Highlights of Executive Compensation Issues 2012Robert D. Buford Executive Compensation Consulting LLCFebruary 2012

2012 Executive Compensation Issues & Concerns

The following material summarizes several recent reports and studies regarding executive compensation and offers suggestions for evaluating your pay practices at year-end and into 2012. The ongoing pressure from Congress, regulators, shareholder

advisors and consumers makes it imperative that all companies, especially publicly-traded, take the time to carefully review/audit all executive pay practices, policies, pay levels, pay program designs and other related terms and conditions of employment.

While the current economy may suggest a wait-and-see approach until next year or beyond, the focus and design of your executive compensation programs needs to be addressed immediately.

Based on the national political climate as well as factors such as high unemployment, it is our view that you will continue to face continued pressure to modify your approach to executive compensation, establishing a stronger link between pay and performance.

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Sources for this Summary

This summary is based on a number of recent studies and publications including the following: The Harvard Law School Forum on Corporate Governance and Financial Regulation, posted January,

2012 by Sherman & Sterling McKinsey Quarterly, “What’s in Store for China in 2012. February, 2012 Boardroom IQ, Private vs. Public Companies – What Can They Learn from Each Other, January 2012;

Boardroom IQ, “CEOs Are Paid for Performance: Using Realizable Pay to Demonstrate Alignment with Total Shareholder Return,” Pay Governance, December 2011

PWC, The Point, “What’s Next for Say on Pay, Winter, 2012; PWC, Key Issues: Executive Compensation and Say On Pay, Winter 2012; PWC, 10 Minutes on the Boardroom Agenda, November 2011

Boardmember.com, Executive Compensation: What Will 2012 Bring, Linda Rappaport, December 2011 Pearl Meyer & Partners, “Looking Ahead to Executive Pay Practices in 2012,” Equilar, Preparing for 2012: P4P, January, 2012; Equilar, 2012 Executive Compensation Outlook,

February 2012 Daily Journal, Los Angeles & San Francisco, Executive Compensation in the 2012 Proxy Season, James

Barrall, January 2012

All of these studies are worth reading in order to better understand the scope and details of some of the initiatives now being considered by regulators, shareholder advisors and Congress. However, neither this summary nor the studies cited here are intended as a substitute for professional legal, tax, financial, or compensation advice.

While the scope of these studies is limited to publicly-traded companies, many of the mandates could easily become standard or best practices for both private and public companies.

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Topics to be Reviewed

Legislation and Regulations

Corporate Governance

Independence of Committee and Consultants

Risk Assessment

Optics of Pay Programs

Measures and Goals for Incentives

Peer Group Selection

Total Program Review

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Legislation and Regulations

Say on Pay is here as adopted by the SEC last year Companies must ask shareholders to approve a non-binding, advisory

vote on the pay of named executive officers (SOP or say-on-pay) as disclosed under item 402 of Regulation S-K (in other words, in the proxy statement)

Companies must ask shareholders to approve a non-binding vote on the frequency of whether the SOP vote should occur every one, two or three calendar years (SOF or say-on-frequency)

Companies must disclose to shareholders and ask for a non-binding vote on golden parachute arrangements if the company is seeking shareholder approval of an acquisition, merger, consolidation or proposed sale of disposition of all or substantially all of the assets. The disclosure must be in a clear and simple form and include aggregate total compensation that may be paid or become payable upon a transaction.

While these are non-binding votes for this year, we expect continuing requirements and regulations that will further limit board latitude regarding executive compensation.

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Legislation and Regulations – cont’d.

Other legislative initiatives and trends include: The determination of internal pay equity by reporting the

ratio of CEO pay to the average pay of all employees The requirement for clawback and recovery provisions in all

pay plans The full disclosure and eventual elimination of golden

parachute severance packages and tax gross-up payments Evolving concept of realizable total pay rather than targeted

total compensation or w-2 pay Continued pressure from shareholder advisors such as ISS

and Glass-Lewis, pushing executives and boards for stronger links between pay and performance

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Corporate Governance

With good corporate governance, we are looking for compensation committee members who are active and involved in the management of all aspects of executive compensation, as well as other directors who are equally responsible for pay programs and policies. Examine your Committee Charter and compensation strategy to be certain

that the pay process is fully described and is compatible with the long-term objectives of the business and requirements of your shareholders.

Review the Committee calendar for process steps and timing of decisions so that directors know what is required of them and when pay decisions should be made. Make sure your directors know what they are doing and have the knowledge and experience to effectively serve on the Committee.

When needed, push the Committee Chair to take a more interactive role with Company executives, professional staff and consultants so that detailed compensation considerations are fully understood.

Be certain that all potential payouts and benefits are fully disclosed to the Committee and they understand how their decisions may impact these amounts. This should include cash, equity, severance, change in control payments, retirement benefits, perks and all other items of value.

Avoid conflicts of interest, both real and perceived, including members of the board and consultants.

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Independence of Committee and Consultants

Rules have already been established requiring Compensation Committee independence.

Listed companies committee members are subject to the same independence standards as audit committee members, meaning that Compensation Committee members would not be able to accept any compensation from the company other than board and committee fees and retainers. In addition, other rules of independence must be followed, such as no prior role as an executive of the company.

Compensation Committees retain the right to hire advisors, who under other proposed legislation must also be independent. In addition, the SEC has proposed additional disclosures would be required where compensation consultants are providing other services to the company. The SEC will establish standards of independence for consultants when legislation

is passed. Such multi- service consultants will not be prohibited, but rather their services will be more fully disclosed and monitored.

Clients, however, may decide that the compensation consultant should be fully independent in order to best serve their needs.

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Risk Assessment

One major feature of current compensation planning requires that companies create a process that directly links incentive plan metrics to risk-taking. This is developing as a best practice and some expect it to become standard for all companies. In other words, can the operation of your incentive plans encourage the

company to engage in unreasonable financial or operational business initiatives?

Does your pay-for-performance model really work in terms of creating shareholder value and does it contain effective limits and controls?

Are the outcomes of all of your pay plans reasonably predictable and controllable?

In addition to incentive plan modeling as a risk assessment tool, you should also evaluate if all terms and conditions of executive employment are aligned with long-term shareholder interests. Do you have stock ownership guidelines in place that require retention of

shares for the long-term? Do you have an all-events severance policy, regardless of cause? Do you pay all incentives in current cash? Do you convert any cash to stock? Does your Compensation Committee have and use discretion and apply

common sense to awards that are unreasonable by contemporary standards?9

Optics of Pay Programs

Today, executive compensation is one of the most harshly criticized aspects of the business community, caused in large part by the combination of a terrible economy and years of corporate greed. Rather than pursuing a rational and responsible approach to total compensation, a few companies have done serious damage to the entire process of rewarding management for creating shareholder value.

For sure, some of these violations have been real but we are all in the same boat today in terms of perceptions – pay is too high, performance standards are too low, management is incompetent and greedy.

Here are a few things you should consider to minimize the bad optics (thanks to the Pearl Meyer document from the 2011 update): Minimize perks and tax gross-ups. Both are already in decline in terms of

prevalence. Review employment agreements for severance, change in control and

terminations for cause language and for transactions. Develop realistic pay models for each pay and benefit plan with workable

controls implemented when necessary. Disclose everything in simple language Make sure your actual pay levels are predictable, defensible and

controllable. Avoid raising unnecessary concerns regarding any part of your pay

package; look and be normal10

Measures and Goals for Incentives

Selecting performance measures and setting performance goals for each variable pay feature is a major responsibility of senior management and the Committee. This is an annual exercise which may or may not be related to the

annual operating budget or business plan.

Measures should be directly linked to company-specific value drivers and usually have some degree of relevance within the industry. While measures tend to change over time, we expect to see some

level of enduring standards that remain in place for several years for both short and long-term incentives.

As noted earlier, payouts should be modeled against goals at least quarterly.

Several pay consultants have suggested that the prominence of annual incentive plans is in a gradual decline, with more pay opportunity shifting to long-term plans.

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Peer Group Selection

All listed companies are now required to develop and list in the proxy the firms that are used for performance benchmarking Such companies are generally in the same industry and are of

comparable size and stature but may also be selected on the basis of market share, geography, direct competitor and common talent pool.

In addition to performance benchmarking, the peer group is used compare executive compensation programs as a whole and where jobs are sufficiently similar to compare the pay of individual executives. This comparison may include pay mix, employment contracts and the use of equity in long-term incentive plans.

The number of peers generally ranges from 10 up to 30 and many of the peers will show up in industry compensation surveys as well. Very few US companies include non-US based companies in the peer group. The only

significant exception would be Canada-based organizations where pay practices and disclosure are similar to those in the US.

Most companies review the peer group annually and it is not uncommon to see a few changes each year.

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Total Program Review

As you prepare for 2012, it might be advisable to initiate a review of your entire package of pay and benefit programs in which executives and outside directors participate so that you can develop alternatives approaches where needed or confirm current practices.

Such an audit would include: Review of compensation surveys and proxy statements of competitors to

verify the validity of pay sources and the benchmarking process. Review the design of all short-term incentive plans including

communication, cost, award levels, performance measures, goals, plan documentation and risk assessment.

Review the design, operation and communication of all long-term incentive plans in terms of competitiveness, understanding, impact on retention, plan documentation and cost to shareholders.

Review other terms and conditions of employment for executives including severance, change in control provisions, supplemental benefits, perquisites, employment contracts and the like.

Review other programs such as stock ownership guidelines, performance management, succession planning and other key executive initiatives.

Review proxy CD&A for the last several years for clarity and transparency and start planning for 2012 materials.

Consider doing the same process for outside directors’ terms and conditions.

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