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WMACCA May 18, 2010

Catherine M. Marriott, Williams Mullen Christopher McGee, Mercer

Trends in Executive Compensation

Executive pay design is driven by a number of factors:
employer goals and priorities legal and regulatory requirements best practices, perception within the market, institutional investors (RiskMetrics)

This presentation will examine the conceptual framework for executive pay and incentives, recent regulation of these arrangements, and the latest trends in executive compensation.

Compensation Strategy
Corporate philosophy is the starting point
Attract, motivate, retain top talent
Salary (employment contracts) Bonus and incentives Golden parachutes SERPs

Align interest of executive with shareholders

Equity compensation Share ownership guidelines/requirements

Align interest of executive with stakeholders

New(er) concept Who are the stakeholders?

Compensation Strategy
Pay determination
External Competition
Reference to pay for similar jobs at competing companies SEC disclosure rules require comparison in stock price of peer group companies Benchmarking by consultants

Internal Equity
Comparison among similar jobs in the same company Internal pay relationships

Pay for Performance

Achievement of pre-established goals Corporate and/or individual Are guarantees consistent with this concept?

Compensation Strategy
Pay delivery - form and proportions of pay over time
Base pay or salary Variable pay (bonus or other cash incentive) Equity compensation (stock options, SARS, restricted stock, stock units) Deferred compensation Supplemental retirement plans (SERPs) Severance (golden parachute/change in control payments) Perquisites

Regulatory Environment
Executive pay has been in the spotlight for several years, driven largely by negative corporate/financial events. Fallout from the ENRON collapse followed by a depressed stock market in 2008, and government intervention has resulted in even more regulation.

Regulatory Environment
Existing Tax Law: 162(m) and 280G New Tax Law: 409A Changes to Securities Disclosure in 2010 TARP: clawbacks, prohibition of golden parachutes, sayon-pay Federal Reserve guidance on incentive compensation: risk mitigation Pending legislation
TARP concepts may be applied to all public companies Focus remains on risk, corporate governance, disclosure, excessive pay, deductions for stock options

Regulatory Environment: Section 409A

2004: Congress passes the American Jobs Creation Act and includes a new section of the Internal Revenue Code: 409A
409A is implemented post-Enron to deal with perceived abuses in executive deferred compensation It addresses the form and timing of deferred compensation It does not address compensation generally, incentive compensation, severance, or golden parachutes

Regulatory Environment: Section 409A

Section 409A must be analyzed in most aspects of executive compensation
Can drive bonus and incentive award design Can drive severance pay structure Can drive reimbursement promises Requires advance planning because it makes timing of payout hard to change

Pending Legislation
DATE June 17, 2009 July 10, 2009 July 31, 2009 (passed by House) May 7, 2009 May 7, 2009 May 19, 2009 June 12, 2009 December 2, 2009 (passed by house) April 15, 2010 TITLE White Paper: Financial Reform: A New Foundation Investor Protection Act of 2009 Corporate and Financial Institution Compensation Fairness Act of 2009 Excessive Pay Shareholder Approval Act Excessive Pay Capped Deduction Act of 2009 Shareholder Bill of Rights Act of 2009 Shareholder Empowerment Act of 2009 Wall Street Reform and Consumer Protection Act Restoring American Financial Stability Act of 2010 AUTHOR Obama Administration Treasury Department Frank (House) Durbin (Senate) Durbin (Senate) Schumer (Senate) Peters (Senate) Frank (House) Dodd (Senate) 10

Pending Legislation
Senators Charles Schumer, D-NY, and Maria Cantwell, D-WA, introduced the Shareholder Bill of Rights Act of 2009. If enacted, the bill would require:
Shareholder advisory votes on executive pay (say-on-pay) and golden parachutes Proxy access for shareholders to nominate directors Independent board chairs Annual director elections Majority voting for directors Establishment of a board committee of independent directors responsible for evaluating the companys risk management practices

Pending Legislation
Corporate and Financial Institution Compensation Fairness Act
Proposed by Barney Frank and passed in the House on July 31, 2009; focus is corporate governance Includes a non-binding shareholder vote on compensation for NEOs (say-on-pay) Requires disclosure on golden parachutes plus a separate advisory vote Requires independence of compensation committee (no consulting or advisory fee; no affiliates) Compensation committee may engage independent compensation consultant, counsel, other advisors Financial institutions would have to disclose incentive-based compensation programs to regulators

Pending Litigation
Senate Banking Committee has approved the American Financial Stability Act of 2010 (Dodd). The bill includes provisions on sayon-pay, compensation committee and advisor independence, clawback requirements, and more proxy disclosure. There likely will be intense debate on the bill.


Common Themes in Pending Legislation

Say-on-Pay: Separate shareholder vote to approve compensation of NEOs. Nonbinding Golden Parachutes: disclosure and shareholder approval CEO/Chairman: Separate the roles Clawbacks: implementation of procedure Independent Compensation Consultant: compensation committee can retain consultant Risk Assessments: SEC already requires this disclosure Independent Compensation Committee: Most, if not all, compensation committees of public companies meet these standards Disclosure of Employee Hedging: prohibit or disclose financial instruments used to hedge company stock awards

Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

SEC Final Rule adopted December 16, 2009, to enhance compensation and corporate governance disclosures
SEC Final Rule will require significant additional compensation disclosures
Risk Management Summary and Director Compensation Table disclosure Board disclosure re: qualifications Accelerated reporting of voting results Compensation consultant disclosure

Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Risk Management Companies must address compensation policies and practices for all employees if they create risks that are reasonably likely to have a material adverse effect on the company
This should trigger very few disclosures since most companies do not have plans that are reasonably likely to have a materially adverse effect


Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Risk Management, cont. Companies may consider policies and practices that mitigate or balance incentives in deciding whether compensation-related risks are reasonably likely to have a material adverse effect Disclosure is part of the proxy statement section on Executive Compensation, but not part of the Compensation Discussion & Analysis
However, companies may want to disclose in the CD&A their process for evaluating risk and their policies for mitigating risk such as clawbacks, stock holding requirements, etc.

Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Risk Management, cont.
Company does not need to make an affirmative statement that it has determined that risks are not reasonably likely to have material adverse effect Examples of risk may include a business unit that has a compensation structure significantly different than the rest of the company or a business unit that carries a significant portion of the companys risk profile Given the narrow definition of risk, few companies outside of financial services will have any disclosure requirements

Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Summary and Director Compensation Table Disclosure Full grant date fair value of stock and option awards included, not amount expensed for fiscal year
May result in different executives designated as most highly paid (based on sum of all compensation elements except deferred compensation earnings and changes in pension values)

For performance awards, grant date fair value based on probable outcome of performance conditions, not maximum performance

Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Summary and Director Compensation Table Disclosure, cont. Footnote disclosure required of maximum value assuming highest level of performance

Transition: For fiscal years ending on or after December 20, 2009, companies must recompute disclosure for preceding fiscal years presented in SCT: stock awards, option awards and total compensation columns should reflect full grant date fair values
Not required to include different NEOs for any preceding fiscal year based on recomputing those years


Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Board Disclosure
Disclosure required annually for each director and each nominee, which includes:
Particular experience, qualifications, attributes, or skills that led the board to conclude that the person should serve as a director Directorships at other public companies or registered investment funds held at any time during the past five years Legal proceedings involving directors, nominees, and executive officers extended from five to ten years


Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Board Disclosure
Disclose board leadership structure and rationale:
Whether and why the company combines or keeps separate the CEO and chairman positions Why the company believes that this structure is most appropriate Whether and why the company has a lead independent director and what specific role the position plays in the leadership of the company Description required pertaining to the boards role in risk oversight and how it organizes risk management practices (in Corporate Governance section)

Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Accelerated Reporting of Voting Results The results of shareholder votes must be reported on a Form 8-K within four business days after the meeting where the vote took place Rules include preliminary disclosure within four days even where final outcome is uncertain until definitive voting results are known and a second more accurate filing can be made, for example in contested director elections
Disclosure required regarding whether and, if so, how nominating committee considers diversity

Regulatory Environment: SEC Changes for 2010 Proxy Disclosure

Compensation Consultant Disclosure Fees paid to board compensation consultants and their affiliates (or to management compensation consultants if the board has none) providing executive compensation and additional services must be reported only if the aggregate fees for additional services exceed $120,000 for the fiscal year


Regulatory Environment
The Federal Reserve will work with the SEC to improve the disclosures provided by public banking organizations in ways that promote the safety and soundness of these organizations
The Federal Reserve guidelines require disclosure even where no SEC disclosure is required because a company concludes that compensation arrangements are not reasonably likely to have a material adverse effect


RiskMetrics: 2010 Focus

Withhold votes for Directors may occur on a CASE-BY-CASE basis (their emphasis) in areas such as pay and performance, defined by:
One- and three-year TSR are in bottom half of peer group and CEO total compensation is not aligned with TSR, considering
Five-year period Mix of pay Performance-based incentives (options do not count)


RiskMetrics: 2010 Focus

Withhold votes may also occur if a companys programs contain any features on the problematic pay practices list, such as
Multi-year guarantees for salary increases, nonperformance based bonuses, and equity compensation Change-in-control payments exceeding 3 times base salary and target bonus Tax reimbursements related to executive perquisites Dividends or dividend equivalents paid on unvested performance shares Repricing of underwater stock options/stock appreciation rights without prior shareholder approval

RiskMetrics: GRId Methodology

RiskMetrics has announced a new tool to assess governance-related risk called Governance Risk Indication (GRId)
Absolute basis compared to best practices Best practices are aligned with RiskMetrics proxy voting policies Governance risk is measured in 4 categories- audit, board, shareholder rights, compensation Each category is given a score with a concern level (low, medium, and high) Purpose of the scoring system is to encourage disclosure RiskMetrics will not use the GRId ratings to determine proxy voting recommendations
Will use corporate governance policies Rating will not guarantee positive vote recommendation or cause a negative vote recommendation 28

Implications for 2010: Decision-making in a more stable environment

Improvement in the stock market
S&P 500 has recovered over 150% since its March 2009 low
Many 2009 grants already have substantial paper gains
Companies may get a pass for their 2009 decisions but not for 2010. Shareholders will expect a return to fundamentals.


Implications for 2010: Decision-making in a more stable environment

Cautious signs of economic recovery

Automakers move through bankruptcy in record time and some TARP recipients have paid back government funds

Unemployment is still very high, as jobs and job growth tend to lag economic recovery
Economic recovery may mean that some incentive plans ending in 2009 may pay out


Implications for 2010: Alignment with performance is critical

Pay aligned with results

Pay mix
Risk management Sustainable results

Pay practices
Shareholder engagement

Long-term incentives and general use of equity are top-of-mind in 2010 31

Outlook for 2010: Base pay for executives

Executive Salaries are slowly defrosting A majority of organizations plan to increase salaries for 2010 (65%) or at least to restore reductions made last year (11%). Still, about a quarter of companies wont be increasing salaries and most of those didnt provide increases last year either. Increases are expected to be modest (2.8% on average).


Outlook for 2010: Base pay for executives

Action (N=123) Reduced salaries in 2009 and will likely restore reductions Reduced salaries in 2009 and have no plans to restore reductions Froze salaries in 2009 and will likely increase 2010 salaries Froze salaries in 2009 and have no plans to increase salaries for 2010 Increased salaries in 2009 and will likely increase salaries in 2010 Increased salaries in 2009 and will likely not increase in 2010

Percent of participants 11 1 36 19 29 4


Examining risk and alignment with results

Outlook for 2010: Short-term incentives

Incentive plan goals have been in the spotlight. Organizations want to set credible goals that will motivate employees, but in many cases the economic outlook remains uncertain. At the same time, shareholders and legislators are demanding that pay be aligned with performance.
Target annual incentive levels are remaining constant, however, there are plan design changes underway. Nearly half reported that they have introduced or plan to introduce new performance measures to their annual incentive program.

Outlook for 2010: Short-term incentives

Annual incentive program changes - made or considering for 2010
Introduce new financial measure(s) Introduce new non-financial measure(s) Introduce new relative measures Incr. range of performance for corresponding payout levels

33% 17% 15% 15% 6% 20% 8% 6% 7% 6% 4%


Decr. range of performance for corresponding payout levels Allow for increased discretion related to payouts Incr. threshold payout opportunity Decr. threshold payout opportunity Incr. maximum payout opportunity Decr. maximum payout opportunity Provide for mandatory payout of all or portion of aw ard in stock






Percent of organizations


Outlook for 2010: Long-term incentives

Back to fundamentals Like annual incentive plans, LTI programs are also being examined, although the pace of change has slowed since 2009. A majority of companies expect to deliver the same value of LTI in 2010 as was granted in 2009. A number of companies expect to deliver higher values because of the appreciation in stock prices throughout 2009 and early 2010
There is a noticeable trend in using performance to differentiate grant size among individuals

Outlook for 2010: Long-term incentives

There is also an increase in the use of performance shares/units. Companies that use performance shares/units continue to examine the performance metrics
25% of companies are adjusting the current range of performance Some companies are considering the use of shorter measurement periods with a deferred payout Some are converting the more traditional 3-year performance period to a series of 1-year performance periods with payout at the end of a 3-year timeframe

For non-executive participants, the top action under consideration is a decrease in program participation.

Initial Perspectives for 2010

Implemented in 2009 Planning to implement in 2010 No changes planned or implemented Reduce perquisites Complete a risk assessment of compensation programs Eliminate gross ups or commit to doing so in future contracts Implement a recoupment or clawback policy Separate CEO and Chairman of the Board Supplement competitive pay benchmarking with other analyses Reduce executive severance or change-in-control benefits Eliminate dividends on unvested performance shares Implement holding periods for equity awards 16 15 15 12 12 11 11 5 3 3 5 0% 20% 40% 9 92 93 60% 80% 100% 2 16 80 7 16 87 74 6 21 79 72 79 64


Contact Information
Catherine (Kate) M. Marriott Williams Mullen (w) 804-783-6901 (f) 804-783-6507 Christopher McGee Mercer (w) 202-331-2545 (f) 202-296-0909