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Background on Relative TSR Plans

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  • 1. Relative TSR Programs Terry Adamson, SVP, National Practice Leader Radford Valuation Services June 25, 2009

2. Agenda

  • Overview of Current Equity Marketplace
  • Relative Performance Metrics as a Solution
  • Relative TSR - Description of a Plan Design
    • Example #1
    • Example #2
    • Example #3
  • Relative TSR Value Delivery
  • Relative TSR Significant Plan Design Decisions
    • Selection of a Peer Group
    • Averaging Periods
    • Threshold, Target, and Minimum Payouts
    • Dividend Equivalents
    • Treatment upon Separation / Termination
  • Relative TSR Hidden Plan Design Gotchas
  • Relative TSR FAS123R Valuation and Accounting

Source:www.RelativeTSR.com 3. What do these companies have in common?

  • Intel
  • eBay
  • Motorola
  • Google
  • Toll Brothers
  • Cardinal Health
  • Starbucks
  • Genworth Financial
  • AMD
  • And about 100 other public companies just in the last 12 months..
  • All of these companies went through anUnderwater ExchangeorRepricingof traditional stock options for their employees
  • The fundamental problem of why all of these companies needed to go through these exchange programs are due to the binary and absolute nature of traditional stock options youonlyget paid if the stock price goes up.
  • The solution is to createrelativeequity vehicles.

4. Relative Performance Programs

  • Normally designed with full value shares, since stock options are inherently a performance vehicle
    • Using FAS123R terms, can either be defined asPerformance ConditionsorMarket Conditions
    • Performance Conditions (internal metrics)
      • Typically based on internal metrics such as EBITDA, EPS, or revenue growth
    • Market Conditions (market metrics)
      • Typically based on a Total Shareholder Return (TSR) with dividends re-invested

5. Relative Performance Conditions Pros/Cons

    • Pros
    • Arguably, the best alignment between Performance and Compensation
    • Alignment between compensation delivered and FAS123R expense taken
    • Cons
    • The challenge of picking the most appropriate metric
    • Challenge of comparing relative internal metrics between companies
    • Disconnects in fiscal reporting periods between companies
    • Lag in public disclosure creates communication and financial reporting challenges (need to wait until Qs or Ks are released)
    • Creates volatile quarter over quarter compensation expense, as requires a probability assessment each quarter of the expected number of awards to vest, and a cumulative catch-up reflecting the change

6. Relative Market Conditions Pros/Cons

    • Pros
    • Easily measurable and communicable at any point in time
    • Directly aligned with shareholder returns
    • Objective, auditable, and transparent metric
    • Not required to reconcile FAS123R expense to actual awards paid out (if outperform levels are paid out, not required to take an additional charge -the glass is half-full argument )
    • Very stable and fixed accounting as probability of all future possible payouts are considered in initial valuation
    • Cons
    • Does TSR return accurately reflect performance?
    • Not required to reconcile FAS123R expense to actual awards paid out (if no awards paid out, cannot reverse expense -the glass is half-empty argument )

7.

  • Activist Investors becoming more involved in Executive Compensation decisions
    • Former Chairman of the SEC, Richard Breeden, wrote in a letter to Applebees Board of Directors on January 25, 2007
    • link to Richard Breeden's letter
  • I am writing to you in your capacity as Chairman of the Compensation Committee (the Committee) of Applebees International, Inc. on behalf of Breeden Partners, which owns 3.9 million Applebees shares, or just over 5% of the companys outstanding shares. We wish to express our concerns with the bonus eligibility criteria adopted by the Committee, particularly the failure to utilizerelative shareholder returnsor other measures of competitiveness. In addition, we want to offer specific suggestions for improving the companys compensation policies.In determining the long-term incentive component of CEO compensation, the Executive Compensation Committee will consider, among other matters, the Companys performance and relative shareholder return...Given that the slide in the companys operating performance has now entered its fourth year, it is long past time to start basing senior executive compensation in significant part onrelative shareholder return, exactly as the Committees charter suggests . Unfortunately, the performance criteria recently adopted by the Committee under Applebees 1999 Management and Executive Incentive Plan and the 2001 Senior Executive Bonus Plan as disclosed in the companys Form 8-K dont appear to measure relative performance in any area.Unless there is detail that has not yet been disclosed, the Committees performance criteria seem vague and ineffectively targeted. The result is essentially a license to pay anything to anyone, irrespective of actual performance in the marketplace. While I understand that the Committee held back cash bonuses for 2005 on a discretionary basis, the Committee should revise its current criteria formally to put the performance back into performance criteria. At the same time, other compensation practices should also be changed to eliminate unnecessary expense and unhealthy practices.
  • Postscript: Applebees introduced a Relative TSR plan in 2007
  • With Say-On-Pay, expect more of this

Relative TSR Governance Considerations 8.

  • Data below provided by Equilar
  • For the second straight year, TSR and EPS are the most commonly cited metrics for equity incentive plan awards.

Relative TSR Prevalence of Relative TSR 9. Example Design #1 See Intels Plan, filed 3/23/2009

    • Replacing Annual Stock Option and RSU Grants with Outperformance Stock Units- Beginning with the equity awards that will be granted in 2009, the committee will award outperformance stock units (OSUs) as their primary equity awards. OSUs are performance-based RSUs. The number of shares of Intel common stock that an employee receives will range from 33% to 200% of the target amount. The performance period is three years, and the performance metric to be used is total stockholder return (TSR). TSR is measured against the 15 technology companies included in our peer group for determining executive compensation averaged with the companies included in the S&P 100.If Intel underperforms the peer group, the number of units earned will be reduced from the 100% target amount at a rate of two to one (two-percentage-point reduction in units for each percentage point of underperformance), with a minimum of 33% of units earned. If Intel outperforms the peer group, the number of units earned will be increased from the 100% target amount at a rate of three to one (three-percentage-point increase in units for each percentage point of over-performance), with a maximum of 200% units earned.
    • This planned change to Intels equity incentive design serves a number of purposes. First and foremost, because OSUs deliver value in the form of Intel common stock, it focuses the leadership team on ensuring the long-term viability of the enterprise. Secondly, due to the relative performance metric, this design provides an incentive to outperform the composite index over the three-year performance cycle. By utilizing full shares, this program is typically less dilutive than stock options while providing alignment with stockholders. Finally, the payout range of 33% to 200% of target moderates unnecessary risk taking while still providing an incentive to outperform the composite index over a multi-year period.Link to Intel's SEC filing here , filed 3/23/2009

10. Example #2 See BKNY Mellons Plan, filed 3/16/2009

    • Performance Shares. The committee used performance shares to reward named executive officers based on the companys total shareholder return, which we refer to as TSR, compared to the total shareholder return of the companies in our peer group and the S&P 500 Financials Index during a three-year period of 2008 through 2010. The S&P 500 Financials Index was used in addition to the peer group to assess the degree to which the company creat