Talking Points II - Tally Sheets

1. Background - "In the Beginning"
   1. Defensive analysis to make sure the Compensation Committee did not have a "NYSE - Grasso" surprise
      1. Underscored by The Corporate Counsel/NASPP
      2. Supported by consultants
   2. Focused mostly on termination payments
      1. Termination without cause
      2. Termination following a CIC
      3. Voluntary "quit"
      4. Termination for cause
      5. Termination related to death or disability
   3. Initial reaction by Compensation Committees largely muted
      1. A few "Holy Cow" reactions
      2. Some wanted to disclose in proxy
      3. Most moved quickly to next agenda item
2. Next Phase - Proactive Tally Sheets
   1. What are the essential elements of a "proactive" tally sheet?
      1. Summarize impact of current and past decisions
      2. Project future outcomes under various stock price appreciation and equity grant scenarios
      3. Include pension accruals and projections
   2. As discussed, most tally sheets only cover I.B above.  
   3. We also like to analyze "Comprehensive Income" (CI)*
      1. Defined as the sum of (i) current salary, annual incentive and long term incentive or Total Direct Compensation, (ii) benefits and perquisites, and (iii) the increase (or decrease) in the value of equity awards
      2. CI represents both the "wealth accumulated" by the executive during the year and the economic cost to the company
      3. CI provides the Committee with the insight to both current pay decisions and the impact of past decisions
      4. CI also identifies the "leverage points" for adjusting pay in the future
3. Tally Sheet Experience and Insights So Far
   1. It is difficult to take corrective action, as reductions in future pay increases/equity awards could be viewed by executives as "penalties for success"
   2. There is a lack of agreement on how much is too much in terms of total direct compensation (TDC) and wealth accumulation (Fred Cook recommends a 6x to 15x salary amount)
   3. Pay for performance is rarely introduced into such analyses.  Thus, low or high potential payments are often summarized without a performance context
   4. Compensation Committees rarely take "incremental" steps (i.e., they are more likely to terminate an executive than reduce pay levels) and it is (apparently) very difficult to deny a successful CEO ever increasing pay/wealth accumulation
   5. Growing fear that tally sheet findings are likely to spark a new round of "ratcheting" that was previously experienced with surveys
4. Action Items
   1. Ask for "what if" calculations under various total shareholder return (TSR) scenarios and future equity grant levels
   2. Consider renegotiating/ratcheting back severance multiples, future equity awards, and pension accruals
   3. Review the impact of changing the pay philosophy/targets to median TDC on future equity awards and wealth creation
   4. Add "modified gross up" language to change in control protection
   5. Consider how much is enough - and add caps and/or offset if the Compensation Committee can agree on a top end payment.  To illustrate:
      1. Severance: 2x base and bonus, but no more than $5.0 million
      2. Equity: Maximum option value equal to 2.5x strike price
      3. SERP: 60% of final average earnings with a present value maximum at age 65 of $16 million or 60% of final average earnings, with a limit on "covered" earnings of $2 million
      4. CIC: Full vesting of all equity, with a dollar for dollar reduction in severance to the extent the value of accelerated equity vesting exceeds $10 million
      5. Total Wealth Accumulation: Sum of equity and retirement plan benefits not to exceed $15 million
5. Going Forward - from Pearl Meyer, Steven Hall & Partners
   
   While most useful in correcting/recalibrating the consequences of past decisions and commitments, Tally Sheets should also be used to assess the current effectiveness and viability of a company's executive compensation program in supporting enterprise mission and strategy and in achieving the program's ultimate objectives - attract, retain, motivate and reward for real results. Elements to be reviewed include balance and structure:
   • Fixed vs. variable pay
   • Current vs. long term
   • Cash vs. equity
   • Range of opportunity and leverage vs. degree of stretch
   • Retention power (vesting, restrictive covenants and use of clawbacks)
   • Right metrics and yield curve for annual and long-term incentives
   • Target/grant values vs. actual earnouts and accruals

* The latest issue of The Corporate Counsel discussed the use of an "Accumulated Gains and Carried Interest Table."  We incorporate this into the CI concept.