How to Compete With a dot.com

Jeffrey M. KanterErin Bass-Goldberg

Frederic W. Cook & Co., Inc.May 11, 2000

Wall Street Compensation and Benefits Association

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Today’s Objectives Examine dot.com pay practices Approaches to make you competitive

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Who’s a dot.com? Line is blurring between old and new economy

companies

Bricks & Mortar Bricks & Clicks

Chase Chase.com

DLJ DLJdirect

BankOne Wingspanbank.com

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dot.com Employee Mentality Harsh generalization:

Therefore:

Little loyalty; lots of greed

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dot.com Employee Mentality (cont’d)

Originally a different culture Existing pay structures/guidelines were irrelevant

– Moving too fast– Bureaucracy is a dirty word

Get rich quick– Vs. career and security– Don’t care about old “rules of thumb”

High risk: high reward Typical pay programs may not work But seeing shift to old economy structures

– Best of both worlds

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dot.com Company Mentality Downplay cash; up play stock Would like structures And to create retention But fighting high turnover rates and lack of available

talent at all levels With market downturn and continued talent flight,

more cash and more options required

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Recruiting Can Be Expensive In the money option values:

– 18 internet companies

$0

$50

$100

$150

$200

$250

1999 2000(est.)

1999 2000(est.)

1999 2000(est.)

1999 2000(est.)

Vested Unvested

Option Gains ($000,000)

CEO COO CFO Top Sales

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Different Pay Packages Joseph Galli example:

From To

Company Black & Decker Amazon

Position Head of Power ToolBusiness

President & COO

Compensation (Latest year) $1.1Mannual cash + $460KLTI + 75K options +rich pension/SERP

$200K salary +3.9M options with$20M guarantee +$5M cash signingbonus

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Generic Job Comparisons

$0

$500

$1,000

$1,500

$2,000

$2,500

Salary Bonus Long-Term

CEO CFO Top Sales General Counsel

GI

GIGI GI

Internet

Internet

Internet

Internet

($000)

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Run Rate Comparisons

1.1%

5.0% - 7.0%

2.1%

0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%

Old Economy New Economy

1989 1999

Ann

ual G

rant

s as a

% o

f Out

stan

ding

Sha

res

91% Growth

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Dilution Comparisons

6.9%

13.7%

20.0% - 25.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

Old Economy New Economy

1989 1999

Pote

ntia

l Dilu

tion

as a

% o

f Out

stan

ding

Sha

res

99% Growth

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Stock Option Provisions Relative comparison:

EstablishedCompanies Emerging Companies

Participation Exclusive Inclusive

Grant Timing Annual grants basedon competitiveguidelines

Front-loadedhiring/promotion grants;“refresher” grants forongoing unvested shares Old economy

practices may return

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Stock Option Provisions (cont’d)

Relative comparison (cont’d):

EstablishedCompanies Emerging Companies

IndividualGrants

Uniform by job level Differentiated for technical andcritical-skills employees Tech premium

-- 20% tech vs. non-tech-- 35% tech vs. sales

Vesting 3-4 years annualinstallments

Immediate with repurchaseright or over 3 years, monthly

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Response of Old Economy Companies Many old economy companies are developing and

implementing their own internet- and technology-based strategies– This approach is complementary to their traditional

business Wal-Mart , Barnes & Noble, Toys R Us, GM, Ford,

Sears Others are attempting to convert to a “new economy”

focus– Kodak, AT&T

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Response of Old Economy Companies (cont’d)

The critical success factor is human capital and the ability to attract and retain “hot skills“ employees

The primary objectives include:1. Compete with greater upside of new economy

Need a “great stock”

2. Address loss in incentive and retention value associated with share price depreciation

Need to leverage upside and/or decrease perceived riskiness of current employment situation

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Innovative Approaches Tracking stock Subsidiary stock (external market) Subsidiary stock (internal market) Venture capital funds

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Tracking Stock Tracking stock is a separate class of publicly-traded

parent company stock whose market value relates to the financial results of a particular business– Not a direct ownership interest– No formal separation of assets– No legal separation of the company– No separate board of directors

Separate P&L statements are prepared for each tracking stock business– But only one annual report and proxy statement

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Tracking Stock (cont’d)

Examples:

Parent Company Tracker

AT&T

Disney

Donaldson, Lufkin, Jenrette

Lucent Technologies

Perkin-Elmer

Staples

Liberty Media (cable)/AT&T WirelessGroup (wireless)

Go.com (internet entertainment)

DLJdirect (internet brokerage)

PBX Systimax (proposed)

PE Biosystems (bio-tech)

Staples.com (internet retail; proposed)

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Tracking Stock (cont’d)

Tracking stock objectives include:1. Creation of a “pure play”

Allows investors to focus on specific business segments Provides “currency” for acquisitions

2. Enhance overall market valuation (i.e., eliminate “conglomerate discount”)

Encourages more specific analyst review

3. Provide real equity incentives for business unit employees

Employees in each business receive equity incentives on real shares of their individual businesses

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Tracking Stock (cont’d)

Advantages– Provides a direct “line of sight incentive” – Can be used in all the same ways as parent company

stock– Taxation and accounting treatment are identical to

parent company stock– Does not result in loss of control by parent company

(like a spin-off would)

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Tracking Stock (cont’d)

Disadvantages– Presents challenging corporate governance issues

Potentially creates “self dealing” opportunities among senior management and Board members

» Can be offset by establishing a proper balance of incentives and ownership among different equity classes

Creates divergence of interests among each distinct group of stockholders

Raises the possibility of lawsuits

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Tracking Stock (cont’d)

Disadvantages (cont’d)– Requires complete recapitalization of company

Is expensive and time consuming to establish Would be difficult to unwind

– Unlikely to completely capture “full” market valuation No “take-over” premium

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Subsidiary Stock (External Market) A public market for a free-standing subsidiary is created

by selling a small portion (e.g., 15%) through an IPO– Objectives are similar to those of a tracking stock

structure, except requires real separation of assets and full disclosure

Advantages– Same as tracking stock

Disadvantages– Same as tracking stock, except:

Reduced corporate governance issues More difficult to unwind

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Subsidiary Stock (Internal Market) This approach solely supports compensation

objectives Similar to phantom stock, but uses real shares of a

freestanding business unit– Shares are valued by third-party appraisal and are

traded within an internal market– Employees may be given a “put option” back to

Company to provide liquidity– The employer has a “right of first refusal” or “call

option” to prevent loss of control over stock

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Subsidiary Stock (cont’d)

Advantages– Provides a direct “line of sight” incentive– Can be used in all the same ways as parent company stock– Insulates employees from the vagaries of the financial

markets– Can obtain favorable fixed plan accounting under APB

Opinion 25 if: Stock price based on fair market value Employees hold shares for a minimum of 6 months before

sale to the company– Does not result in loss of control by parent company

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Subsidiary Stock (cont’d)

Disadvantages– Requires independent appraisal or complex valuation

formula – Administration is complex– Six month holding requirement requires employee

capital outlay and increased risk Capital outlay could be addressed with company-

sponsored loan or special dividend No effective solution for stock price risk

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Venture Capital Funds Opportunity to “coinvest” in a company-sponsored

venture capital fund– Or, could be just a “carried-interest” program– Fund set up as a wholly-owned management

company– Investments are generally targeted to those with

strategic value to company; could simply be outside investments

– Realized returns are split between company and executives

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Venture Capital Funds (cont’d)

Advantages– Provides attractive investment diversification

opportunity not available to executives on their own– Can help recreate the partnership and entrepreneurial

culture of private ownership Disadvantages

– Can be administratively complex– May be viewed by shareholders as inappropriate use

of corporate assets

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Company ProfileFrederic W. Cook & Co., Inc. provides management compensation consulting services to business clients.Formed in 1973, our firm has served over 1,000 corporations in a wide variety of industries from our offices in NewYork, Chicago, and Los Angeles. Our primary focus is on performance-based compensation programs which helpcompanies attract and retain key employees, motivate and reward them for improved performance, and align theirinterests with shareholders. Our range of consulting services encompasses the following areas:

Total Compensation Reviews Incentive Grant Guidelines Performance Measurement Strategic Incentives Executive Ownership Programs Globalization Specific Plan Reviews All-Employee Plans Privatization Restructuring Services Directors’ Compensation Compensation Committee Advisor Competitive Comparisons Equity Instruments Stock Option Enhancements

Our offices are located:

New York Chicago Los Angeles90 Park Avenue35th floor

19 South LaSalle StreetSuite 400

2029 Century Park EastSuite 1130

New York, New York 10016 Chicago, Illinois 60603 Los Angeles, California 90067212-986-6330 phone 312-332-0910 phone 310-277-5070 phone212-986-3836 fax 312-332-0647 fax 310-277-5068 fax

Web site address:www.fredericwcook.com