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George B. Paulin Frederic W. Cook & Co., Inc. May 22, 2000

HOT TOPICS IN EXECUTIVE COMPENSATION. George B. Paulin Frederic W. Cook & Co., Inc. May 22, 2000. PRELIMINARIES. “Workshop” means we want you to participate I talk a lot and prepare too much material My experience is mostly with for-profit, public - or soon to be public - companies.

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George B. Paulin Frederic W. Cook & Co., Inc. May 22, 2000

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  1. HOT TOPICS IN EXECUTIVE COMPENSATION George B. Paulin Frederic W. Cook & Co., Inc. May 22, 2000

  2. PRELIMINARIES • “Workshop” means we want you to participate • I talk a lot and prepare too much material • My experience is mostly with for-profit, public - or soon to be public - companies

  3. TOPICS COVERED 1. Option accounting just got more complicated 2. Old economy companies have been losing to new economy companies, but this may change 3. Retaining high-performers is harder than ever

  4. TOPICS COVERED (cont’d.) 4. Investors are pushing back on high stock-grant dilution 5. Rescuing underwater options is difficult, not impossible 6. There are innovations and trends to watch

  5. FASB Interpretation No. 44 BACKGROUND • Released 3/31/00 • Clarifies APB No. 25 -- accounting rule for employee stock grants -- specifies “Measurement Date Principle”

  6. FASB Interpretation No. 44 EMPLOYEE DEFINITION

  7. FASB Interpretation No. 44 CHANGES IN STATUS

  8. FASB Interpretation No. 44 OPTION MODIFICATIONS

  9. FASB Interpretation No. 44 SHARE REPURCHASES • No expense for repurchases more than 6 months from share issuance • No expense for stock-for-tax option withholding -- but only up to minimum statutory rate -- new measurement date if exceeded

  10. FASB Interpretation No. 44 EFFECTIVE DATES All expense recognition prospective after effective date . . . • 12/16/98 for repriced options and grants to nonemployees • 1/13/00 for adding reloads • 7/1/00 for other

  11. Oldcos v. Newcos COMPETING PAY MODELS More attractive in rising stock market

  12. Oldcos v. Newcos STOCK MARKET CORRECTION

  13. Oldcos v. Newcos CANDIDATES’ RESPONSE • More risk adverse • Want additional cash • Will trade-off options for restricted stock, SERPs, deferred annuities, forgivable loans, etc.

  14. Oldcos v. Newcos RECENT INITIATIVES Oldcos are creating leveraged pay opportunities from within . . . • Tracking Stock (Disney, DLJ, Quantum, Staples) • Spinoffs/IPOs (AT&T, GM, HP, Lucent) • Subsidiary Options (?) • Venture Capital Incentives (Merrill Lynch, ?)

  15. Retention REASONS FOR PROBLEM

  16. Retention CARLY FIORINA EXAMPLE

  17. Retention DESIGN PROVISIONS Beyond the traditional . . . • Option Claw-Backs (Cigna, Delta, Goodyear, IBM) • Tandem Option Guarantees (Amazon) • Stock Purchase Loans (eBay, Excite@Home, Kodak) • Career Restricted Stock (Coca-Cola, GE, 3M) • Forfeitable Deferral Premiums (Alcoa, Dell, GM)

  18. Dilution UPWARD TREND

  19. Dilution INFLATIONARY FACTORS • More pay for performance -- support shareholder value strategies and ownership objectives • Expanded participation • Companies buying back shares • Non-shareholder approved grants • Illogical grant guideline approach

  20. Dilution 2000 VOTING; ISS • Opposed majority of plans ( 55%) with limited impact on outcome, but still a concern • Continued flaws in model -- overvalues grants at high performers and vice versa -- penalizes omnibus plans without limits on outright grants -- discourages break out from low utilization industry groups (e.g., utilities, defense, etc.)

  21. Dilution 2000 VOTING; OTHERS • Same basic guidelines, usually applied on fully diluted basis • Fidelity (FMR) opposed to restricted stock and performance shares without minimum 2-3 year vesting

  22. Dilution LOOKING AHEAD • NYSE may limit broad-based exemption • Efforts needed to encourage improved investor voting rules, especially ISS • %-of-salary option grant guidelines no longer useful -- need to start with competitive total share usage %, and use surveys for allocation

  23. Underwater Options IF SHARES AVAILABLE • Front-load future grants • Next 2-3 years • Incentive for price recovery and retention • No additional “competitive” compensation value

  24. Underwater Options IF SHARES NOT AVAILABLE New option grants could be made after 6 months with no variable accounting expense . . . • Executives voluntarily cancel • Company buys back for restricted stock or cash -- at fair value (i.e., Black-Scholes) -- discount from fair value

  25. Innovations/Trends ASCENDING; OPTION RELATED • Opportunistic grant timing • Offset guarantees • Reloads • Automatic vesting acceleration at termination except cause or voluntary quit • Price thresholds for exercise

  26. Innovations/Trends ASCENDING; OTHER • Double-trigger change in control stock vesting • Personal loans -- forgivable and non-forgivable • Flexible deferrals

  27. Innovations/Trends DESCENDING • Performance options -- premiums, indexed, and performance accelerated • Stock purchase loans (except start-ups) • Non-shareholder approved stock plans?

  28. CONCLUSION Economy Stock Market Regulations EXECUTIVE COMPENSATION Management Theory Investor Attitudes Corporate Governance

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