Download Best Practices

Practising Law Institute
Developments and Trends in
Compensation Practices –
Aftermath of Enron
Jeffrey M. Kanter
Max J. Schwartz
Scott P. Spector
Things We’ll Discuss
• The Environment
• Worst Practices
• Best Practices
• Possible Change Areas
2
The Environment
• Enron/Andersen collapse
• Depressed market despite stronger earnings
• Continued investor dilution concerns
• New disclosure for stock plans
• Continued concern about stock plan approval
• Finalization of EITF 00-23, but IASB is here
• Options continue to be underwater
• Missed incentive goals
3
Enron/Andersen Collapse
• Heavy scrutiny of stock options
• Distrust of financial disclosure
• Earnings comparisons less meaningful
– What’s in the numbers?
• Re-thinking director compensation
– Are options right?
4
Continued Investor Concerns
• Higher average potential dilution from stock
plans
–
–
–
–
S&P 500
S&P Mid Cap
S&P Small Cap
Total Super 1500
1997
10.0%
10.5%
13.8%
11.6%
2001
13.7%
15.6%
17.0%
14.1%
% change
37.0%
48.5%
23.2%
21.6%
• Continued scrutiny from institutional investors
Source: Stock Plan Dilution, 2002: Overhang from Stock Plans at S&P Super 1,500 Companies—Investor Responsibility Research Corp
5
Continued Investor Concern
35%
22%
# of plans
100
80
32%
31%
25%
18%
20%
60
15%
18%
40
20
30%
10%
37
95
97
81
35
0
5%
% Negative Votes
120
0%
< 10%
10-15% 15-20% 20%-30% > 30%
Total Potential Dilution Range
No. of Companies-2001
% Negative Votes-2001
Source: Stock Plan Dilution, 2002: Overhang from Stock Plans at S&P Super 1,500 Companies—Investor Responsibility Research Corp
6
Public Perceptions
• Executive greed and duplicity contributed to
Enron debacle
– Mega-options drove management to falsify accounting
to keep stock prices high and rising
– Executives used inside information to exercise and sell
options while price high
• Stock option accounting contributed to the
speculative bubble in stocks by inflating the
growth rate in EPS
• Stock options cause short-term behavior and are
misaligned with long-term interests of
shareholders
7
New Financials
EBIT:
Earnings Before Irregularities and
Tampering
ROIC:
Restated on Instructions of Counsel
CFO:
Chief Fraud Officers
8
Worst Practices
Enron
• Philosophy to reward shareholder value
creation
• Stock options and restricted stock (50/50)
– RS vesting accelerated based on TSR performance
– 4 year reduced to 1 year
• Large grants (Lay: 1.3 million in 2000)
• Limited partnership interests
• Executive loans and repayments
9
Worst Practices
Tyco
• Loans
• Stock sales
• Actions without compensation committee
knowledge
• $20 million to director
– Chair of Corporate Governance and Nominating
Committee
• Reloads with 10-year terms
10
Worst Practices
E-Trade
• CEO loan settlement
• Forgiveness
Tax Gross-Up
$15,000,000
15,211,481
$30,211,481
• “For elimination of certain contractual
relocation benefits”
11
Worst Practices
K-Mart
• Full recourse retention loans
• $2.5 - $5.0 million
• Made in 2000 – 2002
• “Vest” in 2004, i.e.,
– Forgiveness
– Tax gross-up
12
Worst Practices
WorldCom
• Stock options only
• Large grants (Ebbers – 1.2-1.9 million per year)
• Loan arrangements
– Company guaranteed $195.6 million (B of A)
– Company paid at $198.7 million plus $35 million for LC
– Company direct loan of $165 million
• Why: “to avoid the need for Mr. Ebbers to sell
large quantities of WorldCom stock
13
Worst Practices - Other
GE
• 3,000,000 stock options and 850,000 RSUs
($48 million) to Welch
• 1 year vesting
• “Recognize 20 years of service and developing
and implementing plans”
Conseco
• $45 million cash signing bonus to Gary Wendt
14
Worst Practices - Other
Dell and Oracle
• 38 million options from 1996 to 1998 to Michael
Dell
– Already owned 353 million shares
• 20 million options to Larry Ellison
– Already owned 700 million shares
Dynergy
• CEO severance 2.99x base and incentive
compensation
• But incentive compensation includes stock options
15
Worst Practices
• Layoffs with big pay
Pay
Layoffs
Disney
$72.8
4,000
Cisco Systems
$28.7
8,500
$10 million
stay bonus
6,000
WorldCom
16
Best Practices (?)
Coca-Cola
• Interesting approach
• Valuation better than FAS 123
17
Best Practices (?)
• Others:
Companies
Expensing Options
Amazon.com
AMB Property Corp.
Bank One
Boeing
Coca-Cola
Dole Foods
Fannie Mae
Freddie Mac
iStar Financial
Level 3 Communications
Sovereign Bancorp
Washington Post
Winn-Dixie
Companies Considering
Expensing Options
Delta Air Lines
Heinz
Target Stores
18
Best Practices
Pepsi
• Enrico reduced salary to $1
• Money went for scholarships for children of
front-line employees
19
Best Practices
Krispy Kreme
• Since 1937; public since early 2000
• Development rights agreements while private
• Also had franchise equity pool for
management
• All pools and rights agreements terminated
– Return of original investment
• All sales through 10b5-1 plans
20
Best Practices
Ownership Guidelines
• 13% of Top 250
– Not a lot, but more considering
• Most use multiple of retainer
– 5x most common
– Comcast & Ford – multiple of retainer/fees
21
Best Practices
Ownership Guidelines
• Other examples
– Citigroup – 75% of shares granted
– Pitney-Bowes – $350k owned in order to sell
stock
– PNC Bank – must use ¼ of retainer to purchase
stock
– Tribune – 5x most recent stock grant
22
Best Practices
Director Performance Options
• Computer Associates – # based on ROE
• ADC Telecom – grant only if 10% ROE
• SYSCO – options granted only if 10% growth
in EPS
• UP & CapOne – options vest on stock price
23
Possible Change Areas
1. Compensation Committee Governance
• Committee Charter
• 100% Disinterested (Audit Standard)
x
x
x
x
• Compensation Literacy and Experience
x
• Strong Chair, Periodic Rotation
x
• Code of Conduct (conflicts of interest; sales)
x
x
• Total Compensation Oversight
x
• Access to Outside Advisors and Staff Support
x
x
• Legal Representation
x
x
• Executive Sessions
x
• CEO Pay Determination
x
24
Possible Change Areas
2. Annual and LTIP Design
• Relevant Metrics
x
• Audit Confirmation of Formula Results
x
• Negative Discretion
x
• Strategic and Qualitative Factors
x
• Recapture for Restatements
• Operational vs. Market Goals
x
x
x
25
Possible Change Areas
3. Stock Options
• SFAS 123 Accounting
x
• Managed Run Rate and Overhang
• Nonshareholder Approved Plans
x
x
x
x
• Mega Grants
x
• Performance Vesting
x
• Ownership Intent
x
• Inside Information
x
• Repricings
x
x
26
Possible Change Areas
4. Ownership Standards
• Code of Conduct
• Timely Sale Disclosure
x
x
• Retention Ratio
x
• Cashless Exercises
x
• Proxy Disclosure of Option Sales
• Recapture of Gains in Bankruptcy
x
x
• Hedging
• Rule 10b5-1(c) Sell Programs
• Loans, Margin, Collateral
x
x
x
x
x
x
27
Possible Change Areas
5. Deferred Compensation
• SERP Accrual Disclosure
x
• Lump Sum Settlements
x
• Recapture for Bankruptcy
x
• Stock Account Switching
x
x
x
28
Possible Change Areas
6. Directors’ Compensation
• Stock Options
x
• Restricted Stock
x
• Committee Chair Fees
x
• Ownership Standards
x
29
Frederic W. Cook & Co., Inc. provides management compensation consulting services to business clients. Formed in 1973, our
firm has served over 1,200 corporations in a wide variety of industries from our offices in New York, Chicago, and Los Angeles. Our
primary focus is on performance-based compensation programs which help companies attract and retain key employees, motivate and
reward them for improved performance, and align their interests with shareholders. Our range of consulting services encompasses the
following areas:
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•
•
•
•
Total Compensation Reviews
•
Strategic Incentives
• Executive Ownership Programs
Specific Plan Reviews
• All-Employee Plans
Restructuring Services
• Directors’ Compensation
• Equity Instruments
Competitive Comparisons
Incentive Grant Guidelines
•
•
•
•
•
Performance Measurement
Globalization
Privatization
Compensation Committee Advisor
Stock Option Enhancements
Our offices are located:
New York
90 Park Avenue
35th Floor
New York, New York 10016
212-986-6330 phone
212-986-3836 fax
Chicago
19 South LaSalle Street
Suite 400
Chicago, Illinois 60603
312-332-0910 phone
312-332-0647 fax
Website address:
www.fwcook.com
Los Angeles
2029 Century Park East
Suite 1130
Los Angeles, California 90067
310-277-5070 phone
310-277-5068 fax