Performance Plans in Current US Compensation Practice Davos 2013 14th Global Employee Equity Forum

07 February 2013

Fred Whittlesey Compensation Venture Group, Inc.

206.780.5547 www.compensationventuregroup.com fred@compensationventuregroup.com

Blog: payandperformance.blogspot.com

Compensation Venture Group and the World of Equity

Equity Interests and Advisory Roles

Professional Roles

Online Content

Pay and Performance: The Compensation Blog

Conscious Compensation: The Impact Compensation Blog

Effective Equity: The Equity Compensation Blog

Executive and

Equity Compensation

Consulting

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Our Topic Today

Reasons for Performance Plans

Types of Performance Plans

Prevalence in the US: Large vs. midcap/smallcap firms

The Problem with Prevalence

Key Issues for Boards of Directors The Governance Ups and Downs of Performance Plans Understanding Valuation

The Continuing Debate: Incentive or Pay Delivery

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Reasons for Performance P lans

Flat equity markets

Growth companies grew up

Accounting rule changes “leveled the playing field”

Volatility was not making stock options “more valuable”

RSUs emerged as stock options were moved into the “bad” column

Pay without performance continued

Global changes in governance mandated change

Line of sight was lacking with stock price

Investor and proxy advisor solution: performance based on stock price

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Types of Performance P lans: Key Design Parameters

Performance plans vs. performance shares

Measurement and settlement

Performance features

Applied to full-value shares or options

Impact of performance on vesting

Contingency or acceleration

Denomination

Shares or dollars

Settlement

Shares or cash

Determination of settlement

Formula or discretion or participant choice

2^5*3 = 96 plan designs

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Types of Performance P lans: Vesting

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Average Time to vest:

Example for 4 years

• (12+24+36+48)/4

• Average = 30 months

ExamplesA3/SA3 = Annual or Semi-Annual 3 yearsA4 =Annual 4 yearsA1M3 = Annual for 1st year/monthly for 3 yearsA1Q3 = Annual for 1st year/qrtly for 3 yearsC3 = Cliff vesting after 3 yearsP3 = performance vesting at end of year 3P1A3 = Performance vest at 1 year/3 year annual

Vesting Frequency in 2010

A =Annual / SA = Semi-Annual

M =Monthly

Q = Quarterly

C = Cliff

P = Performance # = Years

Schedule Avg Time to V Schedule Avg Time to V Schedule Avg Time to V

US CELLULAR CORP USM A3, C6 C3 36.0JUNIPER NETWORKS INC JNPR A1M3 25.9 P3 36.0METROPCS COMMUNICATIONS INC PCS A1M3 25.9 A1Q3 29.6ADOBE SYSTEMS INC ADBE M4 24.5 0-50-25-25, A3 33.0 P1A2 30.0WINDSTREAM CORP WIN A3, C3 P1 12.0LEAP WIRELESS INTL INC LEAP 0-25-25-50 39.0 P20-20-20-40 33.6AOL INC AOL A1M3 25.9 0-50-25-25 33.0ECHOSTAR CORP SATS A5 36.0BROCADE COMMUNICATIONS SYS BRCD A3 24.0 P2A1 36.0BMC SOFTWARE INC BMC M4 24.5 A3 24.0 P2, P3 30.0CROWN CASTLE INTL CORP CCI A3 24.0 P3 36.0TELLABS INC TLAB A3 24.0 A3 24.0 P1A3 36.0IAC/INTERACTIVECORP IACI 0-50-25-25 33.0 0-50-25-25 33.0COMVERSE TECHNOLOGY INC CMVT A1 12.0SYNOPSYS INC SNPS Q4 25.5 P1A3 36.0CINCINNATI BELL INC CBB A1M3 25.9 P3 36.0TW TELECOM INC TWTC A4 30.0 A4 30.0EQUINIX INC EQIX P1-50-25-25 33.0LORAL SPACE & COMMUNICATIONS LORLNUANCE COMMUNICATIONS INC NUAN C2 24.0 C2 24.0 P2 24.0ARRIS GROUP INC ARRS A4 30.0 P3 36.0AKAMAI TECHNOLOGIES INC AKAM A1Q3 29.6 A3 24.0 P3 36.0VIASAT INC VSAT A4 30.0 A4 30.0SBA COMMUNICATIONS CORP SBAC A4 30.0 A4 30.0EARTHLINK INC ELNK X1 14.2FAIR ISAAC CORP FICO A4 30.0 P1, P2 30.0COMTECH TELECOMMUN CMTL A5 36.0ROVI CORP ROVI A1M3 25.9PROGRESS SOFTWARE CORP PRGS M5 30.5 SA3 21.0

Prevalence of LTI Vehicle 69% 69% 52%

Vesting Schedule Avg Time to Vest Mode 25.9 24.0 36.0(months) 75th 30.0 31.5 31.5

Average 28.3 27.1 32.0Median 25.9 29.6 29.625th 25.7 24.0 24.0

Performance PlansCompany Ticker

SO/SAR RS/RSU

And then add vesting alternatives…

Prevalence in the US

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Survey-driven headlines indicate performance award prevalence is booming

A “Top 250” analysis indicates performance share prevalence has grown from 63% in 2009 to 75% in 2012 for “executives” (NEOs)

An analysis of the S&P 1500 companies indicates performance share prevalence for CEOs increased from 47% in 2009 to 58% in 2011

Technology sector survey of 422 companies – “any use of performance shares” = 30%

Directly correlated to revenue size

Revenue Range

Performance Award

Prevalence

<$50mm 3%$50mm-$200mm 16%$200mm-$500mm 25%$500mm-$1B 33%$1B-$3B 42%>$3B 55%ALL 30%

The Problems w ith “Prevalence”

Depth into organization

CEO

NEOs

Officers

Range of # of participants in a company in the US: 1 to 15,000 (4.3%)

Mix of performance awards vs. stock options and RSUs

Ranges from 5% to 100% performance awards

“Rigor” of performance goals

Cases of 3x no payout and 3x max payout

Year-to-year changes in design

Piñata plan design

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Key Issues for Boards of Directors

What Problem are we Trying to Solve?

Check-box plan design?

Specific shareholder/adviser concerns?

Key challenges

Interpreting survey and proxy data

Mix and weighting of equity vehicles

Understanding valuation

Extreme variations in accounting value based on design features

Performance measures

Performance period(s)

Interaction with other market trends

Ownership guidelines and holding requirements

Clawbacks

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Governance Ups and Downs: Emerging Problems

Goals

1. Low ball goals

2. Timing of adoption of relative TSR plans

3. Relative TSR payouts with negative absolute TSR

4. Financial measures that don’t support value creation

5. Interim milestone-based goals

6. Non-GAAP measures

7. Vague subjective goals

8. Remco discretion

9. Mid-cycle modifications

10. After-the-fact overrides

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Plan Structure

11. Valuation-based compensation numbers

12. Annual incentive plans hiding in an “LTI”

13. Part of the “LTI portfolio”

14. Liberal termination provisions

15. Liberal change in control provisions

16. Unnecessary complexity

17. Total cost of plan operation

18. Administration on spreadsheets

19. Participant skepticism and lack of perceived value

Understanding Valuation

From: “Value and Valuation: Making Sense of Long-Term Incentive Data” with Terry Adamson of Aon Hewitt, presented at:

WorldatWork Annual Conference 2012

National Association of Stock Plan Professionals (NASPP) Conference 2012

NASPP Boston Chapter meeting November 2012

WorldatWork White Paper to be published in early 2013

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The Continuing Debate: Incentive or Pay Delivery

Shareholders and advisers want pay delivery tied to results…as they define results and increasingly defined as TSR

TSR-based measures are creating a lottery environment

Over time, few companies will be able to sustain favorable relative TSR

Pattern of TSR adoption and abandonment is correlated with both share price cycles and payout experience of programs

TSR is mistakenly assumed to be a measure of shareholder value

“Share price reflects expectations about future cash flows. So what TSR really measures is a shift in shareholder expectations about future cash flows…It is possible for shareholder value to be destroyed while TSR is indicating otherwise.”*

TSR-based performance awards are enforcing a collar on payouts to executives based on the experience of relatively short-term shareholders

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* From ”Total Shareholder Return and Management Performance: A Performance Metric Appropriately Used, or Mostly Abused?” – Rotman International Journal of Pension Management, Fall 2012, R. Burgman and M. Van Clieaf

The Continuing Debate: Incentive or Pay Delivery

Market trading dynamics and global economic concerns are muting executive impact on share price

Average investors’ holding period in US: 3.5 years 3.5 months

70% of US market trading volume is high-frequency trading: 3.5 hours?

Euro crisis

China currency valuation issue

Climate change

Late breaking news in the US (week of 03 December 2012)

Spread of “special dividend” in December to optimize tax impact given “fiscal cliff” situation

SEC focus on “window dressing” by mutual funds that causes share price spikes on the last day (in the last half-second) of a fiscal period, and a significant drop the next trading day

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The Continuing Debate: Incentive or Pay Delivery

Shareholder-driven plan design is exacerbating single-stakeholder view of performance, but what about…

Employee ownership?

Seen as “dilution” through proxy advisers’ static models

ESG?

Dismissed as “nonquantitative, non-objective measures”

Conscious Capitalism©?

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