How to Compete With a dot.comHow to Compete With a dot.com

Jeffrey M. Kanter

Erin Bass-Goldberg

Frederic W. Cook & Co., Inc.

May 11, 2000

Wall Street Compensation and Benefits Association

2

Today’s ObjectivesToday’s Objectives

Examine dot.com pay practices

Approaches to make you competitive

3

Who’s a dot.com?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

4

dot.com Employee Mentalitydot.com Employee Mentality

Harsh generalization:

Therefore:

Little loyalty; lots of

greed

5

dot.com Employee Mentality (cont’d)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 Mentalitydot.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 ExpensiveRecruiting 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 PackagesDifferent 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 ComparisonsGeneric 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 ComparisonsRun 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

An

nu

al G

ran

ts a

s a

% o

f O

uts

tan

din

g S

har

es

91% Growth

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Dilution ComparisonsDilution 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

Pot

enti

al D

ilu

tion

as

a %

of

Ou

tsta

nd

ing

Sh

ares

99% Growth

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Stock Option ProvisionsStock 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)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 CompaniesResponse 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)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 ApproachesInnovative Approaches

Tracking stock

Subsidiary stock (external market)

Subsidiary stock (internal market)

Venture capital funds

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Tracking StockTracking 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)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 (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)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)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)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)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)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)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)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 FundsVenture 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)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 ProfileCompany Profile

Frederic 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