2010 Proxy Season Review: Say on Pay · 2 Speakers Cynthia M. Krus Partner 202.383.0218 [email protected] Lisa A. Morgan Associate 202.383.0523 [email protected]

Cynthia M. Krus, Sutherland Asbill & Brennan LLPLisa A. Morgan, Sutherland Asbill & Brennan LLPReid Pearson, The Altman GroupFrancis H. Byrd, The Altman Group

July 27, 2010

2010 Proxy Season Review: Say on Pay

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Speakers

Cynthia M. [email protected]

Lisa A. [email protected]

Francis H. ByrdManaging Director201.806.2220

[email protected]

Reid Pearson Managing [email protected]

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Presentation Overview

• Say on Pay: What Will It Mean?Introduction to Say on PaySay on Pay Actions to DateLegislative and Regulatory DevelopmentsGetting Ahead of Your Say On Pay VotePreparing for the 2011 Proxy SeasonSay on Pay “To Do” List

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Introduction to Say on Pay

• What is it?Non-binding proposal included in proxy materials that calls for annual shareholder advisory vote on a company’s executive compensation program

• What is the History?Became required practice for London Stock Exchange companies in 2003 In 2006, Say on Pay proposals were adopted by shareholders at 5 publicly traded companies …

More than 50 in 2007 More than 80 in 2008Exceeding 100 in 2009

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Introduction to Say on Pay

• What are the Benefits?Direct

Incentivize companies to think about how and why they arrived at specific executive compensation decisions and create better disclosure Potential for public censure might lead directors to restrain excessive executive compensation in response to shareholder sentiment and more directly link pay with performance

IndirectPromote dialogue with and feedback from shareholders Give shareholders a sense of empowerment without binding the company

• What are the Costs?Thumbs-up or down vote gives management little information about specific components to which shareholders object Will require companies to spend significant amount of time engaged with various corporate governance activists and proxy advisory firms Unnecessary since shareholders receive detailed information through the SEC’s executive compensation disclosure rules Activist groups might use advisory votes as inroad to promote social or political agendas that are not related to the company’s economic growth

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Management Say on Pay Proposals

2010 2009 2008

Total Proposals 140 140 6

Pass 128 140 6

Fail 3 0 0

Average Support 87.8% 85.4% 94.2%

ISS For 112 99 4

ISS Against 28 40 1

ISS Refer 0 1 (RMG) 1 (RMG)

Stats from Russell 3,000Stats for meeting dates between January 1 and June 30 for each yearSource: ISS Voting Analytics

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Say on Pay Actions to Date

• First time MSOP at US company was rejected by shareholdersUntil 2010, seemed Say on Pay movement did not translate into votes against compensation MSOP failed at three companies in 2010

On May 5, 2010, only 46% of Motorola shareholders voted in support of the company’s compensation plan

Motorola gave its shareholders a Say on Pay vote in 2009 Compensation plan received support of 64% of shareholdersOne of four companies in 2009 to receive less than 65% approval

On May 8, 2010 shareholders of Occidental Petroleum Corp voted against the company’s compensation practices

Voluntarily began offering shareholders Say on Pay in 2009 On May 21, KeyCorp received only 45% support during its Say on Pay vote

First TARP participant to get majority dissent over its pay practicesReceived 87.2% approval during its 2009 advisory vote

• Other MSOP developmentsProposals to put Say on Pay on the ballot received 51% of the vote at EMC, 47.9% of the vote at Johnson & Johnson and 45.3% of the vote at IBM

Number of votes exceeded the support levels for the same resolutions at the three companies last year

In response, many companies have voluntarily adopted Say on Pay policies Aflac, Alaska Air, Apple, Intel and Verizon Communications all had voluntary advisory votes on

executive compensation in 2009

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Say on Pay Actions to Date

• Occidental Petroleum (voluntary): Reasons ISS did not supportRepeated failure to address: pay magnitude; pay disparity; peer group disparity; and performance target issues; CEO CIC agreement contains excise tax-gross ups

• Motorola (voluntary): Reasons ISS did not supportDr. Jha’s payment if business separation does not occur increased from $30M to $38M (inappropriate “pay for failure” arrangement); contains a modified excise tax gross-up provision

• KeyCorp (required): Reasons ISS did not supportPay for performance disconnect; short-term incentive plan more discretionary and performance results only generally referenced; same metrics used for short-term and long-term plan increasing risk profile

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Legislative and Regulatory Developments

• Dodd-Frank ActCompanies must hold advisory votes at any annual or other shareholder meeting that occurs on or after January 21, 2011 (six months after enactment) During 2011 meetings, companies required to hold separate vote on the frequency of future advisory votes

One, two, or three yearsAfterwards, companies required to hold shareholder votes at least every six years on Say on Pay frequency

SEC permitted to draft rules exempting small issuers

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Legislative and Regulatory Developments

• Dodd-Frank Act – Issues to ConsiderEffective date

Requirement will be in effect for the 2011 proxy seasonFrequency of vote

What happens when neither the annual, biennial or triennial options receive majority support? Not entirely clear whether frequency vote binding

Companies CoveredSEC authority to exempt an issuer or class of issuers from Say on Pay requirement (language added during conference)

Preliminary ProxyUnclear whether advisory vote will necessitate filing of preliminary proxy statement

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Getting Ahead of Your SOP Vote

• Although Say on Pay vote against a compensation plan has no legal ramifications and is merely advisory, bottom line is that shareholder vote will be heard

• Preparation for the InevitableRecent Towers Watson survey found

Only 12% of responding companies consider themselves very well prepared for Say on Pay6% of responding companies are currently offering Say on Pay or are already planning to roll it out46% of responding companies said they are only “somewhat prepared”22% said they do not know where their companies stand

While notion of Say on Pay has been in the works for years, only 80 companies currently offer Say on Pay proposals

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• Identify Potential Vulnerabilities: Understanding Shareholder Triggers

One of the easiest steps to take is to avoid a negative SOP vote in the first placePotential triggers (1-5):

A CEO base salary of more than $1 millionThe award of a bonus to the CEO in addition to non-equity incentive compensationA lack of correlation between company performance and annual cash incentives awarded to the CEOA pay differential between the CEO and other named executive officers (NEOs) of more than three to five times the average of other NEOsA change in pension value and non-qualified deferred compensation earnings that is larger than other elements of pay

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• Identify Potential Vulnerabilities: Understanding Shareholder Triggers

Potential Triggers (6-10)An “all other compensation” column that is disproportionately large and contains excessive perksProfits made on the exercise of stock options and value realizedon the vesting of equity awards that does not match long-term performanceAnnual performance and long-term incentive bonuses that are based on the same, single performance metricPayment of incentives for below-median performanceAny perception of conflict of interest in change of control payments

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• Next Step: Shareholder CommunicationIdentify potential root cause for a possible 2011 ‘no’ vote

Consult analytical reports prepared before meetingArrange meetings with key investment and trade organizationsSolicit meetings with representatives of major fund ownersIdentify your public pension and union fund shareholdersReview media reporting about company’s compensation policies. and Review correspondence sent to the company by dissenting shareholders

Example of GlaxoSmithKline post-2003

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• Next Step: Shareholder CommunicationAim to build constructive relationships between investors, directors

Identify key shareholders, trade associations, proxy agents and potentially media outlets with capacity to influence investor and public opinion on compensation mattersIdentify other potential non-compensation governance concernsPrepare and execute outreach plan before the annual meeting – in the “off-season”Consult with institutional shareholders before finalizing the compensation planOffer meetings with chair of compensation committee and/or otherboard members to key market players & consultants, if and when, necessaryPay attention to CD&A disclosure as a persuasive device that requires adequate scrutiny prior to public release

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• Next Step: Shareholder CommunicationConduct an outreach program

SurveysGroup meetingsOne-on-One MeetingsE-Forums (Intel, Verizon)

Issues to consider with any outreach programUnderstand how ISS works and familiarize yourself with its voting guidelines Regulation FD

If a company is considering running proposed changes by shareholders before publicly announcing the changes then the key to avoid a Regulation FD violation is to avoid sharing material nonpublic informationMost changes would not be considered material

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Preparing for the 2011 Proxy Season

• In an effort to avoid a negative Say on Pay vote in the 2011 proxy season, companies should focus on the following areas of their executive compensation programs:

Compensation CommitteesGolden ParachutesTax Gross-UpsPerformance-Based Equity CompensationClawbacks

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• Compensation CommitteesSecurities law as it exists today does not require listed companies to have wholly independent compensation committeesInvestors likely won’t consider compensation committees sufficiently independent unless all members are completely independent from management

Includes “soft” relationships, such as pre-existing friendships and interlocks on charitable foundation boards

• What you can do now …Revise committee charters to provide for total independence of compensation committee members Allow compensation committee to engage independent compensation consultants, legal counsel and other advisers

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• Golden ParachutesNon-binding shareholder vote on and disclosure of “Golden Parachute”compensationLong subject to scrutiny by proxy advisory firms and individual shareholders

• What you can do now …Modify/revise agreements to address shareholder concerns/ eliminate change in control provisionsSwitch from single trigger to double trigger equity vestingModify severance arrangements to provide severance following change in control only if executive is involuntarily terminated or if executive voluntarily terminates employment for certain “good reason” eventsEstablish change in control compensation arrangements in advance, so that can be approved under a Say on Pay vote instead of a separate vote in connection with a merger

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• Tax Gross-Ups Companies have paid an individual’s excise and related income taxes in an effort to offset the excise tax on “parachute payments” and keep the individual whole Providing gross-up or modified gross-up added in 2009 to RiskMetrics’ list of “poor pay practices” for new or materially amended agreements Shareholder groups also view gross-ups for imputed income tax imposed on use of corporate aircraft unfavorably

• What you can do now …Modify or eliminate excise tax gross-up altogether.Replace excise tax gross-up with “best payment” provision that pays executive either the full parachute payment or a reduced amount,whichever will leave the executive in the best after-tax position taking into the account the excise taxEliminate other types of income tax gross-ups, in some cases replacing them with a fixed cash allowance intended to provide the executive with funds that they can choose to use to pay the taxes or for other purposes

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• Performance-Based Equity CompensationCritics of executive compensation practices often focus on extent to which compensation is tied to company performance

• What you can do now …Replace traditional restricted stock or restricted stock units with performance-vesting stock or stock units Utilize design in which dividends and dividend equivalents are accumulated and paid out if/when underlying equity award becomes vested

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• ClawbacksRequire bonuses and long-term incentive compensation to be repaid to company in the event of financial restatement or other circumstances

Provisions can take variety of formsTime period for enforcing a clawback also varies

Significantly more common§304 of the Sarbanes-Oxley Act Dodd-Frank Act

Although clawback provisions have proliferated in recent years, the enforceability of clawback provisions remains relatively untested

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• Compensation Discussion & Analysis (“CD&A”)In addition to reviewing and revising your executive compensation programs, companies should review the description of their programs in their CD&AUse to tell storyConsider additional charts/graphics and bulletsConsider executive summaries/overviewsConsider adding analysis/best practices

Wealth accumulationFull walk away numberInternal pay equity

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Say on Pay “To Do” List

• Revisit your executive compensation program• Revisit the manner in which your executive compensation

program is presented in your proxy statement (CD&A)• Familiarize yourself with guidelines published by proxy advisory

firms – know what would trigger a negative vote recommendation• Reach out to your shareholder base, especially institutional

investors• Follow the SEC rulemaking process

Guidance on how Say on Pay proposal should be phrasedDetermination regarding applicable voting standard for vote on selection of annual, biennial or triennial vote.

*** Stayed tuned for our next webinar in August ***

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Questions?

Cynthia M. [email protected]

Lisa A. [email protected]

Francis H. ByrdManaging Director201.806.2220

[email protected]

Reid Pearson Managing [email protected]

Documents

2010 Proxy Season Review: Say on Pay · 2 Speakers Cynthia M. Krus Partner 202.383.0218 [email protected] Lisa A. Morgan Associate 202.383.0523 [email protected]