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The Executive Edition


Your resource on executive compensation 2010 | Issue 1 The Executive Edition is Hay Group's executive compensation publication offering real-world examples of how companies design and implement executive packages to attract, retain, and motivate key personnel.

Measuring executive pay in 2010 the equity compensation challenge


Recent year-end 2009 changes in proxy disclosure rules will cause a shift in the method and outcome of executive compensation reporting this year. The reported numbers that tend to be the focus of media, pay critics, and analysts do not always capture the true story of executive pay, however; 2010 will be especially challenging in this regard. Understanding reported values of executive pay The complex structure of executive compensation, dominated by various forms of equity and cash-based long-term incentives, can lead to significantly different interpretations of 'pay.' These differences result from the interaction of varying approaches to data collection, analysis, and reporting. Ensuring that all relevant data is collected for incorporation in the analysis, applying meaningful analytical tools to construct pay models, and reporting the information in a way that recognizes the complexity of pay practices all are essential for board-level decision support. Increased disclosure requirements, governance pressures, and continued media attention make it imperative that pay values are well understood and clearly communicated internally and externally. Potential impact of 2009 compensation actions In 2009 many companies acted to address the results of a depressed stock market, increased market volatility, poor business results, and the effects of those conditions on executive pay. These special, often one-time, actions hold the potential for misinterpretation either because they are deemed part of 'annual' pay or, conversely, because they are excluded from pay calculations altogether. Such decisions made during the data collection process can lead to a flawed analysis as true pay levels resulting from these items are not represented properly. A particular executive's compensation often can only be interpreted properly by understanding pay actions on a 'before and after' basis. For example, companies that implemented stock option exchange programs cancelled many years of stock options and regranted some or all of those at a more favorable price. Merely reporting the Black-Scholes value of the regrant as an element of 2009 pay oversimplifies the total compensation implications. Some of those companies excluded officers from their programs yet took other action such as skipping or deferring the normal annual grant that also needs to be considered. A company whose compensation peer group consists of several companies that made these types of pay decisions in 2009 may find that their executives' pay is deemed to be 'high' without recognizing these dynamics. These complexities highlight the need this year for heightened attention to a three-faceted approach to executive equity compensation interpretation collection, analysis, and reporting. Data collection Discussions of executive compensation focus primarily on single-year values, forming the root of many misunderstandings. But executive equity awards often are developed as part of a multi-year plan. SEC proxy disclosure rules recognize this through the required three-year reporting format for the Summary Compensation Table and the multi-year aggregations in other tables. A common example is when an executive receives a large new hire equity grant, often two to four times the size of a typical annual grant, and then receives no equity award the following year. The single-year approach often leads to the conclusion that there has been a 'pay cut' or an 'elimination' of long-term incentive awards when pay in year two is compared to that of year one. Much of the important detail is contained in footnotes and narrative in the proxy statement, without which the tabular figures may be misinterpreted. In addition, many pay actions not captured in the tables are nevertheless disclosed in the Compensation Discussion and Analysis (CD&A) section or appear in 8-K filings subsequent to the issuance of the proxy statement. Given the dated nature of tabular information (i.e., the 2009 proxy tables report pay for fiscal 2008), these additional sources are critical to understanding the true current market for executive pay. The complexities of executive

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equity compensation have long required a multi-year, multi-source perspective and the economic turmoil of 2008-2009 certainly has increased the importance of this approach. Data analysis While the valuation of equity instruments receives much attention, the variations in fair value that may result from volatility or expected life assumptions are less significant than the effects on deemed value from a series of decisions that guide the equity compensation calculation. Such analysis is often bypassed and the fair value resulting from the reporting process typically what appears in SEC filings is accepted as the pay value without any further consideration. Compensation committees and executives need to understand these dynamics to ensure effective pay decisions. The volatile equity markets of 2008 and 2009 resulted in equity grants with an unprecedented variation of values relative to business fundamentals and significant intra-year variations in relative grant values. For example, assume two companies whose share prices directly track the Nasdaq index both granted stock options in 2009, the first in early March and the other in early September. The first company will report grant date fair values approximately 50 percent lower than the second company, but by the end of 2009 will have provided intrinsic value that is 260 percent greater. Variations of this magnitude are unprecedented in the history of executive pay and cannot be ignored. An unusually large number of companies awarded stock options in February through April of 2009 near the market low and in many cases those grants have quickly accumulated value far greater than the artificially-low BlackScholes value that will be reported in SEC filings. Ironically, many of those companies granted a larger number of shares to offset the lower fair value at the time, exacerbating this effect. These dynamics require that companies understand not only what was granted (stock options, time-vested shares, performance-based shares, cash LTI) and how much was granted, but when it was granted. In addition to understanding award type and timing, the emergence of performance features requires attention to the impact of performance contingencies or accelerators, thresholds and targets, absolute versus relative performance measures, and the interaction of time-based and performance-based conditions. Also, as companies add stock ownership guidelines and share retention requirements, the risk-reward balance has changed. Thoughtful analysis will be required this year to understand the real impact on executive pay value resulting from the interaction of these features. Data reporting With proper collection and analysis, pay can be reported in ways that provide a meaningful picture of executive pay practices over the past years. A single snapshot of pay will not be adequate for telling the story in this complex environment. Merely viewing pay as a single number may lead a compensation committee to reach flawed conclusions about the company's competitive position in the market. Scenario-based pay projections incorporated into tally sheet and wealth accumulation analyses will provide the compensation committee and the executive team with a point of view consistent with other business decision processes. Pay granted, earned, and realized A greater scrutiny of pay values introduces a need for the multi-dimensional view of pay, with at least three possible pay 'views' to be considered. This approach requires taking pay analysis beyond a grant-based focus to a dynamic view of the life cycle of executive pay when granted, earned, and realized. A significant change in the revised proxy disclosure rules changes the equity incentive figures in the Summary Compensation Table from an 'earned' to a 'granted' basis. The fair value of all equity awards made during the reporting year are deemed to have been what was 'paid' to the executive for that year rather than what was accrued for accounting purposes. There are lengthy and complex arguments around which of these two methods is preferable, and why, but sound pay analysis does not force an either-or decision. It is important to understand what was granted, the incremental amount earned, and as media organizations often do the pay realized over a period of time to obtain a true picture of executive pay. While no single analytical structure will make sense for all companies, compensation committees and executive teams should: think through the three data processes collection, analysis, and reporting in the context of three alternative views of pay (granted, earned, and realized) and ask a series of questions to ensure a comprehensive approach. The matrix below illustrates the types of questions that may result to help guide this year's analyses and decisions.

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Granted
Did we capture all of the grants and actions taken last year? Have we properly categorized 'annual' pay actions?

Earned
Did many of our peers grant during the market lows? How is that affecting reported grant value and fair value?

Realized
Were there significant realization events that created compensation not captured in the typical proxy and survey formats? Have we compared vested but unexercised in-the-money option gains?

Collection

Analysis

Have we explored the stock price patterns of our peers and reviewed scenario-based pay values?

Have we analyzed competitors' changes in vesting schedules, acceleration provisions, and holding requirements to understand changes in earnings opportunities?

Have we conducted an historical analysis of realized pay to understand how this may be affecting current grant patterns?

Reporting

Have we accounted for new hires, promotions, terminations, founders, and special qualifications of incumbents?

Are we considering risk-adjusted differences in pay values - options vs. time-vested full-value awards vs. thresholds and targets on performance awards?

Do our tally sheet and wealth accumulation tools capture realized value including post-vesting accumulation?

Many emerging tools tally sheets, wealth accumulation models, 'walk away' value calculations, and scenario-based analysis address some of these issues. A methodical approach will help a company understand the tools being used and the rationale for using a tool to the exclusion of others. It can be helpful to view these alternatives in this threeby-three analytical framework to capture the issues surrounding the collection, analysis, and reporting of equity compensation data and recognize alternative measurement points of grant, earning, and realization to ensure a clear understanding of market pay levels and practices. Fred Whittlesey is a consultant in Hay Group's executive compensation practice. He can be reached at +1.415.644.3739 or fred.whittlesey@haygroup.com.

CEO pay: full year 2009 proxy reporting at the largest companies
In April 2009, Hay Group released the key findings from our second annual study for The Wall Street Journal on CEO pay among the first 200 companies that filed a proxy statement in 2009 and reported annual revenue of at least $5 billion. We now have completed our review of CEO pay at all 422 companies in this revenue range that filed a proxy statement between October 1, 2008 and September 30, 2009. What were the findings from the full sample of companies? CEO pay results at the median were largely consistent with the results of the first 200 companies examined. For the full sample of 422 companies we found: salary increased four percent to $1,080,000 bonuses were down 15.6 percent to $1,186,440 overall cash compensation declined 4.7 percent to $2,295,000 total direct compensation - which includes the value of long-term incentive grants of stock options, restricted stock, and performance awards - was down two percent to $7,314,948.

Chart one: CEO compensation changes and values Base salary Annual incentives Total cash comp Total direct comp

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WSJ/Hay Group 422

$1,080,000

$1,186,440

$2,295,000

$7,314,948

Did pay declines follow performance results? As we have often seen in recent years, annual bonuses track the rise and fall of a company's net income. Annual bonuses for CEOs of the 422 companies were down a median of 15.6 percent as net income fell 15.7 percent. The one-year total shareholder return of all 422 companies was negative, -37.7 percent. Total direct compensation was down -2 percent for the full sample. Stock options and performance shares lead the way According to the results from the full sample, 71 percent of companies awarded stock options to their CEOs while 66 percent granted performance-based awards (55 percent granted performance-based equity and 18 percent awarded performance-based cash, as a number of companies granted both types), and 46 percent of companies granted restricted stock awards. In comparison to last year, option grant values for the full sample are down 0.4 percent, performance award values are flat at 0.0 percent change, and restricted stock award values are up 5.2 percent. Is this a subtle indication that companies are changing the long-term incentive pay mix? Or was it just a very bad year and they decided to make few changes in 2009? The current long-term incentive pay mix of the full sample does indicate that for CEOs in their position for two or more years, the value of their performance award grants exceeds the value of their stock option grants: Performance awards = 41 percent; Stock options = 39 percent; and Restricted stock = 20 percent. More companies are granting stock options but more money is being allocated to performance awards. In fact, for CEOs the total direct compensation pay mix confirms the same relationships, as stock options make up 23 percent and performance awards make up 25 percent of the TDC pay mix. Chart two: CEO total direct compensation pay mix (at 422 companies)

Long-term incentive pay multiples dwarf other elements of CEO pay In recent years, the Securities and Exchange Commission (SEC) has made it possible to determine 100 percent of what the named executive officers receive in annual and long-term incentive compensation. All of the annual and long-term incentives granted in the current fiscal year must be recorded in the proxy statement on the Grants of Plan-Based

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Awards table. Hay Group studied CEO pay at the 422 companies and determined that the typical CEO received a long-term incentive grant of almost five times salary in 2008. With a median salary of almost $1.1 million, that means that the CEO received over a $5 million long-term incentive grant in 2008. Long-term incentive pay multiples (based on actual fair market grant values) for 2008 were a median of 1.75 times salary for restricted stock grants, 2.28 times salary for stock option grants, and 2.30 times salary for performance-based awards. In the group examined, the typical CEO has a current tenure of 5.25 years at the median and stands to make a great deal of money from outstanding long-term incentives should he or she continue their employment with the company. Chart three: CEO long-term incentive pay multiples (grant value as a multiple of salary)

Realized pay elements add millions to annual pay During the 2008 fiscal year the full sample's prototype CEO received a median of $2,295,000 in annual compensation (i.e., salary plus bonus) and also realized substantial amounts in long-term incentive compensation. These CEOs exercised stock options ranging from a value of $9,399 to $184 million, or a median of $3,938,620. Amounts received during 2008 from the vesting of restricted stock awards or the value of performance-based equity that was earned in 2008 ranged from $21,047 to $37 million, or a median of $2,150,810. Cash-based long-term performance awards earned in 2008 ranged from $155,741 to $18.6 million, or a median of $2,011,516. Even in a bad year, most CEOs still received grants and made substantial money from awards that had been made in prior years. How will the new SEC rules impact CEO pay? The new SEC rules, approved on December 16, 2009, require changes to the Summary Compensation Table (and Director Compensation Table) that will eliminate the need for companies to calculate and disclose the compensation costs of long-term incentives in the tables. In the future, companies will be required to disclose aggregate grant date fair values of long-term incentives that are also broken out individually in the Grants of Plan-Based Awards Table in the proxy statement. This will provide investors with a much better and simpler way to arrive at a picture of what companies pay their NEOs in the current year, which is comparable across companies. Companies also will need to restate such amounts that were disclosed in the prior two years if the individual was an NEO in those years. In the end, the new SEC rules will facilitate more comparisons among companies by investors, shareholder groups, consultants, the press ,and other individuals or companies. Looking at 2009 fiscal year data should be especially

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interesting as all calendar year companies are required to make the necessary changes in their 2010 proxy statements. Steve Sabow is a consultant in Hay Group's executive compensation practice. He can be reached at +1.201.557.8401 or steve.sabow@haygroup.com.

Risk assessment: initial process and checklist


The Securities and Exchange Commission (SEC) in mid-December 2009 finalized expanded disclosure requirements regarding executive pay to address potential risk in compensation programs. The new rules require that every publicly held company discuss in its annual proxy statement although not in the Compensation Discussion and Analysis (CD&A) section whether any of its compensation plans or practices (for executives and non-executives) create risk-taking incentives that are reasonably likely to have a material adverse effect on the organization. From a practical viewpoint, the result is that every public company will need to examine each of its compensation programs: to be assured that no such potential risks exist, and to fix or otherwise mitigate any potential risks that may be uncovered. Since many compensation committees have not historically examined broad-based reward programs, the learning curve on these programs may be substantial. One of the most important and immediate challenges for organizations and compensation committees is developing a process to assess and then manage the possible risks posed by the compensation programs they maintain or oversee. As part of the initial process, we have found it useful to develop a checklist to guide the analysis. However, any process and checklist needs to be tailored to a company's specific circumstances real thought and analysis are needed, not simply a 'check-the-box' compliance mentality. Initial process for assessing risk 1. Create a project team (which might well include a senior risk officer, inside and outside legal counsel, a senior HR or compensation officer, and a compensation consultant) to assess the level of risk for each of the distinct compensation programs to be reviewed against a key set of criteria/checklist. (See the sample checklist provided below.) 2. Collect and review the organization's existing written and unwritten pay policies, practices, and plan documents, as well as similar items pertaining to the company's enterprise risk management. 3. Conduct the compensation risk assessment and identify for the compensation committee the risks that the organization faces that could threaten its value or have a material financial, operational, or reputation impact on the company. Identify the features of the organization's executive and non-executive compensation policies, practices, and supporting management processes that could induce executives and employees to take those risks. 4. Analyze the results of the risk assessment and discuss how to mitigate and manage any such excessive risks, and/or establish a process and timetable for revising those compensation and incentive programs that contain excessive risks. Checklist for risk assessment Below is a sample checklist that contains generally relevant criteria for use in assessing the risk profile of compensation programs. To determine the risk exposure of each program, we suggest an organization determine the potential cost under a 'worst case' scenario and the probability of such worst case scenario. In working with companies in these

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analyses, we have found it helpful to characterize (or rank) potential cost and risk on a grid as high, moderate, and low, using a red, yellow, and green 'stoplight gap analysis' (as illustrated below) as a visual means for characterizing and addressing levels of risk.

Review The financial industry crisis spawned the current focus on potential risk in compensation programs. Companies, regulators, and advisors all are attempting to address the various factors that contribute to risk in compensation programs, but many important issues still must be addressed. For instance (and most basically), there is no universal definition of what is meant by 'risk.' While the SEC has eased the reporting burden for public companies by limiting required disclosure to risks that are 'reasonably likely to have a material adverse effect on the company,' the core issue remains. Ultimately companies will receive more guidance (and hopefully more clarity) from the SEC on their initial compliance efforts. Upon review of a company's proxy statement by the SEC (perhaps as part of the SEC's triennial reviews), a failure to show the company conducted a risk assessment in compliance with these new rules could prompt queries on specific programs. Aside from any input or feedback from the SEC, ideas will be exchanged among companies and their advisors and reasonable approaches developed after considering information disclosed in filings during the upcoming proxy season. In the meantime, the initial process and checklist provide a solid starting framework for a company's compensation plan risk assessment. Dana Martin is a consultant in Hay Group's executive compensation practice. He can be reached at +1.312.228.1824 or dana.martin@haygroup.com.

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Tom McMullen is the leader of Hay Group's US reward practice and can be reached at +1.312.228.1848 or tom.mcmullen@haygroup.com.

New SEC rules enhance disclosure of executive pay


The regulation of executive compensation accelerated in 2009 as Congress, the Obama Administration, and various regulatory agencies all added their voices to the debate surrounding sound executive pay practices. As 2009 ended, the Securities and Exchange Commission (SEC) adopted final rules enhancing proxy disclosure of executive compensation for public companies. We focus here on an overview of the new SEC rules and address some of the key compliance issues. Key topics addressed The relationship of the company's compensation policies and practices to risk The reporting of equity awards for executives and directors Fee disclosure related to the retention of a compensation consultant Additional disclosure on the qualifications of directors and nominees for the board Discussion of the company's leadership structure Accelerated reporting of shareholder votes The new rules generally are effective for fiscal years ending after December 19, 2009 for proxy statements and annual reports filed on or after February 28, 2010. Relationship of the company's compensation policies and practices to risk Under the new rules, public companies must discuss compensation policies and practices for all employees not just named executive officers (NEOs) to the extent that risks arising from them are 'reasonably likely to have a material adverse effect' on the company. Companies will need to identify and then review all compensation arrangements to determine whether there are potential risks that might trigger disclosure. Any problems discovered in the review process then can be fixed or appropriately mitigated. The SEC furnished examples of situations that could potentially trigger discussion and analysis: If a business unit of the company carries a significant portion of the company's risk profile If a business unit has a significantly different compensation structure than other units If a business unit is significantly more profitable than others within the company If compensation expense at a business unit represents a significant percentage of the unit's revenues If the compensation policies and practices vary significantly from the overall risk and reward structure of the company In assessing the degree of risk, companies can consider any compensation policies and practices designed to alleviate risk or balance incentives (e.g., clawbacks and recoupment policies; bonus banking; stock ownership requirements). The type of disclosure is determined on a case-by-case basis, but may include: the general design philosophy of compensation policies for employees whose behavior would be most influenced by the incentive programs the company's risk assessment or considerations in structuring its incentive compensation policies the ways in which the company's compensation policies relate to the realization of risks resulting from the actions of employees (e.g., through the use of clawbacks or holding periods) the company's policies regarding adjustments to its compensation practices to address changes in its risk profile material adjustments the registrant has made to its compensation policies or practices as a result of changes in

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its risk profile the extent to which the registrant monitors its compensation policies to determine whether risk management objectives are being met. Risk-related disclosure will have its own section and will not be included in the Compensation Discussion and Analysis (CD&A). Importantly, as stated in the final rules, the SEC does 'not require a company to make an affirmative statement that it has determined that the risks arising from its compensation policies and practices are not likely to have a material adverse effect on the company.' In view of this limitation on the disclosure that is required, it will be interesting to see whether many companies voluntarily make such an affirmative statement as part of demonstrating that they have undertaken the appropriate risk assessment. Reporting of equity awards to executives and directors The full grant date fair value of stock option and share awards will be reported in both the Summary Compensation Table and Director Compensation Table. Existing rules under FASB ASC Topic 718 (formerly FAS 123(R)) required that compensation expense be recognized for financial reporting purposes. This change impacts the calculation of total compensation used to determine a company's named executive officers. Companies will need to update values shown in the stock award, option award, and total compensation columns for prior years for each NEO. Disclosure of grant date fair values of individual equity awards will continue in the Grant of Plan-Based Awards Table. Additional disclosure regarding fees affecting independence of compensation consultants The new disclosure rules require a company to disclose the fees paid to a compensation consultant if the consultant furnishes consulting services related to executive or director compensation and also provides other services to the company. However, fee disclosure is not required if the fees paid to the consultant for additional services did not exceed $120,000 during the company's fiscal year. Where disclosure is required, it must include: aggregate fees paid for executive and director compensation consulting services aggregate fees paid for non-executive compensation consulting services whether the decision to engage the consultant for non-executive compensation consulting services was made or recommended by management and whether the committee or board approved the other services, if the consultant was engaged by the compensation committee. Additional disclosure on the qualifications of directors and nominees Under the expanded disclosure requirements, a company must discuss the particular experience, qualifications, attributes, or skills that qualify an individual to serve as a director for the company based on the company's business and structure at the time the disclosure is being made. However, the final rules do not require disclosure regarding the specifics that qualify the individual to serve as a committee member. Disclosure is required for all directors, even if they are not standing for reelection in the applicable year, and should include: any directorships at public companies held by each director at any time during the past five years (instead of only disclosing currently-held directorships) certain legal proceedings involving any director or executive officer during the last ten years (instead of five years) disclosure of whether and how diversity is considered when identifying director candidates. The SEC has not defined 'diversity'; rather, each company is allowed to define it as it determines to be appropriate for its particular circumstances (e.g., experience, skills, education, race, gender, etc.). If a policy on diversity exists, the company must disclose how the policy is implemented and how its effectiveness is assessed. Discussion of company leadership structure A company is required to disclose whether and why it has chosen to combine or separate the CEO and board chairman positions, along with the reasons why the company believes that this board leadership structure is the most appropriate for it at the time of the filing. If the same person serves as CEO and chairman, the company needs to disclose whether and why the company has a lead independent director and the role of the lead independent director in the leadership of the board. In addition, the new rules require companies to describe the board's role in the oversight of risk (which may include credit risk, liquidity risk, and operational risk). For example, a company may describe whether the entire board reviews risk or if there is a separate committee. Further, a company may find it helpful to discuss how risk information is communicated to the board or relevant committee members. Expedited reporting of results of shareholder votes

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Traditionally, final results of shareholder votes have been reported in a 10-Q or Form 10-K. Under the new rules, reporting will be required on a Form 8-K within four business days of the meeting. The continuing challenge of appropriate disclosure The new rules (i) respond to some criticisms of the 2006 overhaul of the SEC disclosure rules relating to executive compensation, (ii) address various executive compensation issues that have become important in recent years, and (iii) generally expand the scope of required disclosures. Companies are faced with the challenge of accurately explaining their programs and policies in a way that is sufficiently detailed yet understandable and meaningful to investors and other interested parties. We await guidance, comments, and feedback from the SEC as it reviews filings under these new rules. Cory Morrow is a consultant in Hay Group's retail sector executive compensation practice. He can be reached at +1.469.232.3826 or cory.morrow@haygroup.com.

Bill Gerek is the US executive compensation regulatory expertise leader for Hay Group. He can be reached at +1.312.228.1814 or bill.gerek@haygroup.com.

Debate, disclosures and direction: a look at Not-for-Profit executive pay issues


Like their for-profit brethren, not-for-profit (NFP) organizations today operate in an environment of heightened awareness of executive compensation levels. The debate about the magnitude of compensation, whether for a Wall Street executive or a local hospital CEO, has caused a palpable shift in attitudes and raised the sensitivity of key stakeholders. This change has found its way into boardrooms, executive suites, and increasingly, the legislatures of both state and federal government. Background In 2008 the global financial crisis spawned the Troubled Asset Relief Program (TARP) which imposed significant restrictions on executive pay for participating financial institutions. Earlier versions of the legislation contained broad references to limiting executive pay levels for organizations receiving federal subsidies. Some thought tax-exempt organizations with their particular designation, reimbursement structure, and/or federal grantee status might be subjected to limitations on executive pay. While the federal government has been the most vocal on this matter, we have seen state legislatures proposing specific limitations on executive compensation and changes to not-for-profit corporate governance requirements. Although the genesis for legislative action often has come in response to a specific issue (e.g., concern about the level of pay for a local hospital CEO or potential conflict of a board member), compensation levels continue to be an incendiary for leveraging by public officials. In light of this background, we begin with a review of recent changes to the disclosure rules regarding executive compensation for tax-exempt organizations. We then address those areas of executive compensation that we believe, due to today's focus on similar issues in the private sector, will soon have the attention of and provide direction to key stakeholders in the tax-exempt not-for-profit world. Experience has shown that organizations would be well-advised to get ahead of the curve and proactively address any excesses or governance deficiencies. Disclosures Much has been written about the revisions to the annual Form 990 disclosures applicable to most tax-exempt

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organizations. When the revised form was introduced, the Internal Revenue Service (IRS) outlined its guiding principles in terms of enhancing transparency, promoting tax compliance, and minimizing the burden on the filing organization. We can argue whether the third principle has been met, but do believe that substantial progress has been made in clarifying both the disclosure and governance expectations of these organizations. Audit findings An IRS report of March 1, 2007, detailed the key findings from the audit of tax-exempt organizations, providing an early indication that changes were likely; the IRS built a clear business case for enhancing the Form 990 filing requirements. This review specifically focused on reasonable compensation standards applicable to tax-exempt employers and also addressed some procedural questions around governance/decision making. The initiative examined Form 990 compliance, intermediate sanctions imposed under Internal Revenue Code Section 4958, and private foundation self-dealing. While its findings were lengthy, the essence of the study suggested that: disclosures of remunerative arrangements were inconsistent and the existing reporting requirements needed to be modified to provide complete and clear disclosure compensation levels, while high, could generally be defended with comparability studies, thus reducing the likelihood of an excess benefit transaction (based upon current standards) the disclosure of governance processes, business relationships, and decision-making should be refined to shed light on the business practices of these organizations. Interestingly, the study suggested that only 51 percent of audited organizations attempted to satisfy the three elements for obtaining the benefit of the 'rebuttable presumption of reasonableness' under the intermediate sanctions rules. Given the value of meeting these standards (i.e., shifting the burden of proof to the IRS in a claim of excessive compensation), it is worth highlighting here the basic requirements for establishing the rebuttable presumption: The compensation arrangement must be approved in advance by an authorized body of the applicable tax-exempt organization, which body is composed of individuals who do not have a conflict of interest concerning the transaction. Prior to making its determination, the authorized body obtained and relied upon appropriate data as to comparability. The authorized body adequately and timely documented the basis for its determination concurrently with making that determination. The needed documentation must include (1) the terms of the transaction and the date of its approval, (2) the members present during the debate and vote on the transaction, (3) the comparability data obtained and relied upon, (4) the actions of any members having a conflict of interest, and (5) documentation of the basis for the determination.

Direction Most large tax-exempt organizations should be particularly interested in the restrictions and governance initiatives affecting executive pay at public companies. In fact, these employers now share an important similarity with TARP companies in that US taxpayers are key stakeholders in their organizations. Several of the executive pay restrictions imposed on the TARP companies are potentially relevant to tax-exempt NFP organizations; when combined with various governance initiatives and compensation trends, executive pay design in the NFP sector promises to be particularly challenging this year. Limitations on severance. TARP prohibitions on severance compensation were crafted in response to several former high profile CEOs of poor-performing companies who received significant severance payments from their damaged organizations. As more tax-exempt organizations reach into the for-profit ranks for their top talent, severance arrangements have become more generous and could become a target. Restrictions here could pose a challenge to the attraction and retention of key executives because they would not have the significant equity appreciation opportunities available to executives at for-profit companies. To the extent that supplemental retirement and/or deferred compensation arrangements may be used to augment the trade-offs made by these leaders, the programs need to be coordinated in a way that meets both the business and retentive interests of the organization and the recruitment requirements of the leader. Risk orientation of compensation. Many investment banks came under fire for compensation programs that weighted

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annual performance too heavily at the expense of long-term results. This practice caused many executives to focus on having a great year, rather than on achieving sustainable long-term results. Not-for-profit organizations have generally maintained low leverage on their compensation structure and, in particular, the use of long-term incentive programs is not prevalent in the NFP arena. While annual incentive plans generally utilize a balanced portfolio of performance measures, there has not been as great an emphasis on defining, measuring and rewarding for longer-term expectations. While we may never see the magnitude of performance-based pay utilized by the for-profit sector, expanding the dialogue to consider changing the mix of pay and aligning remuneration with performance expectations is a positive. Policy on luxury expenditures. This provision, which forces TARP companies to adopt a policy on excessive or luxury expenditures such as entertainment, office renovations, aviation and other transportation services, special offsite meetings, and the like is designed to address some of the higher profile items that have attracted unfavorable shareholder reaction. While these practices are more limited at NFP organizations, we have seen boards adopt specific policies addressing executive expenses, perquisite utilization, and outside organization activities. Understanding the business purpose of a perquisite and adopting a policy regarding its use can be critical. Compensation committee independence. For many not-for-profits, advisement on executive pay should not work any differently than it does in the for-profit world. Both the compensation committee and its consultant should be independent and should have adopted policies addressing the definition of each. In situations where an organization is served by a consultant that may be obtaining significant revenues from other areas like actuarial services, brokering, or benefits outsourcing, it is important to understand and disclose them to the board and assess each for potential conflict. Overall, requirements applicable to public companies will be critical for NFP organizations to consider and address, including the independence of compensation committee members. Say on pay. This provision, which refers to offering a company's shareholders a non-binding, advisory vote on the compensation decisions made for named executive officers (NEOs), would be difficult to replicate in a not-for-profit environment. That said, we do expect that NFPs will face greater regulation of their executive compensation levels and programs, with the potential for more stringent standards by the IRS around 'reasonableness of compensation' than what is currently provided for by the intermediate sanctions under section 4958 of the Internal Revenue Code. Continuing to learn from the private sector. The Securities and Exchange Commission continues to establish and expand the rules governing the disclosure requirements for the compensation of NEOs at public companies. Central to these efforts is the required narrative in a Compensation Discussion and Analysis (CD&A) regarding named executive officers for each year's proxy statement. Within the CD&A, organizations are required to describe, in plain English, why reward decisions were made, and to explain the interplay between the different elements of compensation, the company, and individual results. NFP organizations would be well served to consider: what the compensation program is designed to reward what each element of the compensation program is why the organization pays each element of compensation how the organization determines the amount (and where applicable, the formula) for each element how each element, and the organization's decisions on the element, fit into the organization's overall objectives. As our government officials contemplate the nature and structure of healthcare reform, we should expect the levels of compensation for executives and physicians to enter the debate. Increasing criticism of remuneration and expanded disclosure requirements imposed by the government will make this activity increasingly important to the organization. Ron Seifert is a consultant in Hay Group's executive compensation practice. He can be reached at +1.215.861.2583 or ron.seifert@haygroup.com.

James Otto is a consultant in Hay Group's executive compensation practice. He can be reached at +1.404.575.8740 or james.otto@haygroup.com.

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Top North American energy organizations' pay and performance navigating economic volatility
For energy companies recent times have veered from one end of the business spectrum to the other. Record profits earned in 2008 on the back of record high oil prices at $150 a barrel were followed by the collapse to $40 a barrel, resulting in cuts in capital expenditure as the full impact of the global slowdown hit home. The credit crunch started in the US and evolved into a global economic crisis e.g., stock market devaluation, financial market meltdown, mining production cutbacks, auto manufacturer's production suspension, layoffs, and more. Organizational strategy and management's ability to navigate volatile commodity prices were put to the test and executive compensation plan designs followed suit. The unstable economy provided an opportunity for Hay Group to stress test the calibration of pay and performance of 75 top North American energy organizations. While each of these issues present their own important and unique challenges, we focused on the outcome of the top North American energy organizations through the year, specifically as it relates to the capital markets and shareholder returns as measured by the alignment of pay and performance of the five named executive officers (NEOs) applying Hay PI Group's Performance Index (Hay Group ). Hay Group's Performance Index (Hay Group ) methodology Hay GroupPI is a composite index based on an equal weighting of four indicators and is intended to provide a balanced view of an organization's overall performance. The four performance metrics are:
1. Total shareholder return (TSR) 2. Return on equity (ROE) 3. Earnings per share growth (EPSG) 4. Corporate governance rating A measure of the return (capital gain + dividends) to shareholders. A measure of how efficiently an organization generates profit on share capital. A measure of profitability growth year over year. A measure of corporate governance and transparency. PI

Each organization's four-metric composite performance is ranked by percentile against the peer group and plotted along the horizontal axis ranging from zero percent to 100 percent. Similarly, the sum of the NEOs' Expected Total Incentives (the sum of short-term incentives and mid/long-term incentives, expressed as a percentage of salary) is ranked by percentile against the peer group and plotted along the vertical axis, again ranging from zero percent to 100 percent. The result of the two relative percentiles is plotted in one of four quadrants as illustrated in the following diagram. A 45-degree diagonal line is drawn through the origin of the graph and theoretically represents a perfect alignment between performance and compensation:

Quadrant one: The company's performance is below median, incentive compensation is above median. The executive is receiving a higher incentive compensation level despite failing to deliver superior results relative to competitors

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Quadrant two: The company's performance is below median, incentive compensation is below median. The executive is receiving a lower incentive compensation level while delivering poorer results relative to competitors. There would appear to be an alignment between pay and performance.

Quadrant three: The company's performance is above median, incentive compensation is below median. The executive is receiving a lower incentive compensation level while delivering superior results relative to competitors.

Quadrant four: The company's performance is above median, incentive compensation is above median. The executive is receiving a higher incentive compensation level while delivering superior results relative to competitors. There would appear to be an alignment between pay and performance.

Profile of top North American energy organizations The median characteristics of the top North American energy organizations are presented in the following table by geography. Our research identified the top 25 Canadian, top 50 US and top 75 (i.e., aggregate sample) energy companies within the exploration and production (E&P), storage and transportation (S&T), integrated oil and gas and refining and marketing (R&M), oil and gas drilling and oil and gas equipment and services market sectors as defined by GICS sub-industry code for fiscal 2008. The US market included the top 50 energy organizations to help narrow the significant gap between the median market cap of the Canadian and the higher US market. Median North American energy organizations by geographic market
Geographic market Canadian Top 25* US Top 50** Market cap ($mm) Revenue ($mm) TSR ROE EPS growth Governance rating (GMI) Expected total incentives as % of salary $4,084 $7,872 $3,148 $7,411 -31% 25% -52% 18% 58% 4% 7.50 8.00 8.00 368% 643% 554%

Canadian & US Top 75** $5,585 $5,363 -38% 19% 19% * Canadian dollars ** In US$, Canadian currency converted to US$ by an exchange rate of CDN$1 = US$0.9346 PI

Hay Group's Performance Index (Hay Group ) findings The following graph illustrates the pay and performance findings for the Top 75 North American energy organizations. Note: the Top 50 US companies are denoted with a blue triangle on the graph and the Top 25 Canadian companies are denoted with a red triangle. In the analysis less than half the sample fall into quadrants two (Q2) and four (Q4), indicating there is still much work to be done in terms of aligning pay and performance. The issue is further compounded when looking at those organizations falling into quadrants one (Q1) and three (Q3), indicating that boards may wish to review their incentive designs. Top 75 North American energy organizations (click the chart to see a larger version)

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In the Top 75 analysis, the companies with the highest pay and performance correlation were Occidental Petroleum (Q4), Williams Companies (Q4), Cimarex Energy Co (Q2), Crescent Point Energy (Q4), Cameron International (Q2), Canadian Natural Resources (Q4) and Baker Hughes (Q4). Occidental Petroleum (Q4) had the fifth highest pay for top PI quartile Hay Group performance. Enbridge (Q3), followed closely by Nexen Inc (Q3) and Enerplus Resources (Q3) had the highest performance of the peer group and compensated the executive team below the peer group median. An interesting geographic observation is the fact that 75 percent of Q4 organizations are US based top pay for top performance. That said, 95 percent of organizations falling in Q1 are also US based top pay for below median performance. In comparison, 73 percent of Q3 organizations are Canadian below median pay for top quartile performance. That aside, a solid 80 percent (i.e., 20 of 25) of the Top 25 Canadian organizations, when compared to the US peers have above median performance, but only four of the 16 organizations lie in Q4. Therefore, one might conclude that Canadian shareholders received better value for performance. In general, Top 50 US organizations continue to compensate executives at the highest cross-border levels in the energy industry, which is not a surprise. However, the results do show that pay is not necessarily aligned to performance, indicating that much work can still be done in the area of calibrating pay to performance that provides value to shareholders. Gainers and decliners The following tables set out the top five gainers and bottom five decliners over last year's results for the Hay Group (horizontal axis on charts) for both the Canadian and US organizations studied over the past two years. The new organizations added to this year's analysis are omitted.
PI

Canadian top and bottom five gainers and decliners by Hay Group Top five Penn West Energy Trust Enerplus Resources Crescent Point Energy Harvest Energy Trust Talisman Energy 500% 233% 188% 150% 118%

PI

One-year Hay GroupPI % change Bottom five Suncor Energy Pengrowth Energy Petrobank Energy Husky Energy Inc Imperial Oil
PI

One-year Hay GroupPI % change -95% -75% -61% -56% -33%

US top and bottom five gainers and decliners by Hay Group Top five Newfield Exploration ONEOK Inc Devon Energy Murphy Oil Chevron Corp One-year Hay Group % change 232% 73% 22% 21% 21%
PI

Bottom five Valero Energy Chesapeake Energy Anadarko Petroleum Marathon Oil Hess Corp

One-year Hay Group -94% -72% -54% -16% -13%

PI

% change

The bottom five decliners in both the Canadian and US peer group showed relatively similar results. However, the Canadian top five gainers illustrated significantly larger year over year change in comparison to the US top five gainers. This observation is likely due to the Canadian capital markets sustaining more value through the financial crisis than the US markets.

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The road ahead The financial crisis has put incentive plans, specifically pay for performance, to the test. The findings in this year's analysis further supported the fact that there is still much room for improvement when it comes to aligning and calibrating pay to performance. More importantly, it helped to raise important issues such as sustainable growth, risk management, and aligning pay to the risk time horizon of capital investments. We expect some interesting results in our 2010 energy pay and performance analysis as our peer companies begin to report FY2009 financial and compensation results. Paul Gryglewicz is a consultant in Hay Group's Canadian executive compensation practice. He can be reached at +1.416.815.6426 or paul.gryglewicz@haygroup.com.

Bob Dill is a consultant in Hay Group's executive compensation practice. He can be reached at 469.212.4344 or robert.dill@haygroup.com.

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