© Grant Thornton LLP. All rights reserved. Top 10 executive compensation ideas to use in today’s environment Eric Gonzaga, JD Managing Director Executive Compensation Practice

2 © Grant Thornton LLP. All rights reserved. Learning objectives Be aware of how the current environment may be affecting your executive pay programs Identify executive pay strategies that you may be interested in considering in the current environment

3 © Grant Thornton LLP. All rights reserved. Agenda Top 10 executive compensation ideas 1.Consider changing bonus plans 2.Assess the right mix of cash and equity awards 3.Consider repricing strategies for underwater options 4.Assess whether plans should foster executive retention 5.Grade your compensation practices against emerging standards 6.Update your compensation benchmarking 7.Consider taking advantage of low stock prices and uncertain future tax rates 8.Consider restricted share plans 9.Consider whether to continue deferred compensation plans 10.Plan for parachute payments in future transactions

4 © Grant Thornton LLP. All rights reserved. 1. Consider changing bonus plans Does the company’s bonus plan reflect the current economic environment? Cash bonus plan design features may need to change –Amount of the bonus leverage –Performance metrics Should a percentage of bonus be withheld once performance metrics are satisfied?

5 © Grant Thornton LLP. All rights reserved. 1. Consider changing bonus plans Focus on long-term performance goals Adjust mix of short-term and long-term performance metrics –Short-term: Is increased revenues of X% each year right? –Long-term: Improve shareholder value by managing risk Enterprise risk management Metrics based on how the company would like to emerge from the current economic environment

6 © Grant Thornton LLP. All rights reserved. Example of how a company could change its bonus plan Begin with pay philosophy (Compensation Discussion and Analysis) Revise key performance metrics –Reconsider X% growth in revenue (too short-term focused goal) –Replace with a goal that promotes diversification of revenue streams Establish performance periods that are greater than 1 year

7 © Grant Thornton LLP. All rights reserved. Example of how a company could change its bonus plan Pay the bonuses over a multiyear schedule –Include a clawback feature Ensures long-term growth was not sacrificed for short-term results

8 © Grant Thornton LLP. All rights reserved. Agenda Top 10 executive compensation ideas 1.Consider changing bonus plans 2.Assess the right mix of cash and equity awards 3.Consider repricing strategies for underwater options 4.Assess whether plans should foster executive retention 5.Grade your compensation practices against emerging standards 6.Update your compensation benchmarking 7.Consider taking advantage of low stock prices and uncertain future tax rates 8.Consider restricted share plans 9.Consider whether to continue deferred compensation plans 10.Plan for parachute payments in future transactions

9 © Grant Thornton LLP. All rights reserved. 2. Assess the right mix of cash and equity awards What is the typical mix of cash and equity awards? Is there a difference in the mix between public and private? –The difference is due to lack of marketability or desire to restrict ownership of closely-held company stock Should private companies consider a different mix if an exit strategy is in place (i.e., sale or IPO)?

10 © Grant Thornton LLP. All rights reserved. 2. Assess the right mix of cash and equity awards Design considerations Short-term (cash) vs. long-term (equity) incentives As “green shoots” sprout, make adjustments to award levels Timing is everything: with stock values at historic lows, increased equity grants may be appropriate Consider linking awards to executive ownership guidelines

11 © Grant Thornton LLP. All rights reserved. Accounting and tax considerations with equity awards Financial statement issues to consider –ASC 718 (formerly SFAS 123(R)) –Performance vs. service vesting Code Section 409A –Issues of establishing fair market value for private companies –Need for third-party valuation Payroll withholding and reporting requirements

12 © Grant Thornton LLP. All rights reserved. Agenda Top 10 executive compensation ideas 1.Consider changing bonus plans 2.Assess the right mix of cash and equity awards 3.Consider repricing strategies for underwater options 4.Assess whether plans should foster executive retention 5.Grade your compensation practices against emerging standards 6.Update your compensation benchmarking 7.Consider taking advantage of low stock prices and uncertain future tax rates 8.Consider restricted share plans 9.Consider whether to continue deferred compensation plans 10.Plan for parachute payments in future transactions

13 © Grant Thornton LLP. All rights reserved. 3. Consider repricing strategies for underwater options ApproachDescriptionAdvantagesDisadvantages Options-for- Options Cancellation of underwater options with immediate re- grant of new options Employees maintain control of taxable event Some reduction in overhang Potential remains for newly issued options to go underwater May not be perceived positively by employees if stock options have not provided value Options-for- Stock (restricted stock or RSUs) Cancellation of underwater options with immediate re- grant of restricted stock/units Eliminates potential future underwater options Greater reduction in overhang Employees lose control of taxable timing Reduced upside vs. stock options

14 © Grant Thornton LLP. All rights reserved. Example of an option-for-stock exchange Value-for-value exchange of options for restricted stock Employer has 1 million underwater options outstanding FMV at grant was $10M, fair value (for book purposes) of options was $5M FMV of the stock now is $2M Zero current benefit to the employees Upon valuation, it is determined that the current fair value of the underwater option is 1/5 of the current value of the company's stock

15 © Grant Thornton LLP. All rights reserved. Example of an option-for-stock exchange Value-for-value exchange of options for restricted stock For every 5 options surrendered, the employees receive 1 share of restricted stock –5-for-1 exchange ratio is based on the current fair value of the options compared to the current fair value of the stock

16 © Grant Thornton LLP. All rights reserved. Example of an option-for-stock exchange Value-for-value exchange of options for restricted stock Benefits of the exchange Employees receive stock with value in exchange for options with no value Strong retention incentive for $0 additional compensation cost over what has been or will be booked –$0 compensation cost = $5M fair value of restricted stock, less $5M current fair value of the options Company reduces overhang by 800K shares –1 million options retired in exchange for 200,000 restricted shares

17 © Grant Thornton LLP. All rights reserved. Agenda Top 10 executive compensation ideas 1.Consider changing bonus plans 2.Assess the right mix of cash and equity awards 3.Consider repricing strategies for underwater options 4.Assess whether plans should foster executive retention 5.Grade your compensation practices against emerging standards 6.Update your compensation benchmarking 7.Consider taking advantage of low stock prices and uncertain future tax rates 8.Consider restricted share plans 9.Consider whether to continue deferred compensation plans 10.Plan for parachute payments in future transactions

18 © Grant Thornton LLP. All rights reserved. 4. Assess the need for plans to foster executive retention Executive retention will be critical in an improving economy Especially for companies that have experienced: –Pay freezes –Reductions in executive pay –Underwater options –Suspensions in section 401(k) plan matching contributions Underwater options can be a disincentive to stay

19 © Grant Thornton LLP. All rights reserved. Foster executive retention As the economy improves, executives will consider other opportunities to enhance their pay with other organizations To address retention, companies will need to: –Identify those executives that may be at risk –Review alternative retention programs

20 © Grant Thornton LLP. All rights reserved. Retention programs Examples of retention programs: –Restricted stock awards –SERPs –Cash compensation tied to years of service –Retention cash bonus Program features –Extended payout schedules –Vesting schedules –Must be employed on payment date to receive payment

21 © Grant Thornton LLP. All rights reserved. Agenda Top 10 executive compensation ideas 1.Consider changing bonus plans 2.Assess the right mix of cash and equity awards 3.Consider repricing strategies for underwater options 4.Assess whether plans should foster executive retention 5.Grade your compensation practices against emerging standards 6.Update your compensation benchmarking 7.Consider taking advantage of low stock prices and uncertain future tax rates 8.Consider restricted share plans 9.Consider whether to continue deferred compensation plans 10.Plan for parachute payments in future transactions

22 © Grant Thornton LLP. All rights reserved. 5. Grade your compensation practices against emerging standards Why should companies strengthen compensation governance? Avoid backlash on executive pay practices Regulators, SEC, IRS, State Attorneys General Volatile stock market easily influenced by public perception and media criticism Bad employee relations in Employee Free Choice Act environment Optimal strategic compensation programs in a recessionary environment Be proactive so when new rules go into effect, the company is prepared.

23 © Grant Thornton LLP. All rights reserved. Emerging governance expectations and requirements – let’s talk risk! Let the independent compensation committee drive a deliberate, formal and documented process, led by a committee chair who is experienced in administering compensation programs Ensure that all decision makers spend ample time to understand the executive compensation program, including the risks associated with any pay-for-performance metrics Review compensation programs on a frequent basis throughout the year to ensure the programs are consistent with the continually changing business environment

24 © Grant Thornton LLP. All rights reserved. Emerging governance expectations and requirements – let’s talk risk! Evaluate necessity of severance, change-in-control, and gross-up payments, with consideration of avoiding, phasing out, or reducing Annually review the independence of the compensation consultant

25 © Grant Thornton LLP. All rights reserved. Agenda Top 10 executive compensation ideas 1.Consider changing bonus plans 2.Assess the right mix of cash and equity awards 3.Consider repricing strategies for underwater options 4.Assess whether plans should foster executive retention 5.Grade your compensation practices against emerging standards 6.Update your compensation benchmarking 7.Consider taking advantage of low stock prices and uncertain future tax rates 8.Consider restricted share plans 9.Consider whether to continue deferred compensation plans 10.Plan for parachute payments in future transactions

26 © Grant Thornton LLP. All rights reserved. 6. Update your compensation benchmarking Why should you be concerned about benchmarking? New benchmarking data are available Includes new data on total compensation and pay mix Evidence of how compensation practices have changed between 2007 and 2009 –Practices have changed greatly, with various alternatives on the table –2008 surveys are not reliable

27 © Grant Thornton LLP. All rights reserved. Why should you be concerned about benchmarking? Business strategies are becoming better defined for long-term growth –Likewise, compensation practices should become better defined Opportunity to improve morale of executives and refocus them –Ensure talented executives are paid market rates and rewarded at above-market rates only for above-market performance

28 © Grant Thornton LLP. All rights reserved. Other considerations for benchmarking Companies should recognize that market values have changed –For some job positions, the market rate has decreased Companies need to pay a reasonable amount of compensation –Defend to regulatory agencies –Media attention associated with executive compensation –Incentivize and retain key executives

29 © Grant Thornton LLP. All rights reserved. Agenda Top 10 executive compensation ideas 1.Consider changing bonus plans 2.Assess the right mix of cash and equity awards 3.Consider repricing strategies for underwater options 4.Assess whether plans should foster executive retention 5.Grade your compensation practices against emerging standards 6.Update your compensation benchmarking 7.Consider taking advantage of low stock prices and uncertain future tax rates 8.Consider restricted share plans 9.Consider whether to continue deferred compensation plans 10.Plan for parachute payments in future transactions

30 © Grant Thornton LLP. All rights reserved. 7. Consider tax strategies to take advantage of low stock prices and uncertain future tax rates Consider exercising nonqualified stock option now Executives should measure the costs and benefits of exercising vested stock options before a possible increase in tax rates.

31 © Grant Thornton LLP. All rights reserved. Example of a nonqualified stock option In 2009, executive holds vested stock options: –Aggregate exercise price is $600 –Aggregate fair market value (“FMV”) of the stock is $900 Executive intends to sell the stock in 2011 and she believes the FMV of the stock will be $1,200 Highest marginal tax rates and capital gains rates: Income tax35%39.6% Capital gains15%20%

32 © Grant Thornton LLP. All rights reserved. Example of a nonqualified stock option If the executive exercises in 2009 and sells in 2011: –Income tax in 2009 is $105 ($300 income X 35% tax rate) –Capital gains tax in 2011 is $60 ($300 capital gain X 20% tax rate) –Total tax paid is $165 If the executive exercises in 2011 and sells in 2011: –Income tax in 2011 is $ ($600 income X 39.6% tax rate) –No capital gain –Total tax paid is $237.60

33 © Grant Thornton LLP. All rights reserved. Example of a nonqualified stock option Benefit: $ of lower taxes Cost: The opportunity cost associated with the $600 paid to exercise the options in 2009 and the $105 of tax paid in 2009

34 © Grant Thornton LLP. All rights reserved. Agenda Top 10 executive compensation ideas 1.Consider changing bonus plans 2.Assess the right mix of cash and equity awards 3.Consider repricing strategies for underwater options 4.Assess whether plans should foster executive retention 5.Grade your compensation practices against emerging standards 6.Update your compensation benchmarking 7.Consider taking advantage of low stock prices and uncertain future tax rates 8.Consider restricted share plans 9.Consider whether to continue deferred compensation plans 10.Plan for parachute payments in future transactions

35 © Grant Thornton LLP. All rights reserved. 8. Consider restricted share plans Time-based vesting drives retention Performance-based vesting drives increased performance

36 © Grant Thornton LLP. All rights reserved. Example restricted share plans Retention incentive: Initial grant that vests at the end of a 3-year period provided that the executive is still employed Performance incentive: Additional restricted share grants –Grant conditioned upon meeting performance goals; or –Vesting is conditioned upon meeting the performance goals

37 © Grant Thornton LLP. All rights reserved. Section 83(b) elections may be attractive to executives when stock values are low Factors to consider Consider the current stock value and determine the probability that the value will increase vs. decrease before the stock vests Consider the executive’s estimated marginal tax rate at the time of vesting versus at grant date Consider the opportunity cost associated with the cash used to pay the taxes up front Consider potential for job loss before vesting After considering these factors, an executive can make an educated decision of whether to make a Section 83(b) election.

38 © Grant Thornton LLP. All rights reserved. Agenda Top 10 executive compensation ideas 1.Consider changing bonus plans 2.Assess the right mix of cash and equity awards 3.Consider repricing strategies for underwater options 4.Assess whether plans should foster executive retention 5.Grade your compensation practices against emerging standards 6.Update your compensation benchmarking 7.Consider taking advantage of low stock prices and uncertain future tax rates 8.Consider restricted share plans 9.Consider whether to continue deferred compensation plans 10.Plan for parachute payments in future transactions

39 © Grant Thornton LLP. All rights reserved. 9. Consider whether to continue deferred compensation plans Potential increases in tax rates may drive changes in deferred compensation May be better to pay tax now at lower rate than later at a higher rate Executives may consider suspending 2010 deferral elections –Decision must be made by Dec. 31, 2009

40 © Grant Thornton LLP. All rights reserved. 9. Consider whether to continue deferred compensation plans Consider terminating deferred compensation plans and paying the balance in the plan Must consider section 409A issues –Payout may not occur until 12 months after the plan termination –Full balance of the plan must be paid in full within 24 months after plan termination –Must terminate the plan and all like plans for all employees –May not start new plans for 3 years

41 © Grant Thornton LLP. All rights reserved. Agenda Top 10 executive compensation ideas 1.Consider changing bonus plans 2.Assess the right mix of cash and equity awards 3.Consider repricing strategies for underwater options 4.Assess whether plans should foster executive retention 5.Grade your compensation practices against emerging standards 6.Update your compensation benchmarking 7.Consider taking advantage of low stock prices and uncertain future tax rates 8.Consider restricted share plans 9.Consider whether to continue deferred compensation plans 10.Plan for parachute payments in future transactions

42 © Grant Thornton LLP. All rights reserved. 10. Plan for parachute payments in future transactions The current economic conditions and credit crunch contributed to a decline in the number of corporate transactions –Transactions were delayed, but may occur in the future Rules under section 280G apply when there is a change in control Tax consequences of excess parachute payments under section 280G –20% excise tax is imposed on the employee –Employer may not deduct the expense

43 © Grant Thornton LLP. All rights reserved. 10. Plan for parachute payments in future transactions Excess parachute calculation –Do total parachute payments exceed 3 times the base amount? Base amount is the average W-2 compensation over past 5 years –If yes, excess parachute payment equals the total parachute payments less 1 times the base amount

44 © Grant Thornton LLP. All rights reserved. Planning for a change in control and parachute payments Private companies: Obtain 75% shareholder approval of payments that will be made in connection with a change in control –Severance payments –Transaction bonuses Increase the base amount –Exercise stock options –Pay annual bonuses early Accelerate the vesting of SERP plans and stock options

45 © Grant Thornton LLP. All rights reserved. Planning for a change in control and parachute payments Stipulate in compensation plans that amounts paid upon a change in control may not be paid if they would result in excess parachute payments

46 © Grant Thornton LLP. All rights reserved. Our presenters will now answer your questions. Top 10 executive compensation ideas 1.Consider changing bonus plans 2.Assess the right mix of cash and equity awards 3.Consider repricing strategies for underwater options 4.Assess whether plans should foster executive retention 5.Grade your compensation practices against emerging standards 6.Update your compensation benchmarking 7.Consider taking advantage of low stock prices and uncertain future tax rates 8.Consider restricted share plans 9.Consider whether to continue deferred compensation plans 10.Plan for parachute payments in future transactions

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