggering events. Twelve companies (18%) disclose a non-compete/non-solicitation/confidentiality violation as a trigger, and three include improper ‘risk analysis’ as a trigger.

Based on our review of CD&A disclosures, companies with a clawback include the ability to clawback or recoup the following types of compensation: earned, exercised, outstanding, vested or unvested.

Compensation Covered in Clawback Policies	No. of Cos.	% of Cos. (n = 68)
Incentive compensation (cash or equity)	40	59%
Annual incentives only	5	17%
Equity incentives only	5	17%
Deferred cash	4	6%
Severance benefits	1	2%
401k plan (company contributions)	1	2%
Future compensation	7	10%
Company discretion regarding type of compensation to recoup	10	15%

Note: Percentages add up to greater than 100% due to multiple responses.

Of interest, examples of some of the less common provisions we found include:

• IBM: Expanded clawback provisions by amending the Excess 401(k) Plus Plan to allow the clawback of Company contributions made after March 2010
• JP Morgan: Failure to identify, raise, or assess, in a timely manner as reasonably expected, risks and/or concerns with respect to risks material to the Firm or its activities, leads to recovery of equity awards for Operating/LOB Management Committee members
• McDonalds: Awards under the severance plan can be recovered if the participant engages in willful fraud that causes harm to the company or is intended to manipulate the performance measures that determine award payouts
• Progressive: Limits recoupment to excess bonus payments as a result of incorrect financial results to the extent that the recovery exceeds the lesser of 5% of the bonus paid or $20,000

In many cases, it is difficult to determine precisely who the clawback policy applies to. Where such disclosure is clear, we note that 17 companies cover all executives in the recovery of any ‘unearned’ compensation, regardless of whether the individuals directly caused any inaccuracy leading to a recovery.

A minority of companies tier their clawback policies, with certain parameters applying to Named Executive Officers, and other parameters applying to a broader ‘executive’ group. In some cases, clawback provisions in long-term incentive awards relate broadly to all eligible award participants.

Many companies did not indicate the time period within which compensation can be recovered after a restatement. Of the 17 cos. that did disclose a time frame for the clawback, the most common is 1 year from the date of restatement, and the range is 1 – 5 years. Three companies indicate that there is no time limit.

Since clawback policies are required by the Wall Street Reform and Consumer Protection Act of 2010 that was recently signed into law, companies will need to review and adopt provisions that align with the new legislation. The law applies to current and former executives who received incentive compensation during the 3 years before the restatement date, with employee misconduct not required as a trigger. SEC guidance is pending.

Stock Ownership Requirements

Stock ownership requirements continue to be an important tool for aligning executives with longer-term shareholder value. The majority of companies have stock ownership guidelines for their executives, typically expressed as a multiple of salary. While less common, many companies also have stock holding requirements where executives must hold a percentage of net shares from stock option exercises or vesting of restricted shares for a period of time. Within our sample, 17 companies, or 20% made changes to their stock ownership requirements. The most significant change among the companies in the study was the adoption or implementation of more restrictive stock holding requirements. Other changes, such as eliminating or extending the compliance time frame, suspending or decreasing ownership guidelines and changing to a fixed number of shares are responses to the volatility in the stock market.

Type of Change Reported in 2010 CD&A	No. of Cos.	% of Cos. (n = 17)
Newly Adopted/More Restrictive Stock Holding Requirements	8	47%
Eliminated/Extended Compliance Timeframe	4	24%
Increased Stock Ownership Guidelines	3	18%
Newly Adopted Stock Ownership Guidelines	2	12%
Suspended Ownership Guidelines	2	12%
Decreased Stock Ownership Guideline	1	6%
Changed Stock Ownership Guideline from Multiple of Salary to Fixed Share Guideline	1	6%

Note: Percentages add up to greater than 100% due to multiple responses.

Perquisites

Companies continued to reduce perquisites in 2009, building on a trend that has been evident for several years. 16 of 85 companies or 19% of the sample made a change to perquisite programs. A number of companies also eliminated tax gross-ups on perquisites, responding to widespread criticism of this practice.

Type of Change Reported in 2010 CD&A	No. of Cos.	% of Cos. (n = 16)
Reduced perks	11	68%
Eliminated tax gross-ups on perks	10	63%

Note: Percentages add up to greater than 100% due to multiple responses.

The most common reduction in perquisites – seen at 6 of 11 companies (38%) that reduced perquisites—involved curbs on personal use of corporate planes by senior executives. Examples include:

• Eli Lilly: No longer allows executive officers to use company planes for travel to outside board meetings
• Genworth Financial: In 2009, suspended all incidental personal use of corporate aircraft
• MetLife: CEO is no longer required to use the company plane for personal travel
• Morgan Stanley: CEO entered into an aircraft time-sharing agreement with the Company and has since fully reimbursed the Company for the cost of his personal use of the Company aircraft up to the maximum amount permitted by federal aviation regulations
• PNC Financial: Required certain executives to pay for all personal trips on corporate aircraft
• Sara Lee: Terminated all use of its corporate aircraft

Severance And Change In Control Benefits

Given the economic and governance climate, change in control severance benefits have garnered a great deal of attention in recent years from shareholders, advisory groups and the media. In response, program changes have gained traction.

14 of our 85 research companies, or 16%, disclosed changes for 2009/2010 in most recent proxy CD&As consistent with what we are seeing in the broad market:

Severance and CIC Program Changes	No. of Cos.	% of Cos. (n = 14)
Removed excise tax gross up feature – For current participants – For future participants (new hires/ promotions)	6 2 4	43%
Changed equity vesting from single to double trigger	3	21%
Reduced overall severance and CIC benefits	2	14%
Changed definition of pay (bonus) for severance calculation	2	14%
Reduced number of eligible participants	1	7%
Eliminated executive CIC agreements, introduced exec severance plan	1	7%
Increased excise tax cutback threshold above IRS limit	1	7%
Eliminated pension supplement	1	7%
Reduced benefit continuation period	1	7%
Adopted new CIC plan	1	7%

Note: Percentages add up to greater than 100% due to multiple responses.

Program changes in 8 companies impact current participants and in 6 companies changes apply to new participants only. Five of the 14 companies making changes are in the pharma industry and three are in health care.

Executive Retirement Benefits

Several companies—9 of 85 or 11% of our sample—made changes to executive retirement benefit plans. The most common approach was to reduce supplemental retirement benefits. This might involve closing SERPs to new participants, freezing future benefit accruals or modifying or capping the formula used to calculate benefits.

Type of Change Reported in 2010 CD&A	No. of Cos.	% of Cos. (n = 9)
Froze DB SERP benefits	4	44%
Scaled back DB SERP benefits	2	22%
Enhanced supplemental DC benefits	2	22%
Added retiree medical coverage	1	11%

Note: Changes to qualified plans available to all employees are not captured here.

Conclusions

In 2009 and 2010, companies continue to reevaluate – and modify – pay and governance practices. Risk assessment disclosure represents the biggest expansion in disclosure requirements. Another trend that emerged is the widespread use of clawbacks. Meanwhile, reductions in perks, change in control severance benefits, and executive retirement benefits, elimination of tax gross-ups, and enhanced stock ownership guidelines continue trends that have been evident for several years. These are all shareholder friendly developments that should improve the alignment between executive compensation and shareholders. We expect companies to continue to re-examine their programs as shareholders continue to demand good governance practices.

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Please contact us at (212) 921-9350 if you have any questions about the issues discussed above or would like to discuss your own executive compensation issues. You can access our website at www.capartners.com for more information on executive compensation.