Compensation and Workforce Trends in the Medical Device Industry Boston, MA Ed Speidel, Partner Ram Kumar, Director Prepared by is part of Aon Hewitt, a business unit of Aon plc.
Today s Topics US Market and Employment Outlook Labor Trends Short-Term Incentive Practices Private and Public Long-Term Incentive Practices Executive Compensation and Governance Trends 2
US Unemployment The unemployment rate in Massachusetts has tracked below the national average for years and stands at 4.7% as of November 2015 Buoyed by the high volume of life sciences jobs, the state emerged strongly out of the recession and experienced solid job growth in recent years 12.0 10.0 8.0 6.0 4.0 5.0 4.7 4.6 2.0 0.0 Northeast Massachusetts US Source: Economic Data, Federal Reserve Bank of St. Louis. 3
US Equity Market High-performing life sciences stocks fell into bear territory in September 2015, and though the market has made a slight recovery, some stocks are still stumbling 350% 300% 250% 200% 150% 100% 50% 0% 1/2015 2/2015 3/2015 4/2015 5/2015 6/2015 7/2015 8/2015 9/2015 10/2015 11/2015 Dow Jones NASDAQ NASDAQ Healthcare Source: Yahoo! Finance. 4
Behind Today s Data To create the data groupings for this presentation, we grouped Medical Device and Diagnostic companies from the October refresh of s Global Life Sciences Survey and Global Technology Survey databases as follows Median Company Profile Public Medical Device + Diagnostics Private Medical Device + Diagnostics Massachusetts Private + Public East Coast Revenue ($M) $355.5 $31.1 $326.2 $326.2 Market Cap ($M) $848.6 $536.7 $918.2 $1,098.9 Headcount 951 141 2,300 2,540 Number of Companies 77 65 21 40 Source: Yahoo! Finance. 5
The Medical Device Industry in the Spotlight Johnson & Johnson to Slash 3000 Jobs in Medtech Biz The healthcare giant is continuing its restructuring of its medical device business by paying off approximately 3000 workers in its medical device unit over the next two years Why Are Investors Running Away From Medical Devices? Venture capital for device manufacturers has been drying up for a while The slowdown in the rise of healthcare spending is also contributing to the drought in venture capital [Further] the FDA is improving its performance, but the recent history of device failures still looms large, and has energized critics of the device industry. (December 2015) With Early Stage Investing Stifled, Things Look Grim for the Medical Device Industry There s a marked lack of investing in early stage companies stifling tech growth in the entire medical device industry The lack of funding in early stage investment comes from an increasingly uncertain reimbursement climate, exacerbated by the repetitive nature of medtech innovation, and the resulting pressure for companies to find new ways to demonstrate the value of their products. (October 2015) 6
M&A in the Medical Device Industry 86 mergers and acquisitions in the first half of 2015 total valuation of $83 billion $100 billion expected full-year valuation for the close of 2015 *(based on closed deals) 7
M&A in the Medical Device Industry Just in the later months of 2015, the industry snagged the headlines below Flextronics Expands Medical Design Capabilities With Acquisition Of Farm Design Technimark Acquires Leading Medical Component Manufacturer Ci Medical Technologies Medtronic CEO Ponders Over Sale of Some Covidien Assets Ekso Bionics Acquires Gravity Balancing Arm Technology From Equipois VC-Backed Kuros Biosurgery Merges with Cytos Biotech Galil Medical Extends Tender Offer Period To Acquire Perseon Symmetry Medical Acquires Single-Use, Low Profile Retractor Product From Insightra Medical Inc. Medtronic Smacks Down $110 Million Cash for Aircraft Medical Quest Diagnostics To Acquire Clinical Laboratory Partners' Outreach Laboratory Service Business In Connecticut Henry Schein Makes Second Purchase in Two Days Endologix Ponies Up $211 Million for TriVascular Tech St. Jude Medical Completes Acquisition Of Thoratec Johnson & Johnson Execs Hint at Possible M&A Drug or Medical Device Deals Amid $10 Billion Share Buyback Move Progenics Makes $7 Million Bid for EXINI Diagnostics 8
Hiring Sentiment for the Next 12 Months Private companies stand out with the highest rate of aggressive hiring, with many of those companies planning to ramp up their workforces over the next 12 months Normal hiring dropped notably from Q2 2015 to Q3 2015 as selective hiring increased Freeze Selective Normal Aggressive 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 26% 31% 48% 26% 31% 38% 40% 10% 60% 40% 50% 20% 19% 45% Public Private Massachusetts East Coast Q3 All US Med. Dev. + Diagnostics 57% 33% 22% 3% 2% Q2 All US Med. Dev. + Diagnostics Source: Q3 2015 Custom Trends Reports for medical device and diagnostics companies. 9
Expected Workforce Changes for the Next 12 Months Interestingly, medical device companies are hardly reporting expected decreases in headcount over the next 12 months Private companies stand out among Massachusetts, the East Coast and the overall US industry, with 62% of companies planning to increase their workforces over the coming year Industries & Regions Decrease Stay The Same Size Increase by up to 10% Increase by more than 10% Unknown Public 4% 35% 35% 17% 8% Private -- 25% 31% 31% 13% Massachusetts -- 40% 40% -- 20% East Coast -- 50% 20% 20% 10% All US Med. Dev. + Diagnostics -- 40% 23% 22% 15% Source: Q3 2015 Custom Trends Reports for medical device and diagnostics companies. 10
Historical Turnover in the US Medical Device and Diagnostics Industry Trailing 12-month voluntary turnover is rising slowly after a post-recession drop and may be stabilizing as we head into 2016 Voluntary Turnover Involuntary Turnover 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 15.2% 16.6% 14.5% 5.9% 5.9% 4.7% 9.3% 9.8% 10.7% 2013 2014 2015 Source: Trends Reports for medical device and diagnostics companies, Q3 2013, Q3 2014 and Q3 2015. 11
Turnover Turnover among private companies is considerably lower than turnover at public companies, however voluntary turnover among the group is relatively high, as many private companies indicate plans to ramp up workforce growth this year Voluntary Turnover Involuntary Turnover 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 17.3% 16.6% 15.7% 14.5% 5.9% 4.7% 5.3% 5.9% 11.4% 9.8% 10.4% 10.7% Public Private Massachusetts East Coast Source: Q3 2015 Custom Trends Reports for medical device and diagnostics companies. 12
Salary Increases Overall 2015 actual and merit budgets are slightly higher in Massachusetts compared to East Coast companies, private companies and the overall industry, but not by much We expect these figures to increase slightly moving into 2016 US Base Salary and Merit Increases 2015 Budget 2015 Actual 2016 Budget Merit Overall Merit Overall Merit Overall Public 2.9% 3.4% 2.9% 3.4% 3.0% 3.5% Private 3.1% 3.4% 2.9% 3.3% 3.1% 3.6% Massachusetts 2.9% 3.5% 3.0% 3.5% 3.5% 4.0% East Coast 2.9% 3.4% 2.9% 3.4% 3.1% 3.4% All US Med. Dev. + Diagnostics 3.1% 3.5% 2.9% 3.4% 3.1% 3.5% Average diluted data Source: Q3 2015 Custom Trends Reports for medical device and diagnostics companies. 13
Short-Term Incentive Practices 14
Types of Incentive Plans Across all groupings, the majority of companies provide some form of cash incentive plan Historically the medical device industry has stood out against other life sciences industries with higher rates of discretionary and cash profit sharing bonus plans Metric Prevalence Bonus Metric Public Private MA East Coast All US Med. Dev. + Diagnostics Companies with bonus/incentive compensation 95.8% 86.2% 100.0% 100.0% 89.3% plan Types of Plans (% companies = of those with any plan) Formal Bonus 96.7% 73.4% 94.1% 93.1% 83.8% Discretionary Bonus 31.5% 44.4% 35.3% 41.4% 39.3% Cash Profit Sharing 9.8% 5.8% -- 3.4% 6.0% Source: Q3 2015 Custom Practices Reports for medical device and diagnostics companies. 15
Formal Bonus Plan Participation Across all groupings, most employees are receiving a formal bonus % Employees Receiving Formal Bonus Public Private MA East Coast All US Med. Dev. + Diagnostics Percent of Employees in the US Percent of Employees Globally (includes US) 64.5% 65.9% 65.2% 65.1% 65.2% 62.9% 64.0% 63.5% 61.6% 63.2% Source: Q3 2015 Custom Practices Reports for medical device and diagnostics companies. 16
Incentive Plan Participation Bonus participation is high across all levels of medical device organizations Annual Cash Participation Rates Level Public Private MA East Coast Executive 100% 99% 100% 100% Director (M4-M5) 98% 93% 94% 93% Manager (M2-M3) 97% 84% 88% 89% Supervisor (M1/M2) 78% 77% 81% 85% Expert (P5-P6) 84% 83% 88% 85% Career (P3-P4) 78% 77% 81% 78% Entry (P1-P2) 69% 69% 75% 70% Support (All) 58% 64% 56% 56% Source: Q3 2015 Custom Practices Reports for medical device and diagnostics companies. 17
Evolution of Incentive Plan Metrics Incentive pay changes to focus more on financial performance (sales and profit) as companies move private to public Generally speaking, bonus metrics shift as a company grows in size Bonus Metric *(more than one may apply) Bonus Plan Metrics Public Private MA East Coast New Product Introduction 27% 25% 31% 37% Other Non-Financial 66% 64% 69% 70% Sales 87% 72% 69% 78% Profit 86% 63% 75% 74% Quality 22% 19% 25% 22% Customer Satisfaction 15% 18% 19% 15% Source: Q3 2015 Custom Practices Reports for medical device and diagnostics companies. 18
Projected Incentive Payouts Most public companies report that 2015 bonus plan funding will be the same as last year Compared with last year, fewer private companies will be making larger payouts (22% planned to make larger payouts last year) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2015 projected payouts based on 2014 performance Source: Q3 2015 Custom Practices Reports for medical device and diagnostics companies. 19 11% 12% 13% Smaller Similar Larger 8% 10% 77% 79% 73% 80% 80% 11% 9% 13% 12% 10% Public Private Massachusetts East Coast All US Med. Dev. + Diagnostics
Private and Public Long-Term Incentive Practices 20
Private vs. Public Pay Philosophies at a Glance Peer Group Development Cash Approach Equity Approach Typical Private Firm Usually, no specific identified peer list Focus on companies similar in size and stage of development Key metrics: industry, invested capital, revenue, stage of development and employee count Base salary must be competitive (no longer getting away with low cash) Annual bonuses are prevalent Aggressive award sizes, especially to those risking early entry Vehicles: Stock options dominate Award sizing metric: Ownership percentage Typical Public Firm Usually, a specific group of 15 to 20 identified public peer companies Focus is often on market cap, R&D spend, product phase/stage Base salary: 50 th percentile Annual bonus: 50 th percentile or above, emphasizing the at-risk nature of compensation 50 th percentile and up to 75 th based on performance Vehicles: Options, RSUs, performance shares Award sizing metric: Value Pay-for- Performance Egalitarian: we re all in this together Pay is targeted to key roles and high performers 21
Private vs. Public Equity Practices Equity Award Sizing New-Hire vs. Ongoing Awards Equity Vehicle Mix Equity Program Participation Typical Private Firm Primarily established by targeting specific ownership percentages; conversion into shares based on total common shares outstanding Large new-hire grants Ongoing grants delayed until IPO approaches, or 3-4 years after hire Ongoing guidelines set anywhere from 25% to 33% of new-hire awards Stock options dominate Caveat: A few notable companies have used RSUs pre-ipo; however, large cash reserves are needed to address taxes New hire awards: nearly 100% Ongoing awards: targeted at key performers and those employees greater than 50% vested (usually 25% to 30% of population at any given time) Typical Public Firm Primarily established by targeting specific values; conversion into shares is typically based on stock price New-hire awards are typically 1.25x- 1.75x ongoing award sizes Most employees are eligible for ongoing awards after six months to one year of service Mix of stock options and RSUs, with an emphasis on RSUs as the firm matures Rising prevalence of performance shares for executives New hire awards: participation drops as companies increase in size Ongoing awards: broad eligibility is maintained, although awards targeted at top performers (usually 40% - 60% of population) 22
Aligning Equity with Stage of Development Company Profile Long-Term Incentive Vehicles Startup/ Pre-IPO Mid-Cap/ Growth Market Mid-Cap/ Mature Market Large Cap/ Mature Market Objectives and Implications Stock Options Only Stock options help employees focus on upside potential, either stock price growth or company valuation growth Restricted Shares/ Units Only Restricted shares/units de-emphasize stock price growth in favor of employee retention and ownership Stock Options and Restricted Shares/ Units A mixed approach attempts to balance growth with retention, and typically involves different mixes for different employee levels Performance Shares/ Units Performance shares allow companies to introduce targeted goals (beyond stock price growth) into their equity programs Long-Term Cash Often used in conjunction with equity, long-term cash allows for more diversity of performance goals, but requires an ability to set goals over multiple years Relative Total Shareholder Return The use of TSR metrics typically reflects alignment with the institutional investor perspective (i.e., portfolio performance) and requires a stable peer group Most Common Practice Emerging Practice Least Common Practice 23
Focus on Individual Ownership Private companies typically focus on employee ownership percentages as the best apples-to-apples point of comparison for delivering competitive equity packages Median Individual Ownership by Level of Invested Capital Employee Level Under $40M $40M to $80M Over $80M CEO 7.509% 4.293% 3.803% Founder 8.623% 5.506% 4.195% Non-Founder 7.127% 4.195% 3.082% CFO 0.926% 0.639% 0.825% Top HR Executive 0.351% 0.347% 0.309% Vice President 0.688% 0.614% 0.548% Director 0.254% 0.283% 0.075% Manager 0.063% 0.120% 0.040% Professional 0.027% 0.032% 0.012% Support 0.006% 0.012% 0.005% Source: s Pre-IPO/Venture-Backed Survey. Data shown are a roll-up of levels taken at the median. 24
Manage Overall Employee Ownership Meanwhile, investors and Boards of Directors focus heavily on the total amount of employee ownership, otherwise known as overhang Fully diluted overhang is the most common metric used by private companies Median Ownership by Level of Invested Capital Employee Level Under $40M $40M to $80M Over $80M Total Employee Ownership 16.0% 10.6% 11.2% Executives (VPs and above) 13.0% 8.2% 8.7% All Other Employees 2.5% 2.0% 2.0% Total 20.1% 15.2% 13.4% Source: s Pre-IPO/Venture-Backed Survey. 25
Equity Receipt: Public Company Practice Broad-based ownership remains common in the medical device industry so long as companies can manage dilution Annual Equity Receipt Rates Employee Level Public MA East Coast CEO 92% 83% 88% VP 90% 93% 87% Director (M4-M5) 84% 72% 82% Manager (M2-M3) 42% 38% 55% Supervisor (M1) 10% 13% 13% Expert (P5-P6) 33% 15% 33% Career (P3-P4) 14% 12% 19% Entry (P1-P2) 4% 8% 8% Support (All) 3% 1% 1% Source: Custom Global Long Term Incentive Reports for medical device and diagnostics companies. 26
Equity Value: Public Company Practice Equity values are heavily concentrated at the executive level, with values diminishing toward the lower levels of the organization Massachusetts companies stand out with higher annual equity values over the overall East Coast, especially at the top levels of the organization Employee Level Annual Equity Value Public MA East Coast CEO $2,040.3 $2,286.8 $1,657.6 VP $97.8 $152.9 $117.3 Director (M4-M5) $35.7 $57.7 $53.3 Manager (M2-M3) $16.2 $13.2 $13.3 Supervisor (M1) $10.1 $5.2 $5.0 Expert (P5-P6) $25.2 $26.6 $19.9 Career (P3-P4) $11.7 $6.5 $6.9 Entry (P1-P2) $7.2 $4.3 $4.3 Support (All) $6.7 $1.3 $1.3 Source: Custom Global Long Term Incentive Reports for medical device and diagnostics companies. 27
Equity Vehicle Mix When we look at vehicle mix, we see that companies use a blend of options and RSUs across all levels, especially at higher levels in the organization, but from the Management 5 level downward, an RSUs-only approach dominates Percent of Employees Receiving Each Vehicle Market 50 th Percentile Massachusetts East Coast All US Med. Dev. + Diagnostics Position/Level Options Only RSUs Only Options + RSUs Options Only RSUs Only Options + RSUs Options Only RSUs Only Options + RSUs CEO 30% 20% 50% 36% 14% 50% 23% 22% 55% SVP/Officer 25% 13% 63% 25% 8% 67% 26% 21% 54% VP 5% 25% 70% 5% 5% 91% 17% 16% 68% Management 5 -- 78% 21% 1% 51% 48% 22% 38% 41% Management 3 1% 95% 4% 1% 96% 3% 22% 58% 20% Professional 5 -- 89% 11% -- 91% 9% 8% 66% 26% Professional 3 2% 96% 2% 2% 97% 2% 13% 75% 12% Source: Q3 2015 Custom Global Long-Term Incentive Reports for the medical device and diagnostic companies. 28
Equity Vesting Schedules Vesting over four years remains the common practice among medical device companies for both options and RSUs, which can aid retention Yet, many companies also use a three-year vesting schedule for RSUs, which can be a competitive advantage 1-2 Years 3 Years 4 Years 5+ Years 9% 2% 13% 8% 8% Options RSUs 30% 53% 75% Source: Q3 2015 Practices Report for medical device and diagnostics companies. 29
Burn Rates in the Medical Device Industry Median last fiscal year (LFY) and 3-year gross burn rates are similar across the full US medical device industry Relative to the East Coast and overall US medical device industry, Massachusetts medical device companies use the most equity Gross Equity Burn Rate 25th 50th 75th 6% 5% 4.9% 4.4% 4% 3.2% 3.3% 3% 2.1% 2% 1.8% 1% 5% 4% 3% 2% 1% Median LFY Burn Rate by Industry 4.0% 3.2% 3.2% 0% LFY 3-Year Average 0% Massachusetts East Coast All US Med. Dev + Diagnostics Source: proprietary database. 30
Overhang in the Medical Device Industry Median issued overhang sits at 8.9% for the industry as a whole, with total overhang at 14.3% Issued Equity and Total Overhang 25th 50th 75th 25% 20% 19.4% 15% 10% 8.9% 12.8% 10.4% 14.3% 5.9% 5% 0% Issued Total Source: proprietary database. 31
Private and Public Company Pay Mix Overall, cash isn t that different between the scientist and manager levels, but it changes substantially at the executive level, with LTI comprising a significant part of the pay package Bonus targets become more formalized and richer as a company evolves, particularly at the manager level and above Pay Mix 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 8% 78% Scientist 14% 15% 14% 47% 53% 8% 8% 77% 78% 79% Public Private MA East Coast Manager 9% 13% 10% 11% 12% 12% 12% 87% 78% 78% Public Private MA East Coast 22% 20% 19% 30% 20% 58% Base Bonus LTI Executive 70% 21% 21% 59% 60% Public Private MA East Coast Source: Custom Compensation Reports, January 2016. 32
Executive Compensation Unlike broad-based employees, executives are still willing to take a discount on cash for higher ownership As companies move from private to public and become more established, CEO pay shifts: fixed pay typically gets higher, and long-term incentive values at the executive level become more meaningful as the company gains traction and as market capitalization values increase CEO Public Private MA East Coast Base Salary $604,135 $350,000 $600,000 $600,000 Target Total Cash $1,126,250 $412,250 $1,200,000 $1,175,000 Annual LTI Value $2,040,278 -- $2,792,350 $2,107,661 Source: Pre-IPO Venture-Backed Survey, Custom Compensation Reports, January 2016. 33
Executive Compensation CFO, Top HR and Top Regulatory Affairs Executive data reflects the same premium to cash compensation among public companies, but the impact of cash is dwarfed by the annual equity delivery for public company executives CFO Public Private MA East Coast Base Salary $350,000 $252,024 $343,382 $343,382 Target Total Cash $532,213 $304,858 $571,159 $541,722 Annual LTI Value $683,485 -- $797,351 $771,678 Top HR Exec. Base Salary $283,086 $257,034 $291,543 $283,086 Target Total Cash $397,500 $323,381 $396,320 $396,435 Annual LTI Value $293,142 -- $447,324 $318,722 Top Regulatory Affairs Executive Base Salary $278,100 $226,600 $253,038 $290,332 Target Total Cash $390,670 $288,563 $341,601 $409,495 Annual LTI Value $255,824 -- $93,881 -- Source: Pre-IPO Venture-Backed Survey, Custom Compensation Reports, January 2016. 34
Medical Device Professional IC Compensation At the Development Engineer 4 position, we see public companies stand out with high annual LTI values For the Scientist 3 position, base pay is higher at private companies, and total target cash is considerably higher among companies located in Massachusetts Development Engineer 4 Public Private MA East Coast Base Salary $123,978 $90,140 $109,847 $109,847 Target Total Cash $140,369 $98,730 $119,732 $119,732 Annual LTI Value $70,166 -- $5,991 -- Scientist 3 Base Salary $96,999 $105,000 $101,436 $97,344 Target Total Cash $105,600 $110,549 $112,750 $107,842 Annual LTI Value $18,040 -- $19,480 $18,040 Source: Pre-IPO Venture-Backed Survey, Custom Compensation Reports, January 2016. 35
Executive Compensation and Governance Trends 36
Dodd-Frank Update Full implementation of Dodd-Frank still remains a work in progress Dodd-Frank Rule Say-on-Pay Say-on-Golden Parachutes Committee Independence Consultant Independence CEO Pay Ratio Disclosure Pay-for-Performance Disclosure Anti-Hedging Policy Clawbacks SEC Status Final and Active Final and Active Final and Active Final and Active Final and Active in 2018 proxy season Rules were proposed (Likely effective in 2017 proxy season) Rules were proposed (Possibly effective for 2016 proxy season) Rules were proposed Comment period ends 9/14/2015 (Possibly effective in 2017 proxy season) 37
Summary of Relevant ISS Policy Updates Equity Plan Scorecard ( EPSC ) modifications: ISS increased post-vesting/exercise holding period requirement to receive full points under the model from 12 months to 36 months or until employment termination. A holding period requirement of 12 months or until stock ownership guidelines are met will continue to receive half points under the revised model Previously, a holding period of at least 12 months resulted in full points under the old scorecard model ISS also renamed the Automatic Single-Trigger Vesting plan features factor to CIC Vesting and modified the scoring levels to take into consideration the treatment of performance-based awards in the event of a CIC Director Overboarding: For non-ceo directors, ISS will now note in its report if a director serves on more than five public company boards during 2016, but will only recommend that shareholders vote against directors who sit on more than six public company boards However, starting on or after February 1, 2017, negative recommendations will be made for non-ceo directors sitting on more than five public company boards Unilateral Bylaw and Charter Changes: Currently, ISS s existing policy recommends that its subscribers vote against/withhold director nominees, certain committees, or the entire board if the board amends company bylaws or charter without shareholder approval in a way that materially diminishes shareholder rights. ISS now bifurcates its analysis as to how it evaluates newly-public companies and companies with a longer trading history 38
Anti-Pledging Possibly effective for proxy season 2016 Take Action: disclose whether your company permits employees (including officers) or directors to engage in hedging activities with respect to shares granted as part of compensation, as well as shares held directly or indirectly If some hedging activity is permitted, identify the categories of persons permitted to engage in hedging activities as well as the types of hedging activities that are permitted (or not permitted) Technically, these disclosures are required under Item 407 (Corporate Governance), and we would expect companies to provide this disclosure outside the CD&A Since hedging is one of the SEC s 15 items to be covered in the CD&A, the proposed rule would allow companies to reference the Item 407 disclosure within the CD&A 39
Pay-for-Performance Disclosure Possibly effective for proxy season 2017 Take Action: include a new Pay Versus Performance table in the proxy statement disclosing: Total compensation disclosed in the Summary Compensation Table (TCSCT) for each of the past 5 years for the CEO Total compensation actually paid (TCAP) to the CEO for each of the past 5 years Average other NEO TCSCT for each of the past 5 years Average other NEO TCAP for each of the past 5 years Total shareholder return (TSR) for each of the past 5 years on a cumulative basis Peer group TSR for each of the past 5 years on a cumulative basis Stock options will use a Black-Scholes value as of the vesting date taking into account changes in share price since grant 40
Pay-for-Performance Disclosure (continued) In addition to the new table, discuss the relationship between (A) the TCAP of the CEO and the average other NEO TCAP and (B) the cumulative total shareholder return (TSR) for each of the last 5 years Continue to use the CD&A to reinforce how certain elements of pay are tied to corporate performance and/or share price movement and reference that discussion in the pay versus performance disclosure Reiterate why various financial metrics have been selected We anticipate that both ISS and Glass Lewis may comment on such disclosures in their say-on-pay evaluations, but will ultimately likely rely on their own existing peer group selection and pay-for-performance methodologies to determine whether a company has a disconnect or linkage in pay versus performance 41
Pay vs. Performance Modeling $60,000 $300 $300 $250 $200 $150 $100 $100 $97 $165 $143 $250 $211 $262 $239 CEO and NEO Pay $50,000 $40,000 $30,000 $20,000 $250 $200 $150 $100 Indexed TSR $50 $10,000 $50 $0 Mar-13 Dec-13 Dec-14 December 2015 Estimate Peer Indexed TSR Company A Indexed TSR $- Mar-13 Dec-13 Dec-14 December 2015 Estimate $- Given the SEC s suggestion regarding the use of graphs, we anticipate most companies will use visuals as part of the requirement of providing a clear description of the relationship between the following: The company s TSR and the peer group s TSR; and The executive compensation actually paid to the NEOs and the company s TSR 42
Clawback Overview When will the clawback be triggered? In event of a restatement without any requirement of misconduct or negligence of executives from whom compensation is being recovered Applies to restatements compelled by error that is material to previously issued financial statements From whom must compensation be recovered? All executive officers with a policy-making role; anyone who met the definition of an executive officer at any point during the incentive compensation s performance period What types of compensation are subject to the policy? All incentive-based compensation, whether short-term or long-term Based on any financial reporting measure or stock price/tsr Equity awards are subject to clawback only to the extent the grant, vesting, or the amount of the award earned is affected by the restated measure or related impact on stock or TSR Time-based stock options and restricted stock are not incentive compensation subject to clawback Board discretion No board discretion recovery is compulsory, with the excess incentive compensation to be recovered pro rata from all executive based on their share of the original overstated award 43
Clawbacks We do not expect the policy to become effective earlier than the 2017 proxy season Under the proposed rules, the listing exchanges must add a listing requirement for companies to adopt a clawback policy that minimally conforms to the SEC s requirements: Clawback is triggered in the event of a restatement due to material non-compliance with GAAP reporting requirements ( no fault ) From the date the company is aware or should be aware that a restatement will be required, the company must look back to the 3 most recently completed fiscal years If the financial restatement affects the amounts originally determined to be earned under incentive pay programs, the company must clawback the excess compensation It is important to note that for life sciences companies, clinical / scientific milestones are not considered financial metrics and therefore plans or portions of plans related to these types of metrics cannot be subject to recoupment 44
CEO Pay Ratio Rule The effective date for the CEO pay ratio is for fiscal years that begin on or after January 1, 2017 (for calendar-year filers, that would mean the first disclosure would occur in the 2018 proxy season) Identifying the median employee is only required once every 3 years (provided the employee population has not changed in a way that would significantly affect the ratio (e.g., corporate mergers and acquisitions) Median Employee can be identified using the employee population as of any date during the last 3 months of the fiscal year This includes any full-time, part-time, seasonal, or temporary worker employed by the registrant or any of its consolidated subsidiaries on that day Nondiscriminatory benefit plans can be added to the numerator and denominator of the ratio Optional narrative and supplemental ratios are permitted to provide helpful context 45
CEO Pay Ratio Modeling Determining the CEO to worker pay ratio isn t so simple The SEC has set forth several operational guidelines for determining the median employee, though companies must be sure to disclose and consistently apply the methodology of their choosing Median Employee Selection Methodology Base Total Target Cash Target Total Direct Compensation W-2 (or int l equiv.) Wages Median Employee Total Pay $95,000 $85,000 $100,000 $90,000 CEO Summary Comp Table Pay $10,500,000 $10,500,000 $10,500,000 $10,500,000 2015 Pay Ratio 11:1 12:1 11:1 12:1 46
CEO Pay Ratio Rule The final rules retained several operational guidelines that give employers flexibility Registrants may use (A) a methodology that uses reasonable estimates to identify the median and (B) reasonable estimates to calculate the annual total compensation or any elements of total compensation In determining the employees from which the median is identified, a registrant may use (A) its entire employee population or (B) statistical sampling or other reasonable methods A registrant may identify the median employee using (A) annual total compensation or (B) any other compensation measure that is consistently applied to all employees included in the calculation, such as amounts derived from the registrant s payroll or tax records A registrant may annualize the total compensation for all permanent employees (other than those in temporary or seasonal positions) that were employed by the registrant for less than the full fiscal year 47
Board of Director Compensation Litigation Recently, we have seen increased scrutiny around director compensation, especially on equity awards Because director compensation is typically set by the Compensation Committee, who also receives the compensation, some are alleging that the compensation constitutes a breach of fiduciary duty A number of publicly traded companies have recently faced legal action around director compensation, causing many to consider implementing a concrete and meaningful limitation on grants to directors to be included in an equity plan and approved by shareholders Companies should consider including a hard coded limit on annual equity awards to directors in the text of the next amendment to their plan; alternatively, a standalone policy could be put forth to shareholders for approval 48