executive compensation in the 2012 proxy season year two of say on pay and beyond - towers watson

© 2012 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.© 2012 Towers Watson. All rights reserved.

Executive Compensation in the 2012 Proxy SeasonYear Two of Say-on-Pay — and Beyond

Presenters: Doug Friske, James Kroll, Steven Seelig, Olivia Wakefield

April 5, 2012

© 2012 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

Today’s experts

Doug Friske is the global leader of Towers Watson's Executive Compensation business and is based in Chicago. He has more than 20 years’ experience advising a wide range of organizations on all aspects of executive compensation.

James Kroll is a senior consultant in Towers Watson’s Executive Compensation practice, based in New York. He specializes in corporate governance and executive compensation issues and assists clients with shareholder approval of equity plans, advisory votes on executive pay and other compensation-related governance issues.

Steve Seelig is the executive compensation counsel for Towers Watson’s Research and Information Center in Washington, D.C. His expertise includes the taxation, accounting and legal implications (including SEC disclosure requirements) of all forms of executive compensation and perquisite programs.

Olivia Wakefield is a director in Towers Watson’s Executive Compensation practice, based in Boston. Specializing in executive compensation programs, she advises clients on topics such as annual and long-term incentive performance metric calibration and plan design, equity pool management and corporate governance.

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The say-on-pay era so far: What we know

Vast majority of companies are doing just fine Russell 3000 received an average of 90% shareholder support in 2011 Similar pattern is taking shape in the early 2012 votes

Pay practices in general haven’t changed that much CEO compensation levels are up slightly, despite improved financial results Incentive designs, by and large, are unchanged High correlation between performance and pay

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The say-on-pay era so far: What we know

The negative consequences of standing out are significant Companies with high pay opportunities (75th percentile or above) were twice

as likely to receive low shareholder support (below 70%) in 2011… …while those with poor (bottom third TSR) performance were three times as

likely to receive low shareholder support (even if CEO had below-median pay)

Unusual plan design features or perquisites remain lightning rods Disclosures that don’t conform to expectations attract scrutiny Peer group selection is also attracting closer scrutiny in 2012

In the say-on-pay environment, companies are increasingly sensitive to shareholder concerns and see a growing need to be vigilant about pay program design and operations

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Today’s discussion

Topic PresenterTrends in Pay Levels and Practices Olivia WakefieldThe Say-on-Pay Experience James KrollThe Regulatory Horizon Steve SeeligWrap-up and Q&A Doug Friske

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Trends in Pay Levels and Practices

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The sample…

To understand trends in pay and pay practices, we examined 225 Fortune 1000 companies that filed proxies by late March

Annual Revenue* Market Capitalization*25th Percentile $3,000 $2,50050th Percentile $6,500 $5,90075th Percentile $14,100 $16,200

*In millions of dollars.Source: Standard and Poor’s Compustat® database.

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Growth in CEO pay opportunity slowed last year

Source: Towers Watson Executive Compensation Resources.

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Pay Element IncludesMedian change

2009 – 2010Median change

2010 – 2011

Base salary Annual salary 0.0% 2.6%

Target cash compensation

Base salary + target bonus (discretionary + short-term non-equity incentive compensation)

3.3% 3.3%

Total pay (SCT) Total pay reported in the Summary Compensation Table (SCT)

23.8% 1.9%

Total direct compensation (TDC)

Target cash + grant date value for stock options, restricted stock and performance plans

14.5% 5.6%


Trends in target and actual incentive levels

Source: Towers Watson Executive Compensation Resources analysis of 171 Fortune 1000 companies that filed 2012 proxies by late March 2012 and had an incumbent CEO for the entire three year period of review.

16% of companies exercised discretion to reduce bonuses, while 6% reduced LTI payouts

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CEO annual bonuses are moving back toward normal distribution around target


Percent of CEOs Receiving an Actual Bonus That is...

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The LTI mix continues to evolve toward performance-based plans…


Stock Options Restricted Stock Performance Plans

43%34%

23%

2009

38%37%

25%

2010

34%40%

26%

2011

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…and the pay/performance alignment remains strongTo

tal D

irect

Com

pens

atio

n

Total Shareholder Returns

Bel

ow M

arke

tA

bove

Mar

ket

Above IndustryBelow Industry

17%

13%

70%

2009

Tota

l Dire

ct C

ompe

nsat

ion


Bel

ow M

arke

tA

bove

Mar

ket


20%

16%

64%

2010

Tota

l Dire

ct C

ompe

nsat

ion


Bel

ow M

arke

tA

bove

Mar

ket


18%

17%

65%

2011


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We also saw a close correlation between investor returns and the value of LTI granted that the CEO realizes

*Values include equity awarded to CEOs in fiscal years 2009, 2010 and 2011.Source: Towers Watson Executive Compensation Resources; Standard and Poor’s Compustat® database.

Three-year TSR(2009 to 2011)

LTI Realized/LTI Granted*

Top-third TSR performance 26% 124%Middle-third TSR performance 9% 73%Bottom-third TSR performance -2% 66%

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The Say-on-Pay Experience

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Say-on-pay voting: Early Year Two experience

Most companies (about 82% of the Russell 3000) will hold say-on-pay votes in 2012 as a result of decisions to hold votes annually

Early 2012 results at 103 companies suggest support levels will remain fairly consistent year over year

Source: Towers Watson Executive Compensation Resources review of 103 companies holding say-on-pay votes in 2011 and 2012 through late March.

Year One Year TwoNumber of say-on-pay resolutions that failed 3 1Average support for say-on-pay resolutions 89.5% 89.8%Percentage of resolutions that ISS recommended a vote against 10.7% 13.6%

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Say-on-pay voting: Early Year Two experience

Recommendations from proxy advisory firms show continuing influence on shareholder support for say-on-pay resolutions

Source: Towers Watson Executive Compensation Resources review of 103 companies holding say-on-pay votes in 2011 and 2012 through late March.

ISS Say-on-Pay Resolution Recommendation

Number of Companies

Average Support

(Year One)

Average Support

(Year Two)

Percentage Change in Support

“Against” recommendations for both 2011 and 2012 resolutions

3 63% 64% 1%

“Against” recommendation in 2011; “for” recommendation in 2012

8 58% 90% 32%

“For” recommendation in 2011; “against” recommendation in 2012

11 89% 65% -24%

“For” recommendations for both 2011 and 2012 resolutions

81 94% 94% 0%

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Drivers of negative vote recommendations…

Pay-for-performance alignment remains the biggest driver of negative recommendations for most companies Concerns over peer group selection are overtaking severance agreements

(primarily excise tax gross-ups) for second place so far in 2012

Source: Towers Watson Executive Compensation Resources review of ISS reports for say-on-pay resolutions that received negative vote recommendations from ISS; categories and ratings are as designated by ISS. Percentages do not add to 100% because companies could be rated a “high concern” in multiple categories.

Concentration of “High Concern” Ratings Among Negative Say-on-pay Recommendations by ISS

Severance/CIC arrangements

Pay-for-performance evaluation

Non-performance-based pay

Peer group benchmarking

Compensation committee communication and effectiveness

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…and drivers of negative votes

Companies with poor performance (low TSR) were three times as likely to receive less than 70% shareholder support last year Regardless of the CEO’s pay level

Companies that provide high CEO pay opportunities were almost twice as likely to receive less than 70% support

Median Pay Opportunity % of Companies with <70% vote$6.5m — High 32.4%

$4.1m — Med 18.6%

$2.0m — Low 9.0%

Three-year TSR (2008 – 2010) % of companies with <70% support11.5% — High 9.6%

0.6% — Med 18.3%

-12% — Low 34.0%

Source: Towers Watson analysis of 2011 say-on-pay voting results for 728 midsize and large U.S. companies

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How companies responded to 2011 say-on-pay votes

Source: Towers Watson Executive Compensation Resources; based on the 145 companies in our 225 Fortune 1000 sample that had a previous say-on-pay vote.

Level of Shareholder Support

Number of Companies No Action

Changed Pay Program

Engaged With Shareholders

Below 70% 15 7% 87% 93%

70% – 90% 31 68% 29% 35%

Over 90% 99 90% 0% 5%

All Companies 145 77% 15% 21%

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Common actions taken in response to 2011 votes


Pay Program Changes

Add or replace performance-based equity

Eliminate gross-ups

Changes to peer group

Lengthen long-term performance award life

Add performance metrics

Shareholder Engagement

More transparent CD&A disclosure

Discussions with major shareholders (before and after the shareholder meeting)

Detailed proxy disclosure of engagement actions

Supplemental filings

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Supplemental filings are making a strong return in 2012

Topics frequently addressed include Rebuttals to proxy advisor policies― Validity of peers selected by companies compared to those used by proxy advisors

and selection criteria― Differing views of pay-for-performance definitions and measurement periods

Affirming key decisions and actions― Recent actions taken and rationale for key pay decisions

Actions taken in response to previous say-on-pay votes― Scope of shareholder engagement and key themes

Pros and cons of supplemental filings should be carefully considered to determine the most effective course of action

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The Regulatory Horizon

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Our analysis also examined how say-on-pay has affected CD&A quality

Most continue to get longer, but some are being tightened up 64% are longer; 36% are shorter

Three-quarters of all companies now provide executive summaries Up from 55% last year

Almost every company discloses annual incentive plan goals, and most disclose details of LTI plan goals 63% disclosed the goals for 2011 grants under their LTI plans

CD&A quality remains a mixed bag, with the best providing a concise yet complete description of: Pay earned during the year and the corporate performance justifying that pay Pay set for the year and the reasons it increased or decreased Any changes made in pay design for the year and the reasons why


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Pay-for-performance disclosures remain a weak spot

Most companies (89%) say they pay for performance However, only 19% provide an analysis of that linkage (up from 10% in 2010) Those that do take a range of approaches


Definition of Pay Definition of PerformanceSummary Compensation Table Pay Metrics

different from variable plan metrics

Total Direct Compensation

RealizedPay

Pay Realizable

Single or combination of variable plan metrics

Variable plan metrics + TSR as an additional measure

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We continue to wait for key Dodd-Frank regulations

How will pay be measured? What is the time period required? How will performance be measured — only TSR? Will this be in place for the 2013 proxy?

Disclosure of pay for performance 1

Disclosure of CEO pay versus median employee pay2 Lobbying to eliminate requirement or simplify calculations is ongoing SEC head Schapiro still predicts proposed regulation within a “few months”

Clawbacks of compensation paid based on misstated financial results3 Recent study shows that almost 4% of companies have an annual restatement, so

these happen with a fair degree of frequency Can discretion be exercised in enforcing the clawback? Would existing contracts be grandfathered? How is incentive compensation defined? Would the SEC regulate indemnity clauses?

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Recent PCAOB proposal could prompt auditor scrutiny of pay plan design

Proposed amendment to PCAOB Auditing Standard No. 12 would require auditors to more carefully consider executive compensation practices in the context of risks of material misstatements during the audit process Certain pay programs may create potential incentives for executives to

exaggerate corporate financial gains or minimize losses This may mean that conventional wisdom regarding executive pay designs

will guide audit firms in their reviews, such that certain designs that include stock options would be deemed inappropriate by auditors

It’s equally plausible that audit firms will be willing to accept statements from the company as to the reasons its pay programs would not encourage manipulation of financial results

Public comments are due by May 15

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At least the politicians have been largely quiet

None of the candidates has made executive pay regulation a major point in their campaigns

Sen. Carl Levin (D-Mich.) continues to push for a tax deduction at grant date for options

The legislative push to repeal the CEO pay ratio disclosure is not expected to have much traction

Only repeal of the “carried interest” tax break seems to have much momentum, but not likely to be considered until after the election

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Where do we go from here? Some possibilities

Total pay caps Late-year equity grants Standardized peer groups Elimination of non-median pay philosophies TSR as the only incentive performance measure Increased use of realizable pay and other alternative methods for

disclosing pay for performance Changes in supplemental pensions to avoid big spikes in reported

values due to changes in economic assumptions

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Questions?

[email protected] [email protected] [email protected] [email protected]

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executive compensation in the 2012 proxy season year two of say on pay and beyond - towers watson

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