the over-compensation trap

The Over-Compensation Trap

Dave Swinford Dan LynchPearl Meyer & Partners Pulte Homes, Inc.New York, NY Bloomfield Hills, MI212-644-2300 248-593-5775

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The Over-Compensation Trap

How We Fall Into The Trap

How To Avoid The Trap

If You’re In It, How You Get Out

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The Over-Compensation Trap

Assuming pay equals or will cause performance

Peer group bias Percentiling Piece-mealing Incrementalizing Special arrangements Not validating degree of difficulty

How We Fall Into The Trap (or, Worst Practices in Executive Compensation

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The Over-Compensation Trap

Truncating risk, or forgiving failure to perform

Ignoring retirement benefits

Minimizing value of non-monetary rewards

How We Fall Into The Trap

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The Over-Compensation Trap

75th percentile target position

75th percentile total compensation does not equal 75th salary + 75th bonus + 75 LTI

Percentiling

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The Over-Compensation Trap

“One piece at a time,” “gradually”

Looking at the trees, ignoring the forest

De-emphasizing one year; “fixing it” the next

Piece-mealing

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The Over-Compensation Trap

Improving specific compensation elements a bit at a time

Raising target bonuses to increase pay for performance

Incrementalizing

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The Over-Compensation Trap

Guarantees

“One-time” incentives for “extraordinary” results• Take care to validate goals

Special Arrangements

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The Over-Compensation Trap

Truncating Risk

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Pay XX

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X X

X

XX

X X

X

X

Performance

"Ideal" RelationshipMedian Performance

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Median Pay

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The Over-Compensation Trap

Truncating Risk

X

Pay XX

X

X X

X

XX

X X

X

X

Median Pay

Performance

"Ideal" Relationship

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Median Performance

Zone of forgiveness; pay for effort

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The Over-Compensation Trap

Truncating Risk

X

Pay XX

X

X X

X

XX

X X

X

X

Performance

"Ideal" Relationship

Median Pay

Median Performance

X

Zone of inadequate pay for performance

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The Over-Compensation Trap

Focus on total value of package• Test all changes for impact on value and risk

profile• Never piece-meal

Need to think about timing as well as value Measure relative performance Performance-justify departures from median

philosophies

How to Avoid the Trap

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The Over-Compensation Trap

Follow the performance “contract”

Keep executive careers in perspective

Don’t dis-respect non-monetary rewards

How to Avoid the Trap

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The Over-Compensation Trap

Focus on Total Value of Package

Total Compensation Value

Salary

STI

LTI

Benefits

Perqs

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The Over-Compensation Trap

Aggregate cost of management compared to income (net or operating)

• Our company, over time

• Compared to peers (Top 5 only)

» Beware of funny numbers (FAS123R; DB accruals)

Measure Relative Performance

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The Over-Compensation Trap

Other measures that may be useful to compare

• Revenue growth

• Gross margin

• Returns (ROE, ROIC)

• TSR (over longer term only)

Measure Relative Performance

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The Over-Compensation Trap

Measure Relative Performance

Simple Rankings vs. Peers Net Income Revenue

CEO Growth Growth TSR Total Comp. (1 year) (1 Year) 1 Year 2 Year 5 Year

H H G G D H US D F D H US G A D A A D D B US H US A Median E G A B G G C US C US B C A E H F C B F F B E E F B C E C F E

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The Over-Compensation Trap

Measure Relative Performance

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Net Income

Net Income Growth

Top 5 Comp. vs. Net Income

0%

US

Peer Company Circle Size Represents Top 5 Total Comp.C

AF

G

E

H

D

B

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The Over-Compensation Trap

Don’t Disrespect Non-monetary Rewards

Company’s reputation and stability

Development track record

Culture and climate

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The Over-Compensation Trap

Rigorously define nature and extent of problem• Must get all parties to acknowledge the problem

Identify areas of acceptable program modification• Some cows are more sacred than others

Develop desired outcome

Develop and implement transition plan

Communicate, communicate, communicate

How to Get Out of the Trap