Compensation Peer Groups at Companies with High Pay

Transcription

1 Compensation Peer Groups at Companies with High Pay June 2010

2 Compensation Peer Groups at Companies with High Pay EXECUTIVE SUMMARY 2 INTRODUCTION 4 Market Factor Explanations 4 Power Relations Arguments 6 Defining High Pay 7 Companies with High Pay 8 SYSTEMIC BIAS IN SELF-SELECTION OF COMPENSATION PEERS 10 Appropriateness of Self-Selected 10 Self-Selected with High Pay 12 CONGRUENCE OF CEO PAY TO COMPENSATION BENCHMARKS 14 Aggregate Compensation 14 Structure of Compensation Packages 15 INFLUENCE OF OTHER CORPORATE FACTORS 20 Composition of Compensation Committee 20 Elements of Corporate Governance 22 FINDINGS AND CONCLUSION 24 GLOSSARY OF KEY TERMS 26 APPENDIX 1: METHODOLOGY 28 APPENDIX 2: PAY VS. PERFORMANCE DETAIL 31 APPENDIX 3: ADDITIONAL REGRESSION ANALYSES 32 NOTES 33 This report is for educational purposes. It was prepared by PROXY Governance, Inc., under contract for the IRRC Institute for Corporate Responsibility. Information contained in this report has been obtained from sources believed to be reliable, but is subject to change. No representations or warranties are made as to the accuracy of the information presented, and no responsibility or liability, including for consequential or incidental damages, can be accepted for any errors, omissions or inaccuracies in this report. Nothing in this report should be deemed a recommendation or offer to purchase or sell any security. Compensation Peer Groups at Companies with High Pay Page 1 of 36

3 Executive Summary Recent changes in compensation disclosure requirements by the U.S. Securities and Exchange Commission have, for the first time ever, made it possible to evaluate potential structural and process bias in the ways boards of directors develop CEO compensation packages. 1 Using independently-constructed peer groups for CEO pay and corporate performance, this study identifies a subset of S&P 500 companies with high pay relative to peers which is not justified by correspondingly superior performance. The study then compares these companies with high pay to a baseline sample of the remaining S&P 500 companies, looking for systematic bias in compensation benchmarking processes. The study also examines the significance of certain observable features of compensation committees themselves, and the influence of selected provisions of corporate governance. Consistent with the findings of other studies, companies in the study tended to select larger peers as measured both by market capitalization and by revenue for their own benchmarking analysis. Companies with high pay were 25% smaller than their selfselected peers when measured by revenues; baseline companies, by contrast, were only 17% smaller than their self-selected peers. Measured by market capitalization the disparity was even more striking: companies with high pay were 45% smaller than their self-selected peers, while baseline companies were just 5% smaller than their selfselected peers. Just as remarkable, however, was the difference in how Compensation Committees used these systemically skewed benchmarking results. Companies with high pay, having selected significantly larger peers, compensated their CEOs an average of 103% above the median of the self-selected peer group. Baseline companies, by contrast, paid their CEOs an average of 15% lower than the median of their benchmarking peers, an adjustment roughly in line with their 17% smaller size by revenue. Compensation Committees at companies with high pay also tended to structure their larger compensation packages with a higher percentage of equity, compared to both their self-selected benchmarking peers or to baseline companies. CEOs at companies with high pay received 69% of their compensation in equity awards, versus 62% for their selfselected peers and 61% for baseline companies. Much of this discrepancy came in grants of full-value awards such as restricted stock, which made up 41% of CEO compensation at companies with high pay versus 35% for either their self-selected peers or baseline companies. Putting another firm s CEO on the compensation committee, surprisingly, appeared to act as a deterrent more than an accelerant to high compensation. Among companies with high pay, 6% had an external CEO on the Compensation Committee, compared to 9% of baseline companies. More tellingly, when these external CEOs sat on a Compensation Committee they represented only 25% of the Committee at companies with high pay, but 36% at baseline companies. (Across the broader Russell 3000 index the difference was even more marked: only 1.7% of companies with high pay had external CEOs on the Compensation Committee, versus 10.5% of baseline companies.) Compensation Peer Groups at Companies with High Pay Page 2 of 36

4 Having women on the board appeared to be a far less significant factor: 49% of companies with high pay had women directors, only modestly lower than the 52% rate among baseline companies. Other features of corporate governance also appeared to have at best a muted influence. Among companies with high pay, 65% had a CEO who was also Chairman moderately higher than the 60% rate among baseline companies. Classified boards were slightly less prevalent at companies with high pay (24%) than at baseline companies (29%). Companies with high pay, ironically, were also less likely than baseline companies to have had a shareholder pay proposal on the ballot in the prior three years, though in both cases this likelihood increased as performance relative to peers worsened. Compensation Peer Groups at Companies with High Pay Page 3 of 36

5 Introduction When you get a guy as good as Al Dunlap, you can't pay him enough." Scott Paper CEO Al Dunlap to Newsweek in 1995, in response to reports that the justannounced sale of his firm to competitor Kimberly-Clark would net him nearly $100 million. Kimberly-Clark later wrote off most of the acquisition. Dunlap s subsequent role as CEO of Sunbeam Corp. ended two years later, when the board uncovered a massive accounting fraud which forced the company into bankruptcy. 2 While concern about overcompensated CEOs has been growing for years, one recent study concedes that much of the fury over CEO pay [was] aimed at executives associated with accounting scandals and collapses in the prices of their company's shares. 3 Part of the problem for shareholders was an asymmetric risk: the expense a company might save by holding the line on CEO pay seemed far smaller than the incremental earnings it might achieve by attracting and retaining a good perhaps even a superstar CEO. As a consequence, the rate of growth in CEO compensation over the past several decades has far outstripped any meaningful benchmark. A 2009 assessment by the Economic Policy Institute found that CEO pay expressed, like most such studies, as a multiple of typical worker pay had grown from a multiple of 24x in 1965 to 275x at the end of the bull market in Shareholder attitudes toward CEO compensation began to shift, however, in response to such watershed events as the 2003 revelation that the not-for-profit NYSE would pay out $188 million in deferred compensation and other retirement benefits to CEO Richard Grasso. 5 Increasingly now, the issue is not the competence and performance of CEOs, but the perception that they received too much. Not surprisingly, a number of studies have attempted to develop theoretical frameworks to explain though not always to justify the increase in CEO pay. A few, such as measuring an economic actor s relative control over the drift of the geometric Brownian motion firm size, defy easy categorization, but most fall into two broad categories. 6 Market Factor Explanations These frameworks assert that rising CEO compensation is a relatively rational function of broader demand, increased scarcity, increased risk, or producing superior corporate returns. They include arguments about: 7 Compensation Peer Groups at Companies with High Pay Page 4 of 36

6 o The Global Market for Executive Talent: with globalization, the market for senior executives has also globalised in recent decades, so that firms now have to offer higher remuneration to attract or retain CEOs. o Increasing CEO Skill Requirements: the work of CEOs has become relatively more complex in recent years, requiring higher levels of skill than previously. A subset of these arguments analyze productivity rather than complexity, arguing that greater CEO skills and hence pay have been necessary to drive improvements in productivity and national prosperity. o Decreasing CEO Job Security: greater pay reflects the greater risk [executives] will lose their job, and the greater losses they will face if this happens. o Increased Shareholder Returns: shareholder returns and company profits have increased in recent years and the higher remuneration of CEOs simply reflects [their contributions to] these greater profits. Because these theoretical frameworks incorporate demonstrable changes in firms economic environments, some researchers have found them useful in modeling individual cases or even specific industries. 8 But each of them implicitly asserts a relationship to increased shareholder value (or at least avoided decrementality) which in one way or another justifies higher average CEO pay. Hard data for the Russell 3000, however, demonstrates the stark dichotomy between theory and practice. Exhibit 1 charts quarterly shareholder returns (relative to peers) versus CEO compensation (relative to peer group median). 9 While there is broad variability in the levels of CEO pay versus, higher relative pay clearly has not gone handin-hand with superior shareholder returns. A regression analysis (R-value of 0.118) shows no meaningful correlation between higher relative pay and higher relative returns. Exhibit 1 50 R Relative Shareholder Returns vs. Relative CEO Pay Relative QSR (ppts. B/(W) ) - 25 (25) (50) (100.0)% (50.0)% 0.0 % 50.0 % % % Relative CEO Pay (Pct. H/(L) Peer Median) Changes in quarterly shareholder return may be an insufficiently robust measure of changes to the intrinsic value of a firm. Additional regression analysis (Appendix 3) of relative performance on other GAAP-based performance measures, however, also found little to no correlation across the broad Russell 3000 sample. Market capitalization, while Compensation Peer Groups at Companies with High Pay Page 5 of 36

7 better correlated with absolute levels of CEO pay, also showed little correlation with CEO pay versus peers. Power Relations Arguments Other researchers contend that a more immediate driver of increasing CEO compensation is the breakdown of corporate governance within firms, so that under current legal arrangements, boards cannot be expected to contract at arm's length with the executives whose pay they set. 10 This research has developed a different set of theoretical frameworks which assert that rising CEO compensation is a consequence of increasing CEO influence over boards of directors, conscious manipulation of the compensation process, or such unconscious or unacknowledged biases as the Lake Wobegon effect. 11 They include arguments about: o Evolving Board/CEO Relations Arguments that CEOs hold positions of relative power, similar or related to the power that capital has in relation to labor, and that as power has shifted from labor to capital the capacity of CEOs to extract rents has increased. o Gaming the Compensation Process Arguments that CEOs are able to persuade boards to attempt to pay them above the 'median' CEO salary for reasons of organizational status, and as it is mathematically impossible for most people to be paid above the median, relative CEO remuneration will rise regardless of performance. These frameworks assert that the CEO s indirect control over the board often through the CEO s influence over its advisors, as well as his or her personal relationships with individual directors is particularly relevant when it comes to developing an executive s compensation package. 12 Some studies have found that other considerations, such as the number of additional boards on which a director serves, are also contributing factors. 13 The difficulty with these frameworks, however, is that hard evidence of CEOs or compensation committees consciously gaming the process is difficult to find. Other researchers have generally found only limited evidence that firms choose peer groups opportunistically to increase CEO pay, 14 or that the effect was modest in terms of the effect on CEO pay. 15 They did find that compensation committees tend to choose peers that pay their CEOs more, which in turn translates into firms paying their CEOs more 16 and sometimes has a chain-reaction leapfrogging effect. 17 Still, these outcomes were not necessarily suboptimal: this peer-pay-effect reflects both higher CEO talent and opportunistic behavior. When it reflects CEO talent, it is positively associated with future performance whereas it is negatively associated when it reflects opportunism. 18 Even analysis of the role of compensation consultants was mixed. Despite the fact that compensation consultants face potential conflicts of interest including the desires to cross-sell services and to secure repeat business that might lead to recommendations for higher CEO pay, several studies found that these potential conflicts were not a Compensation Peer Groups at Companies with High Pay Page 6 of 36

8 primary driver of excessive CEO pay, 19 and even that pay is higher in US firms where the consultant works for the board rather than for management. 20 Defining High Pay Compensation peer groups, which provide the board its most direct benchmark for the level and structure of executive compensation, receive considerable attention within these power relations studies because they are the most likely leverage point in the compensation process. High pay, however, is generally treated as a one-dimensional variable, measured against an objective standard such as industry median, compensation of CEOs at similarly sized firms, or compensation at firms with similar business models. By contrast, a more robust analysis would differentiate between companies where higher CEO compensation is accompanied by superior returns to shareholders, and those where CEO pay is just high. Executive compensation is ultimately a corporate expense: higher compensation expense, relative to an appropriate peer group, should yield higher relative returns. Unfortunately, there is neither a bright line test to define high pay nor a broadly-accepted model, such as the Capital Asset Pricing Model, to define an efficient frontier for executive compensation. This study instead identified companies which appear to be clearly over the line those where CEO pay is significantly out of line with peers given corporate performance to compare their compensation practices against the remaining set of baseline companies. Peer groups were constructed for all companies in the Russell 3000 and S&P 500 indices which reported a self-selected peer group of 35 or fewer companies. Corporate performance versus this independently-constructed peer group was then evaluated over a five-year period, using an aggregate scoring metric which included quarterly shareholder returns, revenue/expenses, ROE and operating cash flow/equity. (See Appendix 1 for full discussion of peer group selection and development of performance scores). Based on performance relative to peers, companies were then assigned to one of five broad performance categories In Line with (performance +/- 10 points of peer average); Above or Below (performance points better or worse than peer average, respectively), and Above or Below (performance more than 20 points above or below peer average, respectively). Average three-year CEO compensation was then evaluated versus median pay for the independently-constructed peer group. Within each of the performance categories identified above, companies were segmented according to the multiple of peer median at which they compensated their CEOs. Using certain natural breakpoints suggested by the data itself (see Appendix 2), companies with high pay were defined as those companies where increased compensation was not justified by superior performance. Compensation Peer Groups at Companies with High Pay Page 7 of 36

9 High Pay vs. Performance vs. Performance Category High Pay Threshold > 20 pts worse Below > peer median pts worse Below > peer median +/- 10 pts of peers In Line with >1x peer median pts better Above >2x peer median > 20 pts better Above >3x peer median Companies with High Pay Across both the Russell 3000 and the S&P 500 indices, approximately 15% of companies which reported their self-selected peer groups met this definition of high pay. As Exhibit 2 shows, 63% to 67% of Russell 3000 companies performing below or significantly below peers had high pay, contributing just over half the total number of companies with high pay. A significant number of these underperforming companies paid their CEOs more than double, triple, or quintuple peer median. Exhibit 2 Relative Pay vs. Relative Performance Russell 3000 w/ Named Performing... S&P 500 w/ Named Performing CEO Pay vs. Peer Median Below Below In Line With Above Above Total Below Below In Line With Above Above Total > 4x x - 4x x - 3x x - 2x , < 1x , Total , , High Pay Baseline , , , , % w/ High Pay 67 % 63 % 11 % 5 % 1 % 15 % 57 % 62 % 10 % 5 % 0 % 15 % % of Total High Pay 11 % 41 % 40 % 7 % 1 % 100 % 8 % 47 % 37 % 8 % 0 % 100 % Only one in ten companies performing in line with peers, by contrast, exceeded the threshold for high pay. While this was by far the largest performance category- more than five times as large as the two underperforming categories combined - it contributed fewer companies with high pay than the underperforming categories. Companies performing above or significantly above peers contributed only about 8% of total companies with high pay. For S&P 500 companies, the breakdown of companies with high pay was relatively consistent with the Russell Among Russell 3000 companies with high pay, as Exhibit 3 illustrates, a third (34%) paid their CEOs in the range of 1x 2x peer median, a similar number (36%) paid their CEOs Compensation Peer Groups at Companies with High Pay Page 8 of 36

10 in the range of 2x 3x peer median, and the remainder paid their CEOs more than 3x peer median. Exhibit 3 Companies with High Pay Russell 3000 S&P x, 34% 1-2x, 45% 2-3x, 36% > 4x, 15% > 4x, 12% 2-3x, 36% 3-4x, 15% 3-4x, 7% For S&P 500 companies with high pay, by contrast, nearly half (45%) paid their CEOs no more than double peer median. Similar to the Russell 3000 profile, another 36% paid their CEOs 2x 3x peer median but a substantially smaller number (19%, versus 30% for the Russell 3000) paid their CEOs more than 3x peer median. Compensation Peer Groups at Companies with High Pay Page 9 of 36

11 Systemic Bias in Self-Selection of Compensation Percent of Category 50% 40% 30% 20% 10% 0% 0.0% 0.0% S&P 500: Size of Named Compensation Peer Group 11.5% 11.3% 23.1% 17.5% 40.4% 39.7% 21.2% 19.5% Companies with High Pay Baseline Companies 1.9% 7.9% 1.9% 0 to 5 5 to to to to to to 35 Named in Compensation Peer Group 4.1% Self-selected peer groups were analyzed for 344 companies from the S&P 500 index. 21 These self-selected peer groups ranged in size from 5 to 35 peers, with an average size of 17.1 peers. Fifty-two companies (15.1%, consistent with the full S&P 500 and the Russell 3000 indices) were identified as high pay, and 292 were included in the baseline. In both groups, approximately 40% of companies had compensation peer groups of 16 to 20 peers. Companies with high pay, however, had a slightly lower average peer group size (mean of 15.8 peers, versus 17.4 for baseline companies), and were clustered slightly more tightly around that mean (standard deviation of 5.0, versus 5.7 for baseline companies). Only 3.8% of the sample (1.9% of those with high pay, and 4.1% of baseline companies) named 30 or more peers. Appropriateness of Self-Selected In general, as Exhibit 4 indicates, companies in the sample tended to be smaller whether measured by Trailing Twelve Months (TTM) revenue or by market capitalization than the average of their self-selected peers. There was a significant difference in the scale of the discrepancy, however. Measured by revenue, companies with high pay were 25% smaller than their self-selected peers, a meaningfully larger gap than the 17% for baseline companies. This was consistent within each performance category, though the difference varied from as little as 4 to as many as 42 percentage points. Measured by market capitalization the difference was even more significant: companies with high pay averaged 45% smaller than their self-selected peers, versus just 5% below peers for baseline companies. CEOs at companies with high pay had an average tenure of 9.9 years 32% longer than their self-selected peers. CEOs at baseline companies, with an average tenure of 7.6 years, had tenure nearly identical to their self-selected peers. The same pattern held true Compensation Peer Groups at Companies with High Pay Page 10 of 36

12 within each performance category except for those companies performing above peers, where the pattern reversed. Exhibit 4 Appropriateness of Self-Selected Benchmarking Baseline Companies Performing... Companies with High Pay Performing... Below Below In Line With Above Above Total/ Avg. Below Below In Line With Above Total/ Avg. Companies w/ High Pay H/(L) Baseline Size H/(L) Peer Group Average... Revenue (TTM on 7/1/2008) (14)% 13 % (13)% (27)% (32)% (17)% (31)% (29)% (18)% (31)% (25)% (7.9) pts Market Capitalization (7/1/2008) (19)% (26)% (2)% (9)% (7)% (5)% (55)% (53)% (46)% 20 % (45)% (39.7) pts Relevant CEO Metrics CEO Tenure (years) H/(L) Peer Average (67)% (27)% (10)% 12 % 43 % (1)% 7 % 7 % 87 % (47)% 32 % 32.9 pts Combined Chairman/CEO Roles 33 % 33 % 53 % 63 % 54 % 54 % 100 % 56 % 74 % 25 % 63 % 9.4 pts H/(L) (pts) (18.7) (14.1) (4.3) (18.8) pts Structure Number of Named (1.6) with High Pay 17 % 17 % 17 % 18 % 17 % 17 % 23 % 21 % 22 % 21 % 21 % 4.5 pts with Same Pay Consultant 28 % 13 % 13 % 14 % 9 % 13 % 19 % 11 % 10 % 3 % 11 % (2.5) pts in same 2-Digit GICS code 78 % 89 % 75 % 73 % 80 % 76 % 71 % 85 % 77 % 100 % 82 % 6.4 pts in same 4-Digit GICS code 37 % 75 % 68 % 59 % 60 % 65 % 67 % 67 % 69 % 56 % 67 % 2.1 pts in same 6-Digit GICS code 33 % 54 % 52 % 46 % 43 % 50 % 55 % 60 % 57 % 45 % 57 % 7.5 pts in same 8-Digit GICS code 15 % 42 % 37 % 32 % 31 % 35 % 47 % 41 % 38 % 34 % 40 % 4.7 pts Performance B/(W) Self-Selected (pts) (19.2) (8.6) (15.6) (13.0) (2.9) 10.6 (7.7) (10.7) pts CEOs also served as Chairman at 63% of companies with high pay, 17.8 percentage points higher than the rate among their self-selected peers. Only 54% of CEOs of baseline companies also served as Chairman a rate nearly identical to their self-selected peers. At baseline companies, however, the rate of a combined Chairman/CEO role generally tended to increase as corporate performance versus peer group improved. Among companies with high pay no such pattern was evident and in fact, all 4 of the CEOs at companies significantly underperforming peers also served as Chairman. On average and consistently within each performance category companies with high pay were more likely to select peers which also had high pay, at 21%, than were baseline companies, at 17%. Surprisingly, though, only 11% of companies with high pay shared a compensation consultant with self-selected peers, a rate slightly lower than among baseline companies (13%). For both groups, the incidence of a shared compensation consultant generally increased as corporate performance worsened, though the rate remained consistently lower among companies with high pay than baseline companies. For companies performing significantly below peers, 19% of those with high pay shared a compensation consultant with their self-selected peers versus 28% of baseline companies. For companies performing above peers, by contrast, the incidence was 3% among companies with high pay versus 9% among baseline companies. As measured by similarity between the Global Industry Classification Standard (GICS) codes, 22 companies with high pay also appear to have selected peers with slightly better Compensation Peer Groups at Companies with High Pay Page 11 of 36

13 operational alignment. This was consistently true across all four levels of the GICS code hierarchy, from the broadest level of business sector (2-digit GICS code, where companies with high pay matched with 82% of their named peers, 6.4 percentage points higher than baseline companies) to industry sub-sector (8-digit GICS code, where companies with high pay matched with 40% of their named peers, 4.7 percentage points higher than baseline companies). Companies with high pay also tended to select better-performing compensation peers, the opposite of baseline companies. Companies with high pay performed an average of 7.7 points lower than self-selected peers on the study s aggregate scoring scale. Baseline companies, by contrast, outperformed their self-selected peers by an average of 3.0 points. Interestingly, the performance of baseline companies versus their self-selected peers closely mirrored their performance versus the independently-selected peer group assigned by the study. The worst relative performers (20 or more percentile points below peers) underperformed their self-selected peers by 19.2 percentile points, while those in the second-worst category (10 or more percentile points worse than peers) underperformed their self-selected peers by 8.2 percentage points. Those identified as performing in-line with the independently-assigned peers (+/- 10 percentile points) averaged performance 0.5 percentage points better than self-selected peers. Those outperforming (more than 10 percentile points above peers) or significantly outperforming (more than 20 percentile points) their independently-assigned peer groups outperformed their self-selected peers by 9.4 and 10.6 percentile points, respectively. Self-Selected with High Pay A slightly higher percentage of companies with high pay (98.1%) than baseline companies (96.6%) were selected as compensation peers by other S&P 500 companies. As Exhibit 5 shows, however, companies with high pay were included in fewer selfselected peer groups compensation peer groups on average, 8.5 peer groups each than were baseline companies, which averaged 10.3 peer groups each. In total, companies with high pay were named as peers in 2.4% of all disclosed S&P 500 compensation peer groups, 0.5 percentage points lower than baseline companies. When selected for a compensation peer group, companies with high pay were smaller than the companies which selected them. Measured by revenue, this difference averaged 17.3%. Measured by market capitalization, the difference was 33.8%. Alignment by sector and industry, as measured by GICS code matches, was relatively strong, and consistently within 3 percentage points of the comparable number for baseline companies selected as peers. Compensation Peer Groups at Companies with High Pay Page 12 of 36

14 Exhibit 5 High Pay Companies - Influence as Companies with High Pay Performing... Below Below In Line With Above Total Total Companies Named in S&P500 Peer Group Utilization 100 % 96 % 100 % 100 % 98.1 % H/(L) Baseline Utilization (pts) Included in Named Peer Groups H/(L) Baseline 3.9 (1.0) (3.3) (1.4) (1.8) Pct All Named Peer Groups 3.6 % 2.5 % 2.0 % 3.0 % 2.4 % H/(L) Baseline (pts) 1.1 (0.2) (0.8) (0.4) (0.5) Relative Size Revenue (Mils; TTM 7/1/2008) $ 16,628 $ 9,933 $ 15,715 $ 9,039 $ 12,594 (O)/U Benchmarking Company (24.7)% (19.7)% (12.7)% (17.3)% (17.3)% Market Cap (Mils; 7/1/2008) $ 15,006 $ 8,465 $ 7,606 $ 40,909 $ 11,203 (O)/U Benchmarking Company (42.0)% (34.4)% (45.5)% 33.5 % (33.8)% GICS Code Alignment Same 8-digit GICS 41.5 % 31.0 % 30.8 % 31.1 % 31.8 % H/(L) Baseline (pts) 21.5 (13.1) (4.5) 5.8 (2.2) Same 6-digit GICS 47.4 % 44.8 % 54.7 % 45.8 % 48.7 % H/(L) Baseline (pts) (5.2) (13.5) (1.3) Same 4-digit GICS 75.3 % 55.0 % 71.6 % 61.1 % 63.1 % H/(L) Baseline (pts) 7.2 (21.8) (2.3) Same 2-digit GICS 81.3 % 79.8 % 77.7 % 93.8 % 80.2 % H/(L) Baseline (pts) (0.2) (6.3) Compensation Peer Groups at Companies with High Pay Page 13 of 36

15 Congruence of CEO Pay to Compensation Benchmarks Among companies with high pay, significant differences versus the self-selected peer group suggest that high pay is a consequence not just of structural bias in the selection of peers, but also of the Compensation Committee s willingness to hew to even the skewed benchmarks its own process has established. Aggregate Compensation As Exhibit 6 shows, companies with high pay already 25% smaller than their selfselected peers by revenue and 45% smaller by market capitalization, and despite having 21% of their peer group composed of other companies with high pay nonetheless paid their CEOs 103% above the median of self-selected peers. Within only two performance categories performance above peers and performance significantly below peers, each representing just 4 companies was the comparison even close, at 1% and 6% above peer median, respectively. The much larger groups those performing below peers, and those performing in line with peers paid their CEOs an average of 79% and 176% above the median of their self-selected peer groups, respectively. Exhibit 6 Pay Metrics vs. Self-Selected Benchmarking Baseline Companies Performing... Companies with High Pay Performing... Below Below In Line With Above Above Total/ Avg. Below Below In Line With Above Total/ Avg. Companies w/ High Pay H/(L) Baseline Pay and Performance CEO Pay H/(L) Peer Median (44)% (40)% (17)% (7)% (9)% (15)% 6 % 79 % 176 % 1 % 103 % 118 pts CEO Pay - Multiple of Other Execs Company 2.3 x 2.2 x 3.0 x 3.2 x 2.9 x 3.0 x 3.9 x 3.5 x 4.5 x 5.9 x 4.1 x 1.2 x H/(L) (13)% (27)% (8)% 1 % (5)% (7)% 6 % 20 % 53 % 79 % 35 % 42.1 pts Among baseline companies, by contrast, compensation committees appeared to have more consistently adjusted for differences in size versus the self-selected peer groups. Smaller than their self-selected peers by 17%, as measured by revenue, these companies paid their CEOs an average of 15% lower than peer median. This below-median pay was characteristic of each category of performance versus peers, but the gap to peer median tended to increase as corporate performance versus peers worsened: companies underperforming or significantly underperforming peers averaged CEO pay 40% and 44% below peer median, respectively. Those performing in line with peers paid their CEOs an average of 17% below peer median, while those outperforming or significantly outperforming peers still paid their CEOs 7% and 9% below median, respectively. The pay gap between the CEO and a company s other Named Executive Officers (NEOs) was significantly larger among companies with high pay than among either their selfselected peers or baseline companies. CEO pay as a multiple of average NEO pay was 4.1x among companies with high pay, 35% higher than the multiple for their self-selected Compensation Peer Groups at Companies with High Pay Page 14 of 36

16 peers. At baseline companies, by contrast, the multiple 3.0x was relatively in line with the self-selected peer group. Among companies with high pay performing significantly below peers, this multiple averaged 3.9x 22% higher than the highest multiple for baseline companies in any performance category; for companies with high pay but performance above peers, the multiple was 5.9x, nearly double the highest multiple among baseline companies in any performance category. Structure of Compensation Packages Companies with high pay also varied the structure of their CEO pay packages significantly from both the benchmarks set by their self-selected peers, and from the typical structure among baseline companies. As Exhibit 7 illustrates, companies with high pay provided a significantly richer mix of equity awards (69% of total compensation) to their CEOs than either their self-selected peers (62.1%) or baseline companies (61.0%). Full value equity awards made up 41.3% of CEO pay at companies with high pay, versus 32.5% of total package for both their self-selected peer group and the baseline companies as a group. Option awards made up 27.7% of CEO pay, versus 26.9% for self-selected peers and 25.8% for baseline companies. Exhibit 7 40 % S&P 500: Structure of CEO Pay 41.3 % Companies with High Pay Self-Selected Baseline Companies 30 % 27.7 % 35.2 % 35.2 % 20 % 26.9 % 25.8 % 17.4 % 20.1 % 22.6 % 10 % 11.2 % 14.6 % 14.0 % 0 % Cash Components Option Awards Full Value Awards Pension/Deferred Comp. All Other 2.3 % 3.2 % 2.4 % Companies with high pay provided a correspondingly lower percentage of CEO compensation in both cash compensation 11.2%, versus 14.6% for self-selected peers and 14.0% for baseline companies and changes to value of pension & deferred compensation 17.4%, versus 20.1% for self-selected peers and 22.6% for baseline companies. All Other compensation characteristically a tiny fraction of total pay accounted for 2.3% of CEO pay at companies with high pay, versus 3.2% for selfselected peers and 2.4% for baseline companies. Within performance categories, as Exhibit 8 illustrates, certain of these differences were exacerbated by significant performance-related trends. Compensation Peer Groups at Companies with High Pay Page 15 of 36

17 o Cash Components: Companies with high pay tended to increase the mix of cash elements, from a low of 9% to a high of 20%, as performance relative to peers improved. The 3 baseline companies with performance significantly below peers paid out 30% of CEO pay in cash. Baseline companies in each of the other performance bins, by contrast, kept cash compensation within a relatively tight range of 12% to 15%. Exhibit 8 Structure of 3-Year Average CEO Pay Relative Corporate Performance Below Below In Line With Above Above Total/ Avg. Sample Size High Pay S&P Baseline S&P Total Cash Components High Pay 9 % 12 % 9 % 20 % 11 % H/(L) (pts) (1.0) (3.0) (5.6) 2.2 (3.4) Baseline 30 % 12 % 14 % 15 % 14 % 14 % H/(L) Baseline (pts) (20.9) (0.8) (4.2) 5.2 (2.8) Option Awards High Pay 18 % 23 % 33 % 42 % 28 % H/(L) (pts) (3.0) (5.3) Baseline 16 % 28 % 24 % 26 % 36 % 26 % H/(L) Baseline (pts) 1.4 (5.3) Full Value Awards High Pay 44 % 44 % 41 % 23 % 41 % H/(L) (pts) (14.2) 6.2 Baseline 39 % 36 % 36 % 34 % 33 % 35 % H/(L) Baseline (pts) (11.6) 6.1 Pension/Deferred Comp. High Pay 27 % 18 % 16 % 13 % 17 % H/(L) (pts) (4.4) (1.0) (5.7) 3.1 (2.7) Baseline 7 % 21 % 25 % 21 % 15 % 23 % H/(L) Baseline (pts) 2.7 (0.2) (0.4) (0.4) (5.2) All Other High Pay 2 % 3 % 1 % 2 % 2 % H/(L) (pts) (0.5) (0.3) (1.7) (2.0) (0.9) Baseline 8 % 2 % 2 % 4 % 2 % 2 % H/(L) Baseline (pts) (6.1) 0.9 (0.6) (1.6) (0.1) Compensation Peer Groups at Companies with High Pay Page 16 of 36

18 o Option Awards: Companies with high pay tended to dramatically increase the mix of option awards as relative performance improved, from an average of 18% for the worst performance category to a high of 42% for the strongest performance category. Both their self-selected peers and the baseline companies also generally increased their mix of stock options as relative performance improved, but at far less steep a rate. Self-selected peers increased from a low of 21% to a high of 32%, while baseline companies increased from a low of 16% to a high of 26%. o Full Value Awards: Companies with high pay tended to decrease the mix of these awards slightly as relative performance improved, but generally maintained them at significantly higher levels than either their self-selected peers or the baseline companies which, like their own peer groups, also reduced their mix as relative performance improved. o Change in Value of Pension/Deferred Compensation: Annual increases in the value of pension and/or deferred compensation tended to decrease, among companies with high pay, as performance versus peers improved. This same trend was true of their self-selected peers, though it was slightly more modest. For baseline companies, by contrast, the increase in the value of pension & deferred compensation tended to be a larger percentage of CEO compensation as relative corporate performance improved. Accumulated compensation benefits, such as Change in Control payout and aggregate pension value, were not included in the calculation of high pay. As Exhibit 9 shows, however, certain of these benefits were strikingly different for CEOs at companies with high pay than for CEOs at their self-selected peers or at baseline companies. o Pension Value: Across all companies with high pay, accumulated pension value as a multiple of average annual pay was relatively in line with self-selected peers 5% larger and baseline companies 6% smaller. The multiple tended to decrease among companies with high pay as relative performance improved, however, rather than increase (as it did among baseline companies). Among companies with high pay performing significantly below peers, the multiple was146% larger than among the corresponding baseline companies. Among companies with high pay performing above peers, however, the multiple was 14% smaller than among the corresponding baseline companies. o Deferred Compensation: Among companies with high pay, deferred compensation as a multiple of annual pay was half that of the self-selected peers, and nearly a third smaller than that of baseline companies. This gap widened as relative performance worsened: among companies with high pay significantly underperforming peers, this deferred compensation multiple was just 7% the size of self-selected peers, and 5% the size of the corresponding baseline companies. Compensation Peer Groups at Companies with High Pay Page 17 of 36

19 o Maximum Change in Control Payout: Across all companies with high pay, this multiple was 42% larger than self-selected peers and 32% larger than baseline companies. For all groups the multiple generally increased as relative performance improved. Among companies with high pay, however, the rate of increase from 1.3x to 6.5x was far more dramatic than among self-selected peers (from 1.1x to 1.6x). For baseline companies the multiple generally trended up from 1.4x to 1.7x, excluding an anomalous result in the category for worst relative performance. Exhibit 9 Accumulated Benefits - Multiples of 3-Year Average Pay Relative Corporate Performance Below Below In Line With Above Above Total/ Avg. Pension High Pay 0.3 x 0.2 x 0.2 x 0.2 x 0.2 x H/(L) (pct) (3)% 8 % (1)% 61 % 5 % Baseline 0.1 x 0.2 x 0.3 x 0.2 x 0.2 x 0.2 x H/(L) Baseline (pct) 142 % 33 % (14)% (14)% (6)% Deferred Compensation High Pay 0.0 x 0.1 x 0.4 x 0.1 x 0.2 x H/(L) (pct) (93)% (65)% (32)% (47)% (50)% Baseline 0.5 x 0.4 x 0.3 x 0.3 x 0.5 x 0.3 x H/(L) Baseline (pct) (95)% (70)% 36 % (47)% (31)% Max Change in Control Payments High Pay 1.3 x 1.4 x 2.3 x 6.5 x 2.1 x H/(L) (pct) 18 % (7)% 49 % 318 % 42 % Baseline 3.8 x 1.4 x 1.6 x 1.7 x 1.4 x 1.6 x H/(L) Baseline (pct) (67)% 1 % 49 % 276 % 32 % Termination w/o Cause Benefits High Pay 0.7 x 0.8 x 1.7 x 4.7 x 1.4 x H/(L) (pct) (8)% 2 % 83 % 365 % 66 % Baseline 2.2 x 1.1 x 0.8 x 0.9 x 0.8 x 0.8 x H/(L) Baseline (pct) (70)% (24)% 120 % 419 % 69 % o Termination without Cause: Across all companies with high pay, this multiple was 62% larger than self-selected peers and 69% larger than baseline companies. As relative performance improved, the multiple increased though at dramatically different rates for companies with high pay (from 0.7x to 4.7x) as well as their self-selected peers (from 0.7 to 1.0). Among baseline Compensation Peer Groups at Companies with High Pay Page 18 of 36

20 companies, however, the multiple generally declined (from 2.2x to 0.9x) as relative performance improved. Compensation Peer Groups at Companies with High Pay Page 19 of 36

21 Influence of Other Corporate Factors Composition of Compensation Committee As Exhibit 10 shows, the structure of Compensation Committees at S&P 500 companies with high pay differed little from the structure of compensation committees at baseline companies. 23 For both groups, Compensation Committees averaged 4.0 members, or about 39% of total board size. Approximately 46% of Compensation Committees in each group included a member of the board leadership Chairman, Lead or Presiding Director, or Vice Chairman as well. In only approximately 7% to 9% of companies, however, was this the board Chairman. Exhibit 10 Compensation Committee Structure S&P 500 Companies w/ High Pay Performing... Below Below In Line With Above Total/ Averag e Base line Companies Companies with High Pay H/(L) Baseline Committee Structure Members (0.1) Pct Total Board 37.7 % 37.2 % 43.6 % 35.4 % 39.4 % 38.3 % 1.1 pts Includes Board Leadership 33.3 % 58.3 % 32.0 % 50.0 % 46.6 % 46.1 % 0.5 pts Includes Board Chairman 0.0 % 16.7 % 0.0 % 0.0 % 8.6 % 6.8 % 1.8 pts Includes CEOs of Other Firms 7.5 % 5.8 % 8.2 % 0.0 % 6.5 % 9.0 % (2.5) pts Pct CEOs on Those Comp Cmtes 33.3 % 19.4 % 36.0 % 0.0 % 25.3 % 36.0 % (10.7) pts Gender Committees with Women Members 83.3 % 50.0 % 38.5 % 50.0 % 48.6 % 51.7 % (3.0) pts H/(L) Boards with Women Dirs (pts) (16.7) (31.6) (34.6) (25.0) Women Dirs Also on Comp Cmte 73.6 % 39.5 % 30.3 % 50.0 % 39.6 % 39.7 % (0.1) pts Gender composition on the Compensation Committee also provided little differentiation between baseline companies and those with high pay. In both populations, approximately 40% of women directors also served on the Compensation Committee. Among companies with high pay, 48.6% had a woman director on the Compensation Committee, only slightly lower than the 51.7% among baseline companies. One noteworthy structural difference, however, was the role of external CEOs. Among companies with high pay, 6.5% had the CEO of another company sitting on the Compensation Committee, where those external CEOs represented 25% of the total committee membership. Among baseline companies, by contrast, 9.0% had external CEOs on the Compensation Committee nearly half again as much as companies with high pay and those external CEOs represented 36% of the Committee s membership. This distinction was even more marked across the broader population of Russell 3000 companies, as Exhibit 11 shows. Among Russell 3000 baseline companies, 16.2% had an external CEO on the board significantly higher than the 2.9% rate among companies Compensation Peer Groups at Companies with High Pay Page 20 of 36

22 with high pay and 10.5% had an external CEO on the Composition Committee itself, more than six times the 1.7% rate at comparable companies with high pay. Exhibit 11 External CEOs on Compensation Committees Companies with High Baseline Companies High Pay H/(L) Baseline Russell 3000 Companies With External CEO... On Board 2.9% 16.2% (13.4) pts On Compensation Committee 1.7% 10.5% (8.7) pts Chairing Compensation Committee 11% 12% (0.2) pts External CEOs on Compensation Committees Average... Non-Employee Directorships (0.1) Prior Year Withhold Votes 6.0% 6.1% (0.1) pts Age (years) (1.1) Tenure (years) (0.5) Males 99% 95% 3.9 pts There were, however, few differences between companies with high pay and baseline companies in the profile of the average external CEO director serving on a Compensation Committee. Excluding their own companies, external CEOs sat on an average of boards and had been an external director for 5.6 to 6.1 years. Those who stood for election the year prior received approximately 6% withhold votes. At companies with high pay, a slightly lower percentage of these external CEOs were women (1%) than at baseline companies (5%) but the incidence of women CEOs serving as external directors may itself may be too low to demonstrate a meaningful distinction. Exhibit 12 Profile of Comp Committee Members S&P 500 Companies w/ High Pay Performing... Below Below In Line With Above Total/ Average Baseline Companies with High Pay H/(L) Baseline Average Directorships H/(L) Board Average (0.4) Prior Year Withold Votes 7.5 % 5.5 % 10.5 % 14.9 % 7.9 % 5.7 % 2.2 pts H/(L) Board Average (pts) Age (years) H/(L) Board Average Board Tenure (years) (0.8) H/(L) Board Average (0.4) (0.6) Members with <75% Attendance 0.0 % 1.3 % 0.0 % 0.0 % 0.7 % 0.3 % 0.4 pts H/(L) Board Average (pts) (0.2) 0.7 Compensation Peer Groups at Companies with High Pay Page 21 of 36

23 Among Compensation Committee members at S&P 500 companies, as Exhibit 12 shows, the distinctions were only slightly more marked. Average age for directors in both populations was 62, and average total board service was boards. Compensation Committee members at companies with high pay had slightly shorter tenure (7.8 years) than those at baseline companies (8.6 years). At companies with high pay, Composition Committee members who stood for election the prior year received higher withhold votes (7.9%) than the corresponding group among baseline companies (5.7%). Both groups received higher withhold votes than their board average, but the gap at companies with high pay (1.8 points) was three times as large as the gap at baseline companies (0.6 points). Finally, though the rate of poor attendance missing more than 25% of total board and committee meetings in the prior year was higher among compensation committee members at companies with high pay, it was less than 1% of all compensation committee members in either population. Elements of Corporate Governance Companies with high pay were moderately more likely than baseline companies (64.9% versus 59.8%) to have a CEO who was also Chairman, but slightly less likely to have a lead or presiding director. Both tendencies were fairly strong across most performance categories. As Exhibit 13 shows, however, companies with high pay were also slightly less likely to have a classified board (35.1% versus 37.4%) and even less likely as relative performance worsened. Exhibit 13 Selected Governance Considerations S&P 500 Companies w/ High Pay Performing... Below Below In Line With Above Total/ Average Baseline Companies with High Pay H/(L) Baseline Governance Provisions Chair Is CEO 66.7 % 60.5 % 76.9 % 25.0 % 64.9 % 59.8 % 5.1 pts Board Has Ind. Lead/Presiding Dir 66.7 % 60.5 % 69.2 % 50.0 % 63.5 % 67.6 % (4.1) pts Classified Board 16.7 % 34.2 % 34.6 % 75.0 % 35.1 % 37.4 % (2.2) pts Shareholder Pay Proposals Had Proposal in Prior 3 Years 66.7 % 26.3 % 15.4 % 0.0 % 24.3 % 28.6 % (4.1) pts Avg Proposals - 3 Prior Years (0.4) Surprisingly, companies with high pay were also less likely (24.3%) than baseline companies (28.6%) to have had a shareholder proposal on executive pay at any of their prior three annual meetings. This incidence increased markedly as relative performance versus peers worsened: none of the companies with high pay which performed above peers had a shareholder pay proposal in the prior three years, while two-thirds of those with performance significantly below peers had at least one shareholder pay proposal in the prior three years. Compensation Peer Groups at Companies with High Pay Page 22 of 36

24 This same trend held among baseline companies, but was both significantly less steep the rate climbed from 11% to 40% as relative performance declined and extended across all five performance categories: 11% of baseline companies performing significantly above peers, and 32% of those performing above peers, had seen at least one shareholder pay proposal in the prior three years. Among all companies which faced a shareholder pay proposal in the prior three years, those with high pay averaged 2.4 proposals during that period, while baseline companies averaged 2.8. For baseline companies, however, the average number of proposals these companies faced during those three years declined slightly, rather than increased, as corporate performance versus peers worsened. Compensation Peer Groups at Companies with High Pay Page 23 of 36

25 Findings and Conclusion This study used independently-developed peer groups to identify S&P 500 companies whose CEO compensation appears high relative to peer group pay and performance, then examined these companies self-selected compensation peers for systematic bias, evaluating them where relevant against a baseline of the remaining S&P 500 companies. Companies with high pay were also evaluated against baseline companies for differences in the structure or composition of their Compensation Committees and certain other features of their corporate governance. Among the study s more significant findings: o While consistent with the findings of other studies all companies in the study tended to select larger compensation peers, the contrast was especially marked among companies with high pay. Measured by revenue, companies with high pay were an average of 25% smaller than self-selected peers, while baseline companies averaged only 17% smaller. Measured by market capitalization, companies with high pay were an average of 45% smaller than self-selected peers, versus an average of just 5% among baseline companies. o Companies with high pay, unlike baseline companies, tended to select higherperforming companies as compensation peers. On average companies with high pay performed 7.7 points worse than self-selected peers on the study s aggregate scoring metric. Baseline companies performed an average of 3.0 percentile points better than their self-selected peers. o Companies with high pay were also meaningfully more likely (21%) than baseline companies (17%) to select other companies with high pay as compensation peers. Conversely, however, the average company with high pay appeared in fewer S&P 500 compensation peer groups, at 8.5, than the average baseline company, at o Significant structural bias in the selection of compensation peers was exacerbated, at companies with high pay, by the Compensation Committee s willingness to deviate from the benchmarks its own processes had established: o Companies with high pay compensated their CEOs an average of 103% above peer group median despite being 25% smaller than those peers by revenue. Baseline companies, by contrast, paid their CEOs an average of 15% below peer group median a discount roughly in line with their approximately 17% smaller average revenue. o Companies with high pay also structured their larger CEO pay packages with a disproportionately richer mix of equity awards (69% of total pay) than either their self-selected peers (62%) or baseline companies (61%). Full value equity awards at companies with high pay constituted 41.3% of total pay, versus 35.2% among self-selected peers and at baseline companies. Compensation Peer Groups at Companies with High Pay Page 24 of 36