Equity Compensation Session

Transcription

1 Equity Compensation Session

2 Current Environment & Hot Topics

3 Current Environment for Executive Pay Evolution has replaced Revolution Executive pay decisions are more disciplined, better documented, and more transparent to constituents Demonstration of pay performance alignment will be critical going forward

4 Hot Topics for Comp Committees Definitions of Pay and Performance Multi Year Performance Measurement Impact of ISS on Plan Design at Public Companies Role of Discretion in Assessing Performance Incentive Program Risk Management Succession Planning for Board and Management

5 Recent Trends in Executive Pay

6 Recent Trends in Executive Pay Increasing Influence of Shareholder Advisory Groups Perspective (through July 19) # of companies disclosing SOP results 3,293 2,683 2,660 Companies receiving > 90% shareholder support 69% 69% 66% Companies that failed to receive 50% shareholder support 1.6% 2.5% 1.9% % of companies ISS recommended "For" 89% 88% 88% % of companies ISS recommended "Against" 11% 12% 12% Average shareholder support with positive ISS recommendation 93% 93% 93% Average shareholder support with negative ISS recommendation 69% 65% 67% Average support for 182 companies that ISS recommended For in 2011 and Against in % 63%

7 Recent Trends in Executive Pay Increasing Pressure to Demonstrate Performance based Pay Viewed Favorably Performance shares/units More than 50% of LTI performance based Significant portion of pay at risk Companies must balance all this pressure for performance based pay with the need for safety & soundness TSR (not necessarily as a goal, but a measuring stick)

8 Recent Trends in Executive Pay Quantification of Relative Pay Performance Alignment 100% low relative pay for high relative performance Relative Performance Percentile 50% high relative pay for low relative performance 0% 0% 50% 100% Relative Pay Percentile

9 Recent Trends in Executive Pay Incentive Target Setting and Slope (Leverage) Scrutiny 200% 175% Payout as % of Target 150% 125% 100% 75% Range of Peer Practices 50% 75% 80% 85% 90% 95% 100% 105% 110% 115% 120% Achievement % of Target Division A Division B Corporate

10 Long-term Incentive Alternatives

11 LTI Compensation Philosophy Objectives might include: Reward for past performance Incentive for future performance Retention Wealth creation Retirement vehicle Alignment with long term shareholder interests Key Considerations: Shareholder dilution and annual share utilization Accounting impact Tax treatment for individual and the company, including tax deductibility under Internal Revenue Code Section 162(m) ($1 million cap) Cash flow impact

12 Alternative LTI Vehicles Full Value Awards Restricted Stock/Units with: Service based vesting Performance contingent vesting Performance Shares/Units Similar to performance contingent restricted stock units, but with greater leverage Variations of full value awards have replaced much of what traditionally was delivered in the form of stock options Appreciation only Awards Stock Options or Stock Appreciation Awards (SARs): Cash Awards Service based vesting Performance contingent vesting (rare) Performance units Long term cash incentive

13 Full-Value Award Alternatives LTI Vehicle Restricted Stock Service Based Vesting Restricted Stock Performance Contingent Vesting Performance Shares/Units Internal Performance Relative Share Price Performance Description Right to receive shares, subject to restrictions on transfer/sale based upon continued service; vesting period is often longer than for stock options Typically, grant recipient is entitled to dividends paid on restricted shares. Conditional grants of shares with vesting contingent upon achievement of pre set performance goals; often all or nothing payout Generally, dividends paid during the performance period are deferred and paid if performance is achieved and shares vest. Conditional grants of notional shares with vesting contingent upon achievement of pre set performance goals; often designed with threshold, target, and maximum payout levels, with interpolated results in between Example: Target award of 100 units/shares; potential for a maximum of 150 shares if performance is superior; 50 shares are earned at threshold performance and no shares below threshold. Generally, dividends paid during the performance period are deferred and paid on the number of shares earned.

14 Financial Impact of LTI Vehicles Share Cash Flow Accounting Expense Subject to $1M Cap LTI Vehicle Utilization Impact (a) ASC Topic 718 Under 162(m) Full-Value Stock Awards Restricted Stock Medium None Equity (non-variable) treatment; fixed at the time of grant Yes Performance Contingent Restricted Stock - Internal Performance Measures Medium None Equity (non-variable) treatment; potentially reversible if performance not met No (b) Performance Shares - Internal Performance Measures (unrelated to stock price) Medium-High None Equity (non-variable) treatment; potentially reversible if performance not met No (b) Performance Shares - Relative Share Price Performance Measures Medium-High None Equity (non-variable) treatment; fixed at the time of grant No (b) Stock Appreciation Awards Stock Options High Positive Equity (non-variable) treatment; fixed at the time of grant No SARs (settled in shares) Medium None Equity (non-variable) treatment; fixed at the time of grant No SARs (settled in cash) None Negative Liability (variable) treatment No Other Awards Long-Term Cash Incentive None Negative Variable No (b) Phantom Equity None Negative Variable No (b) (a) (b) Positive cash flow impact can result if optionee pays exercise prices. Compensation also generally tax deductible, subject to Section 162(m) limitations for Top Five executive officers. Negative cash flow can result if company allows for tax withholding through the surrendering of shares. Not subject to $1 million cap under 162(m) if technical requirements are met.

15 Effectiveness at Meeting LTI Objectives LTI Vehicle Full-Value Stock Awards Allignment with Perceived Upside Leverage / Stock Price Busines Financial Retention Wealth Creation Performance Performance Value Potential Restricted Stock Medium Indirect High Medium Performance Contingent Restricted Stock - Internal Performance Measures Performance Shares - Internal Performance Measures (unrelated to stock price) Performance Shares - Relative Share Price Performance Measures Medium High Medium Medium Medium High Medium Medium-High High Indirect Medium Medium-High Stock Appreciation Awards Stock Options High Indirect Low High SARs (settled in shares) High Indirect Low High SARs (settled in cash) High Indirect Low High Other Awards Long-Term Cash Incentive None High Medium Low-Medium Phantom Equity Medium Indirect High Medium

16 LTI Philosophy & Time/Risk Continuums High Perf. Options Stock Options Risk / Leverage Annual Incentives Perf. Shares Perf. Vested Rest. Stock LTI Cash Restricted Stock Nonqualified Retirement Low Base Salary Qualified Retirement Current Time Horizon Future 0-1 Yrs 3 Yrs +10yrs Paid In cash Paid in Stock Not to scale.

17 Tax Consequences and Considerations

18 Tax Consequences Employee In general, ordinary compensation income on the intrinsic value at award vesting or option exercise Employer Deduction at same time and for same amount as grantee s ordinary income Exceptions Award deferrals Incentive stock options (ISOs) 83(b) elections 162(m) limitations

19 Tax Consequences Intrinsic value Difference between the fair market value of the award received upon vest or when exercised that is in excess of any amounts paid Award deferrals If the requirements of IRC Section 409A are met and payment is deferred, taxation may also be deferred until the award is received. However, payroll taxes may still apply at the time of deferral.

20 Tax Consequences Summary of Taxation Type of Plan Stock Appreciation Rights (SARs) Phantom Stock Performance Share Formula Value Plan Restricted Stock Restricted Stock Units (RSUs) Incentive Stock Options Nonqualified Stock Options Benefit measured by Increase in value of shares Increase in value of shares and dividends Number of shares awarded by performance formula; increase in value of shares and dividends Increase in value of shares and dividends as determined by formula Number of shares awarded by performance formula or continued employment; increase in value of shares and dividends Difference between RSU price and stock FMV upon vesting Difference between option price and fair market value upon exercise Difference between option price and fair market value upon exercise Benefit paid in Cash or stock Stock Stock Option exercisable in stock Executive's income taxation Taxation when executive receives payments; taxation depends on payment type Ordinary income when stock is vested Ordinary income when the stock vests Upon sale, capital and ordinary income as determined by special holding period rules Upon exercise, taxation is the same as restricted stock Employer's tax deduction Deduction when payment to executive is made and the executive includes the payment in income Deduction when executive recognizes taxable income Deduction when the executive recognizes taxable income Deduction for the ordinary income recognized Deduction when executive recognizes taxable income

21 Tax Consequences - ISOs Tax Treatment (Specified in IRC Section 421) No regular tax consequences occur on the grant date or the exercise date. But. AMT adjustment for the difference between FMV of stock and exercise price on exercise date. Upon sale of stock Recognize long term capital gain for difference between sale price and exercise price. (ISO s, by definition, must be held for a minimum of one year) Disqualified Transaction: If a sale becomes disqualified due to insufficient holding period, the employee must recognize ordinary income equal to the option exercise price less the stock's fair market value at the time of option exercise. Any remainder is treated as capital gain. Must inform employer upon disqualifying disposition. Income is taxed as compensation to the employee and is deductible by the employer. However, payroll taxes and withholding do not apply.

22 Comparison of Tax Aspects of ISOs versus NQSOs

23 Tax Consequences 83(b) Elections Under IRC Section 83(b) an election can be made by an employee to be taxed at ordinary income rates on the date of the award (rather than the vesting date) Appreciation in stock value after the award date is then subject to capital gains tax rates, which are generally lower than compensation rates A decrease in value produces a capital loss that is subject to the capital loss limitation rules Applies only to property i.e. restricted stock (but not restricted stock units) Not applicable for ISOs and most other stock options The 83(b) election must be made within 30 days after the restricted stock is granted Employee must provide employer with a copy of the election Employer is entitled to a tax deduction equal to the amount included in the employee s income

24 Tax Considerations Exercise stock options early in the calendar year to allow for long term capital gain treatment if some of this stock is to be sold before taxes are due in the following April (i.e. hold one year, then sell some or all shares before regular or AMT taxes have to be paid). If permitted under the employer s plan, option holders may want to cash in shares acquired in connection with exercising options to pay the exercise price or tender back shares to produce funds for the withholding taxes. Tax Planning Strategies (Assuming a rising stock price) To minimize taxes: Exercise early (soon after grant) to minimize regular tax or AMT impact and start the holding period for long term capital gain treatment. Potentially, more gain will be taxed at the lowest tax rates long term capital gain rates. To minimize risk: Wait to exercise until the price peaks and then sell shares. Gain is taxed as compensation (at higher rates), but profit (before taxes) is guaranteed.

25 M&A Considerations Equity Compensation for Executives

26 CIC Termination Considerations Time vested Awards Typically 100% of unvested awards become vested upon termination following a change in control (CIC), if not already vested under a single trigger provision Performance vested Awards May provide for full or pro rata vesting based on the portion of the performance time period completed as of the CIC Performance tends to either be defined based on 1) actual performance through the transaction date or 2) deemed to satisfy Target level performance, regardless of actual performance (in rare occasions, Maximum performance is deemed to have been satisfied) Careful documentation of CIC termination provisions in the Award Agreement can save heartache and confusion at the time of a CIC transaction

27 Single- or Double-Trigger? Does vesting acceleration occur upon the transaction itself (single trigger), or is involuntary or good reason termination also required (double trigger)? Continued external pressures to adopt double trigger provisions as best practice Double trigger is gaining traction in plan design/documentation However, disclosures from actual transactions indicate single trigger remains the reality Performance based equity awards are especially problematic under a double trigger scenario (i.e. how do you measure post transaction performance against pre established, pre transaction criteria?)

28 Rollover or Cash-Out? Rollover: Equity awards denominated in stock of the target company (e.g. unexercised options or unvested restricted stock) are converted to awards based on acquiror s stock in a way that preserves the value of the award as of the close of the transaction Maintains same, or similar, economic position for participant Does not normally trigger any tax consequences for employee or company Common in all stock transactions and in some cash transactions when the purchaser is a public company Cash out: Equity awards are cancelled in exchange for cash equal to the intrinsic value of the award Common in all cash transactions; treats award holders in equitable fashion with shareholders Important to make sure cash out is permitted under the plan Careful consideration of 409A implications is warranted Which is Best? It Depends The relative desirability of rollover vs cash out depends on a number of factors Terms of transaction, employee retention, dilution, overhang, compensation culture, tax and accounting implications, plan provisions, administration issues, etc.

29 Questions Amy L. Jessup Senior Manager (503) Greg Swanson Vice President (415) Mark Harrison Partner (916)

30 Appendix: Full-Value Award Alternatives Advantages & Disadvantages LTI Vehicle Advantages Disadvantages Restricted Stock Service Based Vesting No need to establish long term performance goals Downside protection/retention value not a disincentive if stock price declines Immediate sense of ownership Less dilution vs. stock options Fixed earnings charge under ASC Topic 718; typically equals employees perceived value Lower risk profile than other equity awards from a safety and soundness perspective Awards vest regardless of performance as long as executive remains employed; may be perceived as pay for pulse (not viewed as performance based pay by shareholder advisory firms) Income tax liability upon vesting unless deferred as restricted stock units 162(m) subject to $1 million dollar deductibility cap; no performance exception Restricted Stock Performance Contingent Vesting Appeals to many investors and their advisory firms, assuming performance measures and goals are appropriate Earnings charge is reversed if performance goals are not achieved (assuming internal performance goals) Usually complies with 162(m) requirements Greater dilution if more shares are granted to offset performance risk Potential disconnect between business/financial performance goals and stock price appreciation The all or nothing nature of the award has the potential to encourage risky behavior in order to hit the goals Potential for de motivation if goals are unattainable

31 Appendix: Full-Value Award Alternatives Advantages & Disadvantages (cont d) LTI Vehicle Advantages Disadvantages Performance Shares/Units tied to Internal Measures Performance Shares/Units tied to Relative Share Price Performance Combines perspective of both internal performance (how many shares are earned) and share price performance (what the value of those shares are) Appeals to many investors and their advisory firms, assuming performance measures and goals are appropriate Design facilitates both upside potential for results that exceed target and downside protection if results exceed threshold but are below target Potential for strong line of sight depending on goals Accounting expense fixed with regard to share price at grant, but will vary to reflect the number of shares earned (results in reduction of expense accruals if shares earned are less than projected) Usually complies with 162(m) requirements Combines perspective of both relative share price performance (how many shares are earned) and absolute share price performance (the value of those shares) Shareholder return does not require explicit goals and more easily accommodates strategic changes like acquisitions and divestitures Particularly when used with other equity vehicles, can provide upside leverage if company s share price performance is exceptionally strong Accounting expense similar to stock option grants fixed, but no reversal for shares that are not earned due to performance results Usually complies with 162(m) requirements Challenge to set performance goals, particularly for companies that are likely to have significant acquisitions/divestitures during measurement period Performance goals must be disclosed (although not necessarily until after performance period), and investors may challenge rigor of goals Until settled, outstanding awards count against share plan reserve at maximum payout level Can result in confusion about company s performance results With threshold, target and stretch goals and overlapping three year plans being typical, even companies using just one performance measure will have nine different performance goals outstanding at any point in time Annual results for a particular year may be outstanding when considered against one cycle s goal but below expectations for another cycle May result in high payouts even if share price declines OR low payouts despite share price growth from grant Some companies incorporate reduced awards if share price declines, but this increases risk for participants and reduces value of awards Works best when a relatively large peer group or index is used, but this may make comparisons of company performance less relevant (either to participants or investors) Relatively poor line of sight for participants who feel limited ability to influence their own company s stock price not to mention the stock prices of other companies